ࡱ> FHE[ 9bjbj  4Fpa!\pa!\w1+ PPPPPddd8dzj}}}$!LP}}}}}PP4}PP}0 7#RJ0z!uF!!P@}}}}}}}}}}z}}}}!}}}}}}}}} > : What Is a Bond? The following is adapted from  HYPERLINK "http://www.amazon.com/Journal-Complete-Investing-Guidebook-Guidebooks/dp/0307236994/ref=pd_bbs_1?ie=UTF8&s=books&qid=1222398797&sr=8-1" \t "_blank" The Complete Money and Investing Guidebook by Dave Kansas. Bonds are a form of debt. Bonds are loans, or IOUs, but you serve as the bank. You loan your money to a company, a city, the government and they promise to pay you back in full, with regular interest payments. A city may sell bonds to raise money to build a bridge, while the federal government issues bonds to finance its spiraling debts. Nervous investors often flock to the safety of bonds and the steady stream of income they generate when the stock market becomes too volatile. Younger investors should carve out a portion of our retirement accounts 15% or less, depending on ones age, goals and risk tolerance to balance out riskier stock-based investments. That doesnt mean that all bonds are risk-free far from it. Some bonds happen to be downright dicey. As with all investments, youre paid more for buying a riskier security. In the bond world, that risk comes in a few different forms. The first is the likelihood the bond issuer will make good on its payments. Less credit-worthy issuers will pay a higher yield, or interest rate. Thats why the riskiest issuers offer whats called high-yield or junk bonds. Those at the opposite end of the spectrum, or those with the best histories, are deemed investment-grade bonds. The safest of the safe are issued by the U.S. government, known as Treasurys; theyre backed by the full faith and credit of the U.S. and are deemed virtually risk-free. As such, a Treasury bond will pay a lower yield then a bond issued by a storied company like Johnson & Johnson (investment grade). But J&J will pay less in interest than a bond issued by, say, Shady Joes Mail-Order Bride Inc. How long you hold the bond (or how long you lend your money to the bond issuer) also comes into play. Bonds with longer durations say a 10-year bond versus a one-year bond pay higher yields. Thats because youre being paid for keeping your money tied up for a longer period of time. Interest rates, however, probably have the single largest impact on bond prices. As interest rates rise, bond prices fall. Thats because when rates climb, new bonds are issued at the higher rate, making existing bonds with lower rates less valuable. Of course, if you hold onto your bond until maturity, it doesnt matter how much the price fluctuates. Your interest rate was set when you bought it, and when the term is up, youll receive the face value (the money you initially invested) of the bond back so long as the issuer doesnt blow up. But if you need to sell your bond on the secondary market before it matures you could get less than your original investment back. Up until now, weve talked about individual bonds. Mutual funds that invest in bonds, or bond funds, are a bit different: Bond funds do not have a maturity date (like individual bonds), so the amount you invested will fluctuate as will the interest payments it throws off. Then why bother with a bond fund? You need a good hunk of money to build a diversified portfolio of individual bonds. Depending on the type of bond portfolio youre looking to build, it could require tens of thousands in order to do it right. Bond funds, meanwhile, provide instant diversification. We explain more on the differences between bonds and bond funds below. Before delving into the world of bonds, youre going to want to familiarize yourself with the types of bonds available and some of the associated vocabulary. Treasurys are issued by the U.S. government and are considered the safest bonds on the market. As such, you wont collect as much in interest as you might elsewhere, but you dont have to worry about defaults. Theyre also used as a benchmark to price all other bonds, such as those issued by companies and municipalities. Treasurys are available in $1,000 increments and are initially sold via auction, where the price of the bond and how much interest it pays out is determined. You can bid directly through  HYPERLINK "http://treasurydirect.gov/" \t "_blank" TreasuryDirect.gov (with no fees) or through your bank or broker. They also trade like any regular security on the open market. Treasury Bills, or T-bills, are a short-term investment sold in terms ranging from a few days to 26 weeks. Theyre sold at a discount to their face value ($1,000), but, when T-bills mature, you redeem the full face value. You pocket the difference between the amount you paid and the face value, which is the interest you earned. Treasury Notes are issued in terms of two, five and 10 years and in increments of $1,000. Mortgage rates are priced off of the 10-year note (more commonly called the 10-year bond even though its technically a note). Treasury Bonds are issued in terms of 30 years. They pay interest every six months until they mature. Treasury Inflation-Protected Securities (TIPS) are used to protect your portfolio against inflation. TIPS usually pay a lower interest rate than other Treasurys, but their principal and interest payments, paid every six months, adjust with inflation as measured by the Consumer Price Index. Its best to hold these in a tax-deferred account, like an individual retirement account, or IRA, because youll have to pay federal taxes on the increase in the underlying principal even though you dont get the principal back until maturity. When TIPS do mature, investors receive either the adjusted principal or the original principal, whichever is greater. TIPS are sold with five, 10, and 20-year terms. Savings Bonds are probably some of the most boring gifts out there, but it cant hurt to understand how they work. You can redeem your savings bonds after a year of holding them, up to 30 years. Theyre currently offered in two flavors, both issued by the U.S. Treasury: EE Savings Bonds earn a fixed-rate of interest (currently 3.4%) and can be redeemed after a year (though you lose 3 months interest if you hold them less than five years), but can be held for up to 30 years. When