How to Buy Bonds? A Trader Beginners Guide 2022
When most beginner traders think about investing money as part of personal finance, bonds don’t often count as a big priority. In most cases, people will look at equity securities or particular stocks, commodities, indices, and the forex market. But intrudingly, bonds are actually some of the safest assets you can buy.
The bond market is also huge. According to the Securities Industry and Financial Markets Association (SIFMA), the US bond sector alone was valued at $46 Trillion in 2021. Now compare this to the entire US equity market which was valued at around $30 Trillion. Based on these figures alone, making a bond investment is a must for anyone who wants to have a diversified portfolio.
In fact, when you look at the portfolio of assets owned by some of the biggest mutual funds in the world, bonds are typically at the center of everything. Whether it’s individual bonds, treasury bonds, or corporate debt, these assets provide added portfolio security against headwinds in the equity market.
So, are you thinking of trying your hand at bond investing? Then this guide will give you all the info you need.
Table of Contents
How to Buy Bonds: What Is a Bond?
A bond is a type of fixed-income security that is offered by a bond issuer to an investor as a way of raising capital through debt. To better understand how bonds work, it is important to first explain how corporations and governments raise money. Governments raise money through taxes. But in most cases, those taxes are not always enough to finance public projects like infrastructure.
For this reason, a government can raise additional money through debt by issuing treasury bonds or municipal bonds. This is called deficit spending. An investor would then buy these treasury bonds and in the end, the government will owe that investor money. The same applies to corporate bonds. Corporations typically raise money either through the equity market or the bond sector.
In the stock market, they normally issue shares to investors in exchange for money. But they can also issue a bond to raise capital through debt. So, if an investor buys a corporate bond, it means they lend money to the organization.
Key Features of A Bond
Bonds typically have four key features and include, the principal, the coupon, the yield, and the maturity date. The principal is the total sum of money an investor pays to acquire a bond from the bond issuer. The coupon on the other hand refers to fixed regular income payments that the bond issuer pays the investor during the duration of the bond.
Coupons can be paid several times before the bond matures and are seen as interest payments. The yield is a measure of bond profitability and is calculated as the percentage of the coupon paid and the principal amount invested. And finally, the maturity date refers to a fixed time frame where the agreement between the debt issuer and the bondholder is valid.
When the bonds mature, the principal paid by the investor is returned at the same price initially paid. But how do you make money through individual bonds or corporate bonds? Well, income comes through the coupons. Remember coupons on bond prices are paid at a fixed rate during the maturity period. This is why bonds are often called investment-grade fixed-income securities.
How To Buy Bonds
There are two main ways to buy a treasury bond or a corporate bond. The first option is through the primary bond market. Here, the bond is issued directly by the issuer to investors at a set price. Think of it as an IPO for stocks but instead of selling shares, companies and governments sell corporate bonds, treasury bonds, and municipal bonds.
The second option is through the secondary market. A Secondary market is simply a marketplace where investors holding various bonds can trade with each other. So, if for example, you missed out on the initial bond offering for a given municipal bond, you can buy it from another investor through the secondary market.
However, bond prices in the secondary market are not fixed and would typically be set based on demand and supply, and prevailing interest rates. The secondary bonds market is also open to everyone. Even the initial issuer can come back and repurchase the corporate and municipal bonds they had issued to investors.
What is a Bond fund?
So, let’s say for example you are not experienced in the bond sector but you still want a taste of it right? The best way to get investment-grade bonds is through bond funds. These funds simply pull together money from different investors and where it is invested in hundreds and sometimes thousands of different bonds, including U.S treasury bonds.
Funds tend to be very diversified. This gives investors exposure to a large scope of the debt security market and treasury bills. There are four major types of bonds funds. Here they are:
- Bond Mutual Funds – Money managers or investment firms pool money from different investors and put it in highly diversified bond investments.
- Closed-End Bond Funds – just like mutual funds, closed-end funds are also actively managed. However, closed-end funds issue shares that can be purchased in the stock exchange.
- Bond Exchange Traded Funds – Bond ETFs simply track an underlying bond index and can be purchased in the stock market as well.
- Bond Unit Investment Trusts – Bond UITs simply comprise a fixed amount of bonds that are held in a trust.
Nonetheless, whether you decide to purchase government bonds through a mutual fund, bond ETFs, or UITs, the face value of these funds is determined by the value of the debt market.
Where to buy Bonds?
Most bonds are normally purchased through specialty bond brokers. In essence, these firms give you access to the debt security market where you can buy corporate bonds, bonds issued by local governments, and other forms of debt securities. There are three main agency bonds brokers out there. Here they are:
Interactive Brokers is one of the biggest brokers in the US. It gives customers access to different types of bonds including U.S government bonds, U.S treasury bills, and debt issued by other local government entities.
The broker has an innovative search tool that allows you to find specific debt assets and build your bond portfolio. You get low and transparent transaction fees, excellent customer support, and up to 1 million bond ladders. For beginners, Interactive Brokers also offers comprehensive educational materials to help you make a reliable income from this market.
