Overview of Bond Categories

There are a variety of types of bonds, ranging from government issue to the more speculative and even foreign company and government bonds. They have different risk and investment characteristics, can create different tax situations, and may be used in a variety of ways to hedge stock exposure in a portfolio or to create an income stream for an investor. That's why it's so important to understand the critical role that bonds can play in helping you create wealth.

There are five basic types of bonds for investors to choose among: U.S. government securities, mortgage-backed securities, municipal bonds, corporate bonds, and junk bonds (a.k.a. high-yield bonds). Each type has its own benefits and drawbacks, and some will fit into your portfolio better than others.

Investors use bonds for two main purposes: to receive the steady income of periodic interest payments or to protect and build up their capital stores. Bonds are predictable: you know when you're going to get your principal back, and you know when to expect your next interest check. For investors looking for reliable current income, the best choice may be bonds that have fixed interest rates until maturity and that pay interest semiannually.

On the other hand, investors saving for the future may fare better investing in zero-coupon bonds. You won't get regular interest payments with these bonds. Instead, you buy these bonds for a deep discount, a price that's much lower than their par value. Upon maturity, you'll receive one lump payment, representing the purchase price plus earned interest, compounded semiannually at the original interest rate; basically, it's the face value and the years of accumulated interest all rolled into one big payment.

The types of bonds you select to help you balance your portfolio should be based on your long-term investment goals. As you read on, you'll be better able to figure out which are the right bonds for your needs.

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