Bond investing

Investing in bonds

Investing in bonds can serve several important purposes in a well-diversified investment portfolio. Bonds often have a low or even negative correlation with stocks. This means that when the stock market is down, bond prices usually may hold steady or even increase, and vice versa. Including bonds in a portfolio can help reduce overall volatility and provide a cushion during market downturns.

Different Types of Bonds:

• Treasury Bonds: Issued by the U.S. federal government, considered the safest in terms of credit risk.

• Agency Bonds: Issued by federal agencies or government-sponsored enterprises (GSEs). 

• Municipal Bonds (Munis): Issued by state and local governments. Interest income is often exempt from federal and sometimes state and local taxes, making them attractive for high-tax brackets.  

• Corporate Bonds: Issued by corporations. They offer potentially higher yields than government bonds but come with higher credit risk. Understand the creditworthiness of the issuing company.  

• High-Yield (Junk) Bonds: Corporate bonds with lower credit ratings. They offer the potential for higher returns but carry significantly higher default risk.  

• International Bonds: Issued by foreign governments or corporations. These can offer diversification but come with currency risk and geopolitical risks.  

US Treasury securities 

Investing in Treasury securities, which are debt instruments issued by the U.S. government, is consider the lowest risk way to invest. These investment are backed by the full faith of the federal government. Interest rates are usually equal or  slightly higher that money marker funds. Also, these securities are exempt from state and local taxes.

The U.S. Treasury offers several types of marketable securities, each with different maturity periods and interest payment structures:  

• Treasury Bills (T-bills): Short-term securities maturing in a few days to 52 weeks. They are sold at a discount, and you receive the face value at maturity. No periodic interest payments are made.   

• Treasury Notes (T-notes): Intermediate-term securities with maturities of 2, 3, 5, 7, or 10 years. They pay interest every six months.

• Treasury Bonds (T-bonds): Long-term securities with maturities of 20 or 30 years. They pay interest every six months.

• Treasury Inflation-Protected Securities (TIPS): The principal is adjusted based on changes in the Consumer Price Index (CPI). They pay interest every six months, and the interest payment also changes with the principal. TIPS are issued with maturities of 5, 10, and 30 years.

How to purchase treasury securities

There are several options for buying Treasury securities:

• TreasuryDirect: This is a website run by the U.S. Department of the Treasury that allows you to buy and manage Treasury securities directly from the government.

• Banks, Brokers, or Dealers: You can purchase Treasury securities through most financial institutions. 

• Treasury ETFs and Mutual Funds: These funds invest in a basket of Treasury securities, offering diversification and liquidity. You can buy shares of these funds through your brokerage account.  

• Secondary Market:  For more advance investors,  previously issued treasury securities can also be brought and sold through the secondary market via a brokerage account (i.e. Fidelity, Schwab, Vanguard etc.)

If you already have a brokerage account, you can easily buy treasury securities.  You can usually find Treasury securities under the "Fixed Income," "Bonds," or similar sections in your broker's platform. New issues usually have no fee.

US Agency bonds 

Agency bonds are debt securities issued by either a federal government agency or a government-sponsored enterprise (GSE). These bonds are generally considered low-risk investments, often offering slightly higher yields than U.S. Treasury bonds. Some are exempt from state and local taxes. They also have call features which will effect interest risk over time.

Below is a summary of the different types of agency bonds and their tax implications.

Types of US Agency Bonds

There are two main categories of US agency bonds:

1. Federal Government Agency Bonds: These bonds are issued by agencies that are part of the federal government. They are backed by the full faith and credit of the U.S. government, making them very safe investments, similar in risk to Treasury bonds. Examples include:

   • • Government National Mortgage Association (GNMA or Ginnie Mae): Ginnie Mae bonds are mortgage-backed securities that are federally insured, primarily consisting of FHA-insured or VA-guaranteed mortgages.

     • Federal Housing Administration (FHA): The FHA issues bonds to support its housing programs.

     • Small Business Administration (SBA): The SBA issues bonds to fund its loan programs for small businesses.

2. Government-Sponsored Enterprise (GSE) Bonds: GSEs are privately owned, publicly chartered corporations created by Congress to enhance credit availability for specific sectors of the economy, such as housing and agriculture. While they are not direct government entities and their bonds are not backed by the full faith and credit of the U.S. government, they are still considered relatively safe due to their government mandate and oversight. Examples include:

   • • Federal National Mortgage Association (FNMA or Fannie Mae): Fannie Mae purchases and guarantees mortgages on the secondary market.

     • Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac): Freddie Mac also purchases and guarantees mortgages on the secondary market.

     • Federal Home Loan Bank (FHLB) System: The FHLB system provides funding to member banks and other financial institutions. Exempt from state and local taxes. 

     • Federal Farm Credit Banks Funding Corporation (FFCB): The FFCB funds agricultural lenders. Exempt from state and local taxes. 

     • Federal Agricultural Mortgage Corporation (Farmer Mac): Farmer Mac provides a secondary market for agricultural real estate and rural infrastructure loans.

     • Tennessee Valley Authority (TVA): The TVA is a federally owned corporation that provides electricity for business customers and local power distributors in the Tennessee Valley.  

Tax Exemptions for US Agency Bonds

The tax treatment of interest income from US agency bonds varies depending on the issuing agency. Table below showing the tax exemptions and rating agencies (Moody's, S&P, Fitch)

How to purchase agency bonds

• Banks, Brokers, or Dealers: You can purchase Treasury securities through most financial institutions. 

• Treasury ETFs and Mutual Funds: These funds invest in a basket of Treasury securities, offering diversification and liquidity. You can buy shares of these funds through your brokerage account.  

• Secondary Market:  For more advance investors,  previously issued treasury securities can also be brought and sold through the secondary market via a brokerage account (i.e. Fidelity, Schwab, Vanguard etc.)

If you already have a brokerage account, you can buy treasury agencies.  They are usually listed under "Fixed Income," "Bonds," or similar sections in your broker's platform. New issues usually have no fee.  Note: not all brokerage accounts offer new agency bonds.