- Government. Governments sell bonds to raise funds for federal spending. U.S. government securities issued by the Treasury are considered safe assets.
- Agencies. Federal agencies and government-sponsored enterprises like Fannie Mae issue bonds. Fannie Mae bonds support housing initiatives. They are riskier than Treasury-issued bonds.
- Municipality. State and local governments also sell bonds to support state and local initiatives. Interest from municipal bonds is often exempt from income taxes.
- Corporations. Businesses also issue bonds to raise capital.
Bonds are additionally categorized by their maturity, which is the timeline for loan repayment. Maturity is an important factor, because it influences the bond's reaction to changes in market interest rates. Bond values in the secondary market usually rise when interest rates fall and vice versa, but this reaction is less severe for shorter-term debts.
Maturities are grouped as short, medium, or long-term:
- Short-term bonds mature in less than one year, up to four years.
- Intermediate-term bonds mature in four to 10 years.
- Long-term bonds mature after 10 years or more.
Lastly, bonds can be classified by credit quality. Rating agencies provide credit quality scores based on the bond issuer's financial health. While there are several ratings categories, investors usually group them in two buckets:
- Investment grade. These are relatively safe because the issuers are financially healthy.
- High yield. High-yield bonds, or junk bonds, have a higher risk of default. If the issuer defaults, bond investors may lose their money.
Investing in bond ETFs
Diversification, liquidity, and accessibility are three reasons to invest in bond ETFs.
- Diversification: Bond exposure can reduce a stock-heavy portfolio's volatility. High-quality bond ETFs should provide stable income over time.
- Liquidity: Because bond ETFs are exchange-traded, they are usually easy to sell.
- Accessibility: If you have a brokerage account or individual retirement account (IRA), investing in bond ETFs is simple. Log into your account and place a trade order for the bond ETF you want. Direct purchase of corporate and municipal bonds can be more complicated.
