What is a Bond?

YearBeginning Balance8% Interest Ending Balace 1$1,000.00$80.00$1, $86.40$1, $93.31$1, $100.78$1, $108.84$1, Total Interest $ Compounding Interest Annually

Types of Bonds Most bonds you'll come across have been issued by one of three groups: the U.S. government, state and local governments or corporations. But to confuse things, these entities issue many different types of bonds that run the gamut in terms of risk and reward. Here's a quick introduction to the ones you'll encounter most often.

Corporate Bonds & Government Bonds Corporate Debentures Mortgage Convertible Government Municipal General Obligation Savings Treasuries Agency

U.S. Government Bonds

Municipal Bonds

Corporate Bonds

Corporate bonds usually offer higher yields than munis for two reasons. First, there is generally more risk involved with corporate bonds since companies are more likely to run into financial problems than local governments. Second, your earnings from a corporate bond are taxable (compared to the tax-free status of muni bonds).

The following are summaries of the definitions of Moody's ratings for long-term bonds. Aaa - Best quality, with smallest degree of investment risk. Aa - High quality by all standards; together with the Aaa group they comprise what are generally known as high-grade bonds. A - Possess many favorable investment attributes. Considered as upper-medium- grade obligations. Baa - Medium-grade obligations (neither highly protected nor poorly secured). Bonds rated Baa and above are considered investment grade. Ba - Have speculative elements; futures are not as well-assured. Bonds rated Ba and below are generally considered speculative. B - Generally lack characteristics of a desirable investment. Caa - Bonds of poor standing. C - Lowest rated class of bonds, with extremely poor prospects of ever attaining any real investment standing.

Savings Bonds: The Old Reliables

The principal and interest of savings bonds are guaranteed by the full faith and credit of the United States. If you ever lose a savings bond, it can be replaced. Interest on savings bonds is exempt from state and local income taxes. Federal income taxes are postponed until you cash your bond, or until it stops earning interest (30 years down the road). When a savings bond reaches maturity, it doesn't stop accumulating interest like most other bonds. It is automatically extended for ten years, and can be extended for additional periods following that. Interest continues to accrue on the bonds during these extensions. Another benefit of U.S. Savings Bonds is that the interest can be exempt from taxes if the bonds are used for college expenses for the bond owner, the owner's spouse, or a dependent. The bonds have to be purchased after December 31, 1989 in order to qualify, and registered in the name of a person who is 24 years of age or older on the first day of the month in which the bonds are issued, not -- and this is very important -- in the name of the future student.

Bonds vs. Bond Funds BONDS ARE COMPLEX -- there's no doubt about it -- especially if you're a novice investor with little experience in the markets. That's why a lot of people opt for bond funds when they seek to diversify their investments with some fixed-income exposure. Our view is that if you're willing to put in the effort, you're better off buying individual bonds instead of bond funds. But in the real world, a fund is sometimes worth the convenience.

Here's what you have to consider:

Zero-Coupon Bonds

Smoothing out the Ride WHETHER YOU are just starting your investing career or have already amassed a tidy nest egg, your portfolio needs some steady and reliable income. For younger people, that income will balance out the periodic dips in a stock-dominated asset mix; for those in retirement, it will provide money to live on.

Treasury Direct

Agency Bonds

Muni Bonds?

What About Corporates?

Bond Laddering

Risk vs. Reward: How Bonds Behave JUST BECAUSE BONDS have a reputation as conservative investments doesn't mean they're always safe. Any time you lend money, after all, you run the risk it won't be paid back. Companies, cities and counties occasionally In fact, economists label the yield of the shortest-term U.S. bonds "the risk-free rate of return." (See Types of Bonds.) Paradoxically, another source of risk for certain bonds is that your loan may be paid back early, or "called." This is known as prepayment risk. While it's certainly better than not being paid back at all, it forces you to find another, possibly less lucrative, place to put your money. When you buy a bond, the prospectus will indicate whether a bond is callable and give you a "yield-to-call" figure. If you have a choice, buy a bond without the call option.

Inflation

Yield vs. Risk