pay scheduled interest payments to the bondholder, and return the face amount of the bond after a specified period of time.” It is the guarantee of a specific return at a specific time that gives bonds — also called fixed-income investments — their strength in an economy fraught with uncertainty. But bonds also have weaknesses. Bond yields (the annual income in dividends or interest that an investment returns) usually depend on the credit worthiness of the issuing body, so if you buy bonds from a corporation that goes out of business, your bonds will be worthless. Some bonds are given ratings to indicate their credit quality. Moody’s Investor Service (www.moody.com) and the Standard & Poors Corp. (www.stan dardandpoors.com) rate bonds based on their capacity to make scheduled interest and principal payments. To make sure that you have the right mix of bonds in your portfolio, it’s important to understand the pros and cons of all of them. (To understand bond ratings, see blackenterprise.com.)
U.S. Treasury securities, also known as T-bills and T-notes, are considered the most secure investment. Yields are relatively modest, ranging from 2.6 % for a two-year T-bill to 4.5% for one that spans 10 years. The negligible risk involved with purchasing bonds from the U.S. government, coupled with the tax benefits (Treasury issues are exempt from state and local taxes), makes these securities attractive to both aggressive and conservative investors. “Most people know fixed-income securities to be Treasuries, and that’s a good part of any portfolio,” says Bryant.
Corporate bonds are securities issued by corporations to raise capital for specific projects such as building new facilities. Because they are generated in the private sector, corporate bonds involve more risk than Treasury issues and, therefore, tend to have higher yields.
Corporate bonds are divided into two main categories: blue chip and higher-yield. Blue chip corporates are issued by giant companies that are considered virtually infallible such as General Motors and IBM. “They’re stable, and the yields can approach 6% to 7%,” says Bryant. High-yield corporates, known colloquially as junk bonds, offer spectacular returns if the investor is willing to accept the risk that comes with his or her precarious credit rating. “All corporate bonds except blue chips are under question because some of the weaker issues might not be able to pay interest in a recession,” Bryant notes.
Municipal bonds are issued by state and local governments and their authorized agencies to pay for various public projects such as highways and other infrastructure needs. Municipals generally have low yields, but they are exempt from federal, state, and — in several states — local taxes. “Municipal bonds make better sense if you’re in the higher tax brackets,” says Bryant. “They have low yields, but the triple-tax benefit looks good to wealthier investors.”
Bryant says zero coupon bonds are a largely ignored but potentially powerful investment tool. “With zeros, the bond is bought at a discount, and the yield is actually the difference between what you bought the coupon for and how much its par (face) value will be