When investing in distressed debt, it takes some skill to separate the wheat from the chafe. It isn’t for the faint of heart. You have to sort through many companies – and sometimes countries – going through tough times.

But before I get too ahead of myself, let’s first take a look at what makes debt distressed. Then from there, we’ll dive into some strategies and different ways to invest.

What Is Distressed Debt Investing?

Debt is money loaned out to borrowers with the promise to repay. For example, a new company might borrow $100 million to scale its first product. Then depending on the loan details, the company will pay it back plus interest in the following years.

Although, if this company doesn’t scale as expected, it might not be able to pay back the loan. For example, it might have overlooked some regulatory issues. No matter the case, if sales and profits don’t follow, the company is less likely to be able to pay back the loan. And this is when the debt can become distressed.

Investing in Debt and Credit Ratings

The investors that initially lent $100 million consider it an asset. Although, as the probability of repayment decreases, that asset is worth less. And like any asset, you can trade it with other investors.

With large companies, you’ll often find that their debt trades on secondary markets. Because it’s an asset, one investor might be willing to buy it from another.

But as mentioned… when the underlying companies struggle, the value of the existing debt drops. Investors are unwilling to pay the full amount for a loan if there’s a higher chance the borrower won’t be able to pay it all back.

To determine the chance of a default – a company missing its loan payments –, you can look at credit ratings. There are three top rating agencies: Standard & Poor’s, Moody’s and Fitch. They each have different systems but the lower the rating, the more distressed the debt becomes.

Companies can even file for bankruptcy and still return money to investors. As a company goes through that process, it might be able to pay back some – if not all – of its loans to bondholders. If the company is reorganizing or liquidating, it might sell off some of its assets. This is why distressed debt investing continues to see trading activity.

Bonds are often considered safer because bondholders come before stockholders. They’re first in line to see money returned during tough times.

Distressed Debt Investing Opportunities

For distressed debt investing, you can find opportunities with large brokers. Schwab, Fidelity and others provide access to corporate debt. Although, it can be more challenging than investing in stocks.

Due to increased risks with investing in distressed debt, there tends to be less trading activity. This means fewer opportunities to buy the bonds from sellers. On top of that, when trading debt, there can be higher minimum requirements.

For this reason, you’ll often see more activity from large funds. They also tend to have a better understanding of the legal process when it comes to bankruptcy and distressed debt. But nonetheless, feel free to explore what your broker provides.

If you buy into some distressed debt and the company turns around, that can provide some big returns. You might pay pennies on the dollar for certain bonds. And it all comes down to finding better ways to measure both the potential risk and reward. Then comparing that to the current market price of the bonds.

Diversify With Bond ETFs

As always, it’s good to diversify when investing. To do this, you can invest in distressed debt across industries. And as alluded to before, you can also invest in distressed sovereign debt. Some countries around the world struggle to meet their debt payments as well. Although, analyzing a country’s financials can be more difficult.

To buy distressed debt, it can require a lot of due diligence. That’s why many investors decide to go with debt funds. Due to the complexity of distressed debt investing, this might be a better path to take.

One popular fund is iShares iBoxx $ High Yield Corporate Bond ETF (NYSE: HYG). It has a wide range of bonds and some are more distressed than others. Due to the higher risk on average, it pays investors a higher return.

There are many more funds to start when distressed debt investing. Although, it’s good to balance portfolios beyond bonds. If you’re looking for more investing opportunities, check out these free investment newsletters. They’re packed with insight from experts.

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Let’s take a closer look at savings bonds: what they are, how they work as investment vehicles and how to best leverage them into a defensive portfolio. Plus, we’ll look at the role of savings bonds within the context of a recession.

What is a Savings Bond?

