In many, but not all, markets, bonds will move in the opposite direction of stocks. If stocks are up, bonds are down and if stocks are down, bonds are up. This is a very broad generalization, but one that helps explain why bonds are a good counter to stocks.
You have a wide variety of bonds to choose from and each type has certain characteristics. Here is an overview of the different bond types:
U.S. Treasury IssuesAt the top of the secure list, are U.S. Treasury issues. The full faith and credit of the U.S. government backs these debt instruments, which makes them the safest investment on the market.
Corresponding with this safety is a very low return. In certain circumstances, the return may not even keep pace with inflation or barely stay up with it. All interest earned from U.S. Treasury issues is generally exempt from state and local taxes, but not federal income tax.
Here are the different types of U.S. Treasury bonds:
- Treasury Bonds have a maturity exceeding 10 years and the Treasury issued them in denominations ranging from $1,000 to $1 million. The U.S. Treasury no longer issues Treasury Bonds, however you can still buy them on the secondary market.
They pay interest every six months and had original maturities of up to 30 years. Even though you buy them from someone or organization other than the U.S. Government, Treasury Bonds are still backed by the full faith and credit of the U.S. government.
- Treasury Notes have maturities of 2, 3, 5 or 10 years and denominations of $1,000. The U.S. Treasury sells Notes at public auction periodically. You bid for the Note by placing a competitive bid or a non-competitive bid.
In the wonderful world of government logic, a noncompetitive bid guarantees you will get the Note. If you issue a competitive bid, you may or may not get the Note. Makes sense, right?
The interest rate for the Note is set at the auction. A competitive bid states what interest rate you will accept. If that happens to be the rate set at the auction, you get the Note. If not, you dont get the note.
A noncompetitive bid states you will accept whatever rate is set at the auction. This guarantees you will get the Note (assuming the auction is not oversubscribed).
- TIPS or Treasury Inflation Protected Securities are bonds with maturities of 5, 10 and 20 years. They are sold in $1,000 denominations at auction just like Treasury Notes.
What makes TIPS different is the inflation adjustment. Every six months the Treasury adjusts the principal by the Consumer Price Index for inflation. The fixed rate of interest is applied to this inflation-adjusted principal.
In an inflationary environment, every six-month interest payment would be higher than the next. At maturity, the TIP pays the inflation-adjusted principal or the original face value, whichever is greater.
How could the principal be less than the face value? During a period of deflation, your principal would be reduced and subsequent interest payments less. Under these circumstances, it is possible that the deflation-adjusted principal could be less than the original face value.
- Treasury Bills are not bonds in the strict sense because their maturities range from 4 to 26 weeks. Along with I, EE/E and H Bonds, T-Bills belong in a cash management category, rather than strictly bonds.
The U.S. Treasury Website has complete information on all of their products.