Bonds may be an attractive option for individuals who have a low tolerance for investment risk. However, there are several types of bonds in the bond market, each with a different rate of return. Bond investors should understand the difference between the total return on corporate bonds and the total return on treasury bonds before investing in the bond market.
A bond is a debt security that pays interest to an investor during the life of the bond. The investor lends money to the bond issuer for the life of the bond. The most common type is a fixed-rate bond, where the issuer of the bond makes regular interest payments to the investor in a specified amount until the bond matures. When the maturity date of the bond arrives, the issuer of the bond repays the investor's principal investment.
Treasury bonds are a long-term investment. Individuals can invest as little as $100 in treasury bonds and add to their investment in $100 increments. Investors often invest in these bonds to build retirement and education accounts. Treasury bonds mature over a period of 30 years and pay a fixed interest rate every six months. Interest income on bonds is subject to federal taxation but exempt from state and local taxes.
Private and public corporations issue corporate bonds to raise money for various purposes. Corporate bonds, unlike stocks, do not give investors equity ownership in the corporation. Rather, a corporate bond is like an IOU from the corporation to the investor. The investor lends the corporation the principal, usually in increments of $1,000 or $5,000. The corporation makes regular interest payments to the investor and repays the principal on the maturity date. If the corporation goes bankrupt before the bond matures, it defaults on its payments. Interest on corporate bonds is taxed by federal and state taxing authorities.
The total return on a bond is the total amount of value the investor earned. Analysts calculate the total rate of return by dividing the investor's earnings by the initial investment value. The total return for corporate bonds compared to treasury bonds will vary from investor to investor based on the terms of each individual investment. However, their rates of return are similar. For example, for the period August 1988 through October 2010, the Barclays Capital Corporate Bond Index provided an annualized total return rate of 7.9 percent, while treasury bonds provided an annualized total return rate of 7.6 percent.
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