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Buying and Selling Bonds

Selecting and Working with a Financial Professional

More than likely you will work with a financial professional to invest in bonds. There are a variety of people who can help you invest in bonds—they go by different titles including financial advisors, brokers, sales representatives, stockbrokers, account executives, or registered representatives. How do you decide whom to use? Do you want to use a full-service or discount broker? Are you comfortable investing through an online firm? How can you know that your broker has access to the types of bonds you are interested in? How is he or she compensated? Here are some tips to help you get the answers.

  • Your Options
  • Considerations for Evaluating a Financial Professional
  • Questions to Ask Before Selecting a Financial Professional
  • Evaluating a Current Broker

Your Options

A bond broker is someone who is licensed or registered to buy and sell bonds for institutional or individual investors. Brokers are required to pass an exam and register with the Financial Industry Regulatory Authority (FINRA). Brokers may work within bond firms or they may work as independent brokers. Different types of brokers offer different levels of service and varying access to bonds.

Full-service brokers offer clients a wide range of services including: helping clients develop investment goals, researching and recommending investment opportunities for individual clients, as well as executing purchases and sales of bonds for a client’s portfolio. Another difference between full service brokers and other types of brokers is that full service brokerage firms maintain an inventory of various bonds to offer directly to clients.

Discount brokers execute buy and sell orders for clients, but they generally do not make investment recommendations and they often do not hold a large inventory of bonds. Instead they purchase bonds from full-service brokers or bond issuers and then resell them to individual investors at a mark-up (price increase) for their services.

Online brokerage companies offer full and discount services for investors who would rather invest directly through the internet. Online brokerage firms may enable you to compare bond inventories across multiple dealers, research bond types, and place orders online. Not all online brokerage firms offer bonds and not all online firms offer you the ability to compare across dealers. You purchase and sell bonds by opening an online account. You can purchase Treasuries and savings bonds commission- and fee-free online through the U.S. Treasury’s website.

Third party brokers do not carry an inventory of bonds. Rather they bid for bonds for individual investors from a wide variety of dealers. Think of third party brokers as “bond headhunters.”

Many banks also offer customers the ability to invest in bonds through on-staff registered representatives.

Considerations for Evaluating a Potential Financial Professional

Consider the following four areas when evaluating a potential financial professional to help you achieve your wealth-building goals.

First, competence. Make sure he or she has the education, experience, and credentials necessary, as well as proven success in the field. You want to know that your potential broker has experience investing for clients in the type of bonds you are most interested in, and is registered with the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) and is licensed to do business in your state.

Second, access to the bonds you are interested in. Not every broker has immediate access to the types of bonds you may be interested in. For example, full service brokers keep a large inventory of various bonds for individual investors while discount brokers maintain a much smaller inventory. Know what type of bonds you are most interested in (U.S. Treasuries, munis, corporate bonds) and determine if your broker has the best access to those bonds.

Third, compliance. Ask whether or not he or she has a history of regulatory disciplinary problems. You can check on a brokers’ background through the Financial Industry Regulatory Authority 's FINRA Broker Check online service or through the U.S. Securities and Exchange Commission Investment Adviser Public Disclosure service.

Fourth, your confidence level. Unless you choose to use an online brokerage firm, you will be working with an individual to invest in bonds. You need to feel confident about this person’s knowledge of the market as well as his or her ability to maintain and manage a professional relationship with you.

Questions to Ask Before Selecting a Financial Professional

Be well-prepared when meeting with a financial professional for the first time in order to determine whether you want to use him or her to invest in bonds. Following are some suggested questions:

  • How long have you been working in this field investing in bonds for clients?
    You want to know that he or she has accumulated experience in the field.
  • What types of bonds do you have experience buying and selling for investors? For example, if you are most interested in munis, consider whether or not you want to use a broker whose background is primarily in corporate bonds. If you are primarily interested in high-yield corporate bonds with a higher degree of credit risk, does your potential broker have more experience in lower-risk U.S. Treasuries?
  • Can you provide references of other clients that I can call?
    A reputable professional should provide you with a list of references upon request.
  • Who else in your firm will work on my account?
    He or she should let you know of anyone else in the office who may also work on your account.
  • How are you paid?
    As compensation for their services for bond transactions, brokers typically receive a portion of the commission charged, if any, or a portion of the dealer markup or markdown that is factored into the price of the bond. Some brokers may charge a flat fee based on the size of your account and your level of trading activity rather than imposing charges on each transaction.
    Brokers expect experienced investors to ask questions about prices and fees. Your broker should be able to explain any transaction costs or fees to you as well as the relationship between those costs and his or her compensation. You can always ask your broker if he or she will consider negotiating commissions or prices on orders. Don’t be afraid to shop around between brokers for the best possible price. For more information see the Investor Costs Associated with Buying and Selling Bonds section below.
  • If you are choosing to use an online brokerage firm, find out if they charge a flat fee or if the firm charges a markup that is built into the price you are offered onscreen.

