5 Types of Bonds Explained: Definition and Differences

There are so many financial vehicles you can invest in. And if you’re thinking about putting your money on investment bonds, it’s best to learn their different types. This is more advisable rather than choosing this particular type of bond without realizing their features.

bonds written on a paper with quotes and a pen pointed on the paper

For starters, bonds represent debt obligations, hence a form of borrowing. So if a company issues a bond, the money they receive in return is a loan. In addition, it must be repaid over time.

To learn the basic of bonds, you can read our Basics of bonds explained.

Different Types of Bonds

From the US government to cities and companies, and other different entities issue bonds. Any bond’s single most important characteristics are the entity that issued it.

front view of the building of the US department of treasury

US Treasury Bonds

The Treasury Department issues Treasury bills, notes, and bonds to finance its budget deficits. Because they’re backed by the US government, they’re considered credit-risk free. These are among the safest investments you can make. However, these bond yields are always going to be the lowest. But in economic downturns, they perform better than higher-yielding bonds. Also, the interest is exempt from state income taxes.

Municipal Bonds

Also known as “munis,” US states and local governments issue these bonds. Their purpose is to raise money to build roads, schools, and a host of other projects for the public. These bonds are one of The interest are tax free bonds, but that doesn’t mean everyone can benefit from them.

Savings Bonds

The Treasury Department also issues savings bonds. You can purchase an investment for as low as $25 since they are for individual investors. It’s one of the types of bonds that help pay for the US government’s borrowing needs. Furthermore, they are of the safest investments because the full faith and credit of the US government back them. However, they are adjusted for inflation every 6 months.

Corporate Bonds

Various types of companies issue corporate bonds to raise money for capital expenditures, operations, and acquisitions. Since they are riskier than government-backed bonds, they offer a higher rate of return.

  • Junk Bonds – or high yield bonds are corporate bonds from companies that have a huge chance of defaulting. These offer higher interest rates to compensate for the risk.
  • Preferred Stocks – like bond payments, they pay you fixed dividend at regular period of time. Since holders of these stocks get paid after bondholders, they are slightly safer than stocks.
  • Certificates of Deposit – these are similar with bonds issued by your bank. You loan the bank your money for a certain period of time for a guaranteed fixed rate of return,

Agency Bonds

Federal agencies issue these bonds. They are mainly Fannie Mae (the Federal Nation Mortgage Association) and Ginnie Mae (the Government National Mortgage Association). Agency yields are higher than Treasury yields due to not being full-faith-and-credit obligations of the US government. On the other hand, the credit risk is minimal. But remember that Interest on bonds is taxable both the federal and state levels.

Conclusion

These are the most common and basic types of bonds you can invest in. Bonds are a great investment if you need portfolio diversification. This could improve your investment portfolio and minimize investment risk.

Moreover, make an in-depth research of your preferred bonds to make sure you won’t lose huge amount of money. Additionally, most people don’t realize it, but the bond market offers investors more opportunities than the stock market. Depending on your goals, tax situation, and risk tolerance, you can choose these different types of bonds.

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