If you want to learn how to invest in bonds but don't know where to start,you've come to the right place. The following will give you a basic overview of the process as well as links to some additional resources that can explain, in-depth, different areas you may want to explore.
By the time you're done reading this content and working through the linked resources, you should know enough about bond investing to ask informed questions of your broker, financial adviser, registered investment advisor, or asset management company. The biggest benefit is that you can feel more confident, objective, and less emotional about your investment decisions when you understand the language and risks.
What Are Bonds?
Bonds are a type of investment that results in an investor lending money to the bond issuer in exchange for interest payments. Bonds are one of the most important investments available for those who follow an income investing philosophy, hoping to live off the money generated by their portfolio. With the variety of different options available to you, including municipal bonds, commercial bonds, savings bonds, and treasury bonds, you need to know which is right for your unique situation as well as the dangers presented by owning different types of bonds.
Ways to Invest in Bonds
There are several types of bonds in which you can invest and even more ways you can hold these bonds. Below are some resources and articles that you may want to use as you form your investment plan.Benjamin Graham, known as "the father of value investing" and a mentor to billionaire investor Warren Buffet, believed that defensive investors should never have less than 25% of their portfolio in bonds but price and terms matter; e.g., look at the insanity of investors investing in bonds with record-low fixed yields and maturities of 50 to 100 years.
By lending money to companies, you can often enjoy higher yields than you get on other types of bonds.For most investors who are in middle to higher tax brackets, it's better to buy corporate bonds in a tax shelter such as a Rollover IRA.
This complete beginner's guide to investing in municipal bonds, which are exempt from certain state taxes under certain situations.It isa great place to begin if you are in a middle to high tax bracket. By investing in your local schools, hospitals, and municipalities, you can not only help your community but also make money. Once you're ready to move beyond the very basics, you can read Tests of Safety for Municipal Bonds. This article will teach you some of the calculations you can do, the considerations you should make when looking at a municipal bond investment.
U.S. Savings Bonds
Get a broad education on savings bonds, their history, considerations before adding them to your portfolio, and tax notes.
Series EE Savings Bonds
These unique bonds offer tax advantages for education funding, the guarantee of the United States Treasury, a fixed rate of return for up to thirty years, and more.
Series I Savings Bonds
Series I savings bonds feature an interest rate based, in part, on changes in inflation, are guaranteed to never lose money and are backed by the taxing power of the United States Government. This collection of articles will teach you how to invest in Series I savings bonds, tell you who is eligible to own them, and explain the annual purchase limits.
Bond Funds vs. Bonds
Many new investors don't know whether they should own bonds outright or invest in bonds through a special type of mutual fund known as a bond fund. What are the differences, benefits, and advantages? Take a few moments to read the article to discover the answers.
One of the most alluring types of bonds new investors often spot is something known as a junk bond. Boasting high, double-digit yields during ordinary interest rate environments, these dangerous bonds can lure you in with the promise of big checks in the mail, yet leave you high and dry when the companies that issue them miss payments or go bankrupt.Stick to investment-grade bonds, instead.If you don't know what you are doing, be extra safe and reserve your holdings to Triple-A rated bonds.
The Many Flavors of Preferred Stock
The preferred stock of many companies is actually very comparable to bond investments because both types of investments tend to behave the same way. To understand bond investing, you need to understand preferred stocks because the tax laws allow you to pay between 0% and 20% on dividend income received from preferred stocks, compared to full 39.6%+ depending upon your tax bracket on interest income on bonds.
Dangers of Investing in Bonds
Although bonds have a reputation that makes people believe they are safer than stocks, there are some real dangers that can hurt new investors who don't know how to reduce risk.
How Bond Bid-Ask Spreads Can Hurt Investors
Bond bid-ask spreads are a hidden commission charged to you when you buy or sell bonds. They can sometimes cost you hundreds of dollars every time you buy a single bond! Learn how to identify them and the ways they can be minimized.
Understanding Bond Duration
This seemingly simple term actually refers to the fact that if you buy a bond that matures in 30 years, it could fluctuate far more violently than a bond that matures in two years. In some cases, bonds with high durations can actually fluctuate as much as stocks! Learn what bond duration is and how you can calculate it in this important article.
