While not the same as investing in the stock market, purchasing bonds – as with any investment – does involve some risk. Although bonds are historically very safe investments, rule number one of investing for dummies is that it’s better to have insurance and not need it than it is to need it and not have it. Follow this guide to insuring the bonds you purchase.
Bond insurance isn’t always necessary – but it has rescued many investors during economic crises.
Bonds are financial securities in which the bond’s issuer goes into debt to the individual or entity that purchases the bond, usually with the promise to pay back the original amount plus interest. This makes bonds similar to an IOU. The date that the bondholder is due repayment plus interest is called the date of the bond’s “maturity.” Historically, bonds have been conservative, low-risk, low-return investments. Bonds are often issued by governments and municipalities to finance everything from the construction of bridges to foreign wars. People who buy bonds are merely lenders, unlike stocks, in which purchasers become shareholders in the company.
As discussed in “Standard & Poor’s Stands Behind Bond Insurance,” the entities that issue bonds rarely default. But since they can and occasionally do, bond insurance exists to protect investors. In exchange for a the payment of a premium, insurers guarantee that bond payments will be received on schedule when the bond matures. Only financial guaranty insurance companies may write bond insurance.
Who Needs Bond Insurance?
Municipalities rarely default on the bonds they issue for public projects, but they occasionally do. It is important to know the financial situation and history of the entity issuing the bond. But that isn’t always enough. When Hurricane Katrina devastated New Orleans, for example, insured Louisiana bonds lost significantly less market value than uninsured Louisiana bonds.
Bond Insurance Regulation and Purchase
Bond insurance is regulated by state, meaning that the insurer must be licensed to write insurance by the state where the bond will be insured. When you purchase a bond, you don’t buy insurance separately, the way you do when you buy car insurance or fire insurance from a third party. Instead, the buyer purchases bonds that have already been insured upon being issued.
Although bonds are historically safe, there is some risk associated with debt securities.
One of the first rules of investing for dummies is that bonds are safe, conservative investments. Often used to mitigate other risks in a portfolio or to comfort older investors or investors who can’t tolerate the risks of the stock market, bonds are not something usually associated with danger. Insurance, however, has rescued bondholders in times of economic uncertainty or natural disasters.
Andrew Lisa is a freelance finance writer. He covers securities and investments.