The Advantages to Investing in Bonds
- Bonds have face amounts in multiples of $1,000, usually pay interest semi-annually and have maturities ranging from three months to 30 years. Bonds can be bought and sold through investment brokers. Once issued, a bond has a fixed interest or coupon amount. A U.S. government bond with a 6% coupon will pay $30 every six months on a $1,000 (face amount) bond. The market value of a bond will change to reflect changing interest rates. If the current interest rate is 4%, your 6% coupon bond will have a market price greater than $1,000 to adjust the buyer's return to current levels. The yield-to-maturity calculation will use the coupon rate, current interest rate and time until the bond matures to show the overall return of the bond. Bonds with coupon rates lower than the current market rate will sell at a discount to the face amount.
- Investors buy bonds to receive a steady income stream. Once a bond has been issued, the issuer is required to pay the interest until the bond matures. The income from U.S. Treasury bonds is exempt from state income tax. Income from municipal bonds is exempt from federal income tax and will be exempt from state income tax, too, if the municipality is located in the state where the bondholder pays taxes. Corporate bonds pay a higher rate of interest, which is based on the credit rating of the issuer. An AAA bond issuer will pay a rate just above the U.S. bond rate, while junk bonds--those rated below BBB+--may have interest rates 5 percent or more above Treasury rates. Investing in bonds provides a higher rate of income on an after-tax basis than can usually be earned from bank certificates of deposit.
- When bonds mature, the face amount or principal is returned to the bond holder. If current market conditions have the bonds trading at a discount, the bondholder can continue to hold the security until maturity to receive a full repayment of principal. Holders of corporate bonds will be repaid before stockholders if the corporation declares bankruptcy. U.S. government and agency bonds are considered the safest investments if held to maturity. Bond mutual funds do not provide the same degree of principal security as direct bond investments. Bond mutual funds have a constant inflow and outflow of money, and there is no maturity date when the principal is to be returned.
