Bonds: The Safe Way to Save

U.S. Treasury bills, notes and bonds and U.S. savings bonds are an excellent, risk-free way to preserve capital, get a pretty good return and keep your investment liquid.

The government sells Treasury securities -- bills, notes and bonds and savings bonds. They are debt instruments sold to raise money to operate the government and pay off debt. Treasury securities are a safe investment because they're backed by the U.S. government.

The minimum amount required to buy a Treasury bill, note or bond is $1,000. Savings bonds can be purchased for as little as $25.

Treasury bills (T-bills) are short-term securities that mature in one year or less. You buy them for less than par (face) value. When the bill matures, you receive par value. For example, you might buy a $10,000 26-week T-bill for $9,750. If you hold it until maturity, you'll be paid $10,000. That extra $250 is the interest you earned.

Treasury notes mature in two to 10 years, while Treasury bonds mature in 10 to 30 years. Both notes and bonds pay a fixed rate of interest every six months until the security matures. Par value is repaid when the security matures.

Treasury bills, notes and bonds are transferable -- you can buy or sell them in the securities market.

Treasury bills, notes and bonds are sold through competitive and noncompetitive bidding at more than 150 auctions held throughout the year. Many newspapers report auction schedules. You can also find auction schedules on the government Web site.

Auction dates are announced seven to 10 days before the auction. The Web site also has detailed information on how bids are placed. There are no fees when you buy Treasuries directly from the government.

You can also buy Treasuries on the securities market, through a broker or dealer. If you choose that method, you'll pay a commission and perhaps a transaction fee.

The income you earn is exempt from state and local taxes.

Savings bonds
Savings bonds are Treasury securities that are payable only to the person to whom they are registered. Savings bonds can earn interest for up to 30 years, but you can cash them in after six months.

Two types of savings bonds can be purchased with cash -- Series EE and I Bonds. Series HH can only be bought in exchange for Series EE bonds or when you reinvest the proceeds of matured Series H bonds.

Series EE -- an accrual security. Interest is periodically added to the amount you originally paid. As the interest accrues, the value of your bond increases.

Series HH -- a current-income security. Interest is paid to you every six months. When you cash the bond, you receive your original investment.

I Bonds -- an accrual security. Interest is added to the bond monthly and paid when the bond is cashed. I Bonds are sold at face value, and they grow in value with inflation-indexed earnings for up to 30 years.

Earnings from savings bonds are exempt from state and local taxes. Federal income taxes can be deferred until interest is received.

Savings bonds can be bought at almost any bank, by mail or online. Many employers offer them through payroll deduction.

Savings bonds can be cashed any time after six months. If you redeem a bond before five years, there's a three-month interest penalty.

For a wealth of information on savings bonds, visit the official U.S. Savings Bonds Web site.

Municipal bonds
Municipal bonds (munis) are interest-bearing debt securities issued by states, counties, cities, etc. Municipal bonds are used to fund public projects such as schools, roads, libraries, hospitals and sewer systems.

The income generated is usually exempt from federal taxes. If you buy a bond issued by the state you live in, the bond may be exempt from state and, possibly, local taxes, too. The negative side to this is that munis usually are offered at a lower yield than equivalent taxable bonds.

Municipal bonds have maturities from one to 40 years and are bought and sold in the over-the-counter market. Their price is based on their credit quality, yield and maturity.

Munis are riskier than Treasuries because local governments can go bankrupt, but they're considered safer than corporate bonds.

There are many types of municipal bonds -- some of the most common are:

• General obligation -- The most common type of municipal bond. They're not tied to any specific project; they're repaid by general revenues.
• Revenue bonds -- Used for revenue-producing projects such as toll roads. They're repaid with revenues generated by the specific project.
• Industrial development -- Fund the construction of new industrial parks, etc. and are repaid by revenue from the project.

Corporate bonds
Companies that are trying to raise money issue corporate bonds.

Corporate bonds are the riskiest of the fixed-income securities because only the individual corporation backs them and companies are much more likely than governments to have serious financial problems. Corporations reward you for taking the extra risk by paying a higher interest rate than you would get on most government securities.

Two debt-rating agencies, Standard & Poor's and Moody's, assign credit ratings to corporate bonds based on the company's ability to repay its debts.