While the presence of online brokerage services has brought investing costs down, dealing with a bond broker can still be prohibitive to some retail investors.
- Most investors should have a portion of their portfolio in bonds as a diversifier since they have different characteristics from stocks.
- Bonds are fixed-income securities that represent debts, making bond owners creditors.
- Many brokers now give access to investors to purchase individual bonds online, although it may be easier to purchase a mutual fund or ETF that specializes in bonds.
- Government bonds can be purchased directly through government-sponsored websites without the need for a broker.
- Municipal bonds can offer tax-exempt income for residents of certain localities.
How to Buy Corporate Bonds
Many specialized bond brokerages require high minimum initial deposits; $5,000 is typical. There may also be account maintenance fees. And of course, commissions on trades. Depending on the quantity and type of bond purchased, broker commissions can range from 0.5% to 2%.
When using a broker (even your regular one) to purchase bonds, you may be told that the trade is free of commission. What often happens, however, is that the price is marked up so that the cost you are charged essentially includes a compensatory fee. If the broker isn't earning anything off of the transaction, they probably would not offer the service.
For example, say you placed an order for 10 corporate bonds that were trading at $1,025 per bond. You'd be told, though, that they cost $1,035.25 per bond, so the total price of your investment comes not to $10,250 but to $10,352.50. The difference represents an effective 1% commission for the broker.
To determine the markup before purchase, look up the latest quote for the bond; you can also use the Trade Reporting and Compliance Engine (TRACE), which shows all over-the-counter (OTC) transactions for the secondary bond market. Use your discretion to decide whether or not the commission fee is excessive or one you are willing to accept.
How to Buy Government Bonds
Purchasing government bonds such as Treasuries (U.S.) or Canada Savings Bonds (Canada) works slightly differently than buying corporate or municipal bonds. Many financial institutions provide services to their clients that allow them to purchase government bonds through their regular investment accounts. If this service is not available to you through your bank or brokerage, you also have the option to purchase these securities directly from the government.
In the U.S., for example, Treasury bonds and bills (T-bonds and T-bills) can be purchased through TreasuryDirect. Sponsored by the U.S. Department of the Treasury Bureau of the Fiscal Service, TreasuryDirect lets individual investors buy, sell and hold Treasury Bills, Notes, Bonds, Inflation-Protected Securities (TIPS), and Series I and Series EE Savings Bonds in paperless form via electronic accounts. No fees or commissions are charged, but you must have a Social Security number or U.S. Taxpayer Identification Number, a U.S. address, and a U.S. bank account to purchase via the site.
How to Buy Bond Funds
Another way to gain exposure in bonds would be to invest in a bond fund (a mutual fund or exchange-traded fund (ETF)) that exclusively holds bonds in its portfolio. These funds are convenient since they are usually low-cost and contain a broad base of diversified bonds so you don't need to do your research to identify specific issues.
When buying and selling these funds (or, for that matter, bonds themselves on the open market), keep in mind that these are “secondary market” transactions, meaning that you are buying from another investor and not directly from the issuer. One drawback of mutual funds and ETFs is that investors do not know the maturity of all the bonds in the fund portfolio since they are changing quite often, and therefore these investment vehicles are not appropriate for an investor who wishes to hold a bond until maturity.
Another drawback of mutual funds is that you will have to pay additional fees to the portfolio managers, though bond funds tend to have lower expense ratios than their equity counterparts. Passively managed bond ETFs, which track a bond index, tend to have the fewest expenses of all.
In addition to the Treasury, corporate, and municipal bonds described above, there are many other bonds that can be used strategically in a well-diversified, income-generating portfolio. Analyzing the yield of these bonds relative to U.S. Treasuries and relative to comparable bonds of the same type and maturity is key to understanding their risks.
More Tips for Buying Bonds
Today, many online brokerage platforms make buying bonds of all types easy and cost-efficient. Therefore, finding the right bonds for your portfolio is key. Depending on your investment goals, tax exposure, risk tolerance, and time horizon, different types of bonds will be most appropriate for you. Most of these platforms will also have tools to screen the universe of bonds and filter based on various criteria such as credit rating, maturity, type of issuer, and yield.
U.S. Treasury bonds are frequently used as a benchmark for other bond prices or yields. Any bond's price is best understood by also looking at its yield. As a measure of relative value, the yields of most bonds are quoted as a yield spread to a comparable U.S. Treasury bond.
If you're willing to give up some yield in exchange for a risk-free portfolio, you can use Treasury bonds to structure a portfolio with coupon payments and maturities that match your income needs. The key is to minimize your reinvestment risk by matching those coupon payments and maturities as closely as possible to your income needs.
A bond ladder is a strategy that attempts to minimize these risks associated with fixed-income securities while managing cash flows for the individual investor. In a bond ladder, the bonds' maturity dates are evenly spaced across several months or several years so that the proceeds are reinvested at regular intervals as the bonds mature. By staggering maturity dates, you won't be locked into one bond for a long duration.
How to Buy Bonds FAQs
How Do You Buy Tax-Free Municipal Bonds?
You can buy munis from your online broker or through a brokerage firm that specializes in municipal bonds. Be sure to check that you will qualify for tax-free status based on your residency.
How Do You Buy Savings Bonds for a Child?
U.S> government savings bonds can only be purchased online using the TreasuryDirect website. You may also be able to use your federal income tax refund to purchase savings bonds.
How Do You Buy Foreign Bonds?
Depending on your brokerage's capabilities and access to international debt markets, you may be able to purchase foreign bonds much the same way as domestic ones. International bond mutual funds and ETFs are also available to trade.
Can You Still Buy Bearer Bonds?
A bearer bond is a fixed-income security that is owned by the holder, or bearer, rather than by a registered owner. Bearer bonds are virtually non-existent anymore as the lack of registration made them ideal for use in money laundering, tax evasion, and any number of other under-handed transactions. They also are vulnerable to theft.
The Bottom Line
A well-diversified portfolio should include investments in bonds, and most brokers today allow for easy access to the bond market, either directly or via bond mutual funds or ETFs. But, the bond market can be complex and overwhelming if taken as a whole. Depending on your investment goals, tax exposure, risk tolerance, and time horizon, different types of bonds will be most appropriate for you. Knowing the risks and features of each type of bond can help you understand when and how much of that asset class to add to your portfolio.