Bonds are a type of investment that results in an investor lending money to the bond issuer in exchange for interest payments. They are one of the most important investments available for those who follow an income investing philosophy.
With the different options available to you, including municipal bonds, commercial bonds, savings bonds, and treasury bonds, you need to know which is right for your unique situation as well as the risks.
All investments carry some degree of risk. Generally, the higher the risk, the higher the return. Thus, lower levels of risk result in lower returns, meaning that you may give up the potential for higher returns in favor of a safer investment.
Read about Risks in Stock Investment.
You want to learn how to invest in bonds, but don’t know where to start? In this article, We will continue to look more at some of the factors you should take note first if you’re thinking about investing in bonds.
THE LINK BETWEEN INTEREST RATES AND MATURITY
Interest rate changes do not have an effect on all bonds in the same way. Generally, the longer a bond’s term, the more its price may be affected by the rise and fall of interest rate. Investors usually expect to be made up for taking that extra risk. This relationship can be shown by drawing a yield curve between the yields available on similar bonds of different maturities, from shortest to longest.
When a bond issuer fails to pay principal or interest when due, it has “defaulted” on the debts. Defaults can also occur for failure to meet obligations unrelated to a payment of principal or interest, such as reporting requirements, or when the issuer faces a material problem, such as bankruptcy.
The collection of credit quality choices available in the bond market ranges from the highest credit quality. Treasury bonds, which are backed by the full faith and credit of the United States government, to those that are below investment-grade and considered hypothetical, such as a bond issued by a start-up company or a company in danger of bankruptcy.
Learn more on Helpful Ways to Raise Your Credit Score.
Since a bond may not reach maturity for years to come, credit quality is an important consideration when evaluating an investment in a bond.
Bond insurance can improve a bond’s credit quality. Specialized insurance firms assure the appropriate payment of principal and interest, based on the claims-paying ability of the insurer, in exchange for a fee. Insured bonds get the same rating as the corporate rating of the insurer, which is based on the latter’s capital and claims-paying resources.
Taxation of cash flows coming from a bond varies based on many factors, such as the taxpayer’s citizenship and residency, and whether the taxpayer is a business or an individual. Taxpayers can also sustain short or long-term capital gains tax upon the sale or maturity of a bond previously acquired.
It is important to consider all the types of taxes and tax jurisdictions that can impact your net return on an investment in bonds.
Always talk with your investment advisor to discuss which investments fit you the most. If you choose to pursue an investment in bonds, make sure to receive more detailed information about each of the specific types of bonds in which you are interested before investing.
In case you have missed it, here is a link to Factors to Consider in Bonds Investment (Part 1).
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