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Investing in The Bond Market

With the value of the Nasdaq roller coastering, many investors are looking for alternative vehicles to invest their money. One such vehicle that you may have overlooked is an investment in bonds.

Similar to the stock market, the types of bonds that an investor can choose from are diverse depending on the amount of risk the investor wants to take. For instance, U.S. government securities and municipal bonds tend to be less risky than corporate or mortgage – and asset-backed securities. Additionally, corporate bonds have differing degrees of risk, ranging from AAA as the safest to so-called junk bonds with the most risk.

When deciding which investment vehicles to put your money in, consider the following advantages of purchasing a bond:

  • Bonds provide fixed income security. When you buy a bond, you know what amount of money you are going to get periodically or at maturity because you lock in an interest rate. Interest may be paid at intervals or at maturity. You may sell your bond before maturity, but it could lose value on the open market if interest rates have increased during the time you have held the bond. The rule of thumb is: if interest rates go up, market value of bonds drop. However, you will NOT lose value if you hold the bond to maturity. You will generally get back the face value or maturity value of the bond.
  • Some bonds are tax-exempt. The interest you receive from a U.S. government security or municipal bond are tax favored. US government securities are generally not taxed at the state level. Muni bonds are not taxed at the federal level, and may be tax exempt at the state level also. Even though government and municipal bonds often offer a lower yield, investors can still make a good return with these types of bonds because of the tax break. For instance, a comparison calculator at www.investinginbonds.com showed that a Colorado resident with a taxable income of $40,000 who bought a tax-free muni bond at 5.5% is earning the same after tax return as the person who bought an 8.01% taxable bond.
  • Most bonds offer annual or semi-annual interest payments. A calculator at www.businessweek.com showed that to calculate the interest bond investors receive each year; multiply the bond’s face value by its coupon rate. For instance, a $1,000 bond with a 5.5% coupon rate would pay $55 a year. Additionally, a $10,000 bond with a 7% coupon rate would pay $700 per year.