Most people aren’t fully aware of the scale in the ‘bond market’, of which bonds issued in various public financial markets exist in the United States and internationally. The famous government issued savings bond is typically the first piece of information that the general population thinks of when the subject of CDs or bonds arises in conversation. The truth is that the bond market is much larger and more complex than the face value savings bonds issued by the U.S government. For every municipality and governing body as a whole, comes the opportunity to invest in fixed return bond projects. The bond market is often overlooked as many advanced investors heavily promote equity trading.
The 1900’s were the time of the savings bond and it was viewed as a safe and responsible investment for the long-term. It wasn’t until the 21st century that savings bonds significantly decreased in face value and more individuals in the U.S. began cashing out their savings bond without purchasing another government issued savings bond. Today there are many government issued options for bonds with low to average yield rates. The shift in focus is to ‘bond funds’ in public markets such as exchange traded bond funds (ETF Bond Funds).
The current fixed income sectors are strong and major investment institutions are capitalizing on a diverse array of public and privately issued bond funds. Keep in mind, these markets are not 100% fixed because private corporations are also issuing bonds called ‘corporate bonds’ which are not government backed and are valued based on rating. Modern day bond rating establishments such as Moody’s and Standard & Poor’s place a rating on an A-D + or – scale. The rating classifications are as follows:
- Investment Grade Bond
- Non-Investment Grade
- High Yield/Junk Bonds (Weakest)
Investment grade bonds contain the strongest rating and have the least chance of folding which is the main reason why many investors balance out their portfolios with a series of investment grade bonds. On the complete opposite end of the spectrum are high yield or also known as ‘junk bonds’. These bonds have the weakest rating and are considered a risky investment with a increased chance of default, however the yield offered on these issued bonds are the highest.
Now you have an understanding of the various types of bond ratings, it’s time to explore further into the broad range of bond classifications and segments within the fixed-income markets. There are many different forms of issued bonds and this largely is based on the type of issuer at hand. Below is a list of bond issuer types:
- Municipal Bonds
- Corporate Bonds
- High Yield Bonds
- Savings Bonds
Municipal bonds are a form of ‘debt security’ issued by public municipalities to finance major capital expenditures such as roads, schools, and highways. Municipal bonds otherwise known as “muni bonds” are exempt of taxation at most levels, making them a safe and trustworthy investment. To put municipal bonds in real terms, one may think of it as loaning money to the government for a fixed rate of return.
Corporate bonds differ from municipal bonds in terms of the issuing party. These bonds are issued by corporations, hence the name ‘corporate’ bonds. The goal of this bond is for the corporation to pay investors from future operations earnings, and the interest rates on these bonds are higher due to the increased perceived risk. In some cases corporate bonds may be backed by a corporations assets.
High yield bonds are higher paying bonds with a lower credit rating than corporate bonds, treasury bonds, and municipal bonds. The yield is much higher than other classifications of bonds due to the increased risk of defaulting. These bonds are also known as “junk bonds”.
U.S. Savings bonds are government issued bond that offers a fixed rate of interest return over a fixed period of time. These were popular in the early-mid to late 1900s and were initially issued during the great depression and world war II. United States savings bonds have been used to raise capital for public projects and the military. In modern times investors have shifted to other bond classifications with higher rates of return.
Now you have an intermediate understanding of the bond market and the various classifications of them. Keep this information as a basis for your bond investment strategy, and keep in mind that municipal bonds are the safest investment out of all bond funds available on publicly traded markets. Savings bonds are usually not included in index bond funds rather issued directly from the government, and are even safer yet have a lower return rate. All of these determinations will unfold as you begin diversifying your bond investments, and as with most things in life you learn as you go.
Thanks for reading,
Managing Partner @ IHG Management