Bond Investment FAQ
Q: What is the difference between bonds and Treasuries?
A: The federal government, state and local governments, and corporations can issue bonds. Bonds issued by the United States federal government are called U.S. Treasuries.
Q: Where can I buy bonds?
A: Corporate bonds can be purchased from a broker. Municipal bonds and U.S. Treasuries can be purchased from a broker or directly from the government that sells them.
Q: What is the best way to invest in bonds in a taxable account?
A: Tax-free municipal bonds are exempt from federal income tax and in most cases, free from state and local income tax as well.
Q: What type of savings bonds are the best to buy?
A: EE savings bonds are best if you're going to hold the bond for more than five years. I saving bonds are best if you're concerned about fluctuating interest rates.
Q: What types of bonds are there?
A: Government bonds include U.S. Treasury bills, notes, and bonds. There are also municipal bonds that are issued by state and local governments, and corporate bonds that are issued by corporations.
Q: What is the difference between corporate bonds and corporate debt funds?
A: Corporations issue corporate bonds. Mutual fund companies buy corporate bonds from several corporations and sell them as bond funds.
Q: What are examples of municipal, treasury, and corporate bonds?
A: A city might issue a bond to finance a new public waterworks project. The U.S. federal government issues Treasury Notes to finance ongoing operations or to pay outstanding debt. A corporation might issue a bond to finance a new building or other capital expenditure.
Q: How safe is corporate bond investment?
A: AAA is the highest rating assigned to corporate bonds and C is the lowest. While there are no guarantees that a corporation won't default on a bond, buying highly rated bonds is safer than buying lower rated ones.
Q: Can the interest on a corporate bond change or be canceled once I buy it?
A: Corporate bonds pay a fixed rate of interest that won't change once the bond is purchased. But if the bond has a call option, the company that issued it could exercise the call option and take back the bond to reissue it at a lower rate.
Q: What are the safest types of bonds?
A: U.S. Treasuries are the safest of all bonds, as they are backed by the full faith and credit of the United States federal government.
Q: What are some things to look out for when selecting corporate bonds?
A: First, make sure the corporation's credit rating is one you can tolerate from a risk and reward standpoint. Second, if the bond has a call option, be prepared to have it called away if interest rates drop.
Q: What accounts for the difference between Treasury bond rates and corporate bonds?
A: Treasury bond rates are tied to national interest rates and have lower risk of default. Corporate bonds pay a higher rate because the risk of default is greater, as compared to Treasuries.
Q: What do the AAA, A, etc ratings on bonds mean?
A: Bonds rated AAA through BBB are investment grade. AAA and AA represent the highest credit quality and lowest risk of default. A and BBB rated bonds are of medium credit quality and present a higher risk of default. BB, B, CCC, CC and C are the lowest quality and are considered to be non-investment grade. Bonds with these ratings are also known as junk bonds. A rating of D means the bond is in default.
Q: How can I find out when a company is offering corporate bonds?
A: The easiest way is to work with a bond broker.
Q: What is the difference between corporate bonds and common stock?
A: Corporations issue bonds and common stock in order to raise capital. But bonds are loans, or debt obligations. In exchange for purchasing the bond (loaning the corporation money) an investor receives a promise of the return of principal along with interest payments. When common stock is issued, the corporation is selling an ownership stake. In other words, a bondholder owns debt while a common stock owner owns part of the corporation.
Q: Is profit on bonds considered capital gains?
A: If a bond is purchased at par value and held to maturity, there is no capital gains tax. If the bond is sold at a gain prior to maturity, then capital gains tax will be due. The gain will either be taxed at the short- or long-term rate, whichever applies.
Q: How much of my portfolio should be composed of bonds?
A: While the exact percentage will be based on an individual's unique circumstances and risk tolerance, in general, a person between the ages of 20 and 40 should have about 10% of his or her holdings in bonds. Those between 40 and 50 should have about 20% in bonds. The percentage moves up to 35% between the ages of 50 and 60, and 45% between 60 and 70. Those over 70 should consider a 50/50 mix of bonds and other assets.