A savings bond is a long-term depository investment made with the United States Treasury. They offer investors a guaranteed rate of return on their money, depending on how long they hold it. There are actually two types of savings bonds investors can consider:

• Series EE. These bonds offer a fixed rate of return that will double the face value after a period of 20 years. They’re available in denominations ranging from $25 to $10,000, capped at $10,000 per year, per taxpayer. Investors need to hold these bonds for at least one year before selling, and there’s a penalty amounting to three months’ interest if sold within five years of purchase.

• Series I. These bonds adjust their interest rate every six months based on inflation. Like Series EE bonds, investors can purchase Series I bonds in increments ranging from $25 to $10,000, capped at $10,000 per year, per taxpayer. A type of zero-coupon bond, investors gain the full bond payout when it’s cashed in. There’s a penalty amounting to three months’ interest if sold within five years of purchase.

Savings bonds are the ultimate “set it and forget it” investments because, unlike other ones that pay interest and fluctuate based on the bond market, these investments are best held for the long-term. It’s best to invest in them when your time horizon on realizing their gains is 20-30 years.

Series HH savings bonds were also available from 1980 through August 2004. These bonds had a maturity date of 20 years and functioned similar to Series EE bonds, though they paid interest bi-annually. Investors who still hold Series HH bonds can continue to collect interest on them or cash them in at face value.

Savings Bonds vs. Other Treasuries

Savings bonds are one type of U.S. Treasury product, alongside T-Bills, T-Notes, T-Bonds and Treasury Inflation-Protected Securities (TIPS). The key difference between savings bonds and other U.S. Treasuries is rate of maturity. T-Bills mature in less than 52 weeks. T-Notes mature in less than 10 years. T-Bonds mature in 20-30 years and pay interest, unlike savings bonds, which deliver ROI at the time of redemption.

It’s often simpler to think about savings bonds as deposits that earn interest, whereas other U.S. Treasuries are debt investment products. They work similarly to a savings account.

The Major Benefits

Given the option to put your money in savings bonds vs. a savings account (or even a debt investment), savings bonds offer some excellent benefits to consider. Some of the primary reasons you might invest include:

• The earnings they generate are exempt from state income taxes
• You can also avoid federal taxes if you use the earnings for education
• There’s a low barrier to entry; they are available for as little as $25
• Redeemable with no penalty after five years
• Backed by the full faith and credit of the United States Government

Savings bonds offer interest-earning opportunities, combined with the flexibility to either let your money grow risk-free for 30 years or pull it out penalty-free after five years. They’re also very accessible to any investor.

How to Use Them in a Recession

If you’re looking to hedge your portfolio and take a more defensive stance against oncoming economic hardship, savings bonds can provide stability. That said, they’re better for those seeking very long-term defensive investments. Depending on the type of one you buy (Series EE vs. Series I), each has its own grouping of pros and cons. Nevertheless, either represents the safest possible investments you can make.

Looking for tips and other strategies to hedge your portfolio against economic hardship? Discover our family of investment newsletters and take advantage of the expert advice of seasoned investors who know how to navigate the market in any conditions, including economic recession.

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Inflation risk can be a tricky concept to understand because it’s impacted by two diverse factors: bond interest rates and current inflation rates. Depending on the bond you hold and the macroeconomic forces affecting inflation, your bond portfolio could face more or less inflation risk than someone else’s.

Here’s a closer look at bonds’ inflation risk: the concept, how to measure it and strategies for mitigating risk over time as you build a healthy bond portfolio.

What is Inflation Risk?

Inflation risk is the amount of your investment yield that’s eroded by inflation over time. It’s measured by subtracting the annual inflation rate from the annual yield of the investment, to arrive at the real rate of return. Investors can apply this calculation in both forward-looking and retrospective capacities, to anticipate real rate of return before investing or to calculate the efficacy of an investment after exiting the position.

Inflationary Risk Example

Stephanie holds a five-year $10,000 bond with a 10% coupon rate. The annual inflation rate is 3%. Stephanie’s bond has a diminishing rate of return year over year due to inflation risk. After year one, her $1,000 coupon payment is akin to $970. In year two, the $1,000 has a value akin to $940. This loss of value continues through the bond’s term.

