How To Buy Bonds

Looking for a ‘safe bet’ to help combat the current upheaval of your finances? A reliable option to diversify your portfolio — even during COVID-19?

We’re all feeling the sharp effects of the coronavirus: looming credit concerns caused by the expected rise in unemployment have left us vulnerable. A recent report by The European Securities and Markets Authority (ESMA) questions the sustainability of the current market rebound. Where do we find solace?

Unsurprisingly, one market benefitting from the pandemic is the bond market. The creation of a new class of bonds – COVID-19 bonds – has opened the door for fund managers to refocus from socially responsible investing, to investing in the health crisis. 💷

By May 31st, an eye-watering $151.5 billion was raised through COVID-19 bonds alone. Securities Industry and Financial Markets Association (SIFMA), quotes the overall bond market value at $100.13 trillion, with COVID-19 bonds presenting as a safe investment option. 

Not only can bonds offer your portfolio protection during the coronavirus pandemic, but the very nature of bonds also sets you up to receive a steady and reliable stream of income. But which type of bonds will get you the best results? And should you buy new-issue bonds directly, or from the secondary market?

Right now, knowing how to buy bonds might just be the best way to calm any financial uncertainty and bring some clarity back into your finances. Let’s get to it. 

What is a Bond? 📚

Bonds are issued to investors as a representation of a loan taken out (by governments or corporations) in exchange for the investor’s principal plus interest in return. The investor taking out the loan is known as the bondholder. Businesses, states, and municipalities could use bonds to fund a project or activity.

How Do Bonds Work ⚙

When you buy a bond you are in credit to the bond issuer. This is a key difference between stocks and bonds. For example, buying a share in Apple buys you the right to a piece of the company and by extension, its profits. 

Though there are many benefits to bonds which we’ll go through below, this is not one of them. Bondholders can receive a fixed or floating interest and principal that isn’t based on the company’s performance. This means that bondholders are always certain about when they’ll be paid.

Unlike dividends, where payment can be withheld from by companies, bondholders are always guaranteed payment. In rare cases, like a company going into bankruptcy or defaulting, a bondholder’s payment might be changed or canceled.

Bonds are typically set at par, usually $100 or $1,000 face value per individual bond. The market price of a bond will depend on several factors including; the length of time until expiration, the credit quality of the issuer, and the coupon rate in comparison to the interest rate at the time. Bondholders repay the face value of the bond once it matures.

Once bonds have been issued they can be sold to other investors by the initial bond holder, in most cases. In other words, investors do not need to hold bonds right through to the maturity date.

Bonds are also commonly rebought by the borrower if the interest rate declines, or if the borrower’s credit improves, and new bonds can be reissued for a lower price.

How Do Bonds Make Money? 💰

Issuers use a coupon rate (the bonds maturity and market interest rates) to determine a competitive interest rate. This is expressed as a percentage of the face values.

A $500 bond with a 10% semiannual coupon will be $50 in interest each year paid out in two installments of $25 until the bond matures.

Bonds can have either a fixed or floating interest rate. Fixed rates remain the same throughout the life of the bond while floating interest rates can be reset periodically.

How Interest Rates Affect Bond Prices 📊

When a bond is issued, investors can trade it on the secondary market. Bonds issued before this can trade at a discount or premium to their face value, depending on the change in market interest rates in comparison to the bond’s coupon rate.

Coupon rates move along with interest rates. When interest rates rise, so do coupon rates on new bonds. This makes the lower rates on old bonds less attractive. Because of this, investors aren’t willing to pay as high a price for older bonds. 

When interest rates decline, older bonds offering higher coupons are more expensive.

Bonds trading lower than its face value are known as discount bonds. Bonds trading above their face value are known as premium bonds.

Benefits of Bonds 📘

There are about three key reasons across the board that investors buy bonds. Some use bonds to create a steady stream of income, as we mentioned above.

Since payments are guaranteed, investors know how much to expect, and when. This aspect makes bonds ideal for funding more long term liabilities like retirement or college. 

Bonds can also be used to mitigate portfolio risk. In general, bonds have a low correlation to stocks, which means their value goes up when stocks are down and down when stocks are up. 

