Traditionally, fixed income securities can be a less volatile component of a portfolio. Bonds and CDs offer a number of other benefits besides a potentially lower risk profile, such as diversification and income generation. With the right mix of bonds and CDs, your overall group of investments can do more than just preserve your capital.
Explore the information and resources below to increase your understanding of how to invest in bonds and CDs. If you have questions along the way, contact a fixed income specialist for help.
In the investing world, bonds and CDs fit into the general category of fixed income. Fixed income investments are those that generate a specific rate of return on a regular basis until the maturity date. What exactly are bonds and CDs?
Bonds: These are loans to corporations, governments or municipalities that are used as investment vehicles. They generally pay a fixed interest rate and return the principal at maturity. Bonds may be subject to liquidity (or market) risk, interest rate risk (bonds ordinarily decline in price when interest rates rise and rise in price when interest rates fall), financial (or credit) risk, inflation (or purchasing power) risk and special tax liabilities.
CDs: Certificates of Deposit (CDs) are a deposit product issued by a bank that’s both fixed in term and rate. Since these are not as flexible as, say a regular savings account, interest rates do tend to be higher. To help protect against risk, CDs are federally insured by the FDIC. The types of CDs available through TD Ameritrade are called brokered CDs. They are similar to CDs purchased directly from a bank, except they can be traded on the open market. Brokered CDs that you choose to sell prior to maturity in a secondary market may result in loss of principal due to fluctuation of interest rates, lack of liquidity, or transaction costs.
Here is a further breakdown of some of the main types of bonds.
Treasury bonds are issued by the U.S. government and are generally considered very safe. They have tax advantages but, because their risk is considered low, the bonds usually earn lower interest than other kinds of fixed-income securities.
Corporate bonds are issued by companies, with the risk varying by credit rating. These bonds usually earn higher interest than CDs or government-backed bonds with the same maturity, but can experience greater price volatility.
Municipal bonds or “munis” are issued by states, their agencies and subdivisions, such as counties and municipalities. There are two main categories of municipal bonds: general obligation backed by taxing power, and revenue bonds, backed by revenues from a project.
Agency bonds are issued by federally-sponsored agencies, though these investments are not guaranteed by the U.S. government. The risk of investing in these bonds varies based on the credit rating of the agency that issued them.
Zero coupon bonds are issued by the federal government or by a municipal government. Unlike other government bonds, investors receive a single payment when the bond matures, but no periodic interest payments prior to that.
Some things to consider before investing in bonds and CDs:
Preservation of capital: Most bonds and CDs are issued with a set interest payment (the coupon) and a maturity date on which the original face value will be repaid. They're designed to let you invest knowing that, although the bonds fluctuate in price from the time they are issued, you will receive the full face amount of the bond when it matures.
Income: They can help provide a steady stream of income. This can be helpful for budgeting and may be indispensable for investors who are retired or otherwise require a steady income stream.
Diversification: They can help provide stability in a portfolio. A portfolio that contains both stocks and bonds tends to be less volatile than one that contains only one of these asset classes. View a Diversifying Your Portfolio with Bonds video for more information.
It’s important to do a little homework to determine the best fixed income investment for you. Looking at credit ratings should be part of your research. All of the different types of bonds carry their own risk, with Treasury bonds being the least risky. This is why credit ratings are so critical, since it’s an indicator of the debtor’s ability to pay the interest on the bond. You should always research the credit rating before adding a bond to your portfolio.
In the United States, major rating agencies include Moody’s Investors Service, Standard & Poor’s Corporation, and Fitch Ratings. TD Ameritrade also gives you direct access to third-party bond commentary and credit rating analysis, such as Moody’s Research Report, which is now available for Corporate Bonds.
Becoming a client gives you access to TD Ameritrade bond research tools and calculators, like Bond Calculator, Bond Wizard, and Taxable Equivalent Yield Calculator, as well. These tools not only help you better understand how bonds work, but show you how fixed income can be used to help you pursue your goals. You can also sign up to receive bond ratings alerts and new issue alerts.