How Inflation Affects Debts vs. Equities

Inflation risk affects all investments, because it’s always working against value appreciation. However, it disproportionately affects debt assets more than equities. This is because the value of bonds remains fixed over the term, whereas equities fluctuate in value and have the potential to appreciate more significantly to downplay inflationary concerns.

In the bond inflation risk example above, there’s nothing the investor can do to raise the value of that bond or the interest payments it yields. However, if they purchase stock in a company and that company appreciates 20% over the course of the year, the real rate of return can still outperform the market. Of course, this is a double-edged sword, since stock prices can also drop and exacerbate the losses incurred by inflation.

How to Combat a Bond’s Inflation Risk

Bonds are particularly at-risk for inflation concerns the longer the term of the bond. For instance, a 90-day Treasury Bill faces significantly less inflation risk than a 10-year Treasury Note. This is often the key to mitigating inflation risk within a bond portfolio.

Investing strategies like bond ladders and dumbbells are a great way to stagger bond terms in a way that allows investors to replace sub-par bonds as interest rates change against inflation. Consider this simple bond ladder:

• A: $10,000 at 2.1%, purchased today, maturing in year one
• B: $10,000 at 3.2%, purchased today, maturing in year two
• C: $10,000 at 3.5%, purchased today, maturing in year three
• D: $10,000 at 3.5%, purchased in year 2 using Bond A, maturing in year four
• E: $10,000 at 3.5%, purchased in year 3 using Bond B, maturing in year five

Staggering maturity dates and funding the purchase of bonds with better rates is a great way to avoid inflation risk. Cycling through bonds gives income investors the flexibility they need to adapt in the face of rising inflation rates, or to take advantage of better coupon rates.

Dumbbell strategies serve much the same purpose. The strategy involves mixing short and long-term bonds to capitalize on the high yield of long-term bonds, while using short-term bonds to avoid inflation risk. It’s a strategy that requires more active portfolio management.

A Closer Look at Treasury Inflation Protected Securities (TIPS)

For investors who want to combat bond inflation risk directly, there are always Treasury Inflation Protected Securities (TIPS). TIPS directly offset the price of inflation by adjusting their principle to match. As a result, investors will never fall behind inflation and there’s no inflation risk to consider.

The downside to TIPS? There’s no way to outperform inflation. TIPS track it to preserve wealth, not accumulate it. These inflation-proof assets are usually in a bond portfolio as a safeguard or a hedge. They come in minimum denominations of $100 and are available in 5-, 10- and 30-year maturities.

It’s worth noting that TIPS are the ultimate safe haven investment, and they typically gain favor with investors during periods of extreme inflation. The current market, in 2021 and 2022, is a great example of a time when TIPS became a popular hedge against record levels of inflation, especially alongside depressed equity markets.

Inflation is an Ever-Present Concern

Bonds can be a great hedge against market downturn and inflation, but you need to utilize them correctly. Treating some bonds as a “set it and forget it” defensive investment can end poorly if investors don’t take inflation into account. Strategies like bond laddering or investment products like TIPS are a smart way to take inflation into account.

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Bond funds offer plenty of stability and the appeal of stable income, but not all bond funds are the same. They vary greatly depending on the type of bonds the fund holds, its objectives and strategies for fund maintenance, and even the changing nature of the bond market. To that end, it’s not always easy to pinpoint the best performing bond funds through objective analysis.

Here’s a closer look at bond funds in 2022, including the most reliable funds based on trailing returns and how they’re expected to perform in the current rising rate environment.

Why Invest in Bond Funds?

The purpose of a bond fund is primarily to generate a steady stream of income through the interest payments generated by bonds. Bond funds offer a simple alternative to building your own bond portfolio. For example, instead of building a bond ladder that ensures accumulated monthly payments, an investor can invest in a bond fund that’ll deliver this same level of payout.

