Is it Fixed Income or Bonds? Here's a Primer

February 6, 2015

You may hear a lot of news about interest rates and bonds.  Or you may be told to hold a certain amount of your assets in fixed income.  Here's a primer on what some of these terms mean.

 

In the simplest form of investing, you can buy something (common stock, real estate, art, oil wells, etc.) or you can loan money to someone or some company.  These loans can be called many different things, so let's explore some of them.

 

Government Bonds

 

One of the simplest and safest loans you can make is to buy US Treasury bonds.  But they come in a lot of formats.  The US government borrows money for the short term using Treasury Bills.  They pay very little interest these days, but are about the safest investment on the planet.

 

The US Government issues 10-year notes and 30-year bonds for most of its borrowing.  These debts are backed by the full faith and credit of the US Government. Most of the time debt issued that matures within 10 years are called notes; longer maturities are called bonds.

 

Inflation protected US Government Bonds (TIPS) pay a lower interest rate, but the principal value goes up based on the rate of inflation.  These can be a good way to protect yourself against higher living expenses later in life.  Right now, though, the amount of interest and inflation protection are very low.

 

Savings bonds (Series EE) were popular for a very long time, but have fallen out of favor due to extremely low interest rates that they pay.  They are issued at a discount and pay no interest until maturity or sale.

 

Government Agency Bonds

 

Sometimes thought of as almost as safe as US Treasury bonds are debts issued by US Government Agencies-Fannie Mae (FNMA), Freddie Mac (FHLMC), Federal Home Loan Bank (FHLB) and Federal Farm Credit Bank (FFCB) are the biggest. These agencies issue notes or bonds from just a few months to 30 years or more in maturity. They pay slightly higher interest rates the US Government bonds.

 

Municipal Bonds

 

State, City and Local governments issue debt to fund projects for municipal buildings (like schools), roads, water and sewer systems, and a variety of other projects.  There are hundreds of thousands of issuers of municipal bonds, and their credit worthiness ranks from very close to the US Government to junk, or very poorly rated issues.

One big attraction of municipal debt is the exemption from Federal taxation in most cases.  If you live in a state with state income tax, interest from municipal bonds issued in your state is often exempt from state income tax.

 

Mortgages

 

Some of the Government Agencies buy mortgages from lenders and issue debt secured by that income stream.  These can be very safe or very risky, depending on the underlying quality of the mortgages.  You could loan a friend or family member money to buy a house and get a first mortgage on the property.  If they don't pay you can take the property from them and sell it to get paid back.

 

Corporate Debt

 

Most big US (and Foreign) companies finance their operations by issuing notes and bonds to the public-investors, banks, mutual funds and the like.  The quality of the debt can vary from very safe to very risky, depending on the company's financial strength.  Some US companies issue debt directly to the public that can be redeemed upon death and are called survivor option bonds.

 

Certificates of Deposit

 

These bank deposits come with Federal insurance so they are super safe.  Most pay very low interest these days and are redeemable upon death even if the term of the CD is not yet over.

 

So, whether you buy a bond, note, CD, mortgage or other debt instrument, be careful who you loan money to.  If the interest rate that's offered sounds too good to be true, you're likely putting your principal at risk.

 

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