There are many investment options available, but choosing exactly what to invest in can feel overwhelming. Whether you’re a new mother or are on the verge of retirement, it’s important to know your unique needs and situation.
Since everyone’s goals and risk tolerances are different, it’s impossible to give blanket advice when it comes to investing. This is why it’s important to understand all of the investment options that are available to you so that you can make the most informed decision possible.
Bonds have been long considered a staple in a well-balanced portfolio. Government bonds were first issued in 1694 by the Bank of England. The English government needed to raise money to fund the war against France, so they issued bonds in the form of lottery and annuity.
Essentially, people purchased a bond from the English government so it could fund the war, then at a later date when the bond matured, investors recouped their money, which had accrued additional interest from the English government.
In other words, bonds are debt securities issued by organizations and governments for an initial investment. This initial investment is called the “principal.” When the bond reaches its maturity date, the investors recoup their principal. Since investors essentially “loaned” money to the bond issuer, they receive a fixed interest payment attached to the bond. Similar to how you pay interest on a loan, the issuer of the bond pays interest to you.
Still, the question remains: are savings bonds a good investment option?
Before we can fully answer that question, it’s important to understand the different types of bonds and their unique characteristics.
What Are the Different Types of Bonds and Which Ones Are the Safest?
Just as there are different types of stocks in the stock market, there are different types of bonds available to investors. The major types of bonds include:
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U.S. Treasury Bonds.
As the name suggests, these bonds are issued by the U.S. Treasury to help fund the operations of the federal government. Generally speaking, these bonds are considered the safest because they are backed and guaranteed by the United States government.
However, that guarantee of safety comes at a cost. These bonds offer the lowest interest rate, making them “safe,” but not as advantageous as other types of bonds and investments.
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Savings Bonds.
Savings bonds are like the U.S. Treasury Bonds in that they are issued by the Treasury Department. The difference, though, is that savings bonds are issued in low enough amounts that they are accessible to everyday investors and regular individuals. Compare that to U.S. Treasury Bonds, which are owned primarily by institutional investors, corporations, and sovereign wealth funds. Savings bonds are the best option for individual investors.
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Agency Bonds.
Unlike savings bonds and U.S. Treasury bonds, agency bonds are not issued by the U.S. government. Rather, agency bonds are issued by quasi-governmental agencies or QGOs (quasi-governmental organizations). These are organizations that aren’t exactly public institutions, but they aren’t entirely private organizations either. They have characteristics of both. A good example of this would be QGOs like Fannie Mae and Freddie Mac. While these bonds are not issued by the Treasury, they still have the benefit of being guaranteed by the federal government.
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Municipal Bonds.
If you want to invest in your local community, municipal bonds are a good option because they are issued by various cities. It’s generally rare for a city to default, but it does happen. This makes municipal bonds inherently riskier than a bond issued and guaranteed by the federal government.
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Corporate bonds.
Companies of different sizes and industries can issue bonds to raise capital. Because companies can rise or fall based on the market, corporate bonds are inherently the most risky, but that risk comes with higher rates of return. Corporate bonds are also called Non-Convertible Debentures (NCDs).
There are many other types of bonds including mortgage bonds, high-yield bonds, muni bonds, and other bonds, but the ones listed above are considered the most common.
The bottom line: Savings bonds are the most accessible to everyday investors.
The minimum required to get into a savings bond is just $25. You can buy any increment up to $10,000 annually, so savings bonds are an investment option that can work with a wide range of budgets!
What Are the Pros and Cons to Investing in Bonds?
Bonds, especially those that are guaranteed by the federal government, are considered relatively safe investments. You are guaranteed a fixed amount of income (the interest rate) as long as you hold the bond until maturity.
In addition to being safe investments in-and-of-themselves, bonds also help bring diversification and safety to your portfolio. While stocks are riskier, stocks have historically outperformed bonds, but having a mix of both in your portfolio reduces your financial risk and helps protect you in the long run.
While bonds are generally safe investments, they are not without their downsides. Generally speaking, the benefits of bonds are also their disadvantages.
For example, a prime benefit is safety, but that safety comes at the cost of smaller returns. Another benefit is predictable income, but interest rates are always changing, so if you lock in a rate today, you may miss out on increased interest rates in the future.
Are Bonds a Good Investment? Are Savings Bonds Right for Me?
At the end of the day, the only person who can best answer this question is you.
Savings bonds are safe investments, but they come at the cost of smaller returns.
One of the adages in the investing industry is from Warren Buffet, who now has a net worth of at least $113.8 billion USD.
He recommends investing 90% of one’s portfolio in index funds (a type of mutual fund that tracks the performance of the stock market) and putting the remaining 10% in bonds. To be clear, this isn’t advice that Buffett gave to the general public. Rather, these are the instructions he gave to the trustee of his wife’s inheritance. Still, given his enormous wealth and fortune, when Warren Buffett says something, people listen.
Buffett’s advice is a little different from conventional investing wisdom, which recommends that stock vs. bond allocation be based on 100 minus your age. For example, if you’re 30 years old, 70 percent should be in the stock market and 30 percent should be in bonds. If you’re 40 years old, 60 percent would be in the market compared to 40 percent in bonds. In other words, the older you get and closer you are to retirement, the more bonds (safety) you should have.
With all of that being said, the question of whether or not bonds are a good investment isn’t a matter of merit, but circumstance. Bonds are excellent investments, but you need to factor in your risk tolerance, age, and overall portfolio allocations.
In most cases, risk tolerance is tied to age. The younger you are, the more you can afford to be riskier with your investments, as you have time to ride out market ups-and-downs. On the other hand, the closer you are to retirement, the more you’ll want to protect your money while keeping up with inflation. This is where savings bonds are a truly excellent option.
An Alternative to Savings Bonds
Since savings bonds are a long-term investment (Series I bonds take 30 years to mature), many people look for alternatives, especially if they may potentially need the cash in the near future.
If you know you want the safety of bonds but can’t currently wait until the bond matures, you may want to consider a high-yield savings account.
Currently, the average savings account interest rate is a paltry 0.06% APY, but there are banks such as CIT Bank that help you accelerate your savings with a 0.40% APY. If you want some of the benefits of savings bonds without the wait for maturity, CIT Bank’s Savings Builder is an excellent alternative to consider.
