How To Buy Bonds: A Beginner’s Guide To Investing

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When you think about how to buy a bond, the bond issuer, or borrower, typically agrees to pay you interest as well as return the original amount loaned once the bond reaches maturity. This can make bonds a good option for more conservative investors looking for a passive source of income.

While buying bonds is usually straightforward, it’s still important to understand how bonds work, how they’re priced and where you can buy them before you invest.

What Are Bonds?

A bond is a loan that an investor makes to a business, the government or another organization. Because of this, they’re sometimes referred to as debt securities.

Types of Bonds You Can Buy

Individual bonds come in three basic types:

• Government bonds
• Corporate bonds
• Municipal bonds

Each has its pros and cons, along with different investment goals. Here’s a look at the features, benefits and characteristics of each:

Government Bonds

U.S. government bonds are issued by the Treasury Department. They are fully guaranteed by the U.S. government, so there is virtually no default risk. This makes Treasury securities the safest type of investment if you’re looking to minimize your risk. However, Treasury securities also tend to offer lower interest rates than other types of bonds.

Although Treasury securities are often lumped together under the single moniker “Treasury bonds,” strictly speaking, there are three main types of Treasury securities:

• Treasury bills: Short-term securities with maturities of 52 weeks or less
• Treasury notes: Intermediate-term securities with maturities of between two and 10 years
• Treasury bonds: Longer-term securities with maturities of 20 or 30 years

All Treasury securities are exempt from state taxes, so they can be particularly attractive to those in high-tax states like California or New Jersey.

Corporate Bonds

With corporate bonds, you loan money to a specific company. If you’re looking for the highest potential payback, these are a good option because they typically pay higher interest rates than other bonds. The downside is, the companies that issue them are more likely to default than government entities. This is why it’s important to research the bond’s rating to find out how much risk you might be taking on.

Municipal Bonds

Municipal bonds, also known as “munis,” are issued by states, cities and other local government entities to finance public projects or offer public services. They are usually exempt from federal income tax, and they’re also usually state tax-free in their place of issue. This makes them an attractive investment for those in high tax brackets.

Where To Buy Bonds

There are three main ways you can buy bonds: from a broker, via a mutual fund, ETF or directly from the government.

Through a Broker

Brokers have access to a vast secondary market for bonds. As the name suggests, secondary market bonds are not new issues. Instead, they are existing bonds that were previously held by other bondholders.

Risks of Buying Bonds

Bonds are typically reliable, stable investments in comparison to stocks. However, like with any investment, they aren’t totally risk-free. Here are some potential risks to consider:

• Interest-rate risk: There’s a risk that rising market interest rates will drive down the price of your bond.
• Credit risk: There’s a risk that the bond issuer will default.
• Inflation risk: There’s the risk that your purchasing power will be eroded due to the effects of inflation.
• Liquidity risk: There’s a risk that you won’t be able to sell your bond quickly and at the price you want.

Is Buying Bonds Right for You?

Consider the type of bond you’re investing in, along with any trends in interest rates and how trustworthy the bond issuer is when it comes to paying back what’s owed.

Buying bonds might be a smart choice if you’re a beginner investor and aren’t ready for bigger risks. Bonds are considered low-risk investments and can be a way to create a steady stream of passive income. While you might not see high returns compared to investing in stocks or real estate, bonds are considered stable, which may be valuable if you’re close to retirement.

Bonds may be a great way to diversify your portfolio, providing you with a mix of safe and aggressive investments. They can even be your main source of income, depending on your financial goals and personal needs.

Melanie Grafil contributed to the reporting for this article.

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