The benefits and drawbacks of municipal, corporate and
government bonds with American Medical News
"The drawback is that in exchange for that safety, you get a pretty
low interest rate," said Bruce Fenton, president of the Westboro,
Mass.-based investment firm Atlantic Financial Inc.
Interest rates on bonds vary depending on the duration or life of
the bond. A two-year government bond rate could be 2.65%, and a
10-year could be 4.50%, said Ronald Sanchez, senior vice president
and head of municipal fixed income for Fiduciary Trust Co.
International of New York. In general, he said, the yields are lower
on shorter bonds than longer ones.
Fenton said government bonds are a good investment for people who
can't stand the thought of any principal risk.
"But there is also the risk of having your investment not keep up
with inflation and taxes," he said. "Sometimes people who think
they're being very prudent in locking everything in a government
bond are not losing out on principal but they are losing out in
another way."
At the other end of the spectrum are corporate bonds, some of which
carry much greater default risk in addition to the threat of how
changing interest rates can affect the investment. But with the
risks, these bonds tend to offer a higher rate of return than more
conservative bonds.
"It's more like investing in a stock. Investors really have got to
look at the stability of the company," Fenton said.
Most bonds won't leave investors shaken or stirred
Personal Finance. By Katherine Vogt, AMNews staff. Aug. 9, 2004.
property of Amed news
In bonds, many investors trust. But for some, that might be blind
faith. Trying to understand the bond market can feel like reading a
book with only half of the necessary words. It can leave investors
with questions having no simple answers.
But experts say even novice investors might be able to benefit from
bonds with a little basic information about what they are and how
they work. Knowing the tax consequences and risks of the bond types
typically bought by individuals -- government bonds, agency bonds,
municipal bonds and corporate bonds -- can help people choose which
investment, if any, is right for them.
The bond market is big business. According to the Bond Market Assn.,
a New York-based trade association, outstanding public and private
debt -- underwritten by bonds -- was valued at more than $22.5
trillion in the first quarter of 2004, up from $16.9 trillion in
2000.
Michael Decker, senior vice president of the association, said
interest in bonds began to surge after the stock market plummeted
because investors were seeking diversity and greater stability in
their portfolios.
"What we're hearing is that the stock market crash of a few years
ago really was a hard lesson for a lot of people, and I think a lot
of them don't want to have a repeat performance," he said.
Walt Woerheide, PhD, a professor of investments and director of the
Irwin Graduate School at the American College in Bryn Mawr, Pa.,
said physicians might be better suited to bond investments later in
their careers because, unlike stocks, bonds tend to be more of a
wealth preservation vehicle than a growth vehicle.
Yields are generally lower on short-term bonds than on longer term
ones. "When they're in the early to peak years of their careers,
it's not clear that they should have a heavy percentage in bonds,
because they have a high current income, which can offset losses in
stock, and they still have a reasonable amount of time to make up
for losses," he said.
But some bonds grow faster than others, and each type is suited to a
different investment strategy. Bonds -- which are essentially IOUs
-- allow an investor to make a loan to the bond issuer and make
money off the interest.
In general terms, Decker said, a healthier overall economy means
higher market interest rates and bond yields. "So we're in a
situation now where interest rates are rising," he said. "And it's
our projection that in the next year or so we're going to see higher
bond yields."
Government bonds are often said to be among the safest investments
available because they are backed by the U.S. government, and
therefore are said to be free from risk of default.
"The drawback is that in exchange for that safety, you get a pretty
low interest rate," said Bruce Fenton, president of the Westboro,
Mass.-based investment firm Atlantic Financial Inc.
Interest rates on bonds vary depending on the duration or life of
the bond. A two-year government bond rate could be 2.65%, and a
10-year could be 4.50%, said Ronald Sanchez, senior vice president
and head of municipal fixed income for Fiduciary Trust Co.
International of New York. In general, he said, the yields are lower
on shorter bonds than longer ones.
Fenton said government bonds are a good investment for people who
can't stand the thought of any principal risk.
"But there is also the risk of having your investment not keep up
with inflation and taxes," he said. "Sometimes people who think
they're being very prudent in locking everything in a government
bond are not losing out on principal but they are losing out in
another way."
At the other end of the spectrum are corporate bonds, some of which
carry much greater default risk in addition to the threat of how
changing interest rates can affect the investment. But with the
risks, these bonds tend to offer a higher rate of return than more
conservative bonds.
"It's more like investing in a stock. Investors really have got to
look at the stability of the company," Fenton said.
Like the others, municipal bonds and agency bonds both carry risks
from inflation and price fluctuation.
Although bond prices are much less volatile than stock prices,
Decker said, they do vary. That can create risk for people who buy
and sell bonds before they reach maturity.
Municipal bonds, which are issued by state, local and related
entities, have yields that are typically lower than those on
treasury bonds, Sanchez said. But after tax adjustments they can
offer higher yields, he added.
Municipal bonds can be alluring to people seeking tax-advantaged
investments. "In general, the interest is almost always exempt from
federal income tax, so they tend to appeal to high tax bracket
investors," Decker said, adding that these bonds also could be
exempt from state or local tax.
Dr. Woerheide said investors who generate substantial income from
municipal bonds could be subject to paying the alternative minimum
tax because the interest from those bonds is one of the indicators
used to calculate who pays the tax.
"If you start investing heavily in municipals, you or your financial
planner need to keep a sharp eye to make sure you don't hit the AMT,
because as soon as you do you lose all of the tax-free advantage of
municipal bonds," he said.
Also, he said that municipal bonds sometimes can be harder to sell
than corporate or treasury bonds. The same could be true for agency
bonds, which are issued by private entities with government ties
such as Fannie Mae.
Investors in all of these bond types can expect to pay commissions
on trades. Dr. Woerheide said the commissions tend to be a fixed
dollar amount, which can have a greater impact on smaller trades.
Bonds sold in the form of mutual funds also might have management
fees, though they can have the advantage of having a professional
team of people making investment decisions and finding deals. "The
flip side is that you pay for that service," Decker said.
Vogt is a reporter for the Business section. You can send her tips
or suggestions by katie_vogt@ama-assn.org e-mail or call her at
312-464-4426.