I’ve written about buying municipal and state bonds in the past but I’ve never actually done it. When reviewing Maryland bonds, the rates just didn’t seem high enough for me (I’d looked at investing directly with the state through one of their partners and at buying bonds out in the market) so I never did it.

While I never thought about municipal bonds defaulting, I knew that it was a possibility. Certificates of deposit are backed by FDIC insurance. Treasury bonds are backed by the Federal government. If the Feds defaulted, I’d have bigger problems than losing what little I invested in those two vehicles. With municipal bonds, backed by states and counties, the default risk is very real.

Just last week, commissioners in Jefferson County in Alabama voted 4-1 to default on $3.14 billion in municipal bonds. The bonds were to fund a sewer renovation and commissions had approved a plan, back in September, that would avoid this that included $1.1 billion in concessions and a sewer rate increase of up to 8.2% over the first three years. Creditors wouldn’t agree to those concessions, the county legislature couldn’t pass a bill, and so now it appears the county will default.

While this particular default made headlines because of its size, the article goes on to discuss other defaults. Jefferson County is just the 11th this year and beat the previous record set by Orange County, California in 1994. In that default, there were $2.2 billion in debt outstanding.

You’ve probably heard of the 120 minus your age diversification rule: subtract your age from 120 and that’s how, as a percentage of your investments, much you should have invested in stocks. The rest should be in bonds. The idea behind that rule is that stocks are “risky” and bonds are “safe.” Are bonds really any safer than stocks?

At it’s core, a bond is a simple instrument. You are basically buying a debt instrument and loaning a company or municipal government or some other entity some money. The bond has terms like a regular interest payout (coupon rate), a life span, and a par (face) value. The bonds are themselves guaranteed by the entity that issued them and riskier entities typically offer higher interest rates to offset the risk that the entity defaults.

As you’d expect with any financial instrument, there are all sorts of variations on this general theme. For example, there are bonds that let the issuer “call” them, or pay them off, early. There are zero coupon bonds sold at a discount to face value (so you pay $80 for a $100 bond, get no interest, but you get $100 when it matures).

So does that make them riskier or safer than stocks?

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Reader Sam asked me if I could write a post about buying foreign government bonds as a way of diversifying your portfolio. The idea of buying foreign government bonds is appealing on several levels because you get to invest in a foreign currency, you get a regular coupon, and it definitely diversifies your portfolio.

I don’t foresee myself investing in foreign government bonds. With so many risk factors at play, I think I’d much rather invest in equities if I were to go international. Bonds should be used as a “safer” investment and when you go international, you introduce so many risks that cut into the idea that bonds are a safe investment.

That being said, it’s still important to understand how things work and if you want to buy foreign government bonds, here’s how.

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Pick any action movie ever made and chances are someone is trying to steal a boatload of bearer bonds. My first introduction to them was in the Bruce Willis classic Die Hard but my favorite movie involving guns and bearer bonds was Heat. As a kid, all I knew was that bearer bonds were valuable. Very valuable.

They were so valuable that guys would arm themselves with automatic weapons and assault rifles just to steal a bunch of them. As a kid, and honestly that’s all you needed to know to understand the plot, I thought bearer bonds were the bee’s knees. Move over Benjamins, I want some bearer bonds.

Only later did I learn that, while still awesome, bearer bonds were just bonds… and bonds are actually quite boring.

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Right now, the best savings account rates aren’t even 2% APY. They’re so low that even those people who are earning nothing, 0%, have very little incentive to move their money! If Bank of America is paying you 0.10% in your savings account, and an online bank is offering 1.50%, do you know how much more money you’d earn if you moved $1,000 over? You wouldn’t even make fifteen bucks more. That’s it. How much is your time worth? Certainly more than $15!

The Federal Reserve is making it hard for savers to save because they’re keeping the target interest rate so low. Why would a bank pay you 1% when they can get it for less than 0.25% from the Fed? It’s a miracle the rate is as high as 1.50%! The problem with trying to find a safe alternative is that in order to get the rewards, you have to take some risks. Savings accounts have zero principal risk because they are FDIC insured, the only risk you face is inflation risk (you earn 1% but inflation goes up 3%, you’ve essentially lost purchasing power) and everyone deals with that.

So what are some “relatively” safe alternatives?
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Last week I was volunteering at Meals on Wheels when one of the other volunteers, Cheryl, asked me about buying state bonds. Until last week, I hadn’t really given it much research because the idea of buying individual bonds was never tremendously appealing. There is a big barrier to entry when you’re buying individual bonds and it’s with the minimum purchase amounts. In Maryland, if you buy the bonds from the state through a broker, your minimum buy is for $5,000 and your purchase must be in increments of $5,000. However, you can buy them in smaller increments on the secondary market so I thought I’d give it a look for this Foundation series post on buying municipal and state bonds.

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I discovered this very informative article, “No-Stock Portfolio,” via Tip’d this weekend and it really gave me a stronger sense of the number of non-stock investment options there are out there. So often I get stuck in the mindset that “investing” refers to either the stock market or real estate when the area is so much larger. Jeffrey Kosnett, the author and a senior editor at Kiplinger’s, goes into a sample portfolio you could build of non-stock investments, he calls it his Tofurky Porfolio (meat that isn’t meat!), and I think its value is in the investments he outlines and not in the percentages he selects.

These are not recommendations, just a listing of non-stock investment options that are available.

The investments he describes were:

• Blue-chip IOUs: These are high quality corporate bonds from companies that have been beat up lately.
• REIT Preferred: Real estate investment trust preferred stock. It’s stock but they are senior to common stock and you get dividends first. One of the companies he mentioned, COPT, owns pretty much every building I’ve ever worked in for the last 5 years (well, except my house).
• Energy: Specifically funds that track oil and natural gas commodities. Oil is down pretty big right now with the fears of a world-wide recession, but you know the black stuff can’t be held down for long.
• Tax-free income: These are tax-exempt bonds like state and local municipal bonds (muni’s). For a little while I was in Vanguard’s tax exempt money market but the yield on that baby pretty much dried up.
• Gold: Another commodity, gold is always a favorite because it’s a hedge against inflation (which we will probably see quite a bit of once the recession subsides, you don’t print money without having some sort of risk). If the idea of gold, or other such commodities, interests you, one of the better books on the subject, including detailed how-to’s, is Peter Schiff’s Bull Moves in Bear Markets.

I’ve been interested in getting more involved with higher yield bonds, either corporate or muni’s, as their yields often beat the best certificate of deposit and high yield savings accounts rates. There’s risk involved, CD’s and savings accounts are FDIC insured and bonds can default, but I would imagine muni’s are pretty safe.

I can’t, for the life of me, figure out how I can buy individual municipal bond. When I do a search, I’m inundated with mutual fund companies with Maryland municipal bond funds, but no way to buy an individual bond. Is this a sign that I should be buying individual muni’s or am I just looking in the wrong place? If Vanguard had a Maryland muni fund I’d be all over it but they don’t and the thought of opening yet another account is unappealing.