What Is a Triple-A (AAA) Bond Rating?
What You Need to Know About the Highest Quality Bonds
Once you build your investment capital and begin investing in bonds, you are likely to hear about bond credit ratings like Triple-A (AAA) bonds. This designation might seem confusing but it comes down to understanding how "safe" a bond is by looking at all sorts of metrics, such as the strength of the issuer's balance sheet, the likelihood of sufficient earnings and cash flows to cover the promised interest and principal repayments, and the collateral that can be seized in the event the bond defaults before or at bond maturity.
Understanding the AAA Bond Rating
AAA bonds are considered the absolute safest by the three primary bond rating agencies: Fitch, Moody's, and Standard & Poor's. Grades go as low as "D" for Fitch and Standard & Poor's, while "C" is the lowest rating for Moody's.
To understand these ratings, remember that bonds are similar to a loan. An entity issues a bond, which an investor buys with the expectation of being paid back in the future—plus interest. By granting the AAA rating, bond rating agencies signal that they have as much faith as possible in these entities to honor the terms of the bond. In other words, they believe there is a very low chance you won't get your money back.
It is extraordinarily difficult to achieve an AAA rating. As of Feb. 3, 2020, only two U.S. companies have AAA ratings: Johnson & Johnson and Microsoft.
Investment-Grade Bonds and Treasuries
AAA bonds belong to a broader category of bonds known as "investment-grade" bonds. Investment-grade bonds include any bond that is rated at or above BBB- (on the S&P and Fitch scale) or Baa3 (on the Moody's scale). This has important regulatory implications. For example, a bank trust department or pension fund may favor investment-grade bonds over lower-grade bonds.
The grading system can break down slightly when comparing investment-grade corporate bonds to government bonds like Treasury Bills and Treasury Notes—also known as "Treasuries." Even though a company like Microsoft may be able to issue AAA bonds, U.S. Treasuries are generally considered the safest bonds. That's because they carry the full weight of the U.S. government behind them.
Not all government bonds are as safe as Treasuries. Municipal bonds (munis) are issued by lower-level government bodies. They can be issued by state authorities, cities, or agencies like a school district. They can also be issued by U.S. territories like Puerto Rico. Since these bonds aren't issued by the federal government, they aren't backed by the federal government. The relative safety of municipal bond investments varies by the entity issuing them.
Junk Bonds: The Opposite of AAA
With lower risk comes fewer rewards. Due to their rock-solid status, AAA-rated bonds offer the lowest yields. What you gain in peace of mind, you lose in income.
On the other end of the spectrum are junk bonds, which have low ratings and high yields. They're also known as high-yield bonds. The companies who issue these kinds of bonds get poor ratings because credit agencies determine that they are in danger of defaulting (or have defaulted in the past). If they do default, bondholders may not get paid. To entice investors, these companies need to offer higher yields. Some investors then decide that it's worth the risk of investing in a junk bond to seek the higher returns offered.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.
Fidelity Investments. "Bond Ratings." Accessed Feb. 3, 2020.
Fitch Ratings. "Rating Definitions." Accessed Feb. 3, 2020.
Moody's Corporation. "Rating Symbols and Definitions," Page 6. Accessed Feb. 3, 2020.
S&P Global Ratings. "S&P Global Ratings Definition." Accessed Feb. 3, 2020.
Securities and Exchange Commission. "Form 10-K: Microsoft Corporation." Accessed Feb. 3, 2020.
S&P Global. "Fitch Affirms J&J's Ratings on Consistent Operating, Financial Performance." Accessed Feb. 3, 2020.
Office of Investor Education and Advocacy. "Bonds." Accessed Feb. 3, 2020.
Office of Investor Education and Advocacy. "Investor Bulletin: Municipal Bonds – An Overview." Accessed Feb. 3, 2020.
Fidelity Investments. "Bond Prices, Rates, and Yields." Accessed Feb. 3, 2020.
Office of Investor Education and Advocacy. "High-Yield Bond (Or Junk Bond)." Accessed Feb. 3, 2020.
Office of Investor Education and Advocacy. "What Are High-Yield Corporate Bonds?" Accessed Feb. 3, 2020.