How to invest in bonds
BAirwaves are an important part of the economy as they allow governments and businesses to borrow money at attractive rates with structured repayment terms. They also allow investors to earn stable and predictable returns on their investments with less risk than the stock market.
You can invest in bonds by buying individual bonds or bond funds. However, there are important differences between the two, and it is important to understand them as an investor.
Whether you’re a new bond investor or exploring options to update your portfolio, it helps to understand what bonds are, how they work, and how they react to market fluctuations.
What are bonds?
A bond is a loan. When you buy one, you are lending money to the issuing body in exchange for interest payments. Here are some of the different types of bonds and their characteristics:
- Agency bonds may be issued or guaranteed by US federal government agencies or government-sponsored companies.
- Corporate bonds are issued by companies to raise funds for acquisitions or capital expenditures.
- International bonds Include debt sold by governments and corporations outside of the United States
- Municipal bonds are issued by city, state and local governments to fund new schools, roads and other community-oriented projects.
- Savings bonds issued by the US Treasury Department are available in denominations as small as $25.
- treasury bonds are issued by the federal government and are backed by the full confidence and credit of the US government.
What investors need to know about bonds
The most important characteristics of a bond from an investment perspective are its duration and its yield.
Maturity of bonds
A bond matures when it reaches its set redemption date and the issuer repays the principal, which is the amount you originally invested. The value paid at maturity is also called the face value. For most bonds, the face or maturity value is $1,000.
Some bonds never mature. For example, callable bonds give the issuer the right to repay the loan at specified times before maturity, often at a higher price. When this happens, investors have no choice but to waive the bond in exchange for the promised payment.
A bond’s yield is its annual interest rate divided by its current price.
Most bonds are sold at face value and earn interest through coupon payments, usually issued every three or six months. A $1,000 bond with a 5% yield would yield $50 per year in two installments of $25. However, if you could buy this bond on the open market at $900 instead of $1,000, its current yield would drop to 5.6%. Most bonds offer a fixed rate that pays the same return year after year.
What are the risks of investing in bonds?
Although there are a number of risks associated with investing in bonds, two of the most important are interest rate risk and credit risk.
Interest rate risk
Interest rate risk refers to how bond prices trade when interest rates rise. This is because investors are less willing to buy your 5% bond if current market interest rates are 6%.
If you invest in a bond fund, be aware that there is no maturity date on which you will receive a return of your capital. Maturing bonds are continuously reinvested by fund managers, so no capital is returned to investors. Thus, bond funds are subject to greater interest rate risk than individual bonds, the prices of which will eventually trend towards the value at maturity.
Credit risk refers to the possibility that the bond issuer will default and fail to make promised principal and interest payments. Many bonds carry ratings issued by third-party agencies to help investors assess the risk of default.
Are bonds a good investment?
Whether or not bonds are good investments depends on your risk tolerance and financial goals.
Bonds are generally considered defensive investments because they return capital to investors at maturity. They are also called income investments because they regularly pay interest. Bonds are therefore generally a good investment for those looking for a safe and stable investment that generates income, as opposed to the growth offered by more volatile securities. stock Exchange.
Within the general bond asset class, however, there is a wide variety of investment options. Treasury securities are generally considered the safest investments, but they pay low returns. so called high yield bonds carry a much higher risk of default but pay significantly higher returns in compensation.
So even within the bond asset class, investors may choose more aggressive or more conservative options.
How to invest in bonds
You can buy bonds in different ways: Individual bonds directly from banks, brokerage firms or the US Treasury directly.
Mutual funds are sold by various financial services companies, including the fund companies themselves. Exchange-traded funds can be purchased directly on the exchange through a broker.
Individual bonds often have a $5,000 or $10,000 minimum, and some funds require at least $1,000 to invest. But exchange traded funds generally have no minimum – you may even be able to purchase fractional shares of certain AND F.
Investing in bonds for beginners
Knowing the best bonds to invest in can be tricky, so take the time to educate yourself about bonds before you invest. It is important to become familiar with some basic things you need to understand before you start.
Market value vs face value
The market value of a bond is what someone would be willing to pay for it in the present. A bond may have a market value above or below its face value.
Bonds have an inverse relationship with interest rates, meaning that bond prices rise when interest rates fall and fall when interest rates rise.
Can you lose money investing in bonds?
If you sell an individual bond before maturity, you will receive the market price, which may be higher or lower than face value.
Bond funds do not have a maturity date, so if interest rates rise and remain high, you may never receive the full amount you invested, although you will continue to receive payments from interests. A bond that defaults could also cause you to lose the amount you originally invested.
Stocks vs Bonds
Since the bond and stock markets are essentially in competition for investment dollars, they tend to contradict each other. When bond yields rise, they can drive people away from riskier stocks. When bond yields are falling, the higher yields offered by equities will be more attractive.
When stock markets are volatile, investors often rush to move money from stocks to the safety of bonds, which dramatically increases the value of bonds.
Can you get rich from bonds? Although some professionals trade bonds, you generally won’t use bonds to get rich.
Instead, bonds offer a defensive, usually conservative, way to preserve your principal while earning interest. But there are so many different ways to invest in bonds that you should consult your financial adviser before jumping in.
Joel Anderson contributed to the reporting of this article.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.