A bond is a loan an investor makes to an organization in exchange for regular interest payments over a specific period of time. At the end of that period, known as its maturity date, the loan is repaid in full. A key differentiator as to whether a bond investment is safe or risky depends on to whom the loan is made.
Treasuries are considered the safest bonds available because they are backed by the “full faith and credit” of the U.S. government. They are quite liquid because certain primary dealers are required to buy Treasuries in large quantities when they are initially sold and then trade them on the secondary market. Treasuries also are more affordable than other types of bonds; you can buy one for as little as $100. Investors can purchase Treasuries through brokerage firms, banks or the Treasury Direct website.
A treasury bond with a maturity of one year or less is called a Treasury bill, or T-bill. A maturity between two and 10 years is a Treasury note, or T-note. The term Treasury bond generally refers to long-term maturities of 10 to 30 years from their issue date.
Other types of government bonds include those issued or guaranteed by U.S. federal government agencies and those issued by government-sponsored enterprises, which are corporations created by Congress for public use. GSEs include the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage (Freddie Mac) and the Federal Agricultural Mortgage Corp. (Farmer Mac). Agency bonds are backed by the U.S. government, but GSE bonds do not enjoy quite the same guarantee and therefore pose greater credit risk.
Next on the bond risk spectrum are municipal bonds (muni bonds), which are issued and guaranteed by individual states, cities, counties and other government entities. These bonds use loan funds to build roads, schools and other public projects. The guarantee for muni bonds is made by the issuer, so while they are relatively secure because they come from government issuers, their level of risk varies depending on the financial stability of the backing agency.
Next on the risk spectrum are corporate bonds, which are issued by all types of companies in order to raise money for capital expenditures, operations and acquisitions. They work just like government bonds and, should the issuer claim bankruptcy before the principal is repaid, bondholders are positioned toward the front of the line for at least a partial repayment. Corporate bonds are generally categorized as either investment grade or non-investment grade, which refers to how risky they are. Investment grade bonds are generally lower risk, but non-investment grade bonds – also referred to as high yield or junk bonds – tend to pay out higher interest to compensate for that risk.
While global diversification can be a good risk mitigation strategy for some investors, international bonds are considered more risky than domestic bonds, and emerging markets bonds are considered the most risky. Because these bonds are issued by foreign governments and companies, the risk varies by issuer and is impacted by political, cultural, environmental and economic factors. Furthermore, foreign bonds expose investors to currency risk, which means the value of payments can fluctuate once funds are converted to U.S. dollars.
FAQs
Treasuries are considered the safest bonds available because they are backed by the “full faith and credit” of the U.S. government.
Which form of bond is safer for bondholders? ›
Government bonds from the U.S. Treasury are some of the most secure worldwide, while those floated by other countries may carry a greater degree of risk. Due to this nearly risk-free nature, market participants and analysts use Treasuries as a benchmark in comparing the risk associated with securities.
Which bond is more secure? ›
Government securities, or gilts, are more secure than corporate bonds and are likely to perform well when interest rates fall.
Which bond would be the safest credit risk? ›
While U.S. Treasurys are considered safe from default, corporate bonds carry varying degrees of risk, particularly high-yield "junk" bonds. Although these bonds might be rated by credit agencies, it's crucial for investors to conduct their own due diligence and not take them at face value.
Which type of bond is the safest quizlet? ›
Bonds issued by the US government are considered to be the safest of all financial assets because they have almost no risk of ever being in default.
Why are bonds the safest? ›
“Bonds, such as Treasurys, corporate bonds and municipal bonds, have contractual cash flows,” Kowalski says. “Compared to stocks, there is a much lower likelihood of losing your initial investment because the issuer of the bond agrees to pay interest and principal back at specific dates.”
What are considered to be the safest types of bonds and why? ›
Governments worldwide sell bonds and securities to print money, fund government spending and services and pay down debt. U.S. government and agency bonds and securities carry the "full faith and credit" guarantee of the U.S. government and are considered one of the safest investments.
Which bond has the lowest risk? ›
Treasury bonds are viewed as essentially free from the risk of default because the government can always print more money to meet its obligations.
Which type of bond is the safest and or have no credit risk? ›
U.S. Treasuries are considered among the safest available investments because of the very low risk of default. Unfortunately, this also means they have among the lowest yields, even if interest income from Treasuries is generally exempt from local and state income taxes.
Can I lose any money by investing in bonds? ›
Bonds are often touted as less risky than stocks—and for the most part, they are—but that does not mean you cannot lose money owning bonds. Bond prices decline when interest rates rise, when the issuer experiences a negative credit event, or as market liquidity dries up.
If bond yields rise, existing bonds lose value. The change in bond values only relates to a bond's price on the open market, meaning if the bond is sold before maturity, the seller will obtain a higher or lower price for the bond compared to its face value, depending on current interest rates.
Should I buy government bonds? ›
Are Treasury bonds a good investment? Generally, yes, but that depends on your investing goals, your risk tolerance and your portfolio's makeup. With investing, in many cases, the higher the risk, the higher the potential return.
What bonds should I buy right now? ›
- Pimco Active Bond Exchange-Traded Fund (BOND) ...
- Vanguard Intermediate-Term Treasury Index Fund ETF (VGIT) ...
- Pimco Enhanced Short Maturity Active ESG ETF (EMNT) ...
- ProShares Investment Grade-Interest Rate Hedged ETF (IGHG) ...
- iShares National Muni Bond ETF (MUB) ...
- iShares 0-5 Year TIPS Bond ETF (STIP)
After bonds are initially issued, their worth will fluctuate like a stock's would. If you're holding the bond to maturity, the fluctuations won't matter—your interest payments and face value won't change.
Why not to invest in bonds? ›
All bonds carry some degree of "credit risk," or the risk that the bond issuer may default on one or more payments before the bond reaches maturity. In the event of a default, you may lose some or all of the income you were entitled to, and even some or all of principal amount invested.
What type of bond has the least risk? ›
Treasury bonds are viewed as essentially free from the risk of default because the government can always print more money to meet its obligations.
What type of bonds have the least risk? ›
GOVERNMENT BONDS
Intermediate-term bonds mature in three to 10 years, whereas long-term bonds generally mature in 10 to 30 years. Risk Considerations: Among the lowest risk of all bond investments, these bonds have low credit risk because they are backed by the full faith and credit of the U.S. government.
What type of bond has the lowest risk? ›
Series I savings bonds
A Series I savings bond is a low-risk bond that adjusts for inflation, helping protect your investment. When inflation rises, the bond's interest rate is adjusted upward. But when inflation falls, the bond's payment falls as well.
What is the most risk-free bond? ›
U.S. Treasury bonds (T-bonds) are often touted as risk-free investments. And it's true. You would have to envision the utter collapse of the government and society to find a scenario that would involve losing any of the principal invested in a T-bond.
