There is not just one type of bonds to choose from if you’re planning to invest in the bond market. As a matter of fact, there are many to choose from. For instance, if your tax is large enough, it will be better to diversify your stock portfolio with municipal bonds, whose yields are the lowest because the interest payments are exempt from federal income taxes.
Here are the different types of bonds that you can invest on. Check them out and see which one suits you the best.
Treasuries are issued by the federal government to finance its budget deficits. Because they’re backed by the US’s taxing authority, they’re considered credit-risk free. The catch is that their yields are always the lowest, except for the tax-free munis. However, in economic downturns, they perform better than the higher-yielding bonds, and the interest is exempt from the state income taxes.
Other US Government Bonds
These are also called government bonds, and government bonds are issued by federal agencies, mainly the Federal National Mortgage Association and the Government National Mortgage Association. They are different from mortgage-backed securities that are issued by those same agencies, and by the Federal Home Loan Mortgage Corp. Agency yields are higher than Treasury yields since they are not full-faith- and-credit obligations of the US government, but the credit risk is considered minimal. Interest on the bonds is taxable at both the federal and state level, on the other hand.
Investment-Grade Corporate Bonds
Investment-grade corporates are issued by companies or financing vehicles with relatively strong balance sheets. They carry ratings of at least triple B from the Standard & Poor’s, Moody Investors Service, or both. For investment-grade bonds, the risk of default is considered pretty remote.
Still, their yields are higher than either treasury or agency bonds, although like most agencies they are fully taxable. In economic downturns, these bonds usually tend to underperform Treasuries and agencies.
These bond come from companies or financing vehicles with relatively weak balance sheets. They carry ratings below triple-B, and there’s a distinct possibility of default. As a result, high-yield bond prices are more closely tied to the health of corporate balance sheets. They track stock prices more closely than investment-grade bond prices.
These securities are something else altogether. Some are dollar-denominated, but the average foreign bond fund has about a third of its assets in foreign-currency denominated debt. With the foreign-currency denominated bonds, the issuer promises to make fixed interest payments and to return the principal in another currency. The size of those payments when they are exchanged for dollars depends on the prevailing exchange rates.
If the dollar strengthens against foreign currencies, foreign interest payments convert into smaller and smaller dollar amounts; if the opposite scenario occurs, the dollar will weaken. Exchange rates, more so than interest rates, can show how a foreign bond fund performs.
Municipal bonds, which are often called “munis,” are issued by US states and local governments or their agencies and they come in both the investment-grade and high-yield varieties. The interest is tax-free but that doesn’t mean everyone can benefit from them.