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Buying bonds can potentially be a way for investors to create an additional source of income, which is difficult to find in an investment. However, there’s more to bonds than you might think.
As an investor, understanding your risk tolerance and how to buy bonds is important. There are also different types of bonds and sources of bonds.
In this guide, we’ll talk about how to buy bonds for beginners and cover some basic investment terms. Here are some things you may want to consider before investing in bonds.
How to Buy Bonds
There are several ways to go about buying bonds including from the government, through a brokerage, or exchange-traded funds. How bonds are purchased depends on your investment goals.
How to Buy Bonds: Step by Step
Before you invest your hard-earned money, it’s important to know how to buy bonds. Understanding how to buy a bond means knowing how to determine when it’s the right time to buy, knowing what type of bond to purchase, and purchasing your bond from the right source.
Step 1: Determine Whether It’s The Right Time to Buy
Part of investing in bonds is knowing when it’s the right time to buy. Bond prices vary with the current economic climate, with bond prices decreasing as the economy improves and interest rates go up. When the economy has a downturn and interest rates go down, bond prices tend to become higher again. It might sound like buying during economic booms and selling during downturns is the easy solution, but there are other things to consider as well.
One potential problem with this strategy is that it’s not typically easy to predict the cycles of the market. You don’t know when interest rates are going to go up or down, and you certainly don’t know when they’ve reached the highest or lowest point they’re going to reach. Usually, bonds pay out interest 2x per year, but inflation can potentially erode your returns over the years. While bonds are often considered a lower-risk investment than many other types of investments, there’s no way to reliably predict the future of the economy.
If you’re waiting for the right time, you could end up waiting around for a long time to buy bonds. The same is true if you want to sell your bond. While there may be an economic downturn in the near future, there could just as easily be a boom that causes the value of your bond to decrease. You can’t account for inflation, changing interest rates, and the massive changes that can potentially affect the economy.
One way that investors can attempt to minimize risk when investing in bonds is by laddering. Laddering your bonds is when you buy several bonds that mature at different points in time. As each bond matures, the principle of that bond can be reinvested to grow the ladder, and the process repeats itself over again.
Step 2: Decide What Type of Bond You Want to Purchase
Whether you’re investing in stocks or bonds or any other type of investment, choosing how to invest is important. There are a handful of different types of bonds, each offered by different organizations and used for different purposes. While municipal bonds may be a well-suited choice for one investor, savings bonds might be better for the next. Below, we’ll talk about some of the different types of bonds that are available to investors.
Treasury Bonds: Treasury bonds are issued by the U.S. Department of Treasury, which means they carry the full faith and credit of the U.S. government. Government backing makes Treasury bonds one of the options usually considered if you’re just learning how to buy bonds. There are actually several types of U.S. Treasury debt, including treasury bills, notes, bonds, and Treasury Inflation-Protected Securities (TIPS).Savings Bonds: Savings bonds are similar to treasury bonds in that they’re backed by the U.S. government. The key difference between savings bonds and Treasury bonds is that with savings bonds, you can potentially invest as little as $25, while Treasuries typically require a larger investment. While the interest that a savings bond earns is subject to federal tax, you don’t have to worry about paying state or local taxes on it. These bonds also cannot be bought and sold in a secondary market, unlike other types of bonds.Corporate Bonds: Corporate bonds are issued by companies to raise money for expenses, such as construction and normal business operations. These bonds are issued by many different companies, and they’re separated into different categories based on the industry they’re for. One of the benefits of corporate bonds is that you have a lot of freedom to choose, from the bond structure to the industry and maturity date.Municipal Bonds: Municipal bonds are offered by government organizations, just not the U.S. government. Instead, these bonds are offered by city, county, and state government organizations, and they’re used for the expenses that these governments occur. For example, a city might issue municipal bonds to get the funding needed to build new roads. No two municipal bonds are the same, so it helps to have experience or expert advice.Agency Bonds: Agency bonds can either be issued and guaranteed by the U.S. government, or they can be issued by a government-sponsored enterprise (GSE). GSEs include the Federal National Mortgage Association and the Federal Agricultural Mortgage Corporation, among others. Getting all the info about the bond you’re investing in is crucial with agency bonds, especially if you’re dealing with a GSE.
If you’re not sure what type of bond is right for you, you might want to consider talking to an online financial advisor. Getting one-on-one advice from an expert can potentially help you better understand the different types of bonds and which bonds may work well with your current investment portfolio. Just keep in mind that working with a financial advisor will cost you additional money.
Step 3: Purchase the Bonds from the Appropriate Source
Different bonds come from different sources, so it’s important to understand how to buy bonds based on how you want to invest. You can generally buy U.S. Treasury bonds directly from the U.S. Treasury Department; these bonds are sold on the Treasury Direct website. It’s also possible to purchase these bonds through a brokerage, but there’s a fee involved if you do.
Treasuries are pretty much the only bonds that are easy to buy as an individual. Some of the benefits of treasury bonds are that you can buy them without additional fees or help from a broker.
Like some short-term investments, most types of bonds are easier to invest in with help from a broker. Newer bonds are sold to the public by an underwriter, who takes on the sales commission. This means that you don’t have to pay additional fees.
Older bonds are different because they’re sold on the secondary market. Shopping for bonds on the secondary market might be complicated because the seller sets the price. The Bond market Association does post some municipal bond prices, but the dealer markup is included in those listings.
Finally, the last option is to buy bonds from exchange-traded funds. This may be one way to diversify and get a stake in more bonds than you could invest in on your own. That being said, it might be difficult to find a fund with a good total return and low expenses, so you may prefer another route.
Is Buying Bonds the Right Investment for You?
From investing in gold to buying bonds, there are a lot of investment strategies available to individuals. So, is buying bonds the right investment for you?
As is the case with any investment, there’s a lot to consider if you’re thinking about how to buy Treasury bonds or how to buy savings bonds. You may want to consider your current investment portfolio along with your financial goals; will buying bonds help you meet your goals? Are bonds an appropriate investment based on your risk tolerance and how much you can invest?
It’s also important to choose the right type of bond and to buy it at the right time. You also have your choice of buying through a brokerage, exchange-traded funds, or directly from the U.S. government. If all these investment terms and decisions make your head spin, you might consider working with an investment advisor.
Buying Bonds Is One Way to Diversify Your Portfolio
Bonds can potentially be a low-risk investment for beginners to diversify their portfolios. However, the type of bond, timing, and source all should be considered and selected carefully.
If you want to diversify your portfolio with bonds, you may want to do thorough research before making any big purchases. Whether you’re learning how to buy government bonds or investing in a mutual fund for bonds, patience is key. Consider talking to a financial advisor if you’re not sure where to start with investing.
This is for informational purposes only and should not be construed as legal, investment, credit repair, debt management, or tax advice. You should seek the assistance of a professional for tax and investment advice.
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