Today we’re going to talk about the different types of bonds to choose from. Before we do that, though, let’s remember a couple points:
- Long-term bonds fluctuate more than short-term bonds.
- Bond returns are based on credit worthiness.
The safest bonds are ultra-short duration bonds.
Banks exchange money quickly, and these ultra-short bonds invest in that system.
The second safest bonds are government bonds.
When I say government bonds, the safest of all are loans to the US government. Bonds of other countries depend on their credit rating. Also, bonds of other countries will gyrate more due to currency fluctuation. For that reason alone, we normally don’t use international government bonds. Too much going on that can cause you to lose money without the opportunity for big returns.
Third safest are government agency bonds.
These are some of my favorites. GNMA is the government national mortgage association. It isn’t a government entity, but this agency is implicitly backed by the US government. Because of that implicit backing, GNMAs have little risk but higher returns than treasuries.
After that are corporate bonds.
Generically, these bonds are classified according to their duration. Their either short, intermediate, or long term bonds. Long term bonds will have the highest risk and reward in most markets.
Finally, the riskiest types of bonds are called “junk” bonds or “high yield” bonds.
These are loans to companies with bad credit. You’ll receive a nice big dividend check but also your principle will fluctuate a ton. While they’re considered the most risky bond asset class, junk bonds are still less risky than large company stocks on a risk/reward chart.
So Which Should I Buy?
In a normal market, we’d tell you to buy longer range and riskier bonds if you’re a long-term investor and shorter duration bonds for shorter-term goals. In this market, as I mentioned Friday, we recommend buying short duration bonds or ultra short duration bonds.
How To Tell What Type of Bond You’re Buying
First, we’d never recommend buying individual bonds. There’s WAY too much risk in the market and it’s too difficult to price bonds (we’ll cover that more in our upcoming 201 and 301 classes). Instead, you’ll want to buy a bond mutual fund or ETN (exchange traded note).
Bond funds are easy to evaluate. If you go to Morningstar, you’ll be able to look up the different types of bonds listed above and then sort according to risk, fees or past returns using the Quickrank feature (go to Morningstar, log in, use the “funds” tab, and then “Quickrank.”).
Look up your funds to see how they perform. Add their performance to your fund tracker to see which you’ll keep and which need to be replaced.