you redeem the bond, youll collect the interest accrued plus the amount you paid for the bond. They can be purchased in the form of a paper certificate at a bank for half of their face value (for example, a $100 bond can be purchased for $50) in varying increments from $50 to $10,000. If theyre purchased online, theyre purchased at face value, but can be bought for any amount starting at $25. I Savings Bonds are similar to EE savings bonds, except that theyre indexed for inflation every six months. These are always sold at face value, regardless of whether you buy paper bond certificates or you buy them electronically. Agency bonds are not quite as safe as Treasurys, but yet its often safer than the most pristine corporate bonds. Theyre issued by government-sponsored enterprises. Because these companies are chartered and regulated in part by the government, the bonds they issue are perceived to be safer than corporate bonds. They are not, however, backed by the full faith and credit of the U.S. government like Treasurys, which would make them virtually risk-free. Municipal bonds, or Munis, as theyre commonly known, are issued by states, cities and local governments to fund various projects. Municipals arent subject to federal taxes, and if you live where the bonds are issued, they may also be exempt from state taxes. Some municipal bonds are more credit-worthy than others, though some munis are insured. If the issuer defaults, the insurance company will have to cover the tab. Corporate bonds are bonds issued by companies. Corporate debt can range from extremely safe to super risky. Coupon is another word for the interest rate paid by a bond. For instance, a $1,000 bond with a 6% coupon will pay $60 a year. The word coupon is used because some bonds really had a paper coupon attached to them, which could be redeemed for the payment. Par is also known as the face value of a bond, this is the amount a bondholder receives when the bond matures. If interest rates rise higher than the bonds rate, the bond will trade at a discount, or below par; if rates fall below the bonds rate, it will trade at a premium, or above par. Duration is a measure of a bond prices sensitivity to a change in interest rates, measured in years. Bonds with longer durations are more sensitive to interest rate changes. If youre in a bond with a duration of 10 years and rates rise 1%, youll see a 10% decline in the bonds price.  HYPERLINK "http://guides.wsj.com/personal-finance/investing/what-is-a-bond/tab/print/" http://guides.wsj.com/personal-finance/investing/what-is-a-bond/tab/print/ What Is a Mutual Fund? The following is an excerpt from  HYPERLINK "http://www.amazon.com/Journal-Complete-Investing-Guidebook-Guidebooks/dp/0307236994/ref=pd_bbs_1?ie=UTF8&s=books&qid=1222398797&sr=8-1" \t "_blank" The Complete Money and Investing Guidebook by Dave Kansas. A mutual fund pools the assets of its investors and invests the money on behalf of those investors. The companies that issue these funds, such as  HYPERLINK "https://www.fidelity.com/" \t "_blank" Fidelity or  HYPERLINK "http://vanguard.com/" \t "_blank" Vanguard, manage the pool of money on the investors behalf. The underlying logic of mutual funds is that they provide diverse investments in stocks, bonds and cash without requiring investors to make separate purchases and trades. An individual would need more than $100,000 to build a similarly diversified portfolio of individual shares and bonds, but a mutual fund investor can send $1,000 to a fund company and find herself holding an ownership stake in a number of companies. For instance, a Fidelity fund manager will take in millions of dollars and buy up stock in IBM or General Motors; each investor in the mutual fund is then, by extension, an investor in those companies. The rise of mutual funds has given individual investors the chance to participate in the stock market in a way not previously possible. Even after the burst of the stock market bubble in 2000, more than half of U.S. the households owned stocks, mainly through mutual funds. At the end of 2004, nearly $8 trillion was held in more than 8,000 mutual funds that invest in stocks, bonds and other investments. The largest segment of the fund industry focuses on stocks, and just under half of the assets held by the industry are stocks. Within that universe, investors have an eye-popping number of options: index funds, growth funds, sector funds and many more. Fidelity Investments, one of the biggest mutual fund companies in the world, has about forty-five different kinds of stock mutual funds focused on the United States alone. Fidelity gives investors mutual funds that focus on small stocks, mid-sized stocks, dividend-paying stocks, growth funds and value funds. If youve got an investment notion, chances are that Fidelity has a fund that would fit. And its not just Fidelity. Other big fund companies, such as  HYPERLINK "http://www.putnam.com/" \t "_blank" Putnam Investments and  HYPERLINK "https://www.janus.wallst.com/janus/IPSS/home.asp?user_id=institutional" \t "_blank" Janus Investment Professionals, also offer a range of investing choices. Many investors have become familiar with mutual funds via their 401(k) or other retirement programs. Most such programs provide employees with a menu of fund options the employee can choose among to build his or her investment plan. Its always smart to check with a financial adviser or an in-house retirement adviser before deciding how to deploy your retirement savings. Factors such as your age, your anticipated date of retirement and the amount of corporate matching all play a role in mapping out the proper investment strategy. Mutual funds have costs, not just in terms of investment risk, but also in terms of fees. Like any investment, these funds have operating costs. Fees are disclosed in a funds prospectus under the heading Shareholder fees. The SEC does not limit the fees that a mutual fund can charge, but although the SEC limits redemption fees to 2%. To read more about what kind of fees you can expect with mutual funds,  HYPERLINK "http://www.sec.gov/answers/mffees.htm" \t "_blank" check out the SECs guide.  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