Most new investors think about the stock market and the high gains associated with investing in stocks. However, they miss the opportunities in one other asset class – bonds.
Bonds are a type of asset class based on debt. Instead of a company or government agency going to a bank, they offer the public to lend money to them, which they repay later.
Having bonds can have a positive impact on your portfolio, yet many investors sidestep bonds. Some may be confused or put off by the terminology or perceived complexity. However, bonds are easy to invest in and are not complex to understand. Investors can check out here to find out more about bonds and where to buy them.
In this article, we’ll take a look at how you can get started in buying bonds and what you need to look out for when managing your portfolio.
What we’ll cover:
- Why invest in bonds?
- What are the different types of bonds?
- How to buy bonds
- Things to look out for before you invest in bonds
Why invest in bonds?
Bonds provide more predictability in your portfolio and deliver a better yield compared to a money market fund or bank savings account. The lower-risk factor does come with a trade-off, as low-risk investments don’t produce higher rates of return.
Investors purchase bonds to:
- Acquire a predictable income source.
- Get back the money you invested once the bond matures, including the interest.
- Provide divarication to offset risks.
What are the different types of bonds?
Here are some of the bond types investors look to diversify their portfolio:
A city or state issues these tax-free bonds to raise money for municipal projects and come in two forms:
- General Obligation bonds: An issuing municipality fully back these bonds
- Revenue bonds: Investors are paid back with expected income from a municipal project
Companies issue corporate bonds to raise capital. Corporate bonds offer higher yields than other bonds but are taxable.
With these bonds, The U.S government issues them to the public and considers them the most secure kind of bond.
Bond funds are like ETFs (Exchange Traded Funds), where multiple stocks are managed in one fund. Bond funds have a higher interest rate but do carry more risk.
How to buy Bonds
Once you understand the different types of bonds, it’s time to invest. The are several ways you can go about purchasing bonds, but here we’ll look at some methods:
- Purchase through a broker: Like stocks, you can purchase bonds through a professional broker.
- Buy an ETF: An asset manager manages an ETF and typically buys bonds from different companies. These ETFs can focus from short to long-term and provide broad exposure to many industries.
- Purchase directly from the government: You can purchase Municipal bonds and treasuries from the government. As it’s a direct purchase, no brokerage is necessary.
New issues vs. secondary bonds
You can purchase bonds as a new issue or used or a secondary market.
New issued bonds are similar to IPOs (Initial Public Offering) on the stock market. When buying new issue corporate bonds, you need to work with a broker that manages the primary bond offering. You will need to set up a breakage account to pay the purchasing price and the commission fees.
When considering a purchase, always consider:
- Is it the bond investment grade or non-investment grade?
- What is the maturity period (short, medium, or long-term)?
- What is the interest rate, and how frequently do the bonds pay-out (once/twice a year)?
Secondary Bonds enter the secondary bond market when they are sold before their maturity is up. You can use a broker to purchase secondary bonds or via a public exchange. Be aware that prices can vary for secondary bonds as well as differences in transaction fees. So, do your research.
A bond ladder is a strategy where investors spread out the different maturity dates for each bond to manage interest rate risks.
For example, if you have $10,000 for bond investments, spread it over four bonds with different maturity dates like one, three, five, and ten years. Therefore, you don’t keep your funds in one fund over a long time. This makes your portfolio more flexible if problems occur in the market.
Things to look out for before you invest in bonds
Here are quick tips to think about before you jump into bond investing:
- Define your goals.
- What is your risk profile – high or low.
- Reinvest your interest – compounding interest over time brings better returns.
- If buying separate bonds, hire a specialist broker.
- Calculate transaction fees, mark-ups, and tax payable.
- Access if the bond issuer can pay back the debt. This applies more to corporate bonds.
- Avoid speculating on the market and stick to your investment strategy.
Bonds offer a stable investment asset that can diversify your portfolio and safeguard your wealth from severe risk. As with any investment, it’s crucial to do your research and compare the risks to the possible gains.
The above information does not constitute any form of advice or recommendation by London Loves Business and is not intended to be relied upon by users in making (or refraining from making) any investment decisions. Appropriate independent advice should be obtained before making any such decision.