What’s The Difference Between All These Types Of Bonds?

As you know, the markets had a very up-and-down year in 2022. Whenever that happens, many investors start showing renewed interest in bonds, because they tend to be less volatile than stocks. This interest may continue in 2023. But there are several types of bonds to choose from, each with different characteristics. All those options can be confusing, so I figured now would be a good time to give people a brief overview of the main types that investors have to choose from.

When you buy bonds, you are lending money to the issuer – generally a company or government. In return, the issuer promises to pay you a specified rate of interest on a regular basis. They then repay the principal when the bond matures after a set period of time.

Corporate Bonds

One of the most common types of bonds is Corporate bonds. Public and private corporations issue them. Companies use the proceeds of these bonds to buy new equipment, invest in new research, and expand into new markets, among other reasons. Credit rating agencies usually evaluate these bonds based on the risk of the company defaulting on its debt.

You can break corporate bonds down into two sub-categories: Investment-grade and High-Yield. Investment-grade bonds come with a higher credit rating, implying less risk for the lender. Investment-grade bonds are more likely to make interest payments on time compared to non-investment grade bonds.

High-yield bonds have a lower credit rating, implying higher risk for the investor. These are typically issued by companies that already have more debt to repay than the average business or are contending with financial issues. Newer companies may also issue high-yield bonds, because they simply don’t have the track record yet to garner a high credit rating.

In return for this added risk, high-yield bonds typically pay higher interest rates than investment-grade bonds. In short, investment-grade implies a lower risk for a lower return; high yield implies a higher risk for a higher return.

Municipal Bonds

Municipal bonds, or “munis”, are issued by states, cities, counties, and other government entities so that entities can raise funds. Sometimes these funds are to pay for daily operations like maintaining roads, sewers, and other public services. Sometimes the funds are to finance a new project, like the building of a new school or highway.

You can also break muni bonds down into two sub-categories: Revenue bonds and general-obligation bonds. Revenue bonds are backed by the revenues from a specific project, such as highway tolls, while general-obligation bonds are not secured by any asset. Instead, they rely on the issuer’s “full faith and credit,” which includes the power to tax residents to pay bondholders if necessary.

In other respects, muni bonds work similarly to corporate bonds in that the holder receives regular interest payments and the return of their original investment. But they do come with one additional advantage, in that the interest on muni bonds is exempt from federal income tax. (It may also be exempt from state and/or local taxes if the holder resides in the community where the bond is issued.) However, muni bonds often pay lower interest rates than corporate bonds do.

U.S. Treasuries

Treasury bonds are the type of bonds you usually hear about in the news. As the name suggests, these are issued by the U.S. Department of Treasury on behalf of the federal government. They carry the full faith and credit of the government, which has historically made them a very stable and popular investment. In fact, U.S. treasuries tend to be so stable that economists often use them as a bellwether for the overall health of the entire economy.

There are several types of U.S. Treasury bonds. Treasury Bills are short-term bonds that mature in a few days to 52 weeks. Notes refer to longer-term securities that mature in 2, 3, 5, 7, or 10 years. Finally, actual U.S. Treasury Bonds typically mature every 20 or 30 years. Both Notes and Bonds pay interest every six months.

Treasury-Inflation-Protected Securities or TIPS

These notes and bonds adjust their principal based on changes in the Consumer Price Index, which tracks inflation. Interest payments occur every six months and the calculation is based on the inflation-adjusted principal. That means if inflation rises, the principal in the bond increases, which in turn raises the amount of interest paid. However, if inflation goes down, the principal does too, thereby decreasing the interest rate.

The Bottom Line About Types Of Bonds

The different types of bonds are an important subject that all investors should know about, so we hope this overview was helpful!

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Disclosures:
Hennion & Walsh Asset Management currently has allocations within its managed money program, and Hennion & Walsh currently has allocations within certain SmartTrust® Unit Investment Trusts (UITs) consistent with several of the portfolio management ideas for consideration cited above.

Past performance does not guarantee future results. We have taken this information from sources that we believe to be reliable and accurate. Hennion and Walsh cannot guarantee the accuracy of said information and cannot be held liable. You cannot invest directly in an index. Diversification can help mitigate the risk and volatility in your portfolio but does not ensure a profit or guarantee against a loss.