Types of Bonds: Guide to Risks, Ratings and Returns

Bonds are a form of lending, not ownership. Issued by businesses, governments or agencies, they work like IOUs — investors lend money in exchange for regular interest payments and the return of principal at maturity. Common types include government bonds, corporate bonds, municipal bonds and savings bonds, each offering different levels of risk, return and tax advantages. Understanding the different types of bonds can help you choose the ones that best match your goals.

Key Features of Bonds

Although there are many different types of bonds, they share common traits:

• Face value or par value: The amount that a bond is worth at maturity. 
• Coupon rate: The interest rate that a bond pays.
• Maturity date: The date a bond comes due, when the issuer must repay the face value.
• Issuer’s credit rating: A score assigned by rating agencies to indicate the issuer’s risk level.
• Yield and price fluctuations: Bond prices move inversely to interest rates — as prices rise, yields fall, and vice versa.

Types of Bonds: Overview and Comparison

There are many types of bonds, but most fall into five main categories. The table below offers a quick overview:

Government Bonds

U.S. government bonds are 20- or 30-year debt securities issued by the U.S. Treasury. However, the U.S. government also issues other securities:

• Treasury bills: Mature in up to 52 weeks
• Treasury notes: Maturities ranging from 2 to 10 years
• Treasury bonds: Long-term, with 20- or 30-year maturities

Here are some key points to know about government bonds:

• All U.S. Treasury securities carry the backing of the full faith and credit of the U.S. government.
• They are considered among the safest investments in the world in terms of default risk.
• In exchange for safety, U.S. Treasuries generally offer low rates of return.
• Best suited for conservative investors looking for stability and low risk.

Municipal Bonds

Municipal bonds are issued by cities, states and local governments.

They are popular with investors because interest is exempt from federal taxes and often from state or local taxes if purchased in your home state. For example, a California municipal bond is usually exempt from both federal and California state taxes.

There are two main types of municipal bonds:

• Revenue bonds: Repaid with fees from a specific project, such as a toll road or bridge.
• General obligation bonds (GOs): Repaid with general tax revenues from the issuing government.

Corporate Bonds

Corporate bonds are securities issued by public or private corporations that need to raise money for their working capital or capital expenditures, such as equipment purchases.

Some types of corporate bonds include:

• Debentures. The majority of corporate bonds fall into this category. These bonds are secured only by the creditworthiness of the corporation issuing the bond.
• Mortgage bonds. These corporate bonds are secured by physical assets of the corporation, including equipment and buildings.
• Convertible bonds. These corporate bonds allow bondholders to convert their bonds into shares of stock from the issuing corporation.
• Callable bonds. These bonds allow issuers to redeem an issue prior to maturity.
• Guaranteed bonds. These corporate bonds offer interest payments and/or principal repayment that is guaranteed by a corporation that is not the issuer.

Agency Bonds

Agency bonds are issued by two main types of institutions:

Government-Sponsored Entities (GSEs)

• Examples include Fannie Mae and Freddie Mac.
• These bonds have the implicit backing of the U.S. government but not its full faith and credit, making them slightly riskier than U.S. Treasuries.
• They’re generally considered safe investments.

Fully Backed Federal Agencies

• Examples include Ginnie Mae, the Small Business Administration and the Federal Housing Administration.
• These bonds carry the full faith and credit of the U.S. government.
• They are among the safest types of agency bonds.

Foreign Bonds

Also known as sovereign bonds, foreign government bonds are issued by national governments in their own currency. They function similarly to U.S. Treasury or corporate bonds but come with a few unique characteristics.

Here’s what to know:

• Foreign bonds are often used to fund government operations, similar to U.S. Treasury bonds.
• They carry currency risk, meaning they can gain or lose value in U.S. dollar terms as exchange rates fluctuate.
• These bonds offer diversification by adding international exposure to your investment portfolio.
• They also tend to provide higher yields than U.S. Treasuries.

How Bonds Are Rated

Bond ratings help investors gauge how likely it is that the bond issuer will repay them. Here’s how it works:

• Top-tier bonds — AAA, AA: Seen as extremely dependable and have minimal risk of default — but that security usually comes with lower returns.
• Mid-tier bonds — A, BBB: Generally stable, though they come with a bit more risk.
• Lower-tier bonds — BB and below: Often labeled as “junk” or “high-yield” because they offer bigger returns — but with a higher chance the issuer could default.

How To Buy Bonds

You can buy bonds in a few ways:

• Through a brokerage firm: Most brokers offer a range of newly issued and secondary market bonds.
• Directly from the government: Some bonds can be bought through TreasuryDirect.gov.
• Via the secondary market: Buy existing bonds from other investors if the terms and rates meet your goals.
• Through bond funds and exchange-traded funds (ETFs): Bond ETFs provide diversification without picking individual bonds yourself.

Regardless of how you buy your bonds, your selection should match your investment objectives and risk tolerance.

For example, if you have a short-term financial goal and want to prioritize capital preservation, avoid long-term bonds — rising interest rates can dramatically reduce their prices.

Need help getting started? Here’s a quick guide to the five basic steps to buy bonds:

Risks of Investing in Bonds

All investments carry risk, and bonds are no different. Here’s a look at a few:

Why Bonds Belong in Your Portfolio

Bonds are an obvious choice for an income-oriented investor. However, there are a number of reasons why other types of investors might want to consider bonds for their portfolios. 

• Diversification: Bond prices don’t typically move as much as stock prices, you can use bonds to dampen the volatility of your overall portfolio.
• Set maturity dates: Because bonds have specific maturity dates, you can tailor your portfolio so that your bonds come due when you need the money.
• Fixed payments: Bonds offer investors payments in regular, pre-determined intervals, meaning you’ll always know when you’re going to get paid.
• Higher interest rates: While bonds may not offer the return potential of stocks, their interest rates are typically higher than those provided by bank savings accounts. 
• Conservative way to earn income: Bonds are often favored by retirees, as they provide predictable, fixed income with stability of principal.

Choosing the Right Type of Bond for You

The bond market offers something for almost every investor — but only if you match your picks to your needs. Use your financial goals as your compass: Are you aiming for stability, growth or income?

Not sure where to start? Consider speaking with a financial advisor who can help you build a bond portfolio that fits your timeline and risk level. A little planning now can set you up for stronger returns down the road.

Elizabeth Constantineau contributed to the reporting for this article.