The other instance in which a bond fund is useful is as a portfolio hedge. Investors seeking to bring stability to an equity-focused portfolio might invest in a bond ETF. It’s a way to hedge against volatility, as well as create passive investment income that someone can reinvest in equities.

Bond ETFs vs. Bond Mutual Funds

Like equity funds, bond funds come in both ETF and mutual fund varieties. For most investors, the decision comes down to fund performance vs. expense ratio. Bond funds typically have a lower expense ratio than equity funds, but there’s still a level of active management that’s needed to ensure they perform as-expected.

The type of bonds you’re interested in can also have an effect on the type of fund you choose. Those interested in U.S. Treasuries, large corporate bonds and even municipal bonds will find both ETFs and mutual funds accessible. Those looking for riskier investments like foreign bonds or bonds from subprime issuers will want to trend toward ETFs, since most mutual funds will stick to safer investments.

The Best Performing Bond ETFs

The appeal of many bond ETFs is that it’s easy to enter and exit positions, giving bond investors flexibility to pursue the best yield. That, and there aren’t typically minimum investments for ETFs. Here’s a look at the best performing bond funds in this category:

• Invesco National AMT-Free Municipal Bond ETF (PZA) is continually rebalanced to optimize return and averages roughly 2.3% monthly on municipal bonds.
• iShares Core 1-5 Year USD Bond ETF (ISTB) safeguards against interest rate risk by holding short-term bonds at an extremely low 0.06% expense ratio.
• Pimco Active Bond ETF (BOND) includes corporate and municipal bonds, as well as emerging market bonds, to produce an average yield of 2.53%.
• VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL) is a junk bond ETF that manages an impressive 3% average yield.
• Vanguard Tax-Exempt Bond ETF (VTEB) has an extremely low expense fee of 0.06% and a respectable monthly yield of 1.83%, on average.
• Vanguard Total International Bond ETF (BNDX) focuses on foreign bonds: specifically, non-U.S. denominated investment-grade bonds.

The Top Performing Bond Mutual Funds

Investors looking for a managed bond investment will find it in bond-focused mutual funds. Many of these funds outperform ETF funds on the surface; however, they do come with higher expense ratios that can make these investments a horse apiece. Here are some of the top performers:

• BNY Mellon Bond Market Index Fund (DBIRX) is a short-term focused bond fund that returns 1.85% on average. It requires a minimum $1,000 investment.
• Fidelity Total Bond Fund (FTBFX) tracks both domestic and foreign bonds for broad exposure. This fund carries an expense ratio of 0.45%, but average a return of 2.28%.
• Northern Trust Bond Index (NOBOX) requires $2,500 to invest and has an impressive 2.13% average yield. Its expense ratio sits at 0.15%.
• Schwab U.S. Aggregate Bond Index Fund (SWAGX) has the lowest expense ratio on this list (0.04%) and averages 1.95%. It’s also the youngest fund on the list, est. 2017.
• T. Rowe Price QM U.S. Bond Index Fund (PBDIX) has a minimum investment requirement of $2,500. Investors should expect 1.92% yield and fees of 0.25%.
• Vanguard Total Bond Market Index Fund (VBTLX) requires a minimum investment of $3,000 but has almost no expense ratio (0.05%). It averages 1.95% monthly.

A Smart Way to Maintain Retirement Income

For retirees and investors who rely on bonds for regular income, the performance of the fund matters significantly. To that end, it’s important to carefully select funds that have a trailing history of returns, strong managers at the helm and strategies for adapting to the bond market itself.

Want more tips on how to invest in bond funds with confidence? Discover the best investment newsletters to get the scoop on bond funds and expert picks. You’ll learn not only how to identify the best performing bond funds, but what to expect from them as the bond market continues to take shape in 2022 and beyond.

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Often, investors have turned to gold as an investment to fight high inflation. Some professional investors question gold’s merits as an investment. It does not produce income, and people do not use the metal for anything other than jewelry. For instance, most of the world’s gold sits in bank vaults.

