Bond ETFs: What the Bond Ratings Mean - dummies

By Russell Wild

If you are going to hold a portion of your investment portfolio in bond ETFs, you will need to have some knowledge of bond ratings.

In August 2011, the credit rating agency Standard & Poor’s (S&P) downgraded U.S. Treasury bonds from the highest rating (AAA) to a smidgeon below (AA+). Other bond raters did not follow suit.

Despite S&P’s dramatic announcement, U.S. Treasury bonds are still considered by nearly all to be the safest bonds in the land because they are backed by the full faith and credit of the U.S. government. And even though that government has a huge debt, it does have the ability to raise taxes.

Bonds issued by federal government agencies (such as the Government National Mortgage Association, commonly known as Ginnie Mae) are typically seen as one tiny step below Treasury bonds in terms of safety.

Bonds issued by corporations and municipalities (cities, counties, and their agencies) can vary in safety from quite high to very low, depending on the financial strength of the issuer. (Corporations tend to default more often than do municipalities.) The financial strength of the issuer is judged by credit rating agencies such as S&P and Moody’s. Following are the most common ratings.

S&P Rating Moody’s Rating Quality What It Means
AAA Aaa Highest grade Your money is safe; there’s no risk of default.
AA Aa High grade Your money is safe; there’s almost no risk of
A A Medium grade Your money is likely safe.
BBB Baa A little shaky Your money is probably safe.
BB Ba Somewhat speculative With a little luck, you’ll get your money back.
B B Very speculative With a lotta luck, you’ll get your money back.
CCC Caa Possibly in default Pray!
CC Ca Toilet paper Pray harder!