Active traders on the stock market have known for years that investment bonds are reliable sources of income in balanced portfolios.  The typical trader should learn the differences between various investment bonds before pouring money into this financial vehicle. 

Defining Investment Bonds

An investment bond is a short-term financing tool used by governments and businesses to expand their operations.  As communities build new schools and businesses open new offices, the strain of tightening credit markets will give way to greater numbers of investment bonds.  The typical investment bond is a contract between the issuer and the investor whereby the investor supplies between $1,000 and $100,000 in capital.  The bond document features a maturation date, a fixed interest rate, as well as other provisions for the return of principal plus interest to the investor. 

The maturation date on an investment bond can range from several months to a decade depending on the issuer.  This date is the last day in which the bond issuer can repay the principal plus remaining interest payments to the investor.  The interest rate or bond coupon is a quarterly payment made to the investor on the bond’s principal amount.  In essence, an investment bond is a short-term loan offered by an investor to a government body or corporation. 

Types Of Investment Bonds

Investment bonds can be broken into government, municipal, and corporate varieties.  Government bonds issued by the U.S. Treasury typically have low yields, but offer the safest investment because of the backing of the Federal Government.  The reliability of a Federal Government bond may not attract day traders and active investors, but this safe investment is ideal for more conservative spenders. 

City, county, and state governments offer municipal bonds to the public to get around increasing taxes or cutting budgets.  Municipal bonds are used throughout the United States to fund local streets, schools, broadband systems, and other initiatives.  The primary benefit of a municipal bond is that accrued interest is exempt from local, state, and federal income taxes.  Investors should be warned that the alternative minimum tax (AMT) and capital gains taxes are levied against municipal bond interest especially if bonds are sold before maturation dates. 

The third category of investment bonds is a corporate bond.  Private companies looking to open new stores, invest in research and development, or expand operations overseas issue bonds to increase available revenue.  While interest rates on corporate bonds are not exempt from taxes, the interest rates on these bonds are typically higher than government and municipal bonds. 

Investment Bond Ratings

Potential buyers of investment bonds should be aware that municipal and corporate bonds are not always great buys.  The difference between a great investment bond and a junk bond is the rating assigned by rating services like Moodys© (http://www.moodys.com/cust/default.asp) and Standard and Poor’s© (http://www2.standardandpoors.com/portal/site/sp/
en/us/page.siteselection/site_selection/
0,0,0,0,0,0,0,0,0,0,0,0,0,0,0,0.html).  These ratings fall within an A to D range that assesses the ability of the bond issuer to repay the principal and interest by the maturation date.  Ratings services are invaluable tools for newcomers to investment bonds who are looking for reliable investments. 

The top rating for any investment bond is an Aaa or AAA depending on the rating service.  The AAA rating is reserved for those government agencies and businesses with established track records of repayment on bonds and loans.  The bottom of the ratings chart is anchored by a C rating which indicates a near-certainty that the bond issuer will default on the issued bond.  Moodys© and Standard and Poor’s© also issue D ratings for those issuers already in default of past payments. 

Advantages Of Investment Bonds

Investors can find three advantages of choosing municipal and corporate bonds over traditional trading tools.  The primary advantage of an investment bond is the reliability of interest payments from the issuer.  The bond coupon remains the same from day one through maturation, ensuring equal quarterly payments to the investor over time.  Since an investment bond is similar to a loan to agencies and businesses, the investor can rely on highly graded issuers for supplementary income over the life of the bond. 

The tax advantages of an investment bond are sufficient for some investors to choose bonds exclusively in their portfolios.  Long-term investors who can hold on to government and municipal bonds can keep their portfolios away from the IRS, keeping a greater portion of their yields.  As the AMT is adjusted by Congress and capital gains taxes are debated, we may see greater tax benefits for bondholders in the foreseeable future. 

The final benefit of an investment bond is that the abundance of market information available to the public has made these tools more reliable.  Moodys© and Standard and Poor’s© have done wonders for first-time investors who may be skittish about entering the world of investment bonds.  While U.S. government bonds remain the safest harbor for bondholders, municipal and corporate bonds are becoming more transparent because of online resources. 

Disadvantages Of Investment Bonds

The stability and steady interest rates of investment bonds create disadvantages for more aggressive investors.  An investment bond may offer a steady interest rate, but the prime interest rate dictated by the Federal Reserve will change over the life of the bond.  As interest rates rise, the value of a municipal or corporate bond will decrease because of the availability of higher-yield bonds.  This disadvantage is troublesome for investors with short-term bonds that may lock up money while better bonds emerge in the market. 

The bigger problem for inexperienced investors is finding the right bond without going over to the dark side of speculation.  The temptation to choose a low-grade investment bond with a potentially high yield is too big for many investors to pass.  The Federal Government’s relaxed regulation of financial markets over the past decade has allowed speculation to run rampant, sweeping first-time investors into a sea of troubles.
 

Accessing Municipal And Corporate Bonds

The first word on a municipal or corporate bond issue is likely to be found in local newspapers and magazines.  Municipal and county governments in many states ask voters to authorize bond issues to fund schools and city improvement projects.  Stockholders may improve bond issues at annual meetings, which are reported to business papers and magazines in communities nationwide. 

Once you have identified an investment grade corporate bond or municipal bond, you can use a traditional brokerage firm like Charles Schwab© (http://www.schwab.com) to handle the transaction.  Investment bonds are treated similar to stocks, mutual funds, and other investment tools with the appropriate brokerage fees and other expenses.  Online brokerage accounts allow investors to determine how their bond is faring compared to prevailing market values while researching additional investment bonds.