If you are interested in investing but are
wary of stocks or are simply looking to diversify
the asset classes in
your portfolio, debt securities may be worth
considering.
To use a simplified example, a debt security
is
essentially an I.O.U.
As an investor, you lend money to an issuer
for these securities and the issuer, in turn,
agrees to repay the debt at a later date,
often along with any accrued interest.
There are several types of debt
securities to be aware of.
Let’s explore them, beginning with the U.S
Government securities.
These securities are backed by the full faith
and credit of the United States Government.
Savings bonds and U.S.
treasury issues, such as treasury bills, notes,
bonds and treasury inflation-protected securities
or TIPS, are
included in this category.
Government agency issues are debt securities
issued by U.S government agencies and
corporations.
Some better known agencies include the Federal
National Mortgage Association, also known
as FANNIE
MAE; the Federal Home Loan Mortgage Corporation,
or FREDDIE MAC; the Federal Agricultural Mortgage
Corporation, or
FARMER MAC; and the Government National Mortgage
Association or GINNIE MAE, which is the only
agency fully backed
by the U.S government.
Municipal bonds are securities issued by cities,
states, and school districts, and other such
entities to fund
public projects.
Some of these bonds may be tax advantaged,
such as being free from federal income tax.
There are
two types of municipal issues.
General obligation bonds, often issued for
public utilities, are backed by the taxing
authority of the issuer.
Revenue bonds are typically backed by fees
associated with the use of the funded project,
like a public airport.
Finally, corporate bonds are issued by corporations
to build capital and are backed by the credit
of the issuer.
As a result, a corporation’s ability to
repay their investors is strongly tied to
its success.
As with all securities, it’s important to
understand the risks of bond investing such
as ‘call risk’- or the chance
your bond will be bought back by the issuer
prior to the maturity date - and ‘default
risk’ - or the potential that
the issuer goes bankrupt and you lose your
investment.
Evaluating your current and future liquidity
needs,
investment horizon, and risk tolerance will
help you determine which investments are right
for you.
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