Investors who want to choose a safe and secure place for their money, will often elect to purchase bonds. Bonds are generally sold through either the local or national government, sometimes through a foreign government, and occasionally through corporations. These investments are considered very safe because you are always guaranteed to get your initial investment back. If you know that you have a low risk tolerance, then investing in bonds may be the right choice for you. Here is a brief description of the five most common types of bonds investors purchase and how they work.
Government Bonds
The US government sells Treasury Bonds, Treasury Notes and Treasury Bills, with maturity dates that can range from three months to thirty years. These bonds are guaranteed by the government which is why they are so low risk, and are also attractive because tax is charged only on the interest that the bonds earn during their term.
Real Return Bonds
These are similar to the bonds described above, but are sold by the Canadian government. Rates of interest on these bonds are adjusted according to inflation.
Corporate Bonds
Corporate Bonds hold a much higher level of risk than Government bonds, simply because there is always the chance that the company will close its doors and leave its investors empty handed. The up side of corporate bonds is that they generally pay a higher level of interest, so if the company does well and your investment remains intact, you will earn more. It is wise to check a company’s financial background and credit ratings before purchasing in order to help analyze the level of risk involved. Generally speaking, the higher the credit rating of a company, the more secure the investment. Some corporate bonds are also referred to as redeemable, meaning they can be purchased back by the company, or replaced with stock shares before they reach their maturity date. Interest rates on corporate bonds, while usually higher than government bonds, are still lower than some others.
Junk Bonds
Companies that have lower than average credit ratings or poorer financial histories will often issue what are referred to as Junk bonds. These companies are eager to receive investor’s money to improve growth, but lack the backing of major banks and financial institutions. Junk bonds do pose somewhat of a higher risk than regular corporate bonds but when the company is able to improve their bottom line, the payout to investors can be well worth the risk.
Zero Coupon Bonds
These bonds offer no interest payments during their term but are priced at a much lower rate initially, making them attractive to new to intermediate investors with limited funds. The major downside of these bonds is that tax must be paid on the interest that is earned each year. However, when you consider that you could essentially buy bonds at a 30% discount, it is a relatively minor drawback.
In summary, it is clear to see these five types of bonds vary greatly in their level of risk and return. If you like the idea of buying bonds but are uncertain which type is best for you, be sure to get the advice of an experienced and knowledgeable professional.
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