How To Invest
There are several ways to invest in bonds, including purchasing individual bonds or investing in bond funds or unit investment trusts.
There is a wide variety of individual bonds to choose from in creating a portfolio that matches your investment needs and expectations. Most individual bonds are bought and sold in the over-the-counter (OTC) market, although some corporate bonds are also listed on the New York Stock Exchange. The OTC market comprises securities firms and banks that trade bonds; brokers or agents, who buy and sell bonds on behalf of customers in response to specific requests; and dealers, who keep an inventory of bonds to buy and sell.
If you’re interested in purchasing a new bond issue in the primary market (when it is first issued), your investment advisor will provide you with the offering document, official statement or prospectus. You can also buy and sell bonds in the secondary market, after they have already been in issued in the primary market.
Usually, bonds sold in the OTC market are usually sold in $5,000 denominations. In the secondary market for outstanding bonds, prices are quoted as if the bond were traded in $100 increments. Thus, a bond quoted at 98 refers to a bond priced at $98 per $100 of face value, which equates to buying a bond with a face value of $5,000 for $4,900 (or at a two percent discount).
Bond prices in the secondary market normally include a markup, which consists of the dealer’s costs and profit. An additional commission may be added if a broker or dealer has to locate a specific bond that is not in its inventory. Each firm establishes its own prices, within regulatory guidelines, which will vary depending upon the type of bond, size of the transaction, and service the firm provides.
There are a number of resources to help investors compare current prices of bonds. SIFMA's investor education web sites, such as this one, www.investinginbonds.com and www.investinginbondseurope.org, offer recent and historical price data on corporate and municipal bonds. Investors can sort and search the data by a variety of criteria and broad categories, such as yields, ratings, or prices. Prices of U.S. corporate bonds are now more widely available, as mandated by rules issued by the Financial Industry Regulatory Authority (FINRA). For municipal bonds, transaction price data and daily summary of trading activity can be obtained from the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access portal at http://emma.msrb.org.
For the U.S. government bond market, Treasury bond yields are also posted on both www.investinginbonds.com and www.investinginbondseurope.org and are updated throughout the day. SIFMA’s investor websites also provide links to multiple services that provide price and yield information on many market segments. There are also a number of other internet sites, media sources and vendors that provide current and historical information on the primary and secondary markets. You can also compare prices for specific bonds through your broker or financial advisor.
Bond funds, like stock funds, offer professional selection and management of a portfolio of bonds for a fee. Through a bond fund, an investor can diversify risks across a broad range of issues and opt for a number of other conveniences, such as the option of having interest payments either reinvested or distributed periodically.
Some funds are designed to follow a market, in general or a specified index of bonds. These are often referred to as index or passive funds. Other funds are actively managed according to a stated objective, with bonds purchased and sold at the discretion of a fund manager. In contrast to an individual bond investment, a bond fund does not have a specified maturity date because bonds being added to and eliminated from the portfolio in response to market conditions and investor demand. With open-end mutual funds, an investor is able to buy or sell a share in the fund at any time at the fund’s net asset value. Because the market value of bonds fluctuates, a fund’s net asset value will change to reflect the aggregate value of the bonds in the portfolio. As a result, the value of an investment bond fund may be higher or lower than the original purchase price, depending upon how the underlying portfolio of bonds has performed. Alternatively, closed-end mutual funds have a specific number of shares that are listed and traded on a stock exchange. The price of closed-end funds will fluctuate not only with the price of the underlying portfolio, but also the supply and demand of the shares of the fund, and so may be priced at, above, or below the net asset value of the fund’s holdings. Because the fund managers are less concerned about having to meet investor redemptions on any given day, their strategies can be more aggressive. Exchange-traded funds, or ETFs, are similar to closed-end funds, but have transparent portfolios and are generally passively managed.
There are numerous sources of bond fund information available, including personal finance magazines and the internet. Fund research firms also provide detailed analyses by subscription to which many libraries subscribe. In addition, rating agencies also evaluate bond funds for credit and safety.
Most funds charge annual management fees while some also impose initial sales charges or fees for selling shares. When taken into account, fees and sales charges will lower overall returns, so investors need to be aware of total costs when calculating expected returns. Many funds also require a minimum initial investment.
Like individual bonds and other investments, bond fund investments entail risk. Investors should not automatically conclude that a fund offering a higher rate of return or income is better than a fund offering lower rates of return or income. Investors need to be aware of several factors, including the total costs, credit quality, manager quality, risks and the ability to exit these funds before making investment decisions.
Money Market Funds
Money market funds refer to pooled investments in short-term, highly liquid securities. These securities include short-term U.S. Treasuries, municipal bonds, certificates of deposit issued by major commercial banks, and commercial paper issued by corporations. Generally, these funds consist of securities and other instruments having maturities of three months or less. Money market funds may offer convenient liquidity, since most allow investors to withdraw their money at any time. The minimum initial investment is usually between $1,000 and $10,000.
Bond Unit Investment Trusts
Bond unit investment trusts offer a fixed portfolio of investments in government, municipal, mortgage-backed or corporate bonds, which are professionally selected and remain constant throughout the life of the trust. One of the benefits of a unit trust is that you know exactly how much you will earn while you are invested because the composition of the portfolio remains stable. Since the unit trust is not an actively managed pool of assets, there is usually no management fee, but investors do pay a sales charge, plus a small annual fee to cover supervision, evaluation expenses and trustee fees. The minimum initial investment is usually between $1,000. As an investor, you can earn interest income during the life of the trust and recover your principal as securities within the trust are redeemed. The trust typically ends when the last investment matures.