Definitions in personal finance and investment: bonds

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A bond, simply put, is a loan to the government. When you buy a government bond you are lending money to your government. They pay you back by giving regular interest payments on your bond, and returning the full face value amount of your bond at the date of maturity. So, it works like a loan, where you are the lender.

Types of bonds

All countries issue their own bonds. Within those countries some cities are also allowed to issue city bonds, to raise funds for those cities. Some corporations also issue bonds instead of shares.

In the United States, when there is talk of bonds, it can mean one of four things

Savings bonds: the price of these start at $50 and they are the consumer approach to treasury bonds.

They have the longest maturity terms of all government bonds. The current bonds on sale by the United States government are those of Series I, with a maturity of 30 years. They are a good and safe way to spend without risk. They also can be redeemed before their full maturity, though if that is the case the redeemer will not get his or her full interest payment from the bond, and will be charged a small penalty for early exchange.

Treasury bills, known as T-bills: these are short term bonds that mature within one year. They also work differently from savings bonds in that they don’t grant dividends, but rather grow on par from their discounted sale price. Another difference is that the Treasury sells them on auction, not regular sale as they do with bonds. Here’s an example: The government puts X amount of $10,000 T-bills on sale. You bid less than that amount for them. The highest bidders win. So, you can get a $10,000 T-bill for $9,600, $9,700, $9,800 depending on how the conditions are on the days of sale. When the bond expires, the government gives you the $10,000 face value of the bon, and you have gained the difference between the face value and what you paid for it. Their beginning purchasing price is $100.

Treasury notes or T-notes work the same as T-bill but have greater maturity terms, between one and ten years. The 10-year Treasury note is the most followed of all securities, and many banks use its prices to set mortgage rates. Treasury notes are sold at auction, but they earn interest like savings bonds do; however, whereas bonds give interest quarterly, Treasury notes do so every six months. They come in denominations of $1,000.

Treasury bonds or T-bonds should not be confused with savings bonds even though both are sold by the U.S. Treasury. They are extra-long terms securities, with terms of 20 or 30 years. They give interest semi-annually and their starting face value is $1,000.

Tax considerations

The interest earned from any of the bonds issues by the U.S. Treasury is exempt from state and local taxes, but subject to federal tax. Keep that in mind when considering investment.

Who should buy bonds? And when?

From an individual investor’s point of view, the government bonds of most nations are a very safe bet, if a tad boring. After all, you have a guaranteed safe return on your investment.

If you are near retirement or retired and have extra cash, bonds are good as they can just gather interest on their own (savings bonds) or provide you semiannual payments of dividends that can be a tidy addition to your monthly income. And as I said they are a safe bet.

You should also consider investing in bonds when stocks are soaring. I am not going to explain why today, but know this: when stocks are high, bonds are low, and vice versa. So, if you want to save on purchasing bonds and make a tidy bit of safe cash, they are good to buy when the stock market is doing well and stocks are overpriced. Bonds are low means that you get them at a greater discount, as I explained before. The greater the discount, the more you make at maturity.