Bonds: Making the Grade

Fixed income securities are one of the best places to be right now. Why? Because this is one of the safer places to make money, even if it barely outpaces inflation. Every corporate bond has a grade given out by Standard & Poor's and Moody's among others. So when investing in a corporate bond, you should probably consider looking at the grade along with the yield and the debt this company has run into. These grades are separated into two groups: investment grade and non-investment grade. Investment grade bonds are given to companies who have a strong balance sheet and income statement who have the capacity to pay back bondholders. They are the most reliable, stable companies with the highest quality bonds. They are given a grade from AAA to BBB. Non-investment grade bonds, also called junk bonds, are those companies who may be smaller companies with a short track record and are heavily invested in debt or it may be companies who are losing money. These companies are also usually sensitive to economic changes. They are given a grade from BB down to D. C means the company is close to bankruptcy. D means it has defaulted on its obligations. The lower the grade, the higher the yield. Companies who need the money the most will ultimately pay a higher yield. Investors also demand a risk premium for the level of risk they are taking on investing in a weak company.

While in a decent economic environment, it is perfectly acceptable to chase higher yielding bonds with a lower rating. As long as the economy is doing well and people are buying their product, the company should be able to pay back bondholders, even if it is a declining company. So why not go for the higher risk, higher reward. When times are good you can afford to be speculative. However, in times like this it is only the highest graded companies that you should invest in. These are companies that are large, stable, and have dominated their industry for years. These won't yield as much as junk bonds, but at least you will be making some money. We all have seen how reliable the stock market has been lately.

I want to warn you about investing in Treasuries. A lot of international investors and even countries are pouring money into the US government in exchange for bonds. While it is good that these countries are investing in the US, a word of caution. With all the money the government is spending, will they really have enough to pay back these bondholders? It will take years to get back money from the financial institutions we are supporting right now. Let's say things get worse in other countries and they want their money back. Where will we go to give them their money? Taxpayers? We can only print so much money. Right? Could we consider this to be the next bubble? There are only so many places to look to invest in and feel safe about. You should always examine even the most reliable of places to make sure you will be making cash money.