What Are Term Bonds?
A term bond is a type of bond that has an expiration date. They are bonds with fixed maturity dates, and they give you the opportunity to invest in bonds at lower interest rates than traditional bonds since they have less risk attached.
Term bonds are usually issued by state or local governments, but some companies also issue them for their employees’ retirement savings plans.
Why Should I Invest In Term Bonds?
There are 3 main reasons why you should invest in term bonds.
- Term bonds are the safest type of bonds because they have a fixed date for when you can cash out.
The risk is lower compared to bonds with an open-ended maturity period since your return is known from the start, and there’s no chance that you will lose all of your money if interest rates change before it matures.
- Term bonds offer higher returns than traditional savings accounts or CDs (certificate deposits).
Term bonds often provide between two and five percent more in yield over regular accounts, which means greater earnings on your money.
- Term bonds allow you to diversify your portfolio instead of putting all your eggs in one basket.
This means that if the market changes and interest rates go up or down, term bonds don’t have it as bad since they will mature before any major fluctuations occur.
How Do Term Bonds Work?
When investing in bonds issued by companies and governments, there are usually two ways to buy them: face value and market value (also called “par”).
The bond price is directly linked with interest rates, so if interest rates go up, bonds sell at lower prices and vice versa.
With regular bonds, investors have the option of selling their bonds back into the market.
If you are looking for a stable investment, term bonds can be the perfect choice since they have lower interest rates than traditional bonds.
Term bonds also allow you to invest in high-quality bonds with low risk attached.
Finally, this type of bond is usually very safe and does not lose its value over time like other types of investments do.
Types of Term Bonds
While bonds with a fixed maturity period can be bought and sold in the market, term bonds are not traded between investors.
- Term bonds issued by the state or local government
When you purchase bonds directly from the issuer (state or local government), they often have some restrictions on when you can cash out your investment.
Term bonds issued by state governments usually give you full control over them since their prices vary based on interest rates, so there’s no need for penalty charges if you want to sell them before the maturation date.
- Term bonds issued by municipalities
Term bonds issued by municipalities are different because these bonds carry an additional risk that changes depending on how well the city is doing financially.
If this type of bond carries credit risk, then any change in financial status will affect its price as well as penalties associated with early redemption.
- Term bonds issued by companies as part of employee’s savings plan
Companies’ term bonds are excellent opportunities for employees to save money and receive tax benefits because the company will match some or all of its contributions up to a certain amount.
Employees may also choose what type of investments they want to make from various choices, including bonds, stocks, or mutual funds.
Example of a Term Bond
To see how term bonds work, let’s say that you have decided to invest $100,000 into bonds issued by a company.
The first thing you will need to do is decide how long you want your term bonds to mature for; in this case, let’s say five years.
Once you’ve determined the length of time, the next step would be figuring out what kind of bond interest rates you want to get.
Let’s say that the bonds currently offer a rate of three percent, and since it is likely that interest rates will go up in five years, this may be your best option for maximizing returns on your money.
Who Can Invest in Term Bonds?
Anyone who has enough money saved up can buy these types of bonds with no limitations attached to them.
Term bonds have lower interest rates than regular bonds, but they allow investors to earn more without taking the significant risks that will cause them to lose when investing in other assets like stocks or mutual funds.
Finally, term bonds are a great way to diversify your investments and help you earn more money without taking too many of the risks that come with investing in stocks or mutual funds.
Pros & Cons of Term Bonds
The biggest pro associated with these bonds is their higher yield than regular savings accounts, which means greater earnings on your investment over time.
Term bonds are a great option if you want to take advantage of higher interest rates without taking too much risk.
Another pro associated with term bonds is that they are generally very safe and do not lose their value over time, making them an excellent choice for those who don’t have the time or knowledge to invest in stocks or mutual funds.
The biggest con associated with term bonds is that they have a fixed maturity period, so you won’t be able to cash them in if rates drop, which means you’ll lose some money when the price falls.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.