- Most investors should have a portion of their portfolio in bonds as a diversifier since they have different characteristics from stocks.
- 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.
How Bond Brokers Work
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, he or she 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.
Buying 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 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.
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 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.