Evaluating a Current Broker

How do I know if I’m getting the best service from a broker I’m already working with?

Just as it is a good idea to periodically review your portfolio balance and asset allocations, it’s always a good idea to periodically evaluate what type of advice and service your broker is giving you and if he or she is helping you achieve your financial goals. Here are a few questions to ask:

  • Does your broker consistently suggest bonds that are outside your stated investment preferences? For example, if you have told your broker that you prefer U.S. Treasuries, does he or she routinely pitch you on high-yield issues instead?
  • Are you satisfied with your portfolio’s performance? Does your broker keep you informed on market influences and possible alternative bond investments given your financial objectives?
  • When your broker advises you to buy, sell or hold a particular bond or bond fund, does he or she explain why? You should always know how a recommendation fits into your personal financial plan.
  • Is your broker communicative? Does your broker call you or keep in touch via email or letters regularly, regardless of what the bond markets are doing? Is your broker responsive to your calls and emails?
  • Does your broker routinely recommend one or two types of bond investments over others? If so, why?

Ultimately you are responsible for managing your personal wealth-building strategy. Determine your financial objectives, identify what types of bonds are appropriate for your portfolio, research brokers, and regularly review your investments’ performance with your financial professional to stay on target.

Investor Costs Associated with Buying and Selling Bonds

Investors buy and sell bonds through financial professionals who get compensated for their services.

This professional will typically be a broker working for a brokerage firm. Many but not all brokerage firms are also dealers, or broker-dealers, meaning they buy and sell securities from each other and hold some of these securities in inventory.

Markups and Markdowns

Broker-dealers who hold bonds in inventory increase or “mark up” the price when a customer buys a bond from them, and reduce or “mark down” the price when a customer sells a bond back to them. This markup or markdown is built into the customer’s price rather than identified separately.

This pricing method of these so-called “principal” transactions is similar to that used by any retail store. A store that sells stereos, for example, will buy a stereo from the manufacturer for one price and sell it to the customer for a higher price. Built into the difference or markup is the store owners’ proportional cost of rent and other overhead, the salaries of the salespeople, some compensation for the risk that the price may have to be reduced if the stereo doesn’t sell, and a profit for themselves. The person who buys the stereo does not know the amount of the markup, but can shop around for the best price.

Bond dealers face virtually the same issues: they have overhead costs, they need to pay their salespeople, they face the risk that interest rates or market conditions might cause a bond they hold in inventory to decline in value, and they need to make a profit. Their markups and markdowns may also be affected by the size of the transaction—the larger the amount, the lower the cost—and the liquidity of the security. Bonds that trade frequently should have lower markups and markdowns than thinly traded securities.

Both the Financial Industry Regulatory Authority (FINRA) and the Municipal Securities Rulemaking Board (MSRB) have rules governing how much a broker-dealer can mark up (or mark down) the price of a bond he or she sells (or buys from) you.

You can sometimes estimate the amount of the markup if you know the “bid-ask” spread, or the difference between a price a dealer is willing to pay for a bond (the bid) and the usually higher price the dealer is willing to sell the same bond for (the ask).

Commissions

Brokers who are not also dealers or who do not have the particular bond you want in inventory will have to go into the marketplace to get it. In this case, the broker acts as an agent rather than as a principal, and the trade is sometimes called an agency transaction. In most cases, brokers will charge investors commissions on agency transactions, and the amount of the commission will be identified on the trade confirmation. (Remember, though, the agency broker also pays a markup to the dealer selling the bond.) Sometimes the commission will be based on a percentage of the bond’s price, and this percentage may decline as the size of the transaction increases. Other times, especially in the case of a discount or on-line broker, the commission may be a flat fee.

Keep in mind that the markup or commission is the fee imposed by the brokerage firm; the individual broker you work with will get a portion of that amount.

The bottom line is that you want the best price, and the broker you work with deserves to be compensated. To get the best price, you may have to shop around. Or you may decide that the service you receive from your broker is worth a higher price. If you build a relationship with a particular broker, you may also find that your transaction costs can be negotiated.

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