Even if you’re new to investing, you’ve probably heard of bonds. A bond is a loan that an investor makes to a corporation, government body or other organization. That’s why bonds are also referred to as debt securities.
When you buy a bond, the bond issuer, or borrower, typically enters into a legal agreement to pay you interest as well as the original sum loaned at the bond’s maturity date. The process of buying bonds is usually pretty straightforward, but there are some things you’ll need to know. Keep reading to learn more.
How and Where You Can Buy Bonds: Tips for Getting Started
As an investor, you can buy individual bonds either through a broker or directly from an issuing government entity. Most corporate bonds are issued in increments of $1,000, so you’ll need to fund your brokerage account balance with at least that much money to get started.
U.S. Treasury bonds are a little different. They have a face value of $1,000, but the minimum bid is $100, and they are sold in $100 increments. U.S. Treasury bonds can be purchased through a broker or directly at the Treasury Direct website.
You can purchase bonds as new issues or on the secondary market.
What To Keep an Eye On When Buying Bonds
Before putting your money into bonds, there are some things you’ll need to research and consider. Here’s a quick look:
Which Bonds Should You Buy?
Individual bonds come in three basic forms, and each has its own pros and cons to fit different investment goals. The biggest risk you face is that a bond might default, which means you could lose your entire investment. Here are the three main types of bonds, and what to keep an eye on:
- 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, e.g. investment-grade or non-investment grade/junk bonds, 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. Munis also have the risk of default, so you’ll want to research the issuer and what the proceeds are being used for.
- Treasury bonds. Also known as T-bonds, these are fully guaranteed by the U.S. government, so there is virtually no default risk. This makes T-bonds the safest type in case you want to minimize your risk. But Treasury bonds also tend to offer lower interest rates than corporate bonds.
What Terms Should You Know?
As with any other investment, bonds come with their own language that you’ll need to be familiar with before diving in. Here are some terms that will likely pop up as you start investing in bonds:
Bond Investment Terms:
- Coupon: This refers to the interest rate paid by the bond. In most cases, it won’t change after the bond is issued.
- Yield: A bond’s yield is an interest measurement that takes into account the bond’s fluctuating changes in value. Yields can be measured in different ways, but the simplest way is to divide the bond’s coupon by the current price.
- Face value: This refers to the amount the bond is worth when it’s issued, also known as the “par” value. The face value of most bonds is $1,000.
- Price: In the bond world, the price is the amount the bond would currently cost on the secondary market. A bond’s price can be influenced by several factors, but one of the biggest is how favorable its coupon is compared with other similar bonds.
What Are Secondary Market Bonds?
As the name suggests, secondary market bonds are not new issues. Instead, they were previously held by other bondholders. You can purchase secondary bonds from brokerages, specialty bond brokers or public exchanges.
You’ll need to research secondary market bonds because their pricing is less transparent than with new issues. With secondary market bonds, you might see a markup in price. You might also see the same bond offered by two different dealers at two different prices. Another thing to keep in mind is that you might be charged commissions, transaction fees and contract fees on the secondary market.
What Other Investment Options Are Available?
Although many investors prefer buying individual bonds, those aren’t the only, or even the best, option available, especially for beginners. Here are some other ways to enter the bond market:
Bond Mutual Funds
Bond mutual funds are similar to stock mutual funds in that they let you pool money with other investors to purchase shares of a bond portfolio. They offer many of the same benefits as individual bonds, but with less risk. Buying mutual bond funds is also simpler, though you’ll likely face management fees and minimum investments.
One benefit of bond mutual funds is that you get greater liquidity because you can buy and sell shares of bonds as easily as buying and selling stocks. Funds also make it easy to reinvest your income payment dividends back into the fund to keep growing your investment.
Another option is to buy bond exchange-traded funds. These are similar to bond mutual funds in that they are made up of baskets of bonds that follow a particular investment strategy. The main difference is that shares of ETFs trade like stocks during regular market hours, rather than only once a day as with mutual funds. Like bond mutual funds, bond ETFs offer regular income payments. ETFs also typically have lower fees than regular mutual funds.
The Bottom Line
No matter how you invest in bonds – through individual bonds, bond mutual funds or bond ETFs – doing so adds both diversification and reliable income to your portfolio. The key to successful bond investing, as with any investing, is to do your due diligence and find the right fit for your investment goals. Take the time to research issuers, learn about different interest rates and maturity terms, and compare bond ratings.
This article has been updated with additional reporting since its original publication.