Long Term Planning

Bonds

Bands are a loan of money to a corporation or a government unit. Just like a car loan or mortgage, what you cane expect to get is fixed by the initial contract terms. Bonds have returned an average of 6% over the past 50 years.

Bonds do a really good job of providing a stable stream of income and at maturing at a known date with a certain amount of money available. They are typically purchased through stockbrokers. Treasury bills and bonds can be bought directly from the Federal Reserve in amounts as low as a thousand dollars. If you are interested in Treasury bills and bonds, you can call the Federal Reserve Bank in your area for the latest details regarding them.

Bonds are a great investment when you have a short term goal with a known date and the amount if reasonably certain. Meaning, if you have a child who starts college in the fall of 2007, you might invest in a bond maturing in July of 2007 so you can have the money available for the initial payment of tuition for that child. You will lock in a fixed rate of interest, the principle will be ready at the time the first check needs to be written for tuition, and you will not have to make any further decisions until the bond matures.

Treasury bills

Bonds come in many forms. A loan to the US government in the form of a one year treasury bill carries almost no risk of you not getting your money back at the end of the bill’s term. No matter what, the government can always print enough money to pay you back. While you will receive a very low interest rate on your very low risk investment, the US government has always paid interest when it was due.

You can loan money to the US government for periods of time as short as 3 months or as long as 30 years. Usually the longer the loan term, the higher the interest rate will be. But the difference in rates is not as large as you might expect to get. 3 month treasury bills might pay about 3.5% when the 30 years ones pay about 5.5%. The interest is taxable on your federal income tax form, but it is exempt from state income taxes.  

Corporate bonds

Loans to private companies usually pay higher interest rate, depending on the length of the loan and the likelihood that the loan will be repaid on time. Corporations may borrow millions or billions of dollars at a time, but you can typically but a bond fro as little as $1,000. The interest from these types of bonds is fully taxable on federal and state tax forms.

When buying bonds, it is vital that you understand the credit quality of the bond. The highest rated bonds, those in which there is confidence that payments will be paid on time, are rated AAA. The next grade of bond is AA, then A, then BBB. Do not consider ever buying anything rated lower than that in this junk bond market.

Municipal bonds

Loans to state and local governments are known as municipal bonds. These bonds are exempt from federal income taxes and not taxed by the state if you are a resident there (the state that issues the bond). For these reasons, these types of bonds carry a lower rate of interest. The risk is somewhat dependent on where the money will come from to repay the bond.

Savings bonds

Many people own US savings bonds. They are popular. Many times, they are given as gifts to family members, grandchildren and such. Many companies have plans where you can buy US savings bonds through payroll deduction. Be sure that this is a good idea fro you first.

Series E and EE bonds

There are 3 types of US savings bonds. Series E and EE bonds, Series H and HH bonds, and Series I bonds. The series E and EE bonds are purchased at a discount, which is half of their face value. At this time, E bonds are being eliminated and replaced by EE bonds.

These bonds all earn interest only for a period of time – a limited number of years, depending on when they were issued. You may have Series E or EE bonds that are no longer earning interest. Holding these matured is no better than hiding a stack of cash in your home. These bonds should be cashed in immediately and the money put to better use like paying down debt or for starting an emergency fund.

Series H, HH and I bonds

Series H and HH bonds are purchased at face value. The H bonds are also phasing out and being replaced by HH bonds. They pay out their interest every year to the bond holder, making them more useful for income than for investment purposes.

Series I bonds are bought for face value. These types of bonds carry 2 types of returns. The first type is a fixed annual interest rate, and the second one is a semi annual inflation rate adjustment. The fixed annual interest rate works like the Series EE band (it increases the value of the bond and is taxable as interest when the bond is cashed in). The semi annual inflation rate adjustment is made to keep up with inflation. A small amount is added to the value of the bond, but taxed as income when it is added.

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