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Bonds are powerful economic tools and investment instruments offered by a borrower to an investor. It represents a loan that an investor makes to a borrower for a fixed period.
They are investments that can give you profit from interest payments.
Here’s how to invest in bonds:
- Choose a bond.
- Buy the bond.
- Make a profit on the bond.
Investing doesn't have to be overly complicated. I’ve made this article as simple as possible to ensure you are armed with all the knowledge required before you start investing in bonds.
Let's get started!
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1. Choose a Bond
Bonds are debt-based investments that allow an organization to raise funds and enable investors to profit from recurring interests.
The organization could be a private company or the government, and there are several bonds you could invest in today. However, there are three types of bonds available to investors, and each type has different revenue structures based on its issuer.
The following are the three types of bonds you can invest in:
- Corporate bonds
- Municipal bonds
- Treasury bonds
These three types of bonds are similar in that they are all investment securities, but they each have peculiar advantages and disadvantages.
Corporate bonds are issued by businesses and corporations to secure funds for long-term projects, expansion, research, and innovation.
Interest from these is taxable by the US government, although the revenue generated is significantly more than that of other types of bonds.
Corporate bonds have a few drawbacks. Despite the considerable interest rates, the corporations that issue corporate bonds are more likely to owe money than government entities.
In addition, holding a corporate bond does not mean you have shares in the business or have a say in its decisions. These bonds are the riskiest bonds you can invest in as your money is only as secure as the business's reputation and returns.
Municipal bonds are not as risky as corporate bonds. Local and state governments issue them to fund government operations or raise funds for public infrastructures.
The US government does not tax municipal bond interest, so investing in them means you won't be making tax payments on your revenue.
The returns on municipal bonds are also not as much as what you'd make with corporate bonds. Municipal bonds are much safer than corporate bonds since government agencies issue them.
However, they still carry some risks. There are two types of municipal bonds that you can choose from.
General Obligation Bonds
They are used by local and state governments to fund zero-income projects like libraries, pedestrian bridges, parks, and streetlights.
However, since they are guaranteed by the issuing issuer's confidence and reputation, the government can use whatever methods are required to ensure that the interest on the bonds is paid, including raising taxes.
They are used by local and state governments to fund projects that create income, like highways and train stations. These pay investors with this income and are usually the preferred type of municipal bond for many investors.
Treasury bonds are exclusively issued by the United States federal government and are guaranteed by the government's coffers and reputation.
Consequently, they are zero-risk investments, but they do not pay as high interest as municipal or corporate bonds. The bonds are taxed at the federal level of the US government but not by local and state governments.
Treasury bonds are an excellent investment, especially if there is a rise in inflation rates. You've probably heard of the term DYOR (Do Your Own Research).
This is a phrase that has become increasingly popular primarily due to the influence of the cryptocurrency community. Research is a crucial part of investing in bonds, and you need to have an idea of how the bond will perform and if it works for you.
Therefore, I recommend you perform due diligence to ensure the issuer and type of bond are worth your investment money.
2. Buy the Bonds
You can buy bonds from government issuers or private businesses, depending on the bond you want to purchase. However, bonds require more capital to start investing and are more difficult to invest in than stocks.
Consequently, buying bonds depends solely on the type of bond you want. Here are the ways you can buy bonds:
- From a broker: You'll need to open a brokerage account to buy bonds this way. Buying bonds through brokers means you'll buy from investors who want to sell their bonds.
- From the US government: You can buy municipal and treasury bonds directly from the government. The United States has established a scheme that allows investors like you to invest in government bonds without going through brokers.
- Through ETFs: Exchange-traded funds invest in several bonds from various issuers, and their portfolio typically includes bonds of different maturity dates and sectors.
An ETF is an excellent choice if you want to invest in corporate bonds, as it offers instant portfolio diversification and eliminates the need to buy large amounts of bonds.
Bonds are like stocks in that you can only buy them whole. You can only purchase bonds, especially corporate bonds, in $1,000 increments, so you'll need a minimum of $1,000 in your trading account to begin buying them.
However, the federal government offers treasury bonds in $100 increments, and you can start investing with as little as $100.
3. Make a Profit on the Bond
Bonds are structured like loans and are technically known as fixed-income debt investments, and this means you get your principal when it matures.
Every bond has its maturity period and interest terms guiding its payments. The recurring interest on the bond is the primary way most investors make their profit.
The technical term for interest payments is "coupon," and the number of coupons you get for your bond depends on its maturity period.
Therefore, short-term bonds pay fewer coupons than long-term bonds. The face value of a bond, usually $1,000, is its OTC (over-the-counter) price.
This face value is typically the price for a whole bond. Therefore, you can only get bonds in increments of their face value. Interest rates can affect the value of various securities, and bonds are no different.
Therefore, you can also make a profit on your bonds if you sell them off when it increases in value compared to when you bought them.
Should You Buy Bonds?
Bonds are loan-structured securities that corporations and government agencies offer to investors. You can invest in bonds by choosing one and then buying it from a broker, an ETF, or Treasury Direct directly from the US government.
You can earn a profit from bonds through coupons, or interest payments, and these vary in number, depending on the bond's maturity period.
Bonds are great investments because you can be assured of your principal at the end of the maturity period.