There has been a correlation between inflation and gold prices in the past. If you’re skeptical that correlation can persist, you may consider Series I bonds.

What are Series I Bonds?

Series I bonds are issued by the U.S. Treasury Department. They pay a fixed interest rate plus a variable rate of interest. The Treasury determines the fixed-rate, and the  Consumer Price Index (CPI) determines the variable rate. The CPI measures how much a basket of commonly purchased goods and services changes over time.

With the surge in inflation over the last several months, the rate on Series I bonds has jumped. Currently, they have a rate of 7.12%. Keep in mind that the rate on them resets at the end of April.

March inflation data determines the variable rate for May. Inflation was 8.5%, the highest since the early 1980s. So, investors in Series I bonds could see their rate increase again.

In addition, Series I bonds are low risk. Because the U.S. Treasury issues the bonds, the bonds are backed by the full faith and credit of the U.S. government. Like other treasury-issued bonds, investors consider them to be among the safest in the world.

Though Series I bonds are issued by the Treasury, they’re different from other Treasury notes and bonds in several ways. Make sure you fully understand the ins and outs of Series I bonds before investing. Let’s take a closer look.

How to Buy Series I Bonds

The first thing you need to know about how to buy Series I Bonds is that you can only buy the bonds through the Treasury website. You cannot buy them through your regular brokerage account. Though you would not be able to use your brokerage account, the Treasury does not charge fees for the transaction.

Also, Series I Bonds come in smaller denominations than typical bonds (here’s a free traditional bond yield calculator). Investors can buy them for as little as $50, $100, $200, $500 or $1,000 each. A single investor can purchase up to a maximum of $10,000 each year. Additionally, you could also buy $10,000 for your spouse or children.

If you buy Series I Bonds with your tax refund, you’re eligible for an extra allotment. This allotment is in addition to the regular $10,000 maximum. You can buy up to $5,000 of them if you go this route.

The maximum limit will affect everyone differently. For instance, high-net-worth investors may pass on Series I Bonds because the $10,000 max limit wouldn’t be enough to make a difference in their portfolio. On the other hand, if an allocation of Series I Bonds is a meaningful portion of your portfolio, you could benefit handsomely.

Series I Bonds Interest Rates

The variable part of Series I Bond interest rates resets every six months. If you think inflation will persist for the rest of the year, these may be appealing. On the other hand, if inflation returns to normal levels, the variable part of the interest rate may decrease.

You cannot sell Series I Bonds on a secondary market. You must redeem them with the Treasury if you want to get rid of them. In addition, they have a minimum one-year holding period. Future inflation is an important consideration.

You’ll be subject to early redemption penalties if you decide to redeem your bonds in less than five years. The early redemption penalty requires you to forfeit three months of interest. After five years, there is no penalty.

In some cases, paying the early redemption penalty may not be that bad. Interest paid on bank deposits, CDs and treasury bonds are historically low. The interest you earn from Series I Bonds for one year may be a better option, even if you pay the early redemption penalty.

Readers should also note that they are good for 30 years. So, if you believe that inflation is here to stay, these could be an excellent investment for you. Although, if inflation returns to normal levels soon, the early redemption penalty may be painful.

Final Thoughts

The U.S. Treasury will announce new rates on May 2. There is much to consider if you’re interested in Series I Bonds. One of those considerations is taxes.

Interest from them is exempt from state taxes but is taxable for Federal taxes. If the bondholder uses the interest to fund education, it could be excluded from federal taxes. Please consult your tax advisor before making any decisions.

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Different types of entities can issue bonds. These entities are looking to raise capital by borrowing money (principal) from investors. Bond issuers are mostly corporations or governments. A corporation may want to borrow money to run its business or pay for a project. In addition, a government may issue bonds to raise money for public services or to meet budget shortfalls.

