What are bonds? Find out here

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That’s true but we’re talking about a different kind of bond.  What are bonds?

 

If you have a 401K or some other retirement vehicle or if you watch the news or read articles about finance, you have most likely heard of bonds.  For this article, we are going to look at Treasury Bills although the federal government issues a variety of investment choices.  What are bonds?

 

To understand how these Treasury Bills work, you’re going to have to think back to when you were a child.  Your parents took you to the toy store and the lights of the store were shining down on the most perfect Tonka bulldozer you had ever seen.  From there your mind shifted to how you would get your hands on something clearly made by the hands of Heaven.

 

Given your lack of gainful employment at the age of 8 you had only one option:  Ask your parents for a loan.  You thought it through and decided you would get this loan by cleaning the house, mowing the lawn, washing the car, and any other odd job asked of you.  You even got a piece of paper and wrote all of this down.  You wrote an IOU.

 

Recounting a story similar to this from your childhood, you now know how a bond works.  In this case the United States of America is the 8 year old boy and you are the parents.  The government issues a Treasury Bill, or IOU to you so they can use your money for whatever they please.  The 700 dollar bailout made popular recently will be financed by these bonds but you still may be asking, what are bonds?

 

What’s in it for you?  You buy them at a discount kind of like buying a $100 gift card for $80.  How do you know what the discount will be?  The government doesn’t set it.  You do!  T-bill rates are set at auction.  The government issues bonds and an auction determines the discount.

 

What is best about bonds is that they are as safe as any investment can be.  In order for you to lose your money, the United States government would have to cease to exist.  Other types of bonds are at risk of defaulting (that means that you lose all of the money you invested)

 

With all of these great benefits, what is the downside?  The biggest down side is that the yield is currently less than 1%.  You would buy your $100 treasury “gift card” for more than $99.  Your savings account pays more than a Treasury Bill.  With the inflation rate averaging 5% each year, that means that each year you are making less than one dollar but losing $5 due to inflation.

 

If that sounds like a pretty worthless investment, your right.  It is!  What it is good for is something called a hedge.  A hedge is a protection for your money and that protection comes with some tax benefits that your savings account does not so if you are close to retirement and want to protect your hard earned money, a Treasury Bill is perfect for you.  What are bonds?  Do you know now?

 

Now that you know what a Treasury Bill is, understand that there are other types of bonds out there that might be appropriate for you.  We will look at other types in other articles but we started with the question, what are bonds?  Now that you know, tell somebody else so they know too.

 

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