Some companies do go bankrupt and billions of dollars of bond investments are lost each year though, so there is a rating system to know how safe a bond is.  The safest is an AAA bond, then an AA bond, then an A bond, then a BBB bond and so on.   Bonds with bad ratings usually offer a higher interest rate to lure you in.  These are called "junk bonds" and are not for the weak at heart.

Bonds are similar to CD's (certificates of deposit) in that they have a set maturity date and you get your principal back (usually, anyway).  Unlike CD's though, you can sell a bond at anytime and they, typically, yield a higher interest rate.

The older you get, the safer you'll want your investments to be.  Whatever your age is, that's the percentage of bonds you should have in your portfolio.

Here are the main types of bonds:

Treasury Bonds:
Treasury bonds are issued by the U.S. government.  Obviously, they are very safe (since the U.S. won't go out of business  - hopefully!) and will pay a little more than CD's.  One nice thing about treasury bonds is that you don't have to pay any state tax on the interest you earn.

T-Bills are treasury bonds that mature (end) in 1 year.  T-Notes are treasury bonds that mature in 1- 10 years.  T-Bonds are treasury bonds that mature in more than 10 years. 

You can purchase treasury bonds straight from the Federal Reserve, but it's a pain to do and a bigger pain to try to sell them yourself.  It's the easiest to find a good discount broker to buy and sell treasury bonds.

Inflation-indexed Bonds:
This is a new type of U.S. government bond.  When interest rates go up, they'll add that amount to your principal (the amount you put into the bond.)  For example, say you bought a bond for $1000 and the next year, interest rates in our country went up 2%...  They'd add 2% of $1000 to your account...  .02 x 1000 = 20...  So, they'd add $20 to your account.  Since inflation-indexed bonds have this extra safety net, they pay a lower interest rate.

Corporate Bonds:
Corporate bonds are issued by companies...  They are as safe as the company is.  Safe and solid company = safe corporate bonds.  Shaky company = risky bonds.  This is where you really need that rating system.  Corporate bonds with bad ratings are the ones you have heard called "junk bonds."  Yeah, they offer a lot of interest, but the company is likely to fail... and you'll lose your money.

Convertible Bonds:
Convertible bonds are a type of corporate bond.  You can choose to convert them to stock in the company.  Because of this, they offer a lower interest rate than the nonconvertible variety.

Mortgage Bonds:
Banks often sell their mortgages out as bonds...  So, you are really loaning the bank money so they can loan it out to someone else in the form of a mortgage.  Mortgage bonds are safe because they are usually guaranteed by a government agency like Fannie Mae (that's a nickname for the Federal National Mortgage Association.)

You can buy and sell bonds through a discount broker (same as stocks and mutual funds), but you'll spend a ton of time deciding on which ones to buy...  And there are a lot of ravenous sales people out there who will talk you into things because they'll make a big commission.  The easiest thing to do is to buy bond mutual funds.  These are mutual funds that just specialize in bonds.  Then you can buy and not worry anymore...  Well, not much!

You can search for bonds using our Google "safe search" option.  Or you can search for a different topic on Finance FREAK.  A new window will open with your results.

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