A bond is a form of debt that you buy. In the transaction, you act as the bank, lending your money to investors, cities, and the government. They pay you back in full with regular interest payments. Because bonds are safer than investing in an often volatile stock market, they are low risk and attract a crowd of investors who enjoy a slow, but steady rate of income. But this doesn’t mean that bonds are entirely risk free. You should always examine the credit-worthiness of bond issuers, even if it is a city selling bonds to build a bridge, by researching how these bonds have been sold in the past.
If you want to make a higher percentage on your bond, chances are you will have to make a riskier investment. Here are some of the different kinds:
Junk Bonds: These bonds are the riskiest to invest in, but often have the highest returns.
Investment grade bonds: these are the safest, and are good for long term investments. Although you won’t make much interest annually, you can rest assured that you will get your money, and then some, back.
Treasurys: These are backed by the U.S. government, and have no risk. They will pay a lower yield than a bond issued by a tried and true company like IBM. Usually treasurys are auctioned off in $1,000 increments, and the interest payment and price is pre-determined.
Treasury Bills: T-bills are short term bonds sold to mature in a range from a few days up to 6 months. They’re discounted, and when they mature, you can redeem the face value. The difference between what you paid and the face value, you keep.
Treasury Notes: Issued in 2, 5, or 10 year increments of $1000, mortgage rates are priced off the 10 year notes.
Savings Bonds: After a year and up to 30 you can cash in these bonds of two kinds: EE: earn a fixed interest rate of currently 3.4% and can be redeemed after a year, although you lose 3 months interest if you hold them for less than 5 years. They are sold at half of face value beginning at $25 (for a $50 bond) and up to $10,000. I Savings Bonds are similar, but are always sold at face value and are indexed for inflation semi-annually.
The length of time you keep the bond also determines to an extent your return”. A 10 year bond will have a higher return than a one year bond because your money is essentially frozen for a longer amount of time. Since the interest rate was set when you bought the bond, you get your original investment back when the bond matures, as long as the issuer doesn’t default. If you want to sell your bond on the secondary market, you may get back less than you originally invested.
Mutual funds that invest in bonds, or bond funds, are different from individual bonds. They don’t mature at a set date so the interest payments will fluctuate along with the original money you invested.