How to invest in bonds
Discover more about what bonds are, how to invest in different types, and the pros and cons of each one.
Summary
Bonds are investments that involve an investor loaning money to a borrower with interest.
Government bonds are some of the most common investment options.
Investing in stocks and bonds allows you to use various strategies.
Bonds are generally considered low-risk investments.
A financial advisor can help you make the right investments to reach your financial goals.
What are bonds?
A bond is a type of investment in which an investor loans money to a borrower to help them finance a project, purchase, or other investment. The two people involved in the conditional lending of this money “bond” them together financially and legally.
A bond is a sort of IOU from one person (or entity) to another. There are a few different types of bonds, and each one comes with unique conditions. For example, you can get corporate bonds, savings, municipal bonds, and Treasurys. You can invest in bonds by obtaining them from brokers. Generally speaking, bonds are considered safer and lower-volatility investments than the more erratic stocks.
How do I invest in bonds?
Knowing how to invest in bonds is the first step. Unlike public market-tradable stocks, bonds must be purchased directly from a broker. If you want to invest in bonds, you’ll need to approach a legitimate brokerage, a US government bank, or via an ETF.
However, when it comes to stocks and bonds, going through a broker (online or in-person) is considered the simplest approach.
What is the minimum investment required for buying bonds?
The minimum investment for bonds varies by type and issuer. Treasury bonds, for example, may have lower minimums, while corporate bonds require larger investments.
On average, the minimum investment of most bonds is between $100 and $1000. But if you buy a bond from another investor, you might be able to obtain it at a discounted rate.
What are the different types of bonds?
Knowing what bonds are is one thing, but knowing the different types of bonds is another.
Researching various bond types is the best way to determine which one best suits your needs. The most common types of bonds are savings bonds, government bonds like Treasurys, corporate bonds, and municipal bonds.
Savings bonds
Debt insecurities billed by and backed up by the US Treasury Department.
Considered one of the safest investments.
Can’t be bought or sold on secondary markets.
Fixed-rate interest over a fixed term, thus the “Savings” part of the bond.
Treasurys
Like savings bonds, debt insecurities are billed by and backed by the US Treasury Department.
Unlike savings bonds, they can be bought on secondary markets.
Helps cover the US Government’s borrowing needs.
More lucrative than savings bonds.
Corporate bonds
Bonds issued by companies or corporations.
Often used to finance the buying of a new branch or raise capital.
Considered somewhat riskier than other bond types.
Municipal bonds
Debt securities backed by municipal or governmental entities.
Often used to finance local community projects such as new schools or sewer systems.
Considered low-risk but not risk-free.
What are some strategies for buying bonds?
There are multiple strategies for buying bonds. Some of the most common ones in today’s market include laddering, indexing, immunization, and a technique referred to as an “active” strategy or activation.
Let’s take a look at what each of these strategies entails.
Laddering - This strategy involves an investor buying bonds with staggered maturities. It is also the most common strategy for bond buying. With laddering, as each bond reaches maturity, the investor re-invests it at the current available rate.
Activation – The ultimate goal of this strategy is to maximize total returns. Some examples of active bond strategies include multiple interest rate scenarios, interest rate anticipation, and spread exploitation. This strategy has a high-risk, high-reward dynamic.
Indexing – This quasi-passive strategy involves indexing a bond portfolio in order to flexibly provide return without the commonly associated risks of a classic buy-and-hold.
Immunization – Immunization shares characteristics with both passive and active bond strategies. It aims to sync the endurance of liabilities and assets to become “immune” (or at least lower the risk of) inflation rate fluctuations.
What is the role of interest rates in bond investing?
Interest rates have a significant impact on bond prices. When interest rates rise, bond prices typically fall, and vice versa. Understanding this relationship is crucial for bond investors.
So, what are some strategies for investing in bonds in a changing interest rate environment?
Strategies include laddering, barbelling, and using bond funds with active management. These approaches can help manage interest rate risk that’s tied to inflation.
How can I build a diversified bond portfolio?
Diversification involves investing in a mix of different types of bonds, maturities, and issuers to spread risk. Bond funds and ETFs can also help achieve diversification.
Can I sell my bonds before they mature?
Yes, you can sell bonds in the secondary market, but only before they mature. The price you get from the sale will depend on market conditions and the bond’s individual characteristics. Additionally, you won’t won't receive any remaining interest payments as you forfeit these on sale.
What are the pros and cons of investing in bonds?
Before answering the question, “Are bonds a good investment?” You must first weigh up the pros and cons. There are advantages and disadvantages to investing in bonds that should be considered before making any final decisions. We’ve compiled a list of each below.
Pros:
Reliability: Bonds have a much lower risk of loss than other types of investment, especially those involving equities. As a result, bonds tend to suffer much less volatility from day-to-day inflation changes and are therefore considered a more predictable and reliable type of investment.
Easy to liquidate: Institutions often sell bonds without changing the price much, a luxury that is much harder to achieve with other investment types.
Bonds have a fixed interest rate payment, which not only means they are more stable, but they’re also easy to turn into tangible, liquid funds once their term has reached maturity.Protected by the government: Bonds come with a fair degree of legal protection by nature of the fact that the US Treasury Department backs them. Even in the unlikely event that a company or institution goes bankrupt, the bond buyer will usually still receive some money.
For example, if you invested in a corporate bond and that corporation failed before the fixed-rate term of the bond was reached, you would still be compensated to a degree for your contribution.
Cons:
Interest rate volatility: Investment interest rates are constantly changing, and this affects bond investments too. At times, interest rates may be very low, resulting in low-reward bond outcomes.
Change in the issuer’s financial stability: If the person or entity you have bought your bond from goes bankrupt or experiences financial trouble, there is a risk of loss.
Market fluctuations: All investments come with a degree of risk, and bonds are no exception. Inflation and market fluctuations can still present challenges for bond investors by increasing market value before bond maturity is reached.
The bottom line
Knowing how bonds work and whether bonds are a good investment is important for anyone considering investing in these low-risk investments. Easy to liquidate but not immune to the pressures of inflation, using the right strategy to invest in bonds can be a great method for success.
Get matched with a financial advisor who can offer you expert advice about investing in bonds.
Senior Content Writer
Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.