Financial Planning, Retirement Plan, 401k, Investment Blog

Financial Planning, Retirement Plan, 401k, Investment Blog

Bonds 101

Posted October 28, 2008 by Bernz

Everyone always talks about stocks and bonds, bonds and stock but are bonds really and how do they work? This little article is here to talk about the largest kind of bonds you can invest in.

by Creative Commons

Keep in mind that for the individual investor who is working with capital of less than 1,000,000 dollars the best way to invest in bonds is to buy into a bond mutual fund. The only exception is that if your municipality is doing a bond issue for a project and you want to invest in something specifically then that can be fun and help you rise up the social strata of the city but overall even though bonds are traded frequently over the open market mutual funds are the easiest way to get involved in the bond market.

Bonds also have what are called maturity dates. The maturity date is when the entity that has issued the bond buys the bond back from you for face value plus interest or they will pay you part interest over the life of the bond and the rest at the end or they will pay you all the interest over the life of the bond. In any of these cases bonds are generally not volatile. They are issued usually by government entities.

There are several types of bonds and these are the most common:

Mortgage bonds

When you take out a mortgage a company will sell bonds on your mortgage.  That way they get the money back they just loaned out to you and they can loan again. Some of the interest you pay the company goes to pay the interest on these bonds. These bonds are very lucrative because most of a mortgage payment is interest. Often times these mortgage bonds are grouped together into a mutual fund and people can live off their share of the interest coming in off these mortgage bonds. They do not mature until they mortgage is paid. The best mutual funds have bond with rolling maturity dates.

Savings Bonds

By far the safest but with the lowest return and longest maturity date. Almost everyone was given one of these when they were a child. Grandparents were known for not giving money but giving you a savings bond that matured in 30 years.  “For the sake of your future.” they said. Fact of the matter is these are horrible investment vehicles unless you want to hide some money for awhile or give an early investment vehicle to your children, nephews, nieces or random children you know!

Municipal Bonds

Muni Bonds are the best! Cities issues these to pay for new roads, highways, downtown development, etc. These pay very good consistent interest and generally have long maturity dates.

Special bonds

These are issued for special projects by any government entity for anything from military munitions to schools. These bonds can also be issued by special districts (water, fire, sewage) to pay for things as well.

Covered Bonds

These have just been developed in the last week. These bonds have been common in Europe for years but are new to the US. Basically, banks will group loans together, keep them on their books, and bond out on the loans. The hitch is that these loans must be very strong loans and if there are any problems then new loans must be found to fund these bonds. The loans stay on their books for the entire time the bond is out. It’s a great way to get capital in a hurry for all sorts of things from schools to highways.

Treasury Bonds

The favorite shelter of the stock brokers when the market has a downturn, these bonds are the way the government makes its debt and the way they pay for it. Treasury bills pay very good interest and they have 5-10 year maturity dates based on how soon the government wants to pay the debt. They are very strong and the most guaranteed investment in existence.

As I states above if your risk capital is less than 1,000,000 than a bond mutual fund (I highly recommend vanguard) is the best way to get involved in the bond market.

Hopefully this article clears up a few things about bonds and what kinds are out there and how to invest in them

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