For each bond an entity issues, it publishes an indenture. A bond indenture spells out the legal disclosures of the bond, including maturity, fixed interest rate (coupon), date of coupon payments, and certain covenants. Covenants place limits on the issuer to ensure the issuer can pay interest and principal at maturity. Fixed-rate bond investors like them because they’ve historically been a lower-risk option compared to stocks and other investments.

Why Invest in Fixed-Rate Bonds

There are many reasons why investors like fixed-rate bonds. One reason is that bond investors view bonds as a safe investment. By issuing an indenture, the borrower commits to making interest and principal payments to investors. The interest and principal payments come from the profits of a corporation, taxes received by governments or revenue from specific government services.

Asset-backed bonds are like folks borrowing money against their home. A corporation can pledge assets to back the bond in some instances. For example, a corporation may borrow money and pledge real estate or other property as collateral. If the corporation cannot pay interest or principal, the investors can claim the asset, sell it and get some or all the money the borrower owes them.

Another reason that investors like fixed-rate bonds is diversification. Bonds do not change in price as much as stocks or other investments. Wild swings in the stock market can cause investors to lose sleep. By investing in a portfolio of bonds, investors may feel better that their portfolio will be more stable over time. Many investors also chose to invest part of their portfolios in bonds and in stocks.

Risks

Though investors believe bonds to be safer than stocks, there are no guarantees. For instance, a corporation may go bankrupt or choose not to pay interest or principal. These are extreme cases, but they do happen.

If a bond issuer cannot make payments, the risk investors take called default risk. If a bond issuer goes bankrupt, it will sell all its assets and pay all its debts, like bonds. Asset-backed bondholders may get their principal and any interest due from the asset’s sale. Bonds not backed by assets will get the money left over from asset sales. Stockholders are last in line for money raised by asset sales.

Bond prices have historically swung less than stocks. Though, bond prices do change. When overall interest rates change, bond prices for fixed-rate bonds also change. For instance, say you hold a bond with a 5% coupon, and interest rates drop to 4% for new bonds with the same maturity. If you want to sell your bond, you can get a higher price because a seller can either buy the new 4% bond or buy yours for a higher price so that the yield to maturity is 4%. If you hold the bond to maturity, price changes are of little concern because you’ll receive your principal at maturity regardless of the price changes.

Fixed-Rate Bond Mutual Funds and ETFs

If you’re not interested in reading through indentures, disclosures or trading bonds, you’re in luck. Fixed-Rate Bond mutual funds pool investors’ money, and a fund manager invests money in the mutual fund for you. Interest payments for the bonds held in the mutual fund are paid to investors by the fund. Each mutual fund will charge a fee for its services.

Fixed-rate bond ETFs are a bit different. You own a basket of bonds through the ETFs structure instead of a portion of the pooled assets like a mutual fund. ETFs also have managers who invest your money in bonds. The ETF manager pays you the interest on each bond and charges a fee for their services. Though, fees are typically lower than mutual funds.

Bond mutual funds and ETFs can focus on certain types of bonds. For instance, they can hold only treasury, corporate or municipal bonds. Some can focus on short-term maturity bonds, which typically pay a lower coupon but may be safer. Managers can also invest in high-yield (junk) bonds that pay a higher coupon but have higher default risk.

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What are Treasury Direct Bonds?

Treasury bonds are government debt securities. Issued by the federal government, they are sold by the U.S. Treasury Department. Interest on treasury bonds is exempt from state and local taxes.

These bonds are sold on TreasuryDirect.gov which is managed by the Bureau of Fiscal Service.  Because the U.S. government issues Treasury Direct bonds, they are risk-free.

Treasury bonds, issued for terms of 20 or 30 years, pay interest every six months until maturity. At maturity, bond owners receive the face value. Note that once bonds mature, they no longer pay interest. Prices and yields of treasury bonds are determined at auction.

