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The benefits and drawbacks of municipal, corporate and government bonds with American Medical News

News- economics and investments

"The drawback is that in exchange for that safety, you get a pretty low interest rate," said Bruce Fenton, president of the Westboro, Mass.-based investment firm Atlantic Financial Inc.
Interest rates on bonds vary depending on the duration or life of the bond. A two-year government bond rate could be 2.65%, and a 10-year could be 4.50%, said Ronald Sanchez, senior vice president and head of municipal fixed income for Fiduciary Trust Co. International of New York. In general, he said, the yields are lower on shorter bonds than longer ones.
Fenton said government bonds are a good investment for people who can't stand the thought of any principal risk.
"But there is also the risk of having your investment not keep up with inflation and taxes," he said. "Sometimes people who think they're being very prudent in locking everything in a government bond are not losing out on principal but they are losing out in another way."
At the other end of the spectrum are corporate bonds, some of which carry much greater default risk in addition to the threat of how changing interest rates can affect the investment. But with the risks, these bonds tend to offer a higher rate of return than more conservative bonds.
"It's more like investing in a stock. Investors really have got to look at the stability of the company," Fenton said.


Most bonds won't leave investors shaken or stirred
Personal Finance. By Katherine Vogt, AMNews staff. Aug. 9, 2004.
property of Amed news


In bonds, many investors trust. But for some, that might be blind faith. Trying to understand the bond market can feel like reading a book with only half of the necessary words. It can leave investors with questions having no simple answers.
But experts say even novice investors might be able to benefit from bonds with a little basic information about what they are and how they work. Knowing the tax consequences and risks of the bond types typically bought by individuals -- government bonds, agency bonds, municipal bonds and corporate bonds -- can help people choose which investment, if any, is right for them.
The bond market is big business. According to the Bond Market Assn., a New York-based trade association, outstanding public and private debt -- underwritten by bonds -- was valued at more than $22.5 trillion in the first quarter of 2004, up from $16.9 trillion in 2000.
Michael Decker, senior vice president of the association, said interest in bonds began to surge after the stock market plummeted because investors were seeking diversity and greater stability in their portfolios.
"What we're hearing is that the stock market crash of a few years ago really was a hard lesson for a lot of people, and I think a lot of them don't want to have a repeat performance," he said.
Walt Woerheide, PhD, a professor of investments and director of the Irwin Graduate School at the American College in Bryn Mawr, Pa., said physicians might be better suited to bond investments later in their careers because, unlike stocks, bonds tend to be more of a wealth preservation vehicle than a growth vehicle.
Yields are generally lower on short-term bonds than on longer term ones. "When they're in the early to peak years of their careers, it's not clear that they should have a heavy percentage in bonds, because they have a high current income, which can offset losses in stock, and they still have a reasonable amount of time to make up for losses," he said.
But some bonds grow faster than others, and each type is suited to a different investment strategy. Bonds -- which are essentially IOUs -- allow an investor to make a loan to the bond issuer and make money off the interest.
In general terms, Decker said, a healthier overall economy means higher market interest rates and bond yields. "So we're in a situation now where interest rates are rising," he said. "And it's our projection that in the next year or so we're going to see higher bond yields."
Government bonds are often said to be among the safest investments available because they are backed by the U.S. government, and therefore are said to be free from risk of default.
"The drawback is that in exchange for that safety, you get a pretty low interest rate," said Bruce Fenton, president of the Westboro, Mass.-based investment firm Atlantic Financial Inc.
Interest rates on bonds vary depending on the duration or life of the bond. A two-year government bond rate could be 2.65%, and a 10-year could be 4.50%, said Ronald Sanchez, senior vice president and head of municipal fixed income for Fiduciary Trust Co. International of New York. In general, he said, the yields are lower on shorter bonds than longer ones.
Fenton said government bonds are a good investment for people who can't stand the thought of any principal risk.
"But there is also the risk of having your investment not keep up with inflation and taxes," he said. "Sometimes people who think they're being very prudent in locking everything in a government bond are not losing out on principal but they are losing out in another way."
At the other end of the spectrum are corporate bonds, some of which carry much greater default risk in addition to the threat of how changing interest rates can affect the investment. But with the risks, these bonds tend to offer a higher rate of return than more conservative bonds.
"It's more like investing in a stock. Investors really have got to look at the stability of the company," Fenton said.
Like the others, municipal bonds and agency bonds both carry risks from inflation and price fluctuation.
Although bond prices are much less volatile than stock prices, Decker said, they do vary. That can create risk for people who buy and sell bonds before they reach maturity.
Municipal bonds, which are issued by state, local and related entities, have yields that are typically lower than those on treasury bonds, Sanchez said. But after tax adjustments they can offer higher yields, he added.
Municipal bonds can be alluring to people seeking tax-advantaged investments. "In general, the interest is almost always exempt from federal income tax, so they tend to appeal to high tax bracket investors," Decker said, adding that these bonds also could be exempt from state or local tax.
Dr. Woerheide said investors who generate substantial income from municipal bonds could be subject to paying the alternative minimum tax because the interest from those bonds is one of the indicators used to calculate who pays the tax.
"If you start investing heavily in municipals, you or your financial planner need to keep a sharp eye to make sure you don't hit the AMT, because as soon as you do you lose all of the tax-free advantage of municipal bonds," he said.
Also, he said that municipal bonds sometimes can be harder to sell than corporate or treasury bonds. The same could be true for agency bonds, which are issued by private entities with government ties such as Fannie Mae.
Investors in all of these bond types can expect to pay commissions on trades. Dr. Woerheide said the commissions tend to be a fixed dollar amount, which can have a greater impact on smaller trades.
Bonds sold in the form of mutual funds also might have management fees, though they can have the advantage of having a professional team of people making investment decisions and finding deals. "The flip side is that you pay for that service," Decker said.
Vogt is a reporter for the Business section. You can send her tips or suggestions by [email protected] e-mail or call her at 312-464-4426.



 








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