Investing in Bonds: A Comprehensive Guide

Bonds are often considered safe, low-risk investments. By purchasing a bond, you’re effectively loaning money to the issuer—usually a corporation or government agency. This allows these organizations to raise capital for various projects and initiatives. The upside for investors is receiving regular interest payments during the bond’s term. Here, we’ll explore the different types of bonds, where to buy them, and tips for making smart bond investments.

Types of Bonds

There are four main types of bonds, each with its own characteristics and benefits:

Treasury Bonds

Issued by the federal government, Treasury bonds are stable, low-risk investments. T-bonds provide a fixed interest payment every six months until the bond matures. At the time of this writing, the interest rate on 30-year Treasury bonds is 4.125%, while 20-year bonds offer 4.375%. Investment gains from T-bonds are subject to federal income tax but are exempt from state and local taxes.

Municipal Bonds

These bonds are issued by states, cities, and counties to fund local projects like maintaining highways and building schools. They are exempt from federal taxes and, in most cases, state taxes as well. Due to these tax benefits, interest rates on municipal bonds tend to be lower than those on corporate bonds with similar maturity periods. Municipal bonds typically pay interest semiannually.

Corporate Bonds

Issued by companies, corporate bonds carry more risk than government-backed bonds. They come with credit ratings that indicate their risk level. AAA-rated companies are considered financially stable, while D-rated companies are seen as less secure. High-yield bonds, also known as junk bonds, have a higher chance of default. Interest rates are generally higher on callable corporate bonds, which the issuer can retire before the maturity date.

Bond Funds

Investors can also buy into bond funds, such as bond exchange-traded funds (ETFs). Bond funds provide access to a large variety of bonds in one trade, offering built-in diversification that can help balance your investment portfolio.

Where to Buy Bonds

Through the Government

You can purchase Treasury bonds and other government bonds directly through the federal government at TreasuryDirect.gov. An auction process determines the offer price and coupon rate for T-bonds. You can also purchase Treasury bills, Treasury notes, and savings bonds through the same website.

• Treasury Bills: Auctioned at a discount and mature in four weeks to one year, with interest paid in full at maturity.
• Treasury Notes: Fixed interest payments are issued every six months. The rate on a 10-year Treasury note is currently 3.875%, with term lengths ranging from two to 10 years.
• Series EE Savings Bonds: Guaranteed to double after 20 years but can earn interest for 30 years. The current interest rate is 2.50%.
• Series I Savings Bonds: Available in 30-year terms, these bonds use a mix of fixed and inflation-adjusted interest rates. The current composite rate is 4.30%.

With a Broker

Many types of bonds are available for purchase through an investment account with a brokerage firm. You can do this online through a brokerage account or robo-advisor. Working with a licensed broker allows you to buy bonds on the secondary market from other investors, including municipal bonds, corporate bonds, and some government bonds. Prices and availability depend on market conditions and the number of sellers.

If you’re looking to buy individual bonds but aren’t sure where to start, going through a broker is a good entry point. Robo-advisors are particularly hands-off, using algorithms to purchase bonds and other investments on your behalf based on your risk tolerance, age, and investment goals.

Through an ETF

Analyzing and buying individual bonds can be time-consuming and expensive. ETFs pool money from investors to buy a variety of different assets, including bonds. They trade on major stock exchanges and can bring diversity to your investment portfolio. Bond ETFs can include a mix of corporate bonds, municipal bonds, government bonds, and international bonds. Fees are often lower than mutual funds, though some brokers do charge trading commissions. You can invest in ETFs through a brokerage account.

Tips for Buying Bonds

Gauge Your Risk Tolerance

While bonds are considered relatively safe investments, there’s always some degree of risk. It’s unlikely that the federal government will default on its bonds, but municipalities can become insolvent, and corporate bonds involve the most risk, especially junk bonds. Gauge your risk tolerance and see how bonds may fit into your overall portfolio.

Review the Rate of Return

Bonds generally produce modest returns compared to the stock market. From 1950 to 2022, the S&P 500 had an average annual return of 11.1%, while bonds averaged 5.5%. Building a bond-heavy portfolio could limit your future returns. Financial experts generally advise investing more in stocks while you’re younger, then gradually shifting to a more conservative asset allocation as you approach retirement. Diversification is key; if stock returns dip, steady bond returns can help offset those losses.

Consider When You’ll Need the Money

Bonds have different maturity periods. Investing in a 30-year Treasury bond may not make sense for short-term financial goals. Consider when you’ll need access to your funds and create a financial game plan to get the best returns. This might mean spreading your money across different types of bonds, ETFs, and certificates of deposit (CDs).

Look at Credit Ratings

Credit ratings help you evaluate the risk associated with different bond issuers. These ratings reflect the likelihood of default. Interest rates may be higher with lower-rated bond issuers, but it’s wise to proceed with caution.

Consider a Bond Ladder

Bond laddering involves buying a variety of bonds with different maturity dates, providing an ongoing stream of predictable interest payments. As each bond matures, you can reinvest in new bonds or use the money as needed. Staggering your bond investments can also allow you to take advantage of rising interest rates.

The Bottom Line

Bonds are low-risk investments that can provide reliable gains. Including them in your portfolio can help complement high-risk investments like stocks. You can purchase bonds from the U.S. government or on the secondary market through brokerage firms and ETFs.

For any mortgage service needs, O1ne Mortgage is here to help. Call us at 213-732-3074 to speak with one of our expert loan salespersons. We are committed to providing you with the best mortgage solutions tailored to your needs.

No matter how you invest, managing your finances with confidence is crucial. Check your credit score and credit report regularly to stay informed and make the best financial decisions.