Investing in the stock market might lead you to think of buying and selling stocks. But it’s not the only type of investment there is.
Bonds are fixed-income debt obligations issued by companies and government agencies that get repaid over time. When you buy a bond, you’re essentially lending money to a company or agency. You’ll earn money off of the interest that bond makes.
You can invest in individual bonds, mutual funds, or exchange-traded funds (ETFs).
Bonds through mutual funds and ETFs are lower risk than buying them individually — you’re buying a part of a bond along with a pool of other investors. Mutual funds and ETFs also offer instant diversification of your portfolio. Unless you’re well-versed in the stock market and feel comfortable hand-picking your bonds, mutual funds and ETFs are good options.
But if you know the market, you can still invest in individual bonds. There are many different types of bonds to choose from. Here are a few of the most popular ones.
1. Municipal bonds
Sometimes referred to as “munis,” these types of bonds are issued by state and local governments or other government agencies. When you buy a government bond, you’re lending money to the government.
One of the main draws of these is that interest from municipal bonds aren’t subjected to federal taxes. If you live in the city and state your bonds are in, they usually aren’t taxed, either.
But bonds are usually sold in $5,000 increments, so if you can afford the hefty price tag, the tax benefits are enticing.
2. Corporate bonds
Corporate bonds are issued by companies that are looking to raise money for operations. These are different from stocks. Stocks mean you have an ownership stake in the company. With bonds, you don’t. However, companies that go bankrupt pay their bondholders before their stockholders.
Investment-grade corporate bonds are issued by high-performing companies, earning at least a triple-B from credit rating agencies. High-yield bonds come from companies with lower credit ratings. They’re considered higher-risk but can get you a higher return on investment.
Corporate bonds are higher risk than munis because it’s more likely for a company to default over a government agency.
3. U.S. Government bonds
Federal government bonds pose much lower risk than other types of bonds. There are a wide range of federal government bonds, including:
- Treasury bonds — These are long-term, fixed securities that are issued to fund budget deficits. They’re exempt from state income tax and pay interest every six months. But they have some of the longest maturities: 10- to 30-year terms.
- Treasury bills — Bills are short-term securities, usually less than a year. You can buy them at a discount to face value and cash them in when they mature to their full value. While exempt from state and local tax, they do get taxed at the federal level.
- Treasury notes — These terms range from two to 10 years, paying interest every six months until they full mature. The principal is paid when the note matures. Like bills, they’re exempt from state and local taxes, but not federal.
- Treasury Inflation Protected Securities (TIPS) — These maturities can last five to 30 years. The principal of these are adjusted for inflation. Your interest is calculated by the inflated amount.
4. Emerging market bonds
While the federal government issues their own bonds, so do other countries. Emerging market (EM) bonds are issued by developing countries and foreign companies.
While EM bonds are a good way to diversify your portfolio, other countries operate differently than the U.S. wgucg could pose a risk if you’re making decisions based on incomplete or downright false information.
If EM and international bonds sounds good, talk to a broker that has experience with international companies and countries. The federal government is unlikely to default, which makes government bonds nearly risk-free. That’s not the case for EM and international bonds.
5. Mortgage-backed securities
These types of bonds are secured by home and real estate loans. Interest is paid out monthly rather than twice a year like government bonds.
Mortgage-backed securities (MBS) are created when similar loans are pooled together. The MBS is then sold to a government agency, like Ginnie Mae, or a government-sponsored enterprise, like Fannie Mae or Freddie Mac. These pools could also be issued by private firms, like investment banks or private institutions. Only those issued by a government agency have the backing of the U.S. government; GSEs and private institutions don’t.
This is a good investment for those who have the cash to put into it. Minimum investments start around $10,000 and you buy them through a broker.
Investing in bonds
Regardless of which bonds are right for you, it’s important to know the different types of bonds you can invest in.
Once you have an idea of which bonds are right for you, determine how to buy them. You can do this through an online brokerage similar to buying stocks. If you like to watch your investments, an online broker might work for you.
Another option is a robo-advisor that can put your money into an ETF. This is a good choice if you aren’t as well-versed in individual bonds from different companies or government agencies. If you’d like your investments to basically handle themselves, a robo-advisor might work for you.
As long as you’re choosing the right strategy for your investment preferences, there is no wrong answer.