There are a couple of ways to purchase corporate and government bonds. You can acquire them individually or through mutual funds. When you buy them individually, you’re actually locking into the bond of a specific organization such as MicroSoft, Wal-Mart, City of Miami, U.S. Government, etc.
This is different from a mutual fund which may be comprised of several hundred different corporate and government bond holdings. So when you buy into a bond mutual fund, you’ll receive shares that represent a fractional ownership of each bond.
For average investors who don’t want to create and actively monitor and manage a portfolio of individual bonds, mutual funds are the best way to go. It’s the way I’ve done it with my portfolio, even though bonds don’t currently account for a large portion of my investments.
In any event, if you want to learn how to invest in bonds through mutual funds, then check out this section of our mutual fund guide.[[[[bond fund investing]]]
In this article, I’m going to walkthrough the steps for buying individual bonds. This tutorial will explain some of the key terminology associated with the process. So even if you decide to ultimately invest in them through mutual funds, you’ll also have a good feel for why the bond fund may be performing well or poorly. Let’s get started.
I accessed my online brokerage account and grabbed the snapshot below of a bond that is available to purchase. As you can see in the upper left hand corner of the image, the bond was issued by the Toyota Motor Credit Corporation. So this is a corporate bond.
Here are some other key elements associated with this bond:
Coupon rate – See where it says 2.000%? This is the amount of interest that the bond will pay on a periodic basis. It’s a fixed rate.
Maturity Date – Right next to the coupon rate is the date of 09/15/2016. This is the termination date for the bond.
Buy – If the money was in my account, all I would have to do is click on this button to purchase the bond.
Bond Details (only key elements mentioned)
Industry – The Toyota Motor Corporation is in the Industrial industry.
Listed – Yes, this bond is listed and traded on one or more of the major exchanges, such as the New York Stock Exchange.
Dated Date – The date interest started being calculated.
Call Schedule – This is an indication of whether the company is permitted to ask for its bond back from you prior to the maturity date.
Tax Status – Yes, you’ll have to pay taxes on the interest you earn on this bond.
Ratings – Moody’s rates this bond AA3. This means it is of high quality and very safe.
Maturity – This is the maturity date already discussed.
Coupon & Yield
Coupon – This is the coupon rate already discussed. It’s the annual interest payout amount expressed as a percentage.
Frequency – This bond will pay out interest semi-annually (every 6 months).
First Coupon – This is the date the bond holder received the first interest payment.
Current Yield – The current yield and coupon rate are always the same unless the bond is sold at a discount or premium prior to the maturity date. When someone else buys it, they will pay more or less than the bond’s face value which never changes. The buying and selling activity also has no affect on the annual interest payout amount which is fixed.
So the current yield for the new buyer will be the fixed annual interest amount divided by the market price they paid for the bond.
Since the Current Yield is less than the Coupon rate for this particular bond, it means that the buyer will pay a little bit above the bond’s face value to own it. This is not unusual for a high quality, in-demand bond that offers a coupon rate or other features that may be better than comparable bonds.
As I mentioned, the buyer will still get 2% interest on the face value of the coupon. The current yield is just a secondary calculation to let the investor know that because they paid extra for the bond, their behind-the-scene rate is a little less than the coupon rate. Think of this way….$100 in interest divided by $5,000 is 2%. But $100 divided by $5,200 is 1.92%.
Offer & Pricing Information
Quantity – This is the total number of bonds available.
Min. Qty – This is the minimum number of bonds you must purchase.
Price – The bond market is quirky because prices are reported on a per $100 basis. But the actual price for this bond is $1,043.09.
Settlement Date – This is the date by which the bond must be paid for by the buyer. In general, there is a 3 day window.
Principal – Amount due when the bond matures.
Accrued Interest – Interest that has accumulated, but not yet paid, since the last interest payout. Remember that for this bond interest is paid every six months.
So now you know how to buy a bond. If you have an online account with one of the brokerage firms, you can quickly do it yourself. That includes buying Treasuries and Municipal bonds.
But if you’re not comfortable with doing it this way, all it takes is a phone call to one of their representatives. Of course, you can also sell your bonds through your online account.
If your goal is to keep things safe and simple, then the best strategy is to look for bonds that are high quality. Compare the interest rates and maturity dates of multiple bonds, and choose the one that fits your investment objectives.
When it’s all said and done, a bond is nothing more than a loan that you make to an organization. In exchange, you’ll be compensated in the form of interest payments that will be sent to you on established dates over an agreed upon period of time.
And while bonds are a safer investment than stocks, they are not 100% risk free. U.S. government Treasury bonds are about as safe as an investment gets. But the trade-off is that you won’t earn very much in the way of interest.
Corporate, municipal, and mortgage-backed bonds will pay out more in interest than Treasuries, but there is a little more risk attached to them.
Of course, bonds come with several different types of risk. For example, if a corporation files for bankruptcy, you may lose all of your investment. In addition, if economic or market interest rates begin to rise, that could make your bond less attractive to other investors if you wanted to sell it before the maturity date.
Speaking of investors, bonds aren’t necessarily a good investment for everyone. For example. I would steer clear of them if I was in my twenties and the stock market was on an upward trend. At this age, you have many years to recover from multiple dips in the market, while experiencing hefty returns on your investment during good times.
But when you do contemplate investing in bonds, make sure you do it for the right reasons. If you’re in your sixties, and are seeking a low risk option, I get it. Even then, though, I would suggest first making sure that the economic environment is displaying the attributes that make bonds attractive.
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