This is the sixth post in our Retirement Investing 101 series written by Amanda Smith, Client Services Specialist at CESI. Check out Part 1 or continue on to Part 7.
As promised, we’ll be learning about bonds today. Bonds are considered to be conservative investments, which means that while they have the potential to increase your principal balance, there is limited risk involved with the investment. Most conservative investments will preserve your principal balance, but due to the limited amount of risk, there are also limited gains associated with these investments. So what is a bond? A bond is a debt owed to you from an entity such as a municipality, governmental agency, or corporation.
Example: The city of Raleigh needs money for a construction project. In order to raise this money, the city will issue bonds, which essentially are a promise to pay back the amount of the bond plus interest. An investor will give the city of Raleigh the money to fund the project and will receive interest in addition to the original principal balance. Bonds are purchased for a specific time period, such as ten years.
Bonds are a good option to offset losses or additional income because of the interest. Because stocks fluctuate in price with a greater risk of losing money, bonds help your overall portfolio due to the interest and limited fluctuation in price. You may purchase bonds directly through the federal government or through a broker. Bonds are purchased initially when offered by the entity and are also traded on the bond market. Please note, bond market trades are tricky when deciding on price so you absolutely want a professional to explain the purchase to you if you are a novice bond investor.
Another benefit of bonds are that they are tax-free opportunities. U.S. Treasury Bonds are included in federal income tax liability but are free from any state and/or local taxes. Municipal bonds are tax-free federally and on the state and local level. Unfortunately, corporate bonds do not offer any tax-free opportunities but usually offer higher interest.
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