When you invest in bonds you can choose among four major subclasses:
corporate bonds, U.S. Treasury bonds, agency bonds, and municipal bonds.
All these bonds promise to repay your principal with interest, which is why bonds are often described as fixed-income investments.
But buying bonds from different categories of issuer lets you balance the potential inflation and investment risks that each type poses with the advantages it can bring to your portfolio.
For example, corporate bonds tend to pay higher rates of interest, providing a higher yield,
than most of the bonds issued by governments and agencies, so they provide more income. But some corporate bonds may put your principal at risk. And the interest that corporate bonds pay is always taxable at your regular income tax rate.
In contrast, you never owe federal income tax on municipal bond interest, and you don't owe state or local tax either if you live in the state or city that issued the bond. But most municipal bonds pay interest at a lower rate than corporate bonds with similar levels of risk.
If you're looking for the highest level of security, you might decide to add U.S. Treasury bills, notes, or bonds to your portfolio. While government bonds typically pay less interest than corporate or agency bonds, you can be sure you'll always receive your interest payments and get your principal back on schedule. And as a middle ground between Treasurys and corporate bonds, you might add agency bonds to your portfolio.
Agency bonds are sold by various government-sponsored agencies, pay slightly higher interest than Treasurys but enjoy almost the same level of security. Agency bond interest is taxable. And sometimes rather than receiving your principal back in a lump
sum, a portion of your principal is returned with each payment. That amount is not taxable.
Don Kittell