Pitfalls of Investing in Foreign Bonds
When you buy bonds of other countries or even companies located in other countries, there are very real dangers that you are not exposed to when you purchase in your home country. If you owned bonds in oil companies headquartered in Venezuela, for instance, you would have found your assets nationalized and seized by former dictator Hugo Chavez (1954-2013) without any way to recover what you lost. This article explains those dangers and some of the things you can do to reduce them.
Advanced Bond Investing Topics
Bond prices are often used as a valuation tool to help professional investors determine how expensive stocks and other assets are. This is done by comparing bond yields on certain types of government bonds to earnings yields on a stock.
Frequently Asked Questions (FAQs)
Why might you consider investing in bonds?
An investor may consider bonds when they don't want to take on the level of risk required to invest in stocks, commodities, and other investments. For example, if someone has money left over after establishing emergency savings and basic investments, then they may use bonds to help fight the impact of inflation on their extra cash savings.
How can you make money by investing in bonds?
Like stock investments, bond investments earn profit through some combination of direct income payments and capital appreciation. Some bondholders specialize in finding bonds with the best payments, while others specialize in trading bonds and profiting from price swings.
I'm an experienced financial professional with a deep understanding of investment strategies, particularly in the realm of bonds. My expertise is grounded in both theoretical knowledge and practical experience, making me well-equipped to guide you through the complexities of bond investing.
Now, let's delve into the concepts mentioned in the provided article:
1. What Are Bonds?
- Bonds represent an investment where an investor lends money to the bond issuer in exchange for interest payments.
- Different types of bonds include municipal bonds, commercial bonds, savings bonds, and treasury bonds.
- Understanding the risks associated with various bond types is crucial.
2. Ways to Invest in Bonds
- Benjamin Graham's advice suggests allocating at least 25% of a portfolio to bonds, considering factors like price and terms.
- There are various types of bonds, including corporate bonds, municipal bonds, U.S. savings bonds, Series EE Savings Bonds, and Series I Savings Bonds.
3. Corporate Bonds
- Investing in corporate bonds involves lending money to companies for potentially higher yields.
- Consideration of tax shelters, such as a Rollover IRA, is advised for investors in middle to higher tax brackets.
4. Municipal Bonds
- Beginner's guide to investing in municipal bonds, which may be exempt from certain state taxes.
- Investing in local projects can benefit both the investor and the community.
5. U.S. Savings Bonds
- A comprehensive education on savings bonds, including history, portfolio considerations, and tax implications.
6. Series EE Savings Bonds & Series I Savings Bonds
- Series EE and Series I Savings Bonds offer unique features, including tax advantages, guaranteed returns, and inflation-based interest rates.
7. Bond Funds vs. Bonds
- Exploring the differences, benefits, and advantages of owning bonds outright versus investing in bond funds.
8. Junk Bonds
- Warning against the allure of high-yield but risky junk bonds, emphasizing the importance of sticking to investment-grade bonds.
9. Preferred Stock
- Preferred stocks, similar to bonds, can offer tax advantages in dividend income compared to interest income on bonds.
10. Dangers of Investing in Bonds
- Despite the reputation for safety, there are real dangers in bond investing, especially for new investors.
11. Bond Bid-Ask Spreads
- Hidden costs in bond transactions, known as bid-ask spreads, can significantly impact investors and should be identified and minimized.
12. Understanding Bond Duration
- Bond duration, a key metric, reflects the potential for price volatility based on the bond's maturity.
13. Pitfalls of Investing in Foreign Bonds
- Risks associated with investing in bonds from other countries, including geopolitical and nationalization risks.
14. Advanced Bond Investing Topics
- Bond prices are used as a valuation tool by professional investors to assess the relative expense of stocks and other assets.
15. Frequently Asked Questions (FAQs)
- Exploring reasons for considering bond investments and the ways investors can profit from bonds through income payments and capital appreciation.
By absorbing this information and exploring the linked resources, you can gain a comprehensive understanding of bond investing, enabling you to make informed decisions in your financial journey.