The focus with bonds is not to achieve compound growth like stock, but to achieve a fixed interest return. That is why the principal – the money you initially invested, gets returned to you after maturation. Before we begin, there is such a thing as a non-taxable bond. It is a municipal bond. Any return (income) from municipal bonds is generally not subject to federal taxes and can be tax-exempt at the state and local level. But it should be clarified that that can only be the case if the bonds were issued by the state in which you live. Keep this in mind as this blog addresses bonds. Here are a few things to keep in mind about bonds:
The 20-year Treasury Bond return rate is between 1-2%
1-2% does not even beat inflation! The stated percent returns reflect a return of pre-tax dollars! And even with a higher yield, you are still not enjoying compound growth.
Gains on Bonds are taxed as Ordinary Income & Capital Gains. You are taxed on bonds as income or as capital gains. The money is typically distributed to you twice a year and is taxed as income.
Bond Funds can be taxed as local, state, or federal municipalities. There are individual bonds and bond funds. Bond funds can be taxed at local, state, or federal levels. Make sure you have a grasp on what you are paying into before entering an agreement so that you are aware of how your return will be taxed and how much of it you will get to keep.
You only get the “guarantee” of doubling on your money if you wait 20 years
If your bond returns 5% on average each year, then, yes, your money will double. But that 5% is not a return that factors taxes. And with a 20-year return percent of 1-2% on Treasury Bonds as has been seen over the last 20 years, that does not look very promising.
There are different ratings for Bonds
Standard and Poor’s, Fitch, Moody’s – all offer scores that give insight into the credibility of the company that you want to do business with. It is based on interest and credit score. The higher a bonds’ rating, the less interest it offers.
Why? Because bonds are high-risk investments for the company that issues them, while there is no risk involved for their investors. To give an insight into what I’m saying: a stock is low risk for the company that issues it, but it is a high-risk for investors(you). Therefore, Bonds are market contingent. Bonds affect the stock market by competing with stocks for investors’ dollars. Bonds have less risk than stocks, but they offer a lower return. So, when stocks go up in value, bonds go down. When the economy is booming, and consumers are making more purchases, stocks rule. When the market goes down, investors want a guarantee and go to bonds. And though bonds may offer less risk and be backed by the U.S. government and can’t lose value, they do not offer exponential wealth accumulation for retirement.
Series I Bonds
Series I Bonds can have great gains attached to them. However, the interest rate is only guaranteed for a matter of months. Also, they are contingent on the market (inflation). When inflation gets lower, so will your bond return. If you can achieve a high gain consistently with I bonds, it should be noted that you cannot redeem them until they have been sitting for 1 year. After that, there is a penalty if you want to access them within five years of holding them. And, again, as stated above, they are taxable.
