Finding new ways to save money when in college can be the difference between being able to afford tuition and taking out more student loans. It goes without saying that debt management is key to your academic and financial success. But if you think there has to be a better way to save than just leaving money in your savings, then you’d be correct. Today, we will cover bonds, their different types, and how to make your money work for you.
What is a Bond?
A bond is a debt security purchased from a corporation or government looking to sell its debt. Regardless of bond type, you’re guaranteed to at least keep your initial investment, and you can cash the bond after 12 months or more. Unlike other savings products, bonds essentially make you a lender to the government or corporation, and all accrued interest is money said entity pays you directly. Plus, bonds use compound interest, a concept that we’ll talk more about later. First, you’ll need to know the three most common types of bonds and how they benefit you.
US Savings Bonds
Generally, when someone thinks of bonds, they think of savings bonds. Savings bonds purchased after 2005 have a fixed rate, meaning inflation, and the economy won’t impact your earned interest. Savings bonds can’t be reinvested but may be cashed out after having them for at least a year. Similar to other bonds in this article, savings bonds are purchased online via TreasuryDirect, a government website. There are two types of savings bonds.
As mentioned, any EE bond purchased after 2005 offers a fixed rate that compounds twice a year. EE bonds are guaranteed to double your investment if kept for 20 years.
The interest yield from I bonds is calculated on the fixed rate at the time of purchase and on the inflation rate, which changes every six months. Because of the inflation rate changes, I bonds are not guaranteed investments.
There are more than a few things both these bond types have in common. Both bonds have an interest penalty that takes the last three months of accrued interest if redeemed within the first five years of ownership. Also, savings bonds are subject to federal tax only, which is subject to change if the bonds are redeemed for school purposes.
Here at Kids Money, we will always back the safest investment. So if you’re uncertain about choosing EE or I bonds, we recommend EE for its guaranteed return on investment.
Municipal bonds, also known as munis, are bonds that a government sells to pay for local infrastructure and public wellbeing. The risk is higher because munis are sold based on the expected return of the specific projects they’re funding. For example, imagine buying municipal bonds that are financing the building of a community pool. Now, imagine the construction of the pool falls through for any reason. Suddenly, the bonds will become nigh impossible to sell because any potential buyers know the pool won’t be built.
The exact yield for a municipal bond depends entirely on the project it’s funding. Much like stock, due diligence is critical before investing in munis. Munis are subject to state and sometimes federal tax. Additionally, the minimum purchase is approx $5,000. We could write an entire article on municipal bonds, but if you want more information, we suggest you speak with a licensed broker who can explain the complexities in depth.
Here are more complex bond types that we recommend avoiding unless you speak with a licensed financial professional.
Agency Security Bonds
State-sponsored programs sell agency security bonds in an attempt to raise money. For example, buying a bond from the national mortgage association constitutes an agency bond.
Emerging Market Bonds
Emerging market bonds are issued by developing nations. Purchasing an emerging market bond is the same as investing in the future of the developing nation.
Mortgage Backed Security Bonds
Also known as MBS. These bonds allow a person to buy and sell mortgages without having to buy and sell an actual property. Like other tradable bonds, a person sells for more than they purchased to turn a profit.
Treasury Security Bonds
Treasury security bonds are bonds sold directly by the US treasury. They typically mature over 30 years and pay out interest semiannually.
Why you Should Invest in Bonds as a College Student
Much like college, bonds are a long-term investment. When the time comes for you to pay back your student loans or pay for the next semester, bonds can be the saving resource you need. Consider investing in bonds to make your money inaccessible for everyday spending but still readily available for emergencies.
Plus, if paying for college isn’t your primary concern, you can purchase bonds to start with a safety net after graduation.
Holding Bonds vs. Trading Bonds
Holding bonds are, more or less, exactly what they sound like. A person buys a bond, holds for it a period, and then redeems it for cash value. Certain bonds like savings bonds, Series I, and EE can’t be traded and can only be redeemed by the purchaser. Although an exception is made should the purchaser become deceased.
Trading bonds operate essentially like a stock market where a person purchases a bond and then sells it for more and pockets the difference. Municipal bonds, for example, can be traded. That said, while any tradable bond potentially has a much higher yield than a savings bond, it also has a great deal more risk.
Common Bond Terms
Explore this short glossary of bond terms
- Annual Percentage Yield: Also known as APY, is the interest yielded from an investment.
- Secondary Market: This term is exclusive to trading bonds and refers to the market in which a bond can be sold after purchase.
- Issuer: The original seller of a bond.
- Bond Maturity: Once a bond begins paying interest to its investor.
- Face Value: A bond purchased for its exact market worth. For example, a $50.00 savings bond costs $50.00.
- Yield to Maturity: Also known as YTM, is the interest a bond is expected to accrue once it matures. The better the YTM, the more valuable the bond.
- Compound Interest: Compound interest means the interest you earned earns interest. For example, let’s say you deposit $100, and over 6 months, the $100 has turned into $101. You’ll earn interest on $101 instead of just your initial deposit.
Important Things to Know about Bonds as a College Student
Bonds turn you into a lender. If you purchase a bond, you’re lending that entity money to fulfill the purpose of said bond. And, after a certain point, you can come to collect whenever you want.
Series EE savings bonds are perfect for a low-risk investment. While their APY is lower than other bonds, they are a great way to guarantee future finances.
Speak with a licensed professional before buying bonds, as your specific federal or state taxes and regulations can eat away at your profit. Also, speak with a professional to get help understanding the risk of certain bonds.
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