How Secure are AAA Bonds?

AAA bonds are a form of corporate bond, and corporate bonds as a whole represent an alternative to the normal stock portfolios. Their regular interest payments and relatively low-level of risk make them a popular choice. However, many wonder how secure these AAA bonds really are. Here are the basics of what AAA bonds are and what level of risk they present you as an investor. 

AAA Bonds

Corporate bonds are issued by companies as a debt instrument. These bonds are offered to investors in exchange for a certain amount of money. When an investor buys a bond, they are investing in a particular company. However, they are not a part owner like when they buy stock. They are actually considered a creditor. Through purchasing a bond, an individual is, in effect, giving a company an interest-only loan. The company pays the individual interest payments over the life of the loan and then makes a "balloon payment" at the end to satisfy the value of the bond. 

When a corporation wants to take out a loan from the bank, the bank will pull their business credit file and take a look at it. They will offer them a loan at a certain percentage of interest based upon their credit rating. As an individual, you will not have access to a company's credit file. Therefore, you need something to determine exactly how much of a credit risk a company is. This is where companies like Standard & Poor's and Moody's come into play. Through their rating systems, you can see exactly what a company's level of credit risk is. If they have a credit rating of AAA, this represents the best possible scenario for an investor. Companies with this rating have the best credit histories and a good chance of staying in business for many years. These are the big companies in the market with an impeccable track record. 

From there, the scale goes all the way down to D for those companies that have bad credit. While you will get a higher interest rate for investing in those companies with bad credit, you also take on greater risk. 

AAA Bond Risk

All that this rating system tells you is that AAA bonds give you the best chance to avoid losing your initial investment compared to other bonds. The company has a great credit score and a good debt situation. You will receive a regular interest payment for as long as that company is in business. In the investment world, this is one of the lowest forms of risk available.

With that being said, anything can happen in the business world. People with great credit scores have been known to eventually go bankrupt. The same is true of a large corporation. Therefore, you should never put all of your investment funds into a single AAA bond just because it is supposedly a safe investment. Diversifying your funds over an entire portfolio with AAA bonds as a part of it is the safest course of action to take for the long term.

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