Credit Quality

Bonds rated AAA, AA, or A by S & P and Fitch (Aaa, Aa, or A by Moody’s) are not likely to default. They pay a lower yield than low-rated corporate bonds, but also a higher yield than you can get on US Treasuries. It’s all about trade-offs when you’re trying to invest. If you choose the absolute safety of US Treasuries over riskier corporate bonds, you will sleep better, but your yield will be much lower. If you choose T-bills over T-bonds based on your unwillingness to set aside money for a long period of time, you simultaneously improve your liquidity and lower your yield. Within the world of corporate bonds you can buy sleep with high-rated securities but, therefore, sacrifice some yield. On the other hand, if you chase after high yield by purchasing low-rated corporate bonds, you could watch a $1,000 bond drop to zero when the company hits a snag and declares bankruptcy.Corporate bonds pay regular streams of interest, but that income is taxable by the federal and state governments. If you’re wealthy and living in a high-tax state such as Maryland or Massachusetts, you might be taking in an 8% income stream from the corporate bond but then sharing close to half of that with the government in Washington, DC and the one in your own state capital. Ouch. To get a break from such nonsense, many people purchase the next type of fixed-income securities.