When you invest in savings bonds, treasury bonds or other types of bonds you’re basically lending your money to another entity. This is usually a federal or state agency, municipality or even a corporation. The issuer (borrower) owes the holder (lender) a debt.
The terms for each bond vary but in some cases the lender is required to pay interest which is called the coupon. The issuer is also required to pay back the amount owed at fixed intervals.
The interest rate it pays is determined based on the issuer’s creditworthiness and interest rates at the time of purchase.
Issuers with the best credit ratings and who are most likely to pay back the holder will usually pay a lower interest rate than those who are riskier.
You should always consider a bond's credit rating before buying. There are three major bond rating agencies, Standard & Poor's, Moody's, and Fitch's Rating Services.
Bonds are rated A, B, or C. "A" is the safest rating and is considered an investment grade bond. "B" and "C" are junk bonds. As with all investment, safety has a price. Safer bonds offer a lower yield. While junk bonds offer higher yields in exchange for the risk you take.
Bonds are required to be paid back at maturity which is set at the time of purchase. They provide capital for government agencies or corporations to finance long-term investments or current expenditures.
Bonds are similar to stocks in that they are both securities. However one difference between them is that bondholders have a creditor stake in the agency or company while stockholders have an equity stake. Stockholders actually own a piece of that company.
Another difference is bonds have a maturity date. At that time the principal amount borrowed is re-paid and the transaction is complete. Stocks on the other hand can be outstanding indefinitely. In fact you can pass your stock ownership to children or other relatives if you so choose.
There are many different types of bonds but some of the most popular are:
Savings bonds are issued by the U.S. Department of Treasury and are debt securities. You are loaning money to the United States government when you purchase these bonds. They are considered one of the safest investments because they are backed the government. Savings bonds can be purchased at your local bank or from a broker.
You can choose from several types of savings bonds.
However, they increase in value as interest accrues over this entire time period. At maturity, you will be paid the entire face value plus 30 years of interest. There is a limit to how many you can purchase each calendar year.
However they do not accrue interest and are purchased at their face value in increments of $500 up to $10,000. So basically at the end of 20 years, if you purchase a Series HH bond for $500, you will receive that $500 back. There is no limit to the amount of these you can purchase each year.
Treasury Bonds, Bills, Notes and TIPS
U.S. Treasury bonds are sold to raise capital to pay for a variety of government activities. They are backed by the U.S. government. These can also be purchased at your local bank or through a broker.
Typically the longer it is until the maturity date the greater the discount at which they can be purchased. You can choose to hold the bill until it matures or sell it early.
Their principal is adjusted by changes in the Consumer Price Index so they keep pace with inflation. Interest is paid every six months on the inflation-adjusted principal.
While corporate bonds don’t usually offer tax advantages, you can receive tax-deferred benefits on interest earned if they’re part of your retirement portfolio.
Also some government-issued bonds offer tax advantages. There’s no state or local tax on the interest earned from Treasury and savings bonds.
Even interest earned from municipal bonds is sometimes exempt from federal and state taxes. So they’re worth considering if for no other reason but the tax breaks.From Treasury and Savings Bonds to Investing Money