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How do you buy bonds, what are the different types, are they a good idea?
A bond is basically an IOU. When you buy a bond, you are lending money to someone else who agrees to pay you interest from time to time and to pay you back the loan. There are a lot of people out there that would like to borrow money from you besides your crazy uncle and black-sheep-of-the-family-brother. Like whom you ask? The U.S. government and governments from around the world, your local city and others throughout the country, big companies, small companies, and everything in between. With all of these groups wanting to borrow money from you, should you lend money to them. If so, who should you lend to?
Buying a bond is an investment, and owning bonds can be a great addition to your investment portfolio. They can offer protection in a bad economy and can give you a steady source of income. Think carefully before you lend your hard-earned money to just anyone, though. There is a risk, that just like the $50 you loaned to your brother that he never paid back, they might not pay you back either.
In order to reduce the risk that someone might not pay you back, you could lend $10 to 10 people instead of $100 to one person. The easiest way to buy a lot of bonds at the same time is to invest in a bond mutual fund. A bond fund might own 100+ different bonds. When you invest your $100 into the fund, you own a piece of the 100+ bonds they own.
U.S. Government Bonds – These bonds are considered the safest bonds in the world because the government promises to pay you your interest and to repay the loan. Because there is virtually no risk with these bonds, they don’t pay you very much interest.
Corporate Bonds – These are bonds issued by companies that need/want to borrow your money so they can use it to expand their business. There is no guarantee that you will get your money back, but if you buy a bond of a large and more established company, you have a greater chance than if you bought a bond from a small company struggling to survive (bonds from these companies are called “junk bonds” or “high-yield” bonds).
Municipal Bonds – These are bonds issued by cities from across the country to build roads, bridges, hospitals, low income housing, etc. If you are in a high tax bracket, you might benefit from municipal bonds because they are free from federal income tax, and if you buy bonds in the state you live in, they are also free from state income tax!
-- Robert Pagliarini
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