How to invest in bonds

What types of bonds are there?

Bonds – also known as fixed income instruments – are used by governments or companies to raise money by borrowing from investors. Bonds are typically issued to raise funds for specific projects. In return, the bond issuer promises to pay back the investment, with interest, over a certain period of time.

Certain types of bonds – corporate and government bonds – are rated by credit agencies to help determine the quality of those bonds. These ratings are used to help assess the likelihood that investors will be repaid. Typically, bond ratings are grouped into two major categories: investment grade (higher rated) and high yield (lower rated).

The three major types of bonds are corporate, municipal, and Treasury bonds:

  • Corporate bonds are debt instruments issued by a company to raise capital for initiatives like expansion, research and development. The interest you earn from corporate bonds is taxable. But corporate bonds usually offer higher yields than government or municipal bonds to offset this disadvantage.
  • Municipal bonds are issued by a city, town or state to raise money for public projects such as schools, roads and hospitals. Unlike corporate bonds, the interest you earn from municipal bonds is tax-free. There are two types of municipal bonds: general obligation and revenue.
    • Municipalities use general obligation bonds to fund projects that don’t produce income, such as playgrounds and parks. Because general obligation bonds are backed by the full faith and credit of the issuing municipality, the issuer can take whatever measures necessary to guarantee payments on the bonds, such as raising taxes.
    • Revenue bonds, on the other hand, pay back investors with the income they’re expected to create. For example, if a state issues revenue bonds to finance a new highway, it would use the funds generated by tolls to pay bondholders. Both general obligation and revenue bonds are exempt from federal taxes, and local municipal bonds are often exempt from state and local taxes as well. Revenue bonds a good way to invest in a community while generating interest.
  • Treasury bonds (also known as T-bonds) are issued by the U.S. government. Since they’re backed by the full faith and credit of the U.S. government, treasury bonds are considered risk-free. But treasury bonds don’t yield interest rates as high as corporate bonds. While treasury bonds are subject to federal tax, they’re exempt from state and local taxes.
Read more  How To Make Money on TikTok in 2023: 8 Proven Ideas

Other types of bonds

  • Bond funds are mutual funds that typically invest in a variety of bonds, such as corporate, municipal, Treasury, or junk bonds. Bond funds usually pay higher interest rates than bank accounts, money market accounts or certificates of deposit. For a low investment minimum ranging from a few hundred to a few thousand dollars, bond funds allow you to invest in a whole range of bonds, managed by professional money managers. When investing in bond funds, keep in mind:
    • Bond funds usually include higher management fees and commissions
    • The income on a bond fund can fluctuate, as bond funds typically invest in more than one type of bond
    • You may be charged a redemption fee if you sell your shares within 60 to 90 days
    • Bond funds that are leveraged have greater risk
  • Junk bonds are a type of high-yield corporate bond that are rated below investment grade. While these bonds offer higher yields, junk bonds are named because of their higher default risk compared to investment grade bonds. Investors with a lower tolerance for risk may want to avoid investing in junk bonds.