Learn about Types of Bonds
There are 4 main categories of bonds, with a couple “sub-categories.” The key to understanding bonds (and investments in general) is that the higher the return, the greater the risk.
This page will help you understand the general kinds of bonds available to investors.
Sovereign Bonds – these are bonds backed by the national governments of developed countries such as the United States (US Treasuries) or Germany (Bunds). They are generally considered to be risk free and are usually purchased to provide principal protection. However, if you are looking for retirement income, they don’t work so well. Check out this case study –> CLICK HERE.
Municipal Bonds – these are bonds issued by municipalities in the United States and are often portrayed as nearly risk free.
But are they?
Some analysts, including Meredith Whitney (predicted that major banks would fail in 2007-2009 crisis) has estimated that municipality impairment could run as high as 50% in the next recession. She predicted a measurable number of municipalities would face bankruptcy and maybe even default on their bond obligations.
In the 2008 crash, many municipal bonds saw drops of -30% or more due to forced selling in mutual funds, banks, and hedge funds. So much for nearly risk free.
Municipals bonds have already seen high profile bankruptcies in Michigan, Illinois, California, Puerto Rico and elsewhere where bond holders experienced either reduced payments or big losses on their investments. How many more will go down when the economy worsens?
Municipalities do not offer protection of your principal, which is okay if you don’t mind that sort of thing in return for a 3% – 5% income.
Corporate Bonds — these are bonds issued by mostly credit worthy corporations to help fund acquisitions or operations. Investors buy the bonds, and collect interest payments. The problems come when companies aren’t managed well and take on too much debt, or when recessions hit. Their revenue often falls and that can make it harder for them to make bond payments. If you were a bond holder in Lehman Brothers, Eastman Kodak, Washington Mutual, Blockbuster, Circuit City or others, you lost your entire investment.
Investment grade corporate bonds pay around 4% and do not guarantee your investment.
High Yield Corporate Bonds – These are also known as “junk bonds.” They can pay a lot more than most other bond types with rates in the 6% – 7% area which sounds great until you realize that more of these companies will have problems during a recession than investment grade bonds like the ones Washington Mutual offered.
Emerging Market Bonds – These are bonds backed by governments in the developing or 3rd world. They typically pay in the 5% range. The problem? Sometimes these governments find a way to mismanage their finances. Think Argentina or Venezuela. There is potential for principal loss that may be worse than US Municipal Bonds.
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Need some help figuring out whether bonds will generate enough income for you? CLICK HERE to have a planner do a comparison to see what sources of retirement income fit you best.
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