3 Types of Bonds to Avoid
When you buy a bond, you are essentially loaning a company or municipality money.
They promise to pay you interest for the loan in the form of a coupon rate and they promise to pay back the loan principal by a certain date, which is referred to as the maturity date.
While in theory bonds are a good investment, there are three types you should steer clear of.
1.
Callable bonds: The issuing company can "call" or payback prior to the maturity date.
These bonds are especially risky for investors because, if they are called, you might lose the yield you anticipated (since you won't get the coupon rate for as long as you thought you would) and you might not be able to reinvest the principal into a bond with as good a rate.
If the bonds are not called then you will end up earning what you anticipated.
2.
Junk bonds: Bonds are rated based on the perceived ability of the issuing company or municipality to pay the interest and pay the principal back by the maturity date.
Some bonds are rated low by Standard and Poor's and other rating companies because the issuer does not seem financially able to live up to the obligation created by the loan.
These bonds are called Junk Bonds and are often popular because of their high interest rates.
But remember, their interest rates are high because they carry such risk.
3.
Municipal bonds in IRAs: Municipal bonds that are highly rated are great bonds to buy--outside of an IRA.
Municipal bonds can be triple tax-exempt when purchased from your home municipality.
They generally have a low interest rate which is compensated for by the tax savings on the earnings.
But when you buy a tax-exempt bond and place it in an already tax-exempt IRA, you lose out on a higher interest rate without increasing your tax savings.
They promise to pay you interest for the loan in the form of a coupon rate and they promise to pay back the loan principal by a certain date, which is referred to as the maturity date.
While in theory bonds are a good investment, there are three types you should steer clear of.
1.
Callable bonds: The issuing company can "call" or payback prior to the maturity date.
These bonds are especially risky for investors because, if they are called, you might lose the yield you anticipated (since you won't get the coupon rate for as long as you thought you would) and you might not be able to reinvest the principal into a bond with as good a rate.
If the bonds are not called then you will end up earning what you anticipated.
2.
Junk bonds: Bonds are rated based on the perceived ability of the issuing company or municipality to pay the interest and pay the principal back by the maturity date.
Some bonds are rated low by Standard and Poor's and other rating companies because the issuer does not seem financially able to live up to the obligation created by the loan.
These bonds are called Junk Bonds and are often popular because of their high interest rates.
But remember, their interest rates are high because they carry such risk.
3.
Municipal bonds in IRAs: Municipal bonds that are highly rated are great bonds to buy--outside of an IRA.
Municipal bonds can be triple tax-exempt when purchased from your home municipality.
They generally have a low interest rate which is compensated for by the tax savings on the earnings.
But when you buy a tax-exempt bond and place it in an already tax-exempt IRA, you lose out on a higher interest rate without increasing your tax savings.
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