Benefits ➕

• ☑️ A steady stream of income 
• ☑️ Ideal for funding long term liabilities like retirement funds
• ☑️ Mitigates risk and reduces effects of volatility
• ☑️ Offers protection from economic downturn

This means that high-quality stocks, like U.S. Government bonds, are really useful in diversifying the risks faced in owning stocks – just make sure to use one of the top stock brokers. By adding bonds to your portfolio you can lower the effects of any volatility and the loss you might incur as a result.

Bonds serve as solid protection in times of crisis. During times of economic downturn falling inflation strengthens the buying power that future bond payments hold.

In the same way, investors usually flock to bonds when the economy is slower, driving up prices. Covered bonds, in particular, could help support economic recovery by assisting the EU to meet its environmental and social objectives.

In rare cases, bonds fall when stocks fall, like the mid-march sell off. These are usually times of uncertainty, where investors sell off holdings that have value, like bonds, to earn income. This happened during the 2008 stock market crash propelled by the financial crisis.

Wondering what a stock broker is exactly? If you’re looking to create a strong portfolio then you’ll probably need to go through a stock broker to help you access stocks.

When considering the best one for you, look at factors like fees, research tools, and account options.

COVID: How Do Bonds Perform in a Pandemic? 📈

In the midst of the coronavirus pandemic new classes of bonds have been created, paving the way for socially responsible investors to make large injections into health.

In general, investors agree that COVID-19 bonds offer a constructive and tangible opportunity to make a positive impact on the current crisis. Issuers reacted impressively quick when considering typical time-frames for aligning organisations and setting up new frameworks. 

By May 31st, Banks, companies, governments, and multinationals successfully raised an eye-watering $151.5 billion across the globe purely from selling Covid-19 bonds, or those with debt that is related to the pandemic, according to research by BNP Paribas. This proves the protection that bonds offer during times of crisis, even in 2020.

Different Types of Bonds 🗃

While the COVID-19 pandemic has given rise to a new label of sustainable bond: COVID-19 bonds, there are three main types of bonds on the market; corporate bonds, municipal bonds, government bonds. Each bond type works differently and has its own individual benefits.

Corporate Bonds 💸

Corporate bonds are issued by companies, and with a recent announcement that U.S. corporate debt had reached $10.5 trillion, they are proving essential in helping to keep companies afloat during Covid-19. 

Generally, companies prefer to issue bonds rather than look for a bank loan because there are better terms and lower interest rates.

These tend to be sold in denominations of $1,000 with a variety of maturities and coupon rates. Corporate bonds make up one of the biggest segments of the U.S. bond market, beaten only by U.S. government bonds.

On Thursday, Bank of America sold a first-of-a-kind COVID-19 corporate bond. This is the first from a global commercial bank with the purpose of specifically financing health.

Government Bonds 🏛️

Government bonds are issued by the U.S. Treasury to cover federal debt for reasons explained by Modern Monetary Theory.

When bonds are issued with one year or less to maturity they are called “Bills”, when they are issued with a maturity of one to ten years they are called “Notes”, when bonds have a maturity of ten years they are called “Bonds.”

The whole category of bonds issued is referred to as “Treasuries.” When government bonds are issued by the national government they’re known as sovereign debt.

U.S. government bonds are favoured because the government is trusted to make payments even in hostile economic environments, for example, during the Great Depression. This makes them one of the safest investment options out there. 

Because it’s highly unlikely the U.S. government will default on its debt, Treasurys are considered some of the safest investments available. Some municipal bonds offer tax-free coupon income for investors.

Treasury Types 📜

Treasury Bills: These are short-term bonds that mature by 52 weeks. They are zero-coupon bonds sold at a discount. 

Treasury Notes: These mature in two, three, five, seven and 10 years. Interest is paid twice a year.

Treasury Bonds: These mature in 30 years and interest is paid every six months.

Treasury inflation-protected securities: These are a combination of notes and bonds that move the principal for inflation. The relevant interest is paid based on the adjusted principal every six month. Once mature, investors receive the higher principal amount.

Floating rate notes: Pay a variable interest rate based on 13-week Treasury Bill interest rates. These pay interest each quarter and mature after two years.

Saving bonds: These are low-risk, making them safe options for saving, and a maturity time of up to 30 years. Interest is paid when they mature.

Treasurys can be bought in increments of $100. The only exception if savings bonds, which can be bought in penny increments of $25 and up.

