There are four types of corporate bonds:
Secured Bond – backed by some sort of collateral in case the of default
Unsecured Bond – backed by just the corporation’s promise to pay
Convertible Bond – the bond can be converted to the corporations common stock (at the option of the bondholder, at a predetermined price)
Zero-coupon Bond – these bonds have no interest payments, they are sold at a discount or premium to the face value of the bond.
Pros: Risk Level: Low to Mid (dependent on Secured or Unsecured Bond)
Rate of Return: Middle
Liquidity: Middle
Cons: Chance of default, ideally offset by rate of return
4. Treasury Inflation-Protection Securities
Inflation protection securities are fixed-income securities that are indexed to inflation; this is a simple and effective method to cut out one of the biggest risks with fixed income securities, inflation risk.
The most common inflation-indexed securities are United States Treasury inflation-protected securities or “TIPS” for short. These TIPS are backed by the United States government which make them considered a very low risk investment.
Once these securities are issued the principal is adjusted each month for inflation (up or down) based on the Consumer Price Index for All Urban Consumers, or CPI-U. The Treasury inflation-protection security coupon rate stay constant, but the dollar amount received would fluctuate with the change in principal each month (as adjusted for inflation)
Treasury inflation-protected securities are issued at a minimum amount of $100 and can scale up in increments of $100. TIPs are issued in 5, 10, or 30 year terms and can be held to maturity or sold before.
As an example:
Let’s assume you invest $100 in a TIPS at the beginning of the year; with a coupon rate of 2%. Let’s say at the end of the year the average inflation rate (as measured by the CPI-U) comes in at 5%.
With the average inflation rate of 5% the new principal amount would be ($100 x 5%) = $105. The coupon rate is constant at 2%; so the resulting interest payment would be ($105 x 2%) = $2.10 over the year.
Treasury inflation-protected securities can be purchased in electronic form at TreasuryDirect.gov
Pros:Risk Level: Risk Free
Rate of Return: Low
Liquidity: Middle to Low (dependent on term)
Cons: Return my be under inflation
5. Online Savings Account
A more traditional approach for holding your money in the short term is an online savings account. The benefits of an online savings account is that your investment is risk free (if under the FDIC coverage amount of $250,000) but can still offer you a modest return.
The reference to an “online” savings account over a more traditional brick and mortar savings account is that there are several banking institutes online offer rates over 1% in savings accounts. (Banks including Ally Savings and Capital One 360 Savings)
Another thing to consider is that your investment would be extremely liquid in an online savings account; meaning you would not at risk of market fluctuations or early withdrawal fees.
Money Market accounts are very similar to savings accounts in that they both are insured by FDIC and essentially risk free. The main two differences are how you are allowed to retrieve your money and certain interest rate tier structures.
Money markets allow you to write checks and use debt cards, while savings accounts typically would require you to retrieve your money via wire transfer or in person at brick and mortar location. In this current market condition many online savings accounts offer a higher interest rate for the same risk level; so that is why we feel online savings accounts is a better option at this point.
Pros: Risk Level: Risk Free (up to FDIC deposit limits)
Rate of Return: Low
Liquidity: High
Cons: Return my be under inflation
Limit on transactions per month
Withdrawal method limitations
6. Certificate of Deposit (CD)
If you like the comfort of a savings account with the feel of investing, then a certificate of deposit (CD) may be right for you. A Certificate of Deposit is essentially a period of time deposit where there is a fixed end date (maturity date) and known fixed interest rate of return.
A CD is a good option for short term investment because the deposits (at commercial banks or credit unions) are insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA) which provides essentially a risk free investment. CDs are also generally issued electronically and typically automatically renewed at the end of the term, which provides some convenience.
Certificate of deposits have many different maturity time frames to choose from and the dollar amounts can be issued in any denomination.
The downside of a CD is that your money is locked up for the specified time frame. That’s not to say you could not withdraw your funds, but you would incur a penalty that would basically offset any interest you would have earned.
Pros:Risk Level: Risk Free (up to FDIC deposit limits)
Rate of Return: Low
Liquidity: Middle to High (dependent on term)
Cons: Return my be under inflation
Early withdrawal fees
This article has been republished with permission from The Modest Money.