Q: If I own corporate bonds do I partially own the company?
A: No. If you own a corporate bond, you have made a loan to the company.
Q: Are municipal bonds riskier than certificate of deposits?
A: All bonds are riskier than CDs. However, municipal bonds are usually less risky than corporate bonds.
Q: How are municipal bonds taxed?The interest paid on municipal bonds is often "triple tax-free". That means it's free from federal, state, and local income tax.
Q: Where can I buy municipal bonds?
A: Municipal bonds can be purchased from almost any brokerage house or bank.
Q: Are municipal bonds safer than corporate bonds?
A: Some municipalities have higher credit ratings than others, just as some corporations have higher credit ratings than others. All things being equal, municipal bonds are safer than corporate bonds, but you must always check the credit rating of the municipality.
Q: What is the difference between investing in municipal bonds, derivatives, and commodities?
A: Municipal bonds are debt obligations that pay interest. Derivatives, like options, are investments that derive their value from an underlying asset. Commodities are investments based on goods such as agricultural products, oil, and precious metals.
Q: What is the historical long-term rate of return on municipal bonds?
A: The historical long-term rate of return on municipal bonds is just over 4%.
Q: How do municipal utility bonds work?
A: Municipal utility bonds are issued to finance public works projects such as sewer and water facilities.
Q: What is the performance of Treasury bonds most closely correlated with?
A: National interest rates determine the price paid for and interest earned on Treasury bonds.
Q: Can bonds be shorted? What are the risks?
A: Yes, bonds can be shorted. The risk of shorting bonds is similar to the risk of shorting stocks. Substantial losses can occur if the price increases rather than decreases.
Q: Are U.S. Treasury bonds insured?
A: No. However, U.S. Treasuries are backed by the full faith and credit of the United States federal government, and the FDIC does insure interest payments that are deposited into a bond owner's bank account.
Q: Where and how can I buy U.S. Treasury bonds?
A: U.S. Treasuries can be purchased directly from the United States Treasury Department or from dealers such as brokers and banks.
Q: Could Treasury bonds get downgraded from AAA? How secure are US Treasury bonds?
A: It is possible that the credit rating of the United States could be downgraded. Even if this happens, it is unlikely that the federal government would default on its loan obligations.
Q: How are Treasury bonds taxed?
A: Interest earned on Treasury bonds is exempt from state and local taxes. Federal income tax can be paid in the year in which the interest is earned or can be deferred until the bond reaches maturity and is redeemed. If the interest is used to pay for qualified educational expenses, the interest may be tax-exempt.
Q: Why are interest rates on U.S. Treasury Bonds usually higher than on municipal bonds?
A: Municipal bonds often pay a lower rate of interest because they are triple tax-free.
Q: What are the differences between Treasury bills, treasury notes, and U.S. savings bonds?
A: Treasury bills are short-term bonds with maturity dates ranging from several days to 52 weeks that are sold at a discount to face value. Treasury notes are issued with maturity dates up to 10 years and pay interest every six months. I Savings Bonds are sold at face value and pay an adjustable rate based on the rate of inflation. EE Savings Bonds are issued at face when sold electronically and at ½ of face value when sold as paper. Both have maturity dates up to 30 years.
Q: Why put money into Treasury bills rather than a money market account?
A: While both are short-term savings vehicles, the amount of interest earned on T-bills can be higher than that of a money market account. But the money that's used to purchase a T-bill cannot be accessed until the maturity date.
While we've covered the basics of bond investing here, there is much more to maximizing the success of your bond investing strategy. To make sure you're on the right track, contact a licensed financial advisor. It only takes a few minutes, Start Now.
More Bond Guidance
- Bond Investment Guide — The complete guide to bond investing.
- US Treasuries — Details about how to invest in US treasuires.
- Municipal Bonds — Details about how to invest in municipal bonds.
- Corporate Bonds — Details about how to invest in corporate bonds.
- Bond Rates — Factors affecting bond rates, and how to find the best ones.
- Bond FAQ — Frequently asked questions about bond investing.