Wonder what investing in bonds might entail? Start with Benzinga’s guide to determine whether bonds are the right investment for you.
Why Invest in Bonds?
Bonds can be an important part of your investment profile, especially when it comes to the long term. Bonds offer predictable financial benefit without complicated strategies, and casual and non-investors can leverage this type of security just as easily as active traders.
Bonds are especially popular if you’re looking to save money for a long-term goal. For example, you might buy bonds when you’re in your 20s or 30s to provide a little extra cushion at retirement. You might also buy them to give to your children to cash out when it’s time to pay for college or buy a house in adulthood.
3 Reasons Bonds are a Good Investment
In terms of trading, there are benefits bonds can offer that other long term investments can’t. Here are 3 reasons bonds are a good investment:
1. Bonds Provide Fixed Income
Bonds are just another way to grow your money, so it’s important to note bonds typically provide a reliable income stream. Some may even say that bonds provide the highest income stream compared to other investment products. The stock market can be volatile.
But with bonds, even when the rates are low, there are still options to make sure you’re hitting your income targets.
2. Bonds Allow You to Diversify Your Portfolio
Diversifying your portfolio basically means you’re making sure you’re not putting all of your eggs in one basket. By investing in a variety of products, you lower your risk of losing out on a return.
For example, if you’re already trading on the stock market, it wouldn’t hurt to consider adding bonds to your investment strategy. When the stock market isn’t doing well, you can lean on your bonds to preserve your capital until the stock market has an upswing.
3. Bonds Provide Tax Benefits
Bonds offer tax benefits. If you trade bonds from U.S. Treasuries, you can rest easy knowing that this income is tax-free on both state and local levels.
Municipal bonds are tax-free at the federal level. And if you buy a municipal bond issued by the state you live in, you won’t need to pay state tax on it either.
Types of Bonds to Invest In
Think of bonds like a bank loan, but you’re the bank that benefits from the interest charged. The difference in types of bonds lies in which entity issues the bond and how the funds are used. We’ve outlined 4 main types of bonds:
1. Treasury Bonds
Treasury bonds are known as the highest-quality securities you can get. They are issued by the U.S. Department of the Treasury and have a maturity date that can range anywhere from 10 to 30 years.
When your bond reaches maturity, the principal interest will be repaid. It will also stop earning interest.
Like we mentioned, you won’t need to pay state or local taxes on the interest earned by these bonds. Since they’re backed by the government, there is little risk of default.
2. Sovereign Bonds
Sovereign bonds are also issued by the federal government and can be denominated in the U.S. dollar or in global reserve currency. The government uses sovereign bonds to fund government spending programs. There are different types of sovereign bonds, such as agency bonds and savings bonds.
3. Municipal Bonds
Municipal bonds are also issued by the government, but this time we’re talking about state and local governments. They’re used to fund the construction of public projects like schools, housing, highways and sewer systems.
There are also different types of municipal bonds — general obligations bonds and revenue bonds. If you trade municipal bonds, note they are exempt from federal income tax. Your bond may be exempt from state and local taxes as well if you live in the issuing state.
However, in some cases, your bond may be subject to federal, state and local alternative minimum tax. Although these bonds are issued by the government, municipal bonds pose a higher risk because local governments are more likely to go bankrupt than the federal government.
4. Corporate Bonds
Corporate bonds are issued by corporations to fund business expansions and large capital investments. Overall, this is a less predictable type of bond because the risk depends on the financial outlook and reputation of the company.
But corporate bonds can also provide higher rewards for your investment. Another corporate option is convertible bonds — corporate bonds that can become company stock.
Should You Invest in Bonds When You are Young?
It’s a myth that you can’t start investing when you have student debt on your back. If you’re a young investor, you have time on your side, and you can reinvest what you earn to generate wealth over time. Young investors also have the time to assume more risk. Once you’re close to retirement age, you must decrease your risk in favor of earning potential and security.
Investing in bonds specifically provides a low-risk way to dip your toe in the water. A bond strategy called buy and hold allows you to buy a bond and hold onto it until it reaches maturity. By doing this, the only way you can lose money is if the issuing entity goes bankrupt and can’t repay you.
Best Brokerages for Bond Trading
When it comes to trading bonds, you’ll want to look for a brokerage. A broker can offer you the tools and resources to help compare and find the best bonds for your portfolio.
Some online brokers will even give you access to a fixed-income specialist to review your portfolio and make suggestions.
Here are some of the best brokerages for bond trading:
Why You Should Invest in Bonds
If you’re ready to invest but want a predictable income stream, you should likely invest in bonds. No matter your age, bonds can provide security when the stock market is failing, offer additional tax benefits and diversify your portfolio.
Whether you’re risk-averse or ready to dive in and take chances with your investments, know there really is a bond investment strategy for everyone — including you.
Frequently Asked Questions
Q: Should I increase my investment in bonds as I age?
Stocks do earn more interest, but bonds are generally considered a safer investment. Some advisors recommend increasing the percentage of your portfolio committed to bonds as you age. And some bonds do bring potential tax breaks.
We recommend you speak to your financial advisor to create an investment strategy.
Q: Does it matter how long I hold on to a bond?
Yes. Bonds are sold for a fixed term from 1 to 30 years. You can sell a bond before it matures, but you run the risk of not making back your original investment.
Some people buy into a bond fund that pools a variety of bonds. This is a good way to diversify, but these funds are more volatile without a fixed price or interest rate.
A bond’s rate is fixed at the time of purchase, and interest is paid regularly for the life of the bond. The full original investment is paid back when the bond matures.
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