Currently, the initial interest rate on Series I savings bonds is 9.62 percent, making them a great option to consider as an investment. While this is close to the average return of stocks, bonds are considered safer and offer some unique benefits.
If you’re thinking about investing in bonds, however, you need to make sure that you understand them fully. Although investing in bonds is more straightforward and simple than you may expect, they’re different from stocks and there are some unique quirks to them.
In this short brief, we’ll tell you 7 things about bonds that you need to know.
1. There Are Various Bond Grades
One of the first things that you should know about bonds is that they are graded and sorted into several different categories. The three main types of bonds include U.S. Treasury bonds, corporate bonds, and municipal bonds.
Each of these types of bonds is graded on its risk. Government bonds are the safest option while corporate bonds may be graded into either a high-yield or investment grade category.
A high-yield bond will have a higher risk of default, higher interest rates, and a low credit rating. Investment-grade bonds, on the other hand, have a low risk of default but also pay lower interest rates as well.
2. An Issuer’s Creditworthiness Affects the Interest Rate
It’s important to recognize that the interest rate of a bond is based on the creditworthiness of the bond’s issuer.
You’ll find that the safest bonds carry the lowest interest rates. US savings bonds rates are relatively low while riskier corporate bonds carry the highest interest rates. Municipal bonds will fall somewhere in the middle.
Because of these differences in risk and interest, you’ll need to make your investment decision carefully. Consider the amount of interest that you could potentially earn as well as the risk to make a choice that you’re comfortable with.
3. Bonds Are Suitable for Beginners
Generally speaking, bonds are a great investment option for beginners. This is due to their increased safety and reduced risk compared to many other investment options. While there is still some risk associated with bonds, they’re usually less risky than stocks overall.
While some investors are confused by bonds, the fact is that bonds are actually pretty simplistic and straightforward. Their safety and relatively low risk can be helpful for balancing out and diversifying an investment portfolio, so they should definitely be considered as an investment option.
4. Term Length Matters
The length of time that you hold a bond matters quite a bit and will impact the amount of money that you can earn.
You’ll buy a bond at a fixed term and this length of time can range anywhere from 1 year to 30 years. The interest will be paid on a regular basis during this timeframe on either a monthly, quarterly, semiannual, or annual basis.
Because longer-term bonds have a greater risk of facing inflation and a reduced value of payments, they’ll usually pay a higher interest rate than short-term bonds will. Many investors choose to opt for bonds that are between 1-10 years in length to avoid the issues that come with the reduction in value over time and the rising interest rates that cause the bond’s value to fall.
Older bonds will be less attractive as time goes on and typically fall behind when compared to new bonds. Newer bonds on the market will seem more worthwhile compared to older ones as interest rates rise.
It’s important to consider the term length of a bond carefully and to weigh out the risks when making an investment decision.
5. Bonds Can Be Resold
It’s also important to realize that bonds can be resold before they mature. You can sell them at any time. However, it’s important to understand that you may or may not lose money when doing so.
Selling a bond when interest rates are low could result in a nice profit while selling after interest rates have risen may lead to you losing money. It’s important to think about current interest rates and the rate of your bond when selling to make sure that it’s worth it.
6. Some Bonds Are Tax-Free
It’s important to realize that there are tax-free bonds available.
While the typical U.S. Treasury bonds are subject to federal income tax they’re usually free from state and local income taxes. However, if you’re looking for tax-free bonds, you’ll be better off with municipal bonds.
Municipal bonds are usually exempt from federal taxes. In many cases, they’ll also be exempt from state and local taxes as well, if you live in the municipality.
Each municipality bond is different, however, and will have various rules. Be sure to do your research when investing in a municipality bond.
7. Bonds Can Serve As a Hedge Against Inflation
Keep in mind that many investors view bonds as a hedge against inflation.
Compared to stocks, you’ll need to worry much less about the effects of inflation on your investment. You’ll continue getting the same interest rate over time.
Your bonds are safe during inflation, and as a result, they can serve as a great way to balance out stock investments and ensure more diversification and security in your investment portfolio.
Many people opt to follow the 60/40 rule, making 60% of their portfolio stocks and 40% bonds.
Understanding How Bonds Work
If you’re interested in growing your investment portfolio, you should consider investing in bonds. Bonds are considered safe and secure investments. However, make sure you do your research when investing in bonds and be sure to understand the different types and interest rates first.