If you need a low-risk investment, you might want to buy bonds. Some people are intimidated by these assets, yet they work in a surprisingly simple way. When you buy bonds, you become a lender while the seller becomes the borrower. You earn money from their interest payments, and you get your money back in full if you withdraw the principal until the maturity date.
Buying bonds is similar to purchasing stocks because there is also a bond market. Also, you must plan your assets carefully by being clear about your investment objectives, and this will help you choose the right bonds and other assets that will further those goals. Of course, you can only do this once you know enough about bonds.
Let’s go deeper into why investors like to buy bonds and what the available options are. Then, we will explain the primary and secondary markets for bonds. We will also talk about their potential benefits and risks and how to choose the ones that fit your portfolio. Later, we will show you the other assets similar to bonds.
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Why do people buy bonds?
As a bondholder, you receive interest payments or coupons over some time. If you hold it until the bond matures, you get the original amount you provided.
People buy bonds for two reasons: for holding or selling. If you keep that debt security with you, it will provide a steady stream of fixed income. Also, bonds are usually low-risk.
That’s because you either buy bonds from the government or a company. The former poses the lowest amount of risk because it’s unlikely to default on its debt obligations.
For example, US Treasury Secretary Janet Yellen warned about the debt ceiling. In response, President Joe Biden signed a bill that raised this limit and covered the country until December 3.
On the other hand, buying bonds from a company may have a slightly higher risk. Unlike governments, there are times when they cannot keep up with their debt payments.
You could sell your bonds for profit instead of holding on to them. It’s better to do so if its coupon rate is higher than the central bank’s interest rate.
The US interest rate is kept near-zero during these COVID times. This could be good news for those who want to buy bonds in the United States.
What are the types of bonds?
We’ll talk about how to buy bonds later because we have to show you the types available. That way, you’ll be ready to purchase the right ones. Here are your choices:
- Corporate bonds – As the name suggests, you buy these from businesses. Company-issued bonds may either be investment-grade or junk. The latter is high-yield, meaning it has a lower credit rating. Yet, the trade-off is that it pays higher interest.
- Municipal bonds – These are the debt securities you get from cities, counties, and states. They’re otherwise known as “munis,” divided into three types: general obligation, revenue, and conduit.
- US Treasuries – Also known as US treasury bonds, the Treasury issues them on behalf of the federal government.
Read More: Should You Invest In Meme Stocks?
How do I buy bonds?
Now, we can talk about how to buy bonds! You may purchase them from the primary or secondary markets, and buying from the former means purchasing new-issue bonds.
We covered the types of bonds first because that determines how you can buy them. Let’s look at how you can buy each of them as new issues:
- Corporate new issues – Most investors can’t access these because you will have to connect with the brokerage or bank that manages the primary bond. You will need a brokerage account that will cover the purchase price and the commissions you must pay to your broker.
- Munis as new issues – You will have to join in the issuer’s retail order period. Moreover, you must have a brokerage account with the financial institution backing this bond issue. You should also complete a request that details the bonds you want to buy.
- Treasury bonds as new issues – You may buy bonds from the government via TreasuryDirect. From there, you may purchase them by placing either a competitive or non-competitive bid. The former means you get to indicate the terms you want, and meanwhile, you accept the terms set by the auction if you buy the latter.
The wealthiest investors are the ones that usually have access to the primary market. For everyone else, it’s a lot easier to buy from the secondary market.
This involves buying it “over the counter,” meaning you’ll have to buy it from someone else directly, without brokers. However, the pricing isn’t as transparent.
This means you may have a hard time identifying the true cost of bonds and how much markup was added. You might want to ask a financial advisor for help.
What are its benefits and risks?
Investors don’t just buy bonds for a steady flow of passive income, and you may gain other benefits from holding bonds. Let’s look at some of them below:
- Diversification – This means having various kinds of assets, so your portfolio can withstand market conditions. For example, stocks are doing poorly right now, but bonds are booming, and the latter can compensate for the losses you may get from shares.
- Preserving capital – If you don’t want to lose the original amount you invested, you might buy bonds. Since they carry less risk, you’re more likely to get your money back if something goes wrong.
- Investing in communities – Let’s say you want to give back to your neighborhood. If you buy municipal bonds, you give money to that community. In turn, this can help in building a new hospital or other facilities in that area.
Of course, even bond investments have risks, and you must be aware of them so that you can plan your portfolio accordingly. Keep these in mind when you buy bonds:
- Interest rate risk – We said it’s great to buy these while the Fed’s interest rates are low. Once they rise again, that’s when bonds become less appealing.
- Inflation – This happens when the price of goods and services goes up over a period of time, reducing money’s purchasing power. This means the value of your bond earnings may decline, and what’s more, this could make bond prices more expensive.
- Credit risk – This refers to the likelihood that a company cannot pay back its debts. Once it can’t, you may suffer losses from bonds.
- Liquidity risk – You’ll encounter this if you intend to sell bonds rather than hold on to them. This type of risk refers to the likelihood that you can’t find someone willing to buy bonds from you.
If you’ve decided on buying bonds, it’s best to ask financial advisors for help. They can guide you through the process so you can purchase the best ones.
Of course, you may choose other low-risk alternatives such as bond funds. These are investment vehicles that invest mainly in individual bonds.
Also, you may buy mutual funds for a more diversified option. They invest in various assets to beat certain market indexes like the S&P 500 and the Dow Jones.