Investments Zero Coupon Bond

Investments in a zero coupon bond may not be as good as financial planners make it out to be. Zero coupon bonds are claimed to be safe investments. Zero coupon bonds are government bonds, meaning they are safer than most bonds. But are investments in zero coupon bond really good?

Returns on investments of zero coupon bond

In practice, when considering tax and inflation, the return on investments of a zero coupon bond is roughly same as treasuries. Return on investments of a zero coupon bond is very low.

Volatility of investments in zero coupon bonds

Most investors do not know this, but zero coupon bonds are much more volatile than ordinary bonds. This is because zero coupon bonds do not pay interests. That means, if the issuer of the zero coupon bonds went bankrupt, you could lose everything. Investors of regular bonds at least would have collected on some interests.

You pay taxes on income from investments in zero coupon bonds

Zero coupon bonds do not pay interests but the IRS treats investments in zero coupon bond as though they earn regular interests just like normal bonds. This is called 'phantom income' which refers to income that you don't actually receive but still have to pay taxes on.

For example, if you purchase a zero coupon bond at 50% discount, say $100 whereas the zero coupon bond has value of $200. Technically, you would not have any benefits of the 50% discount until maturity. However, the IRS treats zero coupon bonds are through they pay regular interests to investors. You will owe taxes for the regular income that you would have gotten with other types of bonds.

Zero coupon bonds are callable

Since zero coupon bonds do not pay regular interests, a lot of owners of zero coupon bonds invested and then forget about them until maturity. When the zero coupon bonds are called, some investors were not informed.