When people think of investing, they generally think of stocks, but many investors’ portfolios are largely comprised of bonds as well. In fact, the U.S. bond market is massively larger than the U.S. stock market; approximately double the size*. Knowing this, it is important to understand the differences in common types bonds and how they behave.
U.S. Treasury Securities
Commonly referred to as Treasuries, U.S. Treasury securities are issued by the federal government and are considered to be the safest type of bond and investment overall, because they are backed by the “full faith and credit” of the U.S. government. This means that despite any possible turmoil, the U.S. Treasury can print money to cover their bondholders. For this reason, investors across the globe flock to treasuries when fear is the prevailing investor sentiment. Keep in mind that with safety comes lower yields.
Treasuries come in the form of bills, notes and bonds in a variety of maturities. Bills are non-interest bearing and are sold at a discount to face value whereas notes and bonds pay interest semi-annually.
Municipal bonds are issued by a U.S. state, municipality or county and are exempt from federal and sometimes also state and local taxes. This makes them especially attractive for investors in a high income tax bracket and are most commonly used with non-qualified (after-tax) money.
Muni bonds are offered as general obligation (GO) bonds or as revenue bonds. GO bonds have a lower default risk than revenue bonds since they are backed by taxpayer dollars. Overall, muni bonds are generally riskier than treasuries, but safer than many corporate bonds.
Corporate bonds are issued by all different types of businesses, and thus can vary widely in their risk. These bonds are rated and can fall into either the investment grade or non-investment grade categories. Investment grade bonds are generally safe investments since the companies issuing them are established and have a low default risk. Although they are considered safe, treasuries are still generally believed to be safer.
Non-investment grade bonds are also referred to as “high yield” or “junk” bonds because they tend to pay higher yields than other types of bonds. Companies issuing high-yield bonds are at a higher risk of defaulting, so they must pay a higher yield to compensate investors for taking on additional risk.
International and Emerging Market Bonds
Foreign bonds are structured similarly to U.S. Treasury securities, but they come with additional risks. A nation’s political, cultural, environmental and economic characteristics are factored into what is known as sovereign risk. Default risk can be very high in countries where political or economic instability is rampant.
You also expose yourself to currency risk, which is the risk that a change in the exchange rate between the currency in which your bond is issued and the U.S. dollar can increase or decrease your investment return.
information on international and emerging market bonds is often less reliable and more difficult to obtain, thus increasing the risk on these types of bonds even more.
So, which bonds should you own? Well, that should be based on a multitude of factors including the specific objective of the money your investing, risk tolerance and tax situation. Working with professionals can help ensure you’re appropriately optimizing your money in this under-discussed, yet very important part of your portfolio.
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the CFP® certification mark, the CERTIFIED FINANCIAL PLANNER™ certification mark, and the CFP® certification mark (with plaque design) logo in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
The information provided does not constitute an offer or a solicitation of an offer to buy any securities, products or services mentioned. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. Consult your financial professional before making any investment decision. Indices are unmanaged and do not incur fees, one cannot directly invest in an index.
Fee-Based Planning offered through W3 Wealth Advisors, LLC – a State Registered Investment Advisor – Third Party Money Management offered through Valmark Advisers, Inc. a SEC Registered Investment Advisor – Securities offered through Valmark Securities, Inc. Member FINRA, SIPC – 130 Springside Drive, Suite 300 Akron, Ohio 44333-2431 * 1-800-765-5201 – W3 Wealth Management, LLC and W3 Wealth Advisors, LLC are separate entities from Valmark Securities, Inc. and Valmark Advisers, Inc.