Investments: A General Overview
Government and Municipal Bonds
As mentioned
earlier, investments can be a
very complicated subject.
Earlier we discussed the two
basic types of investments –
equity and debt. We will
now go a bit further into the
discussion of one of these types
– bonds, or debentures.
Municipal Bonds
We have mentioned the fact that a municipal bond is a bond specific to a state or a municipality. Now we will discuss further details about these instruments, which are necessary in fully understanding how they function.
Municipal
Bonds essentially give a tax
break to investors who pay taxes
in a specific state or
municipality. Why do they
do this? They do this to
give investors a benefit for
funding state or city projects.
This gives the state or
municipality a ready source of
capital that is much cheaper
than alternative sources of
financing. The funds,
which are generated through
Municipal Bonds, are required to
be used in projects that satisfy
state and federal statutory
requirements. Typically
these projects must be public
works projects such as roads or
other types of assets of benefit
to the general public such as
low-income housing.
Obviously only
states with a state tax will
have municipal bonds and only
investors who pay taxes in that
particular state are eligible
for the tax break for investing
in these funds. The tax
rate is “hidden” in the sense
that what happens is that you
receive the income from the
funds but the state does not tax
you for that amount of income.
So it is the amount you avoided
paying taxes on which is your
benefit for investing in
Municipal bonds.
One thing to be aware of is that it is only the income that is tax free in a municipal bond – NOT the capital appreciation received if you sell the bond early for a profit. There are other specific characteristics, which are dependent on an individuals tax situation that should be discussed with your financial advisor.
Government Bonds
So far we have only mentioned Government Bonds in a general manner. Now we will discuss the various types as well as some of the other characteristics of such bonds.
Government Bonds are very similar in concept to municipal bonds. The main difference being that the tax break is at the federal level as opposed to the state. Government Bonds are generally comprised of either short-term United States Government Debentures or Long-Term
Government Debentures.
The tax breaks
for investing in Government
Bonds are received in the same
manner as the break received for
Municipals. It is an
income that you do not have to
pay a federal tax on.
The only other feature of important to Government Bonds is the implied safety and security, which they have by being backed by the full faith and credit of the United States Government. This gives these debentures the highest possible safety in regards to the perception of the market.
Treasury Bills
are the shortest term government
debenture issued by the United
States Government and they
mature in periods ranging
anywhere from 3 to 6 months.
Because of their short maturity
and the backing of the federal
government they are considered
one of the safest investment
possible.
Treasury Notes
are the next longest in terms of
interest and as a result they
pay a bit higher rate than
T-Bills (slang for Treasury
Bills). Treasury notes
mature in periods ranging from 1
to 5 years.
Treasury Bonds are the longest maturing bonds issued by the Federal Government. Treasury Bonds have a maturity ranging anywhere from 5 to 30 years and pay the highest rates available for a Federal Government backed debenture.
Other than the
maturity difference they are for
the most part similar to the
Treasury bills described above.
The tax break for investing in
Government Bond Funds are
received in the same manner as
the break received for
Municipals. Only in this
case, it is an income that is
untaxed at the federal level.
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