NEW YORK (TheStreet) – The most important element of any bonus is the entity that issued it because as an investor, you expect the issuer to refund your money.
There are seven main categories of issuers:
1) Treasury Bonds;
2.) other government bonds in the United States;
3) investment grade corporate bonds (high quality);
4) high yield corporate bonds (low quality), also known as junk bonds;
5.) foreign bonds;
6.) mortgage bonds; and
7) municipal bonds.
What will you? It mainly depends on your tax bracket. If your tax bill is large enough, it will be worth diversify its portfolio with municipal bonds, whose yields are lower, but for a very good reason: interest is exempt from federal income taxes.
If Munis are not for you, your choice of a taxpayer category depends on your risk tolerance. Generally, if you want to keep only the fixed amount of income you need to diversify your portfolio, adhere to government bonds, government or investment grade companies. There are significant differences between the three, but do not need more than one to be diversified, according to Steve Lipper, senior vice president of Lipper Analytical Services.
As for the other types, you can not count on them to protect against downturns in stocks. An example: In the third quarter of 1998, when the S & P 500 lost 10.0%, the average fund long-term government bonds, the average public finance US corporate fund invested mainly medium in high-grade bonds, according to Lipper Analytical Services. Meanwhile, the most dangerous company funds returned less than 2%, the average fund high yield lost 7.2% and the average emerging markets fund lost 27.5%. Other agents are better able to withstand external debt, and various forms of mortgage-backed funds will not go wrong; Nevertheless, these complex investments, which are not intended to fill the portion of the link to your asset allocation.
That’s what you need to know about each of the seven types of bonds:
1. Treasury Bonds
Treasury bonds issued by the federal government to finance its budget deficit. Because they are backed by the taxing authority impressive Uncle Sam, they are considered free of credit risk. The downside: Their interest will always be the lowest (excluding tax Munis). But economic downturns have better results than higher-yielding bonds and interest is exempt from state income taxes.
2. Other government bonds US
Also called agency bonds, these bonds issued by federal agencies, primarily Fannie Mae (FNM) (Federal National Mortgage Association) and Ginnie Mae (Government National Mortgage Association). They are different from mortgage-backed securities issued by the same body, and Freddie Mac (FRE) (Federal Home Loan Mortgage Corp.). The yields of agencies are higher than government bond yields because they are not debt obligations and have confidence in the government of the United States, but the credit risk is minimal. But the interest rate on the bonds is taxed at the federal and state levels.
3. Corporate bonds investment grade
The investment grade companies issued by companies or funding vehicles with relatively strong balance sheets. They carry ratings of at least triple B by Standard & Poors, Moody’s Investors Service, or both. (The scale is triple-A as the highest, followed by the double-A, single-A to triple-B, and so on.) For investment-grade bonds, the risk of default is considered quite remote.
But their yields are higher than government bonds or agency, although like most organs are fully taxable. In economic downturns, these bonds tend to underperform Treasuries and agencies.
4. High Yield Bonds
These bonds are issued by companies or funding vehicles with relatively weak balance sheets. They carry ratings below triple-B. The default is a distinct possibility.
As a result, prices of high yield bonds more closely linked to the health of financial statements. They follow stock prices closer than the prices of investment grade bonds. “The high performance does not provide the same benefits of asset allocation is made by mixing bonds and stocks high,” notes Steve Ward, chief investment officer at Charles Schwab.
5. Foreign Bonds
These values are quite different. Some are denominated in dollars, but the average foreign bond fund has about one-third of its assets in debt in foreign currency, according to Lipper.
With foreign currency bonds, the issuer agrees to make fixed interest payments back-and primarily in another currency. The amount of such payments, when converted into dollars depends on the exchange rates.
If the dollar strengthened against foreign currencies, foreign interest payments become increasingly small amounts (if the dollar weakens, the opposite occurs). Currency exchange rates rather than interest rates can determine how a foreign bond fund works.
6. Bonds secured by real estate
Mortgages, which has a face value of $ 25,000 compared with $ 1,000 or $ 5,000 for other types of bonds, involves “prepayment risk”. Because its value decreases as the mortgage prepayment increases, not covered by falling interest rates, which most other bonds.
7. Municipal Bonds
Municipal bonds – often called “Munis” are issued by US and local governments or their agencies, and come in varieties of investment grade and high yield. Interest is tax-free, but it does not mean that everyone can benefit from them.
Taxable yields are higher than the muni yields to compensate investors for taxes, so depending on your provider, you can still proceed with taxable bonds.