When should you invest in bonds?

When you do not want to expose your money to risky investments like stocks and commodities and also when you need regular income in the form of interest.

Bonds are about safety and interest. Bonds are a place to keep your money safe and to get that extra income through interest. Just like stocks, bonds can be bought individually or through mutual funds.

 Who sells bonds?

Bond issuers or people who sell bonds fall into three categories

1. Federal Bonds: If you lend to the government of your country you get Treasury bonds. For safety you can not beat the federal bonds since they are the ones who print the money and can print as much they want. They always pay their debts no matter what (at least theoretically)

2. Local government bonds: If you lend a state or local government you get municipal bonds.Local government bonds fall between federal and corporate bonds in matter of safety

3. Private companies: If you lend to a company you are investing in a corporate bond.

Corporate bonds depend on the financial well being of the company issuing them. These bonds are rated by rating agencies such as Standard & Poor’s or Moody’s. They check the company’s financial details and rate the bonds. AAA is the best then AA, A, BBB, BB and so on to C. Any bond that gets the rating of AAA, AA, A, BBB is called investment grade bond.

Why would anyone buy the less safe bonds?

Simple; higher the safety rating lesser the return. So generally speaking you will get less interest on treasury bonds than local government bonds which further pay less interest than corporate bonds. Similarly AAA corporate bonds will pay less interest than say BB bonds.

What about taxation on the interest earned on bonds?

Some simple rules of taxation on bonds are as below:

* Corporate bonds are taxed by both state and federal government.

* Federal bonds are free from state tax.