Bonds
Bonds, also known as fixed income, are an investment you can purchase where you essentially lend money to whoever issued the bond in exchange for future income in the form of interest payments. At the end of the life of the bond, you get your original investment back. The interest payments and principal (amount of your investment) are guaranteed by the company or government that issued the bonds.
Who issues bonds?
There are different types of bonds and different types of entities that issue them. Government bonds are issued by different levels of government which can range from a small town to the U.S. government. Corporate bonds are issued by companies and although the companies can be small or large, most corporate bonds are issued by the larger companies.
How do you make money with a bond?
Most bonds pay a set amount of money every so often to the holder of the bond (that’s you). You are lending money out (via the bond) and the borrower (issuing company or government) pays you interest. This is the same sort of thing that happens in a savings account when your bank pays you interest on your deposits.
Why would I want to buy a bond?
Bonds are considered a less risky investment compared to stocks because the interest payments and principal are guaranteed by the issuer. Typically, “safer” bonds that are issued by the US government pay a lower interest rate, whereas “riskier” bonds issued by companies will pay a higher interest rate to compensate for the extra risk.
The risk with bonds is that if the company or government that issues the bond goes bankrupt or runs into financial problems, then the bond holder may not get their money back.
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5 Comments
Peggy
In a future article, I’d love to know where/how to buy bonds and more information about any costs for buying them and how to limit that cost. Thanks!
Oct 23rd, 2008
Joseph
Or even better yet, what is the ROI for some bonds
Oct 26th, 2008
Ray The Money Man
I think you should stay away from Bond Funds, but picking the right individual Bond is a must for a portion of your portfolio. Even more so now.
Great post!
Oct 26th, 2008
kitty
Peggy, you can buy bonds as follows:
- for treasuries you can buy directly from the government - you can open an account on treasurydirect.gov. This website explains everything you need to know about government bonds. You can also buy them from banks.
- for municipal and company bonds, you need to have a brokerage account like eTrade, TD Ameritrade (which I use) or any other. You can buy treasury bonds through the broker as well, but then you are buying bonds on what is called a secondary market i.e. you buy bonds that other are selling at today’s price. This applies to all bonds sold at brokeragre: if your broker is an underwriter for a specific company/municipality, then you buy bonds as they are issued. Otherwise, you buy them at secondary market for what people who bought them first want to sell them to you. It’s too long to explain, google for bonds - there is bonds 101 explanation on both yahoo finance and cnnfn.com. You should read it, and understand the terminology like yield to maturity, callable, etc. before you invest.
Ray - I agree with you. With individual bonds, there is a maturity date, so unless the company defaults one has an option of holding to maturity and getting principal and interest back. Bond funds don’t have maturity date so their value fluctuate with the value of bonds on a secondary market. The value of bonds goes up when the interest rates go down, but the value of bonds can drop a lot when the interest rates go up. Or in situations like the credit crisis we’ve had when there was a lot of fear and people didn’t want to buy bonds.
Joseph - you can go on yahoo finance, select Investing->bonds. Then you can search for individual bonds to see yields.
Because of credit crisis there are some great yields. There were better last week, though. Last week I was able to get a AAA NY state municipal bond with tax-free yield-to-maturity of 5.36 (it was sold below value). I am in 28% tax bracket and live in NY State, so for me it is about the same as taxable 8%. Too bad I only had 5K available as most of my cash is locked in CDs and the rest is invested. The week before I could municipal bonds with tax-free YTM of 6.5%, but it was gone by the time I transferred cash to my broker. Same with company bonds — a couple of weeks ago there were some highly rated bonds with two-digit yields (and low resale value) like 18% on an AmEx bond. Now the yields came down a bit. I have a large CD that matures in mid-November, but I am afraid that by then the yields will come down.
Oct 30th, 2008
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