If you are planning to invest in bonds but have little information on bonds, then you are in the right place. To begin with, investing in bonds is a particular type of investment whereby an investor lends money to a bond issuer, usually big corporations or governments, in exchange for an interest payment. In simple terms, a bond is debt in the form of a loan to a company or government that is to be repaid at a fixed return rate. Some people say it’s better to invest in stock than bonds. Keep I mind that they are both risky due to the ever changing market behavior.
Characteristics of Bonds
- All bonds are repaid on the principal after the maturity date. However, some bonds require interest payment together with the payment of principal to the holders of the bond.
- The bond’s maturity date is fixed.
- Bond is in debt form where bondholders offer credit to bond issuing companies.
- Risks associated with bonds include default/credit risk, interest rate risk, and prepayment risk.
Usually, after bonds issuance in the primary market, they are then traded in the secondary markets between the investors. Unlike stocks, the majority of bonds trading is not done in the secondary markets through exchanges; instead, they are traded over the counter (OTC). Note that investing in bonds investment is essential in your portfolio balancing because bonds investment is a risk reduction tool. There are very many types of bonds in the market to invest in, depending on your investment-specific needs.
Types of Bonds
1. U.S. Treasury Bills, Notes and Bonds.
Treasury bonds are short-term to long- term secured investment by the United States government, making them the safest investment choice in the market. One benefit of investing in these bonds you will be excluded from paying the state income taxes on the interest. These bonds are safe and predictable; that’s why you should have them in your portfolio. Treasury bills are issuance for a year or less, while treasury notes range from 2- 10 years. On the other hand, treasury bonds last for a period of up to 30 years.
2. US Government Bonds
Note that the Treasury Department does not issue all kinds of bonds; some are granted by the agencies of the government such as Ginnie Mae and Fannie Mae, where they have a better yield than the Treasury bonds and are less riskier. The demerit is there is no exemption from the federal and state taxes.
3. Convertible and Non-convertible Bonds
Convertible bonds are also referred to as C.V.s are corporate bonds whereby the holder can convert them into shares of the entity issuer of the loan. The share number is pre-determined. Convertible bonds offer you lower interest rates compared to other types of corporate bonds. Also, this bond provides high yield when compared to common stock or government bonds, and at the same time, it has a holder stock option.
On the other hand, non- convertible bond’s maturity and rates vary over time. The frequent issuer of this bond is corporations and governments and is characterized by zero coupons. The only investors benefit is by receiving the undivided interest upon maturity. The worrying aspect is that you are required to pay taxes on returns despite not receiving any income annually. Also, investing in this bond is highly risky compared to other types of bonds.
4. Corporate Bonds
These are fixed-income securities that are issued by corporations. Corporate bonds are categorized into:
- Short-term bonds with a maturity period of 5 years or less
- Long-term bonds with a maturity period of 12 years or more
- Medium-term bonds with a maturity period ranging from 5-12 years.
The corporate bonds are riskier because of the volatility of companies but yield a higher return.
5. Foreign Bonds
This a bond issued in the local market by a foreign entity. The main feature of this bond is that its trading is done in foreign financial markets and operated in foreign currency. The objective of investing in a foreign bond is for portfolio diversification because of the difference in interest rates of different countries. However, currency risk is one primary concern.
These are just some of the popular types of bonds as a beginner you may opt to invest in. Other types of bonds include municipal bonds, preferred stock, adjustment bonds, and junk bonds.
When considering a bond investment, you need to fully comprehend how bonds work, such as its returns and risks involved. Some of the questions you should be asking yourself before investing in bonds include;
- What is your risk tolerance?
- The magnitude of the bond riskiness?
- How the bond you are about to invest in match with your portfolio?
- Are the rates of interest floating or fixed?
- Is the bond issuer able to cover its debts?
- In case of a default, can I be compensated?
These are just some of the critical questions to ask yourself before investing in Bonds. After finding answers to these vital questions, what follows is deciding on investing in a particular Bond that meets your specific needs. Below are some of the tips for investing in bonds for beginners.
Important Things to do Before investing
- Avoid reaching for yield – This is common when you, as an investor, feel your returns are declining, which is caused by a low rate of interest. Try to avoid any temptation of higher yields than lower credit quality bonds offer. Remember that the higher the return, the more risk.
- Have your defined objectives – know what you want before investing. Beware that if you have no idea where you are headed, you will never get there.
- Do proper research – Ensure your read journals, books, and articles that talk about different types of bonds to have a better understanding. Also, familiarize yourself with the bond offering statements and bond match. You can also find a lot of information on bonds in websites or financial news.
- Read the prospectus keenly if you are planning to buy a bond fund.
- If you have decided to buy an individual bond, source a broker or a firm that mainly specializes in bonds, and don’t forget to ask your broker the price and date when they traded their last bond.
- Strategize on reinvesting your coupons.
- Understand all fees that go hand in hand with bond buying and selling.
Investing in bonds could be lucrative, depending on the bond you choose to invest in for your specific requirement. For beginners, do your homework, and avoid being risk-takers, take calculated risks to grow your investment.