How to Choose Between Different Bond Types
There are many different bond types that a bond investor can invest in and it is important to have different types of bonds in a portfolio because the portfolio. A diversified portfolio is less risky and having different bond types means different issuers, different maturities, and different interest payments. While most people refer to different bond types according to the type of issuer, bonds can also be classified by their characteristics. Below are some common bond types.
Corporate bonds are the most popular type of bonds. Corporate bonds are IOUs issued by corporations to raise money for working capital. Corporations can issue different bond types with different prices, interest rates, call features, and maturity dates. Corporate bonds can be risky if the issuing corporation is in trouble. By looking at bond ratings such as those published by Moody’s Investors Services or S&P, investors can see which ones are safer than others.
If you want safety in bonds, US government bonds usually offer the safest choices. There are a few different bond types issued by the US government such as T-bill, T-notes, and T-bonds. T-bills is short for Treasury Bills, T-bonds, Treasury Bonds, and T-Notes Treasury Notes. These three different bond types issued by the US government have different maturity dates and interest rates. Most people prefer investing in T-bills over the other two types.
Other bonds that are quite safe are agency bonds. Agency bonds are bonds issued by agencies related to the government such as Fannie Mae and Freddie Mac. There can also be different bond types issued by agencies and each may or may not be backed by the full faith and credit of the US government. These bonds usually pay higher interest rates than US government bonds and they are usually backed by collaterals such as mortgages and other types of loans.
Many investors buy bonds, not because of safety and regular income but also the tax benefits some types of bonds can offer. Municipal bonds or munis for short are bonds issued by states, local governments, counties, townships, cities, and other municipalities. Municipal bonds are issued to finance projects such as building a bridge and building a road. Different bond types are issued based on the needs of the municipal issuer.
While most of the different bond types are classified according to the type of issuer that issue them, there are different bond types that are classified based on their characteristics. A zero coupon bond, for example, can be issued by many different types of issuer but the bonds always pay no interests unlike other bond types that pay regular interests and the principal at the end. When building your bond portfolio, you need to include many different bond types, of different characteristics, not simply just bonds issued by different types of issuers.
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Tags: Investments