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What are bonds?
Bonds are a type of loan where you give money to a borrower to get interest in return. Bonds are usually issued by companies, the government, and banks to finance things like projects. Bonds are legal contracts between the lender and borrower. The borrower will have the money until it’s time to pay them back while the lender gets a percentage of interest. If the borrower fails to uphold their end of the contract, the lender has the right to seize the borrower's assets to get their money back.
Criteria for Determining Good Bonds
There are credit ratings for different bonds that rank them by how profitable the borrower is. Ratings are made by independent agencies. The Lowest credit rating is a D while the highest is AAA. Bonds from the rating BBB to AAA are considered good bonds (investment grade), while everything else is considered bad.
It’s also important to look at the yield of the bond. Higher yield = higher risk. Government bonds are considered very low risk because their yield is lower than one percent. Companies that offer bonds are regarded as high risk because their yield is usually above ten percent.
Bond Funds vs. Individual Bonds
Bond funds are hundreds and thousands of bonds in one place so a person can invest in all of them. It’s a great way to diversify your portfolio and it’s low-risk.
Individual bonds are when you invest in one bond. They are very expensive with the minimum amount being around $1,000 with additional fees in commission. These types of bonds are well suited for experienced investors that know what types of bonds to look out for.
Government vs. Corporate Bonds Government bonds are issued at all levels of government (federal, state, and local). US Treasuries are one of the most common bonds from the government. These types of bonds are low risk because the yield is very low and the government is less likely to go bankrupt compared to the company. An IEF is an ETF that invests in U.S. Treasuries.
Corporate bonds are bonds issued by a company. These bonds are much higher risk due to the company is more likely to go bankrupt. These types of bonds are usually higher in yield. LQD is an ETF that contains corporate bonds.
Recommendation
If you’re just starting out, government bonds and bond funds are better for a more stable investment. The return rate is almost guaranteed. For those who are well experienced and want to expand their portfolio, individual bonds are a good option but they have higher risks.
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