Investing in Corporate Bonds vs. Government Bonds

If you’re considering buying bonds to add to your investment portfolio, you may find yourself choosing between corporate bonds and government bonds. Both options can offer a reliable income stream and relatively low risk when compared with stocks, but they also have noteworthy differences. Corporate and government bonds differ in terms of issuer, risk, maturity and more. Before investing in bonds, let’s compare the differences so you can choose the right investments for your portfolio.

Thinking about adding bonds to your investment mix? A financial advisor can show you how investing in bonds can contribute to a balanced portfolio.

What Is a Corporate Bond?

A corporate bond is a type of debt security companies issue to raise capital. When a corporation needs to finance new projects, maintain operations or refinance existing debt, it may issue bonds to investors. By purchasing a corporate bond, you’re essentially lending money to the company in exchange for regular interest payments, typically made semi-annually, and the return of the bond’s face value when it matures.

Corporate bonds are a type of loan. The issuing company agrees to pay the bondholder a fixed interest rate, known as the coupon rate, over a specified period. Once the bond reaches its maturity date, the issuer repays the principal amount, or face value, to the investor. The length of a corporate bond can vary, ranging from a few years to several decades.

Companies often issue bonds to raise capital for large expenditures like expansion, acquisitions or other major projects. Bonds are a more flexible and often cheaper alternative to taking out loans from banks. Issuing bonds also allows companies to maintain control of their operations without diluting ownership, which can occur when selling equity (shares of stock).

What Is a Government Bond?

A government bond is similar to a corporate bond, only instead of lending money to a company, a bondholder lends money to the government. When you buy a government bond, you lend money to the government in exchange for a promise of repayment, plus interest, over a set period of time. These bonds are considered low-risk investments, as they’re backed by the issuing government.

The government sells bonds to investors with the understanding that they’ll repay the principal amount, or face value, when the bond matures. In the meantime, the bondholder earns interest, typically paid semiannually. The interest rate, known as the coupon rate, can vary depending on the type of bond, market conditions and the issuing government’s creditworthiness.

Different countries issue various types of bonds. In the U.S., for example, Treasury bonds, notes and bills are common, with varying terms and interest structures. Treasury bonds have the longest maturities, either 20 or 30 years, while Treasury bills are short-term investments maturing within a year. Some governments also offer inflation-protected bonds, like the U.S. Treasury Inflation-Protected Securities (TIPS), which adjust for inflation over time.

Conservative investors, particularly those nearing retirement, often favor government bonds due to their stability and predictable income. While they may not offer high returns compared to stocks, they provide a steady income stream and serve as a hedge against more volatile investments.

Corporate Bonds vs. Government Bonds

A financial advisor explaining to clients how to add bonds to their portfolio.

Corporate bonds and government bonds work in similar ways, but their differences are worth knowing. Each type has its own pros and cons, and understanding how these types of bonds differ can help you make informed investment decisions.

Below are five common ways in which corporate bonds and government bonds differ:

Risk: Government bonds, particularly those issued by the U.S. Treasury, are often considered among the safest investments because they’re backed by the government. Unless the government defaults, investors can expect to get their principal and interest payments as promised. Corporate bonds carry more risk. Companies may default on their debt, leading to a potential loss for investors. But the level of risk depends on the company’s financial health, and corporate bonds are rated based on their creditworthiness.
Stability: Government bonds tend to be more stable in value, especially during economic downturns. This makes them a go-to choice for risk-averse investors. Corporate bonds, depending on the company, may fluctuate more in value, particularly if the company faces financial difficulties.
Liquidity: Government bonds are also more liquid, meaning investors can easily buy and sell them without much impact on their price. Corporate bonds’ liquidity can also vary, especially for bonds issued by smaller or less well-known companies.
Yield: In general, corporate bonds offer higher yields compared to government bonds. Because they come with higher risk, corporations compensate investors with better returns. This makes corporate bonds an attractive option for those looking to increase their income potential. Government bonds, while safer, usually offer lower interest rates, which can be less appealing to investors looking for strong growth in their portfolios.
Taxes: One of the benefits of government bonds, especially municipal bonds, is that they can be tax-exempt at the federal, state or local levels. This makes them especially attractive to investors in higher tax brackets. Corporate bonds, however, are usually fully taxable, which can reduce their overall appeal for some investors.

How to Use Bonds in Your Portfolio

Bonds can play an important role in diversifying your investment portfolio, especially if you’re looking for stability and steady income. As debt securities issued by governments or corporations, they provide regular interest payments, known as coupons, and return the principal upon maturity. A major advantage of bonds is their lower risk when compared with stocks, which makes them an attractive option for conservative investors or those nearing retirement.

On the other hand, bonds are vulnerable to inflation. As inflation rises, the fixed interest payments from bonds lose purchasing power, making them less attractive in high-inflation environments. So while they provide safety, the tradeoff is that you may miss out on the potential for higher growth that equities offer over the long term. Bonds are also subject to interest rate risk; when interest rates rise, bond prices tend to fall, potentially resulting in capital losses if you sell before maturity.

When deciding whether to include bonds in your portfolio, consider your risk tolerance and financial goals. Bonds can provide stability and income but may not be suitable for everyone, especially if you’re prioritizing growth.

Bottom Line

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Both corporate and government bonds can offer stable income and relatively low risk, but they each have unique advantages and disadvantages, too. Government bonds, typically backed by the full faith and credit of the issuing government, provide a safer option, especially for conservative investors seeking steady, lower-risk returns. Corporate bonds can offer higher yields but come with added risk, as their performance is tied to the financial health of the issuing company. Diversifying between both types of bonds can help balance risk and return, but the right approach for you depends on your financial goals and risk tolerance.

Investment Planning Tips

If you’re interested in creating or building out your portfolio, a financial advisor can work with you to identify investment opportunities and manage risks. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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