Municipal Bonds 🔗

Municipal bonds are used to fund local and state projects, like schools, roads and other infrastructure. They are issued by municipalities and states, and are backed by the U.S. Government. Some municipal bonds offer tax-free coupon income for investors.

How To Buy Individual Bonds 🧾

Despite fears of “social-washing” bonds may be the best investment option for your financial goals. If you’re considering investing in bonds, you can buy them through a broker, or alternatively you can buy them from an issuing government entity directly. 

You might wonder what the difference is between a broker and a trader. Mainly, agency traders are referred to as brokers that handle client orders. Technically, an agency trader and a broker are one and the same.

In most cases, investors are attracted to individual bonds because of their ability to lock in a specific yield for a set time period. This offers stability.

In comparison, the yield on ETF mutual funds or bond mutual funds fluctuates. If you are interested in ETF mutual funds, check out our review of the top ETF brokers to help you reach your financial goals.

It’s important to note that individual bonds need to be purchased whole. Because most bonds are issued in increments of $1,000, you will need to fund your brokerage account with a minimum of$1,000 to get started.

No matter whether you are looking to buy corporate bonds, treasuries, or municipal bonds, the basics of buying an individual bond is the same for all: You buy them as either new issues or from the secondary market.

New Issue Bonds 🆕

When you buy new issue bonds you buy them on the primary market, like buying stock in a company’s IPO. You can acquire new issue bonds at the offering price. 

How To Buy Corporate Bonds as New Issues 👷‍♂️

To buy a corporate bond you should understand the bond’s rating, maturity, and interest rate, as well as how the interest rate is paid.

Acquiring new issue corporate bonds is no easy feat. for everyday investors. You’ll usually need to have a relationship with the broker or banks that’s managing the primary bond offering. You should understand the bond’s rating, maturity, and interest rate, as well as how the interest rate is paid, if you want to buy corporate bonds.

To finalise your purchase, you will need to create a broker account that covers your initial purchase in addition to any extra fees or commissions charged by the broker. Opening an account requires much more than just filling out the required fields, so make sure you understand how to open a brokerage account the right way.

How To Buy Municipal Bonds as New Issues 🏗

You will need to create an account with the financial institution directly backing the bond issue. To buy municipal bonds as new issues you will need to participate in the issuer’s retail order period.

You will need to sign up with the broker or financial institution backing the bond issue and make a request informing it of the coupon, quantity, and maturity date of the bonds you are interested in buying.

How To Buy Government Bonds as New Issues 👨‍🏫

You can buy government bonds like U.S. Treasury bonds directly through Treasury Direct or through a broker. As we mentioned earlier, treasury bonds are issued in increments of $100. 

To buy new issue-government bonds you can do so through auctions at several times during the year, by placing a competitive or non-competitive bid. 

A non-competitive bid means you agree to the terms set out at the auction. A competitive bid means you can give an indication of your preferred discount margin, yield, or rate. You can stay on top of upcoming auctions by tracking them online.

Secondary Market Bonds 💵

In many cases, bondholders sell their bonds on the secondary market before they mature.

If you would like to understand how to buy bonds that are not new issues, you can purchase the same bonds we’ve mentioned above on the secondary market. You can do this through a broker, public exchange, or speciality bond broker.

Buying bonds on the secondary market requires more research because the pricing is not so transparent. While new issues are all priced the same, the secondary market tends to markup on municipal and corporate bonds.

You also might notice the same bond offered at two different prices by separate dealers. You’ll probably also need to pay extra fees and commissions.

Don’t Get Blinded by the COVID-19 Sri Light ⚠

Before we get into how to buy bonds, you should know that they might not all be what they seem. If you are struck by the fact that you could contribute towards helping the health sector battle the pandemic, note that it was recently unveiled that supposed Covid-19 bonds in China were more bond than Covid. Just make sure to do your due diligence.

When to Sell Bonds 💰

Bonds, in particular individual bonds, are a super buy-and-hold investment. But there are times when it makes more sense to sell. This can happen in instances where your bond is at risk of default.

There are also strategies that involve buying an undervalued corporate bond and selling it on when the value appreciates.To sell a bond before it matures you will need a broker, which means you will likely pay some fees, too.

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