Municipal Bond Forum
How Zero Coupon bonds stack up
Q
Using the best rates that can be found, would you please explain if it is better to invest in zero coupon bonds or traditional bonds? Assume I would reinvest (likely in a savings account, until I have the minimum to reinvest in other bonds) the semi-annual money I receive from the traditional bonds.
A
James A. Klotz responds:
There is no simple answer to your question.
Assuming zero coupon bonds are held to maturity, they will accrete at the stated yield. Therefore, you can precisely calculate your return and proceeds at maturity.
On the other hand, by reinvesting the interest from coupon bonds, your total return will vary based on reinvestment rates over the term of the bonds.
Zero coupon bonds add balance to an equity-heavy portfolio and are an excellent vehicle for funding a future event such as a grandchild’s college education or any balloon payment. For more on zero coupon bonds, see: “A Prescription for Growth.”
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