The series EE bonds, long a college savings favorite, earn a fixed rate of interest. These bonds are guaranteed to double in 20 years. In contrast, there is no guarantee that an I bond will grow to a specified amount.

In the past, Treasury bonds were issued in paper form. Now, Treasury bonds are all issued electronically.

How to Buy Treasury Direct Bonds

Purchase Treasury Direct bonds via TreasuryDirect.gov or from banks or brokers. Before buying bonds, you must set up an account. A personal checking or savings account is necessary to pay for bonds through TreasuryDirect. Such an account is also required to accept funds upon bond redemption.

As the New York Times notes, the TreasuryDirect website needs updating. While users submit bank information when signing up, changing that bank account later requires the use of a paper form. To make the change, users must print out a form and take it to their bank or credit union for bank officer certification. It is then mailed to a U.S. Treasury post office address in Minneapolis. It generally takes about 10 business days after form receipt for an updating of the TreasuryDirect account.

While TreasuryDirect representatives say that a modernization is underway that will permit users to change bank accounts without resorting to paper forms, no timetable was given. For now, if you want to set up an account to buy Treasury Direct bonds, choose a checking or savings account you plan to keep for a long time to avoid this hassle.

Buy Treasury Direct Bonds With Your Tax Refund

Expecting a federal or state tax refund? You can have that amount directed to your TreasuryDirect account by requesting the IRS or your state tax department to deposit your refund there. Purchase savings bonds once you receive the funds.

On your tax return, simply add the TreasuryDirect routing number, 051736158, in the routing number field. In the account number field, add your TreasuryDirect account number. For “account type,” choose Savings.

Competitive vs. Non-competitive Bids

Two types of bids are used at Treasury bond auctions. With non-competitive bids, the purchaser agrees to the interest rate determined at auction. The buyer receives the bonds they want at the full amount desired. Virtually all individual investors go the non-competitive route.

With competitive bids, the buyer specifies an acceptable yield. The result is:

• Acceptance of the full amount if the bid is less than or equal to the yield determined at auction.
• Acceptance of less than the full amount if the bid is equal to the high yield.
• Rejection if the specified yield exceeds that of the yield set at auction.

You cannot use competitive bidding through TreasuryDirect.gov. Instead, bidders must use a bank or broker. The majority of competitive bidders are institutional investors.

Minimum and Maximum Purchase Amounts

The minimum amount needed for purchasing Treasury Direct bonds is just $100. Bond amounts rise in increments of $100.

The maximum noncompetitive purchase amount in a single auction is $5 million. For a competitive bid, it is 35 percent of the offering amount.

Treasury Direct Bonds Considerations

You won’t receive 1099 forms or statements from your TreasuryDirect account. You can view the 1099 online and print it. Make sure your spouse and heirs are aware of this account. If you die and don’t leave information about the account, the executor of your estate may never discover it. That’s because most executors use tax returns or financial statements for information about the decedent’s accounts, and TreasuryDirect won’t show up there.

There are a few items to keep in mind when purchasing Treasury Direct bonds. For example, while buyers don’t have to hold an I bond for 30 years, they do have to hold it for one year before redemption. Holding the bond for more than one year but less than five years triggers a three months’ interest penalty. Bonds held for more than five years are not subject to this penalty.

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Federally Tax-Free Bonds

Issued by states, counties, cities and other governmental authorities, municipal bonds are the primary methods by which these entities raise capital for public project financing. Income from these bonds is from federal taxation. In fact, these are the only securities free from federal income tax. Municipal bonds are considered a safe investment. While municipal defaults are a possibility, such events are rare.

The most common types of municipal bonds are:

• General obligation bonds: These bonds are not secured by assets. Instead, backing is via the full faith and credit of the state, city, or county issuing the bond. These issuers have the ability to tax residents so that bondholders are paid.
• Revenue bonds: These bonds are backed by the revenues of a specific project and not by the government’s power to tax. Examples include revenue bonds for toll roads. Tolls from motorists are used to pay off such bonds.

