What the Heck are Bonds Anyway?

Types of Bonds

Corporate bonds are taxable and are traded on most major exchanges. They are not risk-free, but a high-grade corporate bond is safer than most stocks, though generally with less upside potential.

U.S. Treasury securities are the closest thing to a "zero-risk" investment as there is! These bonds are backed by the "full faith and credit" of the United States government. This means that the government will always pay you–no matter what. They promise not to default on your investment. The income from U.S. Treasury securities is, generally, exempt from state and local taxes, but you'll still have to pay federal taxes on your income.

You can buy Treasury securities from a broker, through your bank, or directly from the Federal Reserve, at no commission, which is what we recommend. The maturities on Treasuries range from three months to 30 years. The longer the maturity, the higher the risk you take that inflation or changing interest rates will reduce the value of your investment. Long-term Treasuries usually offer higher interest rates, to reward you for taking more risk. Basically, there are three types of Treasuries:

1. Treasury Bonds: You can buy U.S. Treasury bonds for as little as $1,000. Treasury bonds have maturity dates–meaning the date on which the principal amount becomes payable– of 10 to 30 years from the date of purchase. The interest you earn is paid semi-annually.

2. Treasury Notes: Treasury notes have maturities of 2 to 10 years and are issued in $1,000 denominations. Like T-bonds, T-notes pay interest semi-annually until maturity when you receive your principal back.

Dolan Smart Money Move: The newest twist to T-notes is Treasury Inflation Protected Securities (TIPS), which are designed to keep pace with inflation. We're fans of TIPS. You get a government guarantee that the real purchasing power of the principal will keep pace with the rate of inflation. TIPS also pay interest semi-annually until maturity. They are available in a variety of maturities, with a minimum denomination of $1,000.

3. Treasury Bills: T-bills have maturities of three months and six months. You'll need a minimum of $1,000 to invest in a T-bill. Unlike other Treasuries, T-bills don't pay you any current income. You buy T-bills at a discount to their face value and then you receive the full $1,000 when the bill matures. T-bills are like short-term CDs, guaranteed by the U.S. Treasury instead of the FDIC.