Investors in fixed income have a wide range of options when it comes to the types of bonds they can hold in their portfolios. If you are investing in fixed income securities, you know the value of stable payments over time until the asset matures. Whether they pay dividends or make payments based on interest returns, all bonds come with a time period, after which you can expect to recover your initial investment. The details of these payments, maturity dates, and yields vary based on the type of bond, and there are many types.
Savings Bonds
Savings bonds are considered the safest investments, as they are backed by the U.S. government and guaranteed to not lose capital. They do not offer very high returns, but they are among the safest options in the bond market. They are easy to purchase via TreasuryDirect and are free from state and local taxes. Savings bonds may also be tax-free at the federal level if used for qualified higher education expenses.
U.S. Treasury Bonds
Regardless of the state of the U.S. economy, U.S. Treasury bonds remain one of the safest investments as long as you hold the individual bonds until maturity. In this case, there is no risk of default and no interest rate risk. Most U.S. Treasury bonds offer lower yields than other types of bonds due to the lack of credit risk (or in other words, default risk).
Inflation-Protected Securities
Inflation-protected securities, or TIPS, are a way for investors to help manage inflation risk. They function by adjusting the principal value upward with consumer price inflation. If you invest in inflation-protected securities, this feature guarantees you a “real yield” (or yield after inflation). Therefore, inflation-protected securities can be an important part of your portfolio if you are looking to maintain the purchasing power of your savings over time.
Municipal Bonds
Municipal bonds are issued by cities, states, and other local governmental entities. Generally, they are free from federal taxes. If you buy bonds from the state you live in, they are also free from state and local taxes. The principal value of municipal bonds mainly depends on this tax exemption and may be more beneficial for investors in higher tax brackets. For those in lower tax brackets, it may be better to invest in taxable bonds, as most taxable issues offer higher pre-tax yields than municipal bonds.
Mortgage-Backed Securities
Mortgage-backed securities are pools of home mortgages that are sold by banks acting as mortgage lenders. They are bundled together into “pools” and sold as individual securities. When homeowners make monthly payments, those cash flows pass through the mortgage-backed securities and then to you, if you hold those bonds.
Commercial Mortgage-Backed Securities
Commercial mortgage-backed securities are linked to commercial real estate loans. Most of these loans are secured by commercial properties such as office buildings, hotels, shopping centers, apartment buildings, factories, etc., rather than individual homes. Although commercial mortgage-backed securities carry default risk, they can provide a way to gain exposure to the real estate market without needing to invest in equities. Compared to other types of bonds, the yield on commercial mortgage-backed securities often exceeds the risks associated with them.
Debt Securities
Asset-Backed Securities
Asset-backed securities are pools of loans that are bundled together and sold as securities through a process known as “securitization.” They can consist of various types of loans, such as credit card receivables, auto loans, home loans, student loans, and even loans for boats or recreational vehicles.
Corporate Bonds
Corporate bonds are simply bonds issued by companies to finance their operations. Generally, corporate bonds offer higher yields than government issues but also carry slightly higher risks due to the possibility of default (primarily among lower-rated issues). The corporate bond market offers a full range of options regarding finding a balance between risk and return. You can find what suits you best: from short-term to long-term, senior and subordinated notes, and from very low risk to somewhat low risk.
High-Yield Bonds
High-yield bonds are issued by newer companies or those with uncertain prospects. High-yield companies may have high levels of debt, somewhat unclear business models, or negative earnings. As a result, there is a greater chance that these companies will be unable to meet their obligations. In fact, high-yield bonds are also referred to as “junk bonds,” as their debts cannot be classified as investment grade.
Syndicated Loans
Syndicated loans, also known as leveraged loans or bank loans, are loans provided by banks to companies and then packaged and sold to investors. Although syndicated loans are secured by collateral, they are not without risks.
International Bonds
Investors who only hold domestic bonds may miss out on a significant portion of the fixed income market. This is true even if their portfolios are diversified. Like domestic bonds, foreign bonds are subject to credit risk (i.e., the risk of default) and interest rate risk (sensitivity to current price changes), but international economies do not always move in sync with the U.S. economic cycle. As a result, foreign bonds often perform in ways that contrast with the U.S. market.
Emerging Market Bonds
Emerging market bonds are issued by governments or corporations in developing countries around the world. Emerging market bonds are considered riskier than other types because smaller countries are viewed as more susceptible to sharp economic fluctuations, political pressures, and other factors not always present in established and safer market countries. Due to expectations that investors will be compensated for these additional risks, emerging countries tend to offer higher returns.
The Balance does not offer tax, investment, or financial advice. The information is provided without regard to the investment objectives or risk tolerance or financial circumstances of any specific investor and may not be suitable for all investors. Past performance is not indicative of future results. Investing involves risks, including the risk of loss of principal.
Source: https://www.thebalancemoney.com/types-of-bonds-417075
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