Recognizing different types of bonds

Bonds come in all shapes and sizes, and they enable you to choose one that meet your needs in terms of your investment time horizon, risk profile, and income needs. First, here is a look at the different types of U.S. government securities that are available:

• Treasury bills: T-Bills: T-Bills have a minimum purchase price of $10,000 and are offered in 3-month, 6-month, and 12-month maturities. T-Bills do not pay current interest, but instead are always sold at a discount price, which is lower than par value. The difference between the discount price and the par value received is considered interest. For example, if you pay the discount price of $9,500 for a $10,000 T-Bill, you pay 5% less than you actually get back when the bill matures. Par is considered to be $10,000.
• Treasury notes: Treasury notes have maturities of 2 to 10 years. The minimum investment is $1,000, but they are also issued in $5,000 and $10,000 amounts. Treasury notes have coupons that pay interest every six months.
• Treasury bonds:With maturities of up to 30 years, these are the long-term offerings from the Treasury Department; as such, these bonds typically pay the highest interest. The minimum investment is $1,000, but they are also issued in $5,000 and $10,000 amounts. Treasury bonds have coupons that pay interest every six months.
• Zero-coupon bonds: Zero-coupon bonds do not pay current interest. You buy the bond at a steep discount, and interest accrues (builds up) during the life of the bond. At maturity, the investor receives all the accrued interest plus his/her original investment. Zero-coupon bonds are taxed each year on the interest earned (even though it’s not actually paid out), unless it is a zero-coupon municipal bond (which would be free of federal and possibly state taxes.) Zero-coupon bonds are usually used in IRA accounts.
• Savings bonds: These have been the apple pie of American investing for years. They act like zero coupon bonds, but you can purchase them in small denominations from banks or the Treasury Department. For more zest, the agency began offering inflation-indexed bonds in 1998, which guarantee that your return will outpace inflation. The bond’s yield is actually based on the inflation rate plus a fixed rate of return, such as 3%. Interest on savings bonds is not taxed until the bond is cashed in. Financial experts generally see United States government bonds as the safest investment bet around. But remember that risk and reward are tradeoffs that you need to look at in tandem. As with all investments, the safer the investment, the less you’re likely to earn or lose!

The following are other types of available bonds:

• Municipal bonds: These are loans you make to a local government, whether it’s in your city, town, or state. Because most are free from local (if you live in the municipality issuing the bond), state (if the municipality issuing the bond is in your state of residence), and federal taxes, they can be valuable to those who seek tax relief —often folks in higher income tax brackets. Generally, these bonds have proven their worth as safe investments over the years (although there have been a few instances when municipalities proved unreliable); they pay a stated interest rate over the life of the bond. Some municipal bonds are insured, making them safe from default. Municipal bonds are generally available at minimums of $5,000.
• Corporate bonds: These are issued by companies that need to raise money, including public utilities and transportation companies, industrial corporations and manufacturers, and financial service companies. Minimum investment in corporate bonds is $1,000. Corporate bonds can be riskier than either U.S. government bonds or municipal bonds because companies can go bankrupt. So a company’s credit risk is an important tool for evaluating the safety of a corporate bond. Even if an organization doesn’t throw in the towel, its risk factor can be enough to cause agency analysts, such as Standard & Poors or Moody’s, to downgrade the company’s overall rating. If that happens, you may find it more difficult to sell the bond early.
• Junk bonds: Junk bonds pay high yields because the issuer may be in financial trouble, have a poor credit rating, and are likely to have a difficult time finding buyers for their issues. Although you may decide that junk bonds or junk bond mutual funds have a place in your portfolio, make sure that spot is small because these bonds carry high risk.

Although junk bonds may look particularly attractive at times, think twice before you buy. They don’t call them junk for nothing. You could potentially suffer a total loss if the issuer declares bankruptcy. As one wag suggested, if you really believe in the company so much, invest in its stock, which has unlimited upside potential.