Agency Bonds: The Risks and Returns - dummies

Agency Bonds: The Risks and Returns

All agency bonds are considered high quality with very little risk of default. The honest-and-true federal agencies, such as the Small Business Administration (SBA), are said to have no risk of default; therefore, their bonds pay more or less what Treasuries do. You may get a smidgen more interest (maybe 5 basis points, or 5/100 of 1 percent) to compensate you for the lesser liquidity of such agency bonds (the lesser ability to sell them in a flash).

The majority of agency bonds are issued by government-sponsored enterprises (GSEs), and the risk of default, although real, is probably next to nothing. You get a higher rate of interest on these bonds than you do with Treasuries to compensate you for the fact that the risk of default does exist.

Most agency bonds pay a fixed rate of interest twice a year. About 25 percent of them are callable, meaning that the agencies issuing the bonds have the right to cancel the bond and give you back your principal. The other 75 percent are non-callable bonds (sometimes referred to as bullet bonds). Callable bonds tend to pay somewhat higher rates of interest, but your investment takes on a certain degree of uncertainty.

Investing in individual agency bonds, or individual bonds of any kind, is not an activity for people who live paycheck to paycheck. Although you may be able to get into the game for as little as $1,000, bond brokers typically mark up such small transactions to the point that they simply don’t make sense.

You should probably not even look at individual agency bonds unless you’ve got at least $50,000 to invest in a pop. Otherwise, you should be looking at bond funds, or individual Treasuries that you can buy without paying any markup whatsoever.