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Bond Investing Basics
Bondholder receive back the original investment at the maturity date, and interest payments are made along the way at set intervals, usually quarterly or annually. If you are retired and receiving a monthly or quarterly check from your bond investment, this improves your cash flow. If a retired person or couple had $50,000 invested in bonds earning 7% they are earning $3,500 in interest in which a portion can be sent to the bond holder at set intervals over the year. Another advantage over stocks is that some bonds can provide a tax advantage. There are government and municipal bonds that raise money for community projects such as sewer roads or bridges. Any interest earned on these bonds is tax exempt. This can greatly minimize the investor tax liability. How much interest you earn on the bonds you purchase depends on the strength of the company issuing them. The rule of thumb is usually the higher the interest rate the riskier the investment. Government bonds typically pay the lowest interest rates as they are the lowest credit risk. Corporate bonds are more risky so the interest on them is higher. The riskiest bonds pay the highest interest and are called junk bonds. There is always a possibility of risk when investing in bonds. Bonds are rated for their credit worthiness by Standard and Poor's. Bonds rated AAA, AA or A are considered "investment grade" with a low risk. Bonds rated BBB are considered "medium grade". There are bonds rated below BBB and these are the ones considered as "high yield or "junk bonds". The bond market reacts to interest rate fluctuations. Bond prices move in the opposite direction of interest rates. If interest rates go down bond prices go up. If interest rates rise bond prices go down. They typically go up or down a percentage point equal to the term of the bond. The longer the maturity the greater the impact of interest rates on bonds. You might want to consider staggering the maturity dates of bonds so they do not all mature at the same time, especially for times when market conditions are not good.
Comment on this article:
I heard on CNBC this morning that many Wall St. folks think bonds are overvalued right now. Don't think it's the best time to buy em. However, you never know. I guess it depends on your investment objective.
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