U.S. Government Bonds

Bonds issued by the U.S. government are called “Treasurys”…because, as you guessed, the U.S. Treasury issues them. There are four types of Treasurys:

Bills – maturities from 90 days to one year

Notes – maturities from 2 to 10 years

Bonds – maturities over 10 to 30 years

Savings bonds – redeemable without penalty after 5 years

All Treasurys carry the full faith and credit of U.S. government, which means that the U.S. Government has promised to pay you back. Another nice added benefit is that you don't have to pay state or local taxes on any interest income you make on Treasurys. You can buy Treasurys on-line directly from the government by going to www.publicdebt.treas.gov/sec/sectdes.htm. Savings bonds can be bought in very small amounts and are designed for small investors. For other Treasurys the minimum is $1,000.

Municipal Bonds

Bonds offered by state and local governments, or municipalities, are known as municipal bonds, or “munis.” Any interest income you make on munis is free from federal income taxes, and some states will also drop state and local income taxes (in that case your interest income is “triple tax free”). The trade-off for the tax break is that often you'll get a lower interest rate than you may find with other taxable bonds. How much the tax break is worth to you depends on your income tax bracket and the state in which you live. The Bond Market Association provides a calculator to determine “equivalent taxable yield” on municipal bonds for you. Go to www.investingbonds.com for this information. But don't buy munis for an IRA or other tax-deferred account where you already have a tax break!

Corporate Bonds

Corporate bonds are considered riskier than Treasurys and most munis because all companies are susceptible to competition, economic conditions and even mismanagement that can lead to uncertainty about their ability to pay bond holders and other creditors. The upside is that you will be compensated for taking this somewhat higher risk. The lower the company's credit quality, the higher the interest rate you'll be offered for buying the bond. Click here for more on bond value and safety.

Corporate bonds come in three maturity ranges:

Short-term – 1-5 years

Intermediate term – 5-15 years

Long-term – 15+ years

Zero Coupon Bonds

By now you've grasped that coupon means interest. So why in the world would anyone invest in a “zero” coupon bond? Investing in a zero coupon bond doesn't mean that you'll earn no interest. It just means that you won't receive your interest payment on a twice-yearly basis like regular bonds. Instead, the bond is sold to you at a discount – meaning you can purchase it for less than its face value. Then, when the bond matures, you collect true face value, that is, all of the interest plus principal in one lump sum. Why would someone want to buy a zero coupon bond? Well, for one thing zeros are more attractively priced than other bonds. And they're useful for investors who are looking for a set payout on a given date instead of a steady payout stream over time.