>>Read more About Interactive Brokers Review: Is it the Lowest Cost Online Stock Platform?
Tradier is also a notable US-based brokerage firm that gives customers and other investors a chance to buy quality fixed income securities with good credit ratings. The firm is known for its low fees including a monthly subscription charge that gives you commission-free trading.
Tradier also offers a multiplatform trading approach where users can choose between different state-of-the-art platforms on its website. Whether you are looking to boost your personal finance, pay student loans, or simply build a strong bond portfolio for retirement, this broker is going to help you out.
>>Read more About Tradier Brokerage Review: Is it the Best Intuitive Trading Platform?
Charles Schwab is a global financial institution that offers a wide range of financial services including personal loans, student loans, and more importantly brokerage services. As a listed company on the New York Stock Exchange (NYSE), it adheres to the best possible practices of any bond brokerage firm.
The firm has several bond investment products including mutual funds, bond ETFs, bond ladders, and others. It gives you access to high-yield fixed-income securities with little contract fees and high credit ratings. The brokerage also gives you access to the primary bond market where you can buy debt securities immediately after local government entities issue municipal bonds.
>>Read more About Detailed Charles Schwab Review: Important Notes for 2021!
Buying Bonds Pros and Cons
Buying bonds from an issuing government entity, the treasury direct, or corporations has several benefits and a few downsides. here they are, starting with pros:
- Most fixed-income securities, including savings bonds, are low-risk investments ideal for long term plays
- The bond market is huge and highly liquid, making it a great place to trade
- Bonds provide a guaranteed fixed income return over a specified period of time. This helps to remove uncertainty and anxiety in investing.
- Great variety of options including treasury bonds, municipal bonds, and corporate debt securities.
- Bonds are often seen as a good way to hedge against equity securities, especially in uncertain financial environments.
- While you will pay federal income tax on interest rates earned from a bond, this income is exempted from state and local taxes.
- Bonds have inherent interest rate risk. When prevailing interest rates fall, you will be exposed to a lot of downside risks.
- There is always the risk of default especially with cooperate bonds. This means you may not get your principal back.
- It’s often harder to find fixed-income securities with high credit ratings that pay good yields.
- The profit returns on equity markets have consistently outperformed returns in bonds over the years.
Reasons to Purchase Bonds?
People buy debt when interest rates rise. This is done for three main reasons. First, savings bonds are fixed-income securities and as such, they give you the chance to earn a predictable income every year from your investment. Typically, interest rates are paid at least twice a year from the same bond.
Secondly, your initial principal, which is the bond’s price at the time of purchase, will be returned after the bond matures. This gives you a nice way to preserve your capital while still making investments. Finally, U.S treasury bonds can be used to hedge against a volatile equities market. This ensures your portfolio is protected against any possible risks.
What to do After Purchasing a Bond?
There are three important things you must do once you purchase a bond. First, make sure you are monitoring benchmark interest rates. This affects bond yields in a huge way. You should also monitor the secondary market.
Here, you will be up to date with prevailing trends in bond prices and yields. This can, at face value, help you decide whether or not to sell your fixed-income securities. Finally, track the coupon payments and when they are due. After all, this is why you are buying a bond in the first place right? Do not also forget to track the bond’s maturity date.
Conclusion: Is Buying Bonds a Good Investment?
Buying bonds is one of the best low-risk investments for long-term investors. Although bonds have their risks, you won’t find a more stable investment option in this financial market than this. Besides, there are so many ways to buy bonds issued by the federal government or corporations.
While some people buy directly from the market, you can use a bond fund like bond mutual funds for managed investing. Bond mutual funds allow you to take advantage of professional money managers in your quest to own and profit from individual bonds.
Bonds also give you the chance to preserve your capital while still making a profit in the process. The fixed income market also tends to be very stable compared to the high risk and volatile equity securities and forex.
But there are some challenges. For starters, fixed income securities come with a measure of risk especially when interest rates fall. There is also the risk of default in high-risk corporate bonds. But despite this, bond investing still remains a low-risk option for anyone.
Buying Bonds FAQs
Is it Safe to Buy Bonds?
Yes, it’s very safe to invest in fixed-income securities. The only thing you need to do is pick low-risk bonds. This would typically be government bonds or corporate bonds that have a very strong credit rating from top rating agencies.
What is the Best Bond to Purchase (Municipal Bonds, Treasury Bonds, or Corporate Bonds?)
Federal government bonds are normally safer compared to municipal bonds and corporate bonds. But as a rule, check the credit ratings attached to each bond issued. That way, you will easily be able to determine which investment is more viable.
What is the risk of Bond Funds?
Since bond mutual funds are actively managed by fund managers, you are not in full control of your investment. Besides, even if individual bonds are held in a mutual fund, they still face the same risks associated with fixed-income securities, including falling rates and defaults.
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Author: Wilbert S
Wilbert is an avid researcher and is deeply passionate about finance and health. When he's not working, he writes research and review articles by doing a thorough analysis on the products based on personal experience, user reviews and feedbacks from forums, quora, reddit, trustpilot amongst others.