You can purchase state-specific bonds that are free from federal, state and local tax. You must live in the state issuing these bonds in order to take advantage of state and local tax exemptions.

Keep reading for more info on tax-free bonds.

Pros and Cons of Municipal Bonds

The tax advantages of municipal bonds constitute the primary appeal for investors. Because they are fixed-income investments, bond buyers know they will receive steady, semi-annual income payments for the bond’s life.

On the con side, there’s  a call risk with municipal bonds. That means the issuer can repay the bond prior to its maturity date. When that happens, as when interest rates decline, the investor must reinvest their money at less attractive rates.

Inflation poses another risk factor. Along with purchase power reduction, inflation can lead to higher interest rates. In turn, this reduces the bond’s market value.

Bonds may suffer from a liquidity risk. Because so many bonds are purchased by investors for holding rather than active trading,  when they do want to buy or sell a bond they may not obtain the desired price. In fact, they may discover the same bond has various quotes.

State and Local Tax-Free Bonds

Income from bonds issued by the federal government is not free from federal taxation. However, such bonds are usually exempt from state and local taxes. This includes income from Treasury bonds.

Short, Intermediate and Long-term Tax-Free Bonds

Tax-free bonds are available with short, intermediate and long-term maturities. A bond’s interest rate is determined at its origination.

• Short-term tax-free bonds: Short-term bonds have a maturity date of three years or less. Risk is lower, but so is yield.
• Intermediate-term tax-free bonds: These maturity dates of these bonds is between two and 10 years. Because they fall into the middle of bond categories, their risk and return rate is also in that range.
• Long-term tax-free bonds: Long-term bonds maturity dates range from 10 to 25 years. Higher yields accompany greater risk. Because the bond takes so long to mature, inflation and interest rates are more likely to affect it.

How to Buy Them

Purchase tax-free bonds from an online or full-service brokerage or bank. Such purchases come with commissions. Before buying individual bonds, determine how these securities fit into your overall portfolio and tax strategies. When buying individual bonds, keep in mind that you will not receive the principal back until the bond’s maturity.

Many investors create a “ladder’ of municipal bonds to address the need for regular income. This portfolio involves a maturity date range. As bonds mature or are sold, the principal is regularly reinvested. The investor receives a steady income stream with less exposure to interest rate risk.

For most investors, the simplest way to purchase tax-free bonds is via a tax-free bond fund or ETF. Expect to pay sales charges and other fees. In either case, you own shares of the fund, rather than owning bonds outright. While funds offer more bond diversification, fund managers may sell bonds to offset falling market value when interest rates rise. That means the fund’s value may fluctuate.

One caveat: When purchasing shares of a bond fund or ETF holding any federal government bonds, it is your responsibility to determine the amount of federal bond income received. This information is not included in the tax forms provided by the investment company.

Taxable vs. Tax-Free Bonds

Not all municipal bonds are tax-free. State and local governments may issue taxable municipal bonds that do not meet the IRS criteria for public use or public purposes. Examples include bonds issued to finance sports facilities or boost public pension funding. Taxable municipal bonds tend to offer higher yields than tax-free bonds.

It is possible that taxable municipal bonds are exempt from state and local taxes for residents of that state. Always read the related documents pertaining to the bond or consult a financial advisor to determine a bond’s tax status before investing.

Tax-Free Bonds Ratings

No two municipal bonds are exactly alike. If going the individual tax-free bonds route, perform your due diligence by examining the bond’s rating. Three major agencies rate municipal bonds. These are Moody’s Investors Service, S&P Global and Fitch Ratings. The first two agencies rate over 80 percent of municipal bonds. For all three services, the best bonds are rated Triple-A. High and upper medium grade bonds are A rated, although the different agencies use different investment grading categories. Medium grade bonds have B ratings, although again the agencies use different gradings for essentially the same rating. For instance, Moody’s highest B rating is Baa, while S&P and Fitch use BBB+.

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