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July 11, 2018

Focus on Financial Freedom: Know About That in Which You Invest

Focus on Financial Freedom: An Ongoing Series

In his classic, The Richest Man in Babylon: Seven Cures of a Lean Purse, Clason states:

“Know about that in which you invest.”

Since many of us in our online communities are working in the real estate industry, we sometimes fail to consider, or understand, suitable alternatives to real estate for our investment portfolios.

There are two ways to invest, “Owning: and “Loaning.” We have already talked about Common and Preferred Stock. Owning stock is owning a piece of a company, an entity.

Bonds are a way to loan money as an investment. There are many ways to ‘loan’ money. We will start by looking at government bonds and follow that with the world of corporate finance.

Bonds - Debt Position - Income

Treasury Securities - These are direct obligations of the U.S. Government. They are backed by the "full faith and credit" of the U.S. Government and are perceived by investors as having limited credit risk. They are, however, subject to interest rate risk. Treasury Securities are subject to full federal taxation but are exempted from state and local taxes. They are issued in three forms. This is the great government "Ponzi" scheme, and the U.S. Government raises new money to pay off the old.

Treasury Bills - Issued with maturities of 3,6, and 12 months. No certificates are issued; bills are distributed in electronic book-entry form. Investors receive a purchase confirmation from the seller, typically a brokerage firm or bank. They are sold at a discount, below face value. The discount is determined based on competitive bids submitted to the Federal Reserve Bank, acting on behalf of the U.S. Treasury. From the issue date until maturity, the discount will fluctuate with secondary market conditions and interest rate levels. Bills are redeemed at maturity by the Treasury for full face value. The difference between the purchase price and the matured value is the investors return.

Treasury Notes – Interest-bearing securities issued with maturities from 1 to 10 years. Interest is payable semi-annually; face value is payable at maturity. The interest rate is determined by competitive bids submitted to the Federal Reserve Bank. In the secondary market, notes are quoted as a percentage of par value (either at a discount or at a premium) plus fractional 32nds of a point. Historically, they were sold in bearer or registered form. After July 1983, they were issued in registered form only. Since early 1986, they have been issued in book-entry form.

Treasury Bonds - These U.S. Government Securities have maturities of more than 10 years and resemble Treasury Notes. Interest payments are made semi-annually. They are initially offered for sale at public auction. The Interest rate is determined competitively. For trading purposes, they are quoted the same way as Notes. About half of outstanding bond issues are callable, with the call date generally being 5 years before maturity. In prior years, bonds were available in both registered and bearer form. Since September 1983, they have been offered in registered form only.

Obligations backed by Agencies of the U.S. Government (Ginnie Maes)

Corporate Obligations - High-Grade Corporate Securities and Higher Risk Corporate Securities (Junk Bonds)

Municipal Bonds - These are particularly attractive to individuals in higher tax brackets, because the interest is exempt from federal tax and is also possibly state tax exempt (check with your investment advisor or state taxing entity.)

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