When it comes to investing money for retirement two of the most common investments are stocks and bonds. Today I want to focus on the latter.
When it comes to investing in debt investing there are a few main types which I will briefly mention:
1. Corporate Bonds
These are a form of debt security that is issued by a corporation. Because they aren’t backed by the government, there is a higher risk and therefore higher yield associated with this kind of loan. There are many forms of this kind of bond.
2. Government Bonds
These can refer to Treasury Bills (T-Bills) which are debt securities lasting less than a year, Treasury Notes (T-Notes) which are debt securities lasting between 1 and 10 years or Treasury Bonds which are debt securities lasting more than 10 years. In addition there are also something called Treasury Inflation Protected Securities (TIPS) which involve lending money to the government in return for small payments and ultimately principal that is indexed to inflation.
Under this category I will also place Government agency bonds. These are bonds that are issued by Government Sponsored Enterprises (GSE’s) and/or Federal Government Agencies.
Bonds issued by GSE’s usually have the following characteristics: 1) A small return that is slightly higher than treasuries because 2) they have credit/default risk. Examples of Government Sponsored Enterprises: Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal Home Loan Mortgage Corporation (Fannie Mae).
The second kind of agency bonds, which are issued by Federal Agencies have the following characteristics: 1) less liquidity and therefore 2) slightly higher yields than treasuries but 3) are backed by the full faith and credit of the United States. Examples of government agencies: Small Business Administration, Federal Housing Administration and Government National Mortgage Association.
3. Municipal Bonds
Municipal bonds are debt securities issued by states, cities, counties and smaller government entities. There are two types, General Obligation Bonds (Bonds issued by small local governments that are backed by their full faith and credit), and Revenue Bonds (Bonds backed by specific revenue sources like tolls). These will always have yields higher than government bonds because of the slightly higher risk.
4. Bank Debt Assets (mortgage-backed, asset-backed and collateralized debt obligations)
This is a type of asset-backed security that is secured by a mortgage or collection of mortgages. It can get complicated to explain but for now you just need to know that banks and financial institutions usually own these.
5. Peer-to-Peer Lending
This is by far the most recent debt invention. Peer-to-Peer lending refers to a means by which individuals give and borrow money to each other usually over the internet to produced higher returns than can be given by other bonds or get a loan they otherwise couldn’t get.
So should you invest in lending investments, and if show which ones? The answer really depends on your goals, risk profile, capacity for risk and the options available to you. Talk to your finical advisor about this or refer to one of my upcoming posts on the subject of asset allocation.