How to buy bonds
The best way to get stated on how to buy bonds is to understand how bonds work, how bond prices are affected by current economic conditions, the different types of bonds available and their potential profits and risks of each bond type.
How to Buy Bonds
You have few ways to buy bonds. However, some providers sell only specific bond types.
- Through a broker: You can buy bonds from retail brokers like Interactive Brokers, Fidelity, or Charles Schwab.
- Through an exchange traded fund (ETF) or mutual fund: ETFs and bond funds are good investment vehicles since they provide you with a diversified portfolio of bonds for low management fees. Building a diverse portfolio of individual bonds requires a big investment since the face value of most bonds is $1,000.
- Directly from the US Treasury Department: You can buy only Treasury bonds and notes online by visiting the federal government’s website Treasury Direct. You can buy government bonds directly without paying any brokerage fees.
Your checklist before buying bonds
Before you buy bonds, it is important to follow these steps thoroughly for all bonds in general:
- Monitor the Global economy and make sure the current economic environment is healthy.
Government bonds are the best performing assets during recessions while junk bonds are the one of the best performing financial assets during strong economic environments. If you want to learn about the relationship between bonds and economic conditions continue reading.
- Analyze the current bond market and its future expectations
If you are interested in investing in a specific sector, industry, or an individual corporate bond, then follow these additional steps:
- Carefully read the bond indenture which is a contract stating the lender’s rights and the borrower’s obligations. Any collateral offered as security to the bondholders will be described in this contract.
- Verify that the specific corporate bond sector and the related stock sector currently have strong momentum and trends using MacroVar free credit spreads monitor.
- Analyze the sector’s performance during economic recessions using historical data to make sure you can incur a potential loss if it arises in the future.
- A company’s corporate bond is highly correlated with the company’s stock and credit default swap. By analyzing the company’s stock using our stock trading guide and the company’s credit default swap you can easily verify that the company’s corporate bond is a solid investment.
- Analyze the company’s fundamentals using our bottom-up guide.
Investing in Bonds
Investing in bonds requires an understanding of how bonds work and how their value is affected by the current economic conditions and other financial markets.
There are different types of bonds and each bond type has different risk return characteristics. Along the risk spectrum, U.S. and German Government bonds are considered the safest lowest-risk financial assets while junk bonds are the highest-risk financial assets.
Bonds and the Economy
- Inflation boom: Accelerating Economic growth with Rising inflation
- Stagflation: Slowing Economic Growth with Rising Inflation
- Disinflation boom: Accelerating Economic growth with Slowing Inflation
- Deflation Bust: Slowing Economic Growth with Falling Inflation
During stagflation which is an economic environment of falling inflation and slowing economic growth government bonds are the best performing financial assets while high yield bonds are one fo the worst performing financial assets.
Deflationary busts are economic environments with falling economic growth and falling inflation. During this environment safe government bonds like US treasuries and German bunds are the best performing assets while high yield bonds are one of the worst performing assets.
Bonds and Market Risk
During global economic expansions when inflation expectations are positive, capital flows out of low-risk assets such as US treasuries and German bunds into higher risk financial assets such as high yield bonds and stocks. Inside the government bond market, during healthy economic conditions capital flows from safe German bunds to riskier bonds of the Eurozone periphery like Italian government bonds and Spanish government bonds and from low-risk US treasuries to other emerging market bonds in search of additional yield.
During economic slowdowns where the market expectation is disinflation funds flow from risky assets like emerging market bonds and stocks to low-risk financial assets like US treasuries and German bunds.
Who issues Bonds?
The most important issuers are the federal government, municipalities, and corporations.
Treasury Notes and Treasury Bonds
The US Treasury issues bonds of different maturities to finance the United States national debt. Treasury notes have a maturity ranging from 1 to 10 years while treasury bonds have a maturity from 10 to 30 years.
US treasury notes and bonds are considered low-risk assets since the country’s central bank which in this case is the Federal Reserve can print money to pay off its debt.
Special government sponsored enterprises or U.S. agencies are authorized to issue bonds. These agencies are not guaranteed by the government. Agency bonds are low risk since Agencies issue bonds to finance loans for various purposes and the bonds issued are secured by the loans financed.
Municipal bonds are securities issued by local, county and state governments. Municipal bonds are issued to finance public infrastructure projects like roads and utilities. Municipal bonds are considered low risk investments, but they do not have zero default risk. The reason is that unlike the federal government, during recessions local governments cannot print money to repay the bonds issued. Hence, when local governments’ tax revenues fall, large fiscal deficits are created making it impossible to repay back the bonds issued in full.
Corporate bonds are bonds issued by large corporations, to finance projects or their business activity.
Corporate bonds have higher risk than US government bonds. Hence, corporate bonds interest rates are always higher than US government bonds.
Corporate bonds are having varying degree risk because the risk of default depends on the company’s health which is affected by many different variables. The interest rates of corporate bonds rise with increasing default risk of corporate bonds.