How to Buy Bonds
In this post, you will learn how to buy bonds, and what they are.
What Are Bonds?
A bond is a fixed income investment, whereby an investor loans money to a body over an agreed period of time at a fixed or variable interest rate. Essentially, a bond is a chunk of debt that you are purchasing from an individual or party. To reward you for purchasing their debt, they will pay interest over the holding period until the ending, or maturation date.
It is difficult to provide you with an average bond yield, as yields are always changing. Regarding the 30-year US treasury bond yield, it was around 11-12% in the early 1980s, and has slowly fallen to where it lies today at 2.98%.
You know what bonds are, and what you can expect to earn by purchasing them, now I will explore the different types of bonds to choose from.
Types of Bonds
There are different types of bonds, and it is important to know the difference. I will explore them below.
A premium bond is a “lottery bond” and is issued by the National Savings and Investments agency (NSI) in the United Kingdom. Your premium bonds are entered into a monthly price draw. As of December 2017, the UK government paid a 1.40% annual coupon rate to compliment the lottery.
The prizes range of range from £25 to £1,000,000 ($US31.83 to $US1,273,002). Generally, there were only two winners of the $US1,273,002 payout each month.
You can purchase premium bonds at any time throughout the month; however, you are not entered into the monthly lottery until the start of the next calendar month.
Premium bonds were introduced in the late 1950's to control inflation and encourage saving.
Municipal and savings bonds are slightly different, although I created the title for the sake of simplicity. Savings bond refer to US bonds and municipal bonds relate to any country.
Savings bonds are issued by the United States government and they are some of the safest bonds you can buy. They are backed by the US government, and how likely is it that the US government won't be able to pay you back?
The minimum investment of $US25 makes them attractive for people looking to start saving without a huge commitment. Regarding savings bonds, there are two types, EE and I, as I will explain further below.
Series EE Bonds
Series EE bonds are non-marketable, meaning they cannot be traded on a secondary market such as the NASDAQ or NYSE. Series EE bonds are fixed interest. The US government guarantees that your investment will double in value over the term, which is typically 20 years. Interest earned from EE bonds are exempt from local and state taxes until the bond is cashed.
You can buy a maximum of $US10,000 worth of Series EE bonds per year, with room for an extra $US5,000 investment by using your income tax reform to your advantage.
Series I Bonds
Series I bonds are also non-marketable. They have fixed and variable rate factors. The fixed rate is set on the purchase date, while the variable rate is adjusted every six months based on inflation. The minimum purchase of Series I & EE bonds is $US25.
A corporate bond functions much like the bonds mentioned previously; however, a corporate bond is a way for a company to raise money, as opposed to a government. Corporate bonds provide regular payments which are based on a fixed or variable interest rate. These coupon payments made out regularly are often backed by a company's physical assets, but generally rely on cashflow.
Corporate bonds present a higher level of risk when compared to government bonds. The companies issuing these bonds may be private or public, and different levels of financial stress will affect the level of risk involved with this bond.
It is important that you research the company under consideration before you place your money in their hands.
Junk, or high yield bonds are typically issued by entities with a low credit rating, giving them no other option than to pay an inflated interest rate. These bonds are typically risky and are best suited towards people with a high tolerance for risk.
How to Buy Bonds
I will now explain how to buy bonds—in case you are new to buying investment bonds.
You can purchase bonds on stock exchanges individually, they can also be bought through an Exchange Traded Fund (ETF). Bond ETF's provide you with a diversified holding of bonds, typically located on an individual exchange.
What Should You Buy?
Bonds are often the number one choice when deciding on a safe place to allocate your funds, but what bond you buy is also important. Corporate bonds, as mentioned above, present a higher level of risk and are best left to those following a higher risk/reward plan.
Treasury/Municipal bonds are often your best option when looking for a safe place to invest your money for the long term. Treasury bonds also have a low risk of defaulting, the lowest risk in fact, among all bonds available.
Now that you know how to buy bonds, visit here to learn how to invest in stocks.