How to Buy Bonds

How to Buy Bonds

Bonds are issued by government entities and corporations to raise capital. When you purchase a bond, you're effectively lending money to whoever issued the bond. In return, you'll receive interest payments as the bond is repaid. Below is a step-by-step guide for how to buy bonds.

1. Determine Your Goals

The primary reason to invest in anything is to eventually turn a profit, but how you do that will depend largely on your investment goals. Your goals might include:

• Saving for retirement
• Funding a new business
• Paying for college
• Buying a home
• Growing your travel fund

Once you've clarified your goals, consider the timeline for each one. That can help guide you toward the right types of bonds for your portfolio—which might be short-term bonds, like U.S. Treasury bills, or long-term bonds, like U.S. Treasury bonds or certain corporate bonds.

2. Choose Between Different Types of Bonds

Bonds come in several shapes and sizes. They typically fall into one of the following three categories:

• Treasury bonds: Also called T-bonds, these debt securities are issued by the federal government and pay a fixed interest rate every six months until the bond matures.
• Municipal bonds: These are issued by states, cities and counties, often to fund public works like transportation and health care. Rates on municipal bonds typically lag behind Treasury bonds and corporate bonds.
• Corporate bonds: These bonds carry more risk because they're issued by companies, not government entities. Companies with strong credit ratings are considered more financially stable, which reduces the likelihood of default. You may find that callable corporate bonds offer competitive yields, but the caveat is that the issuer has the right to terminate the bond early.

3. Open and Fund Your Account

You can buy and sell bonds and other securities with a regular brokerage account. You might make trades yourself or allow your broker to do it on your behalf. That may be an individual stockbroker, online investment brokerage or robo-advisor.

With a brokerage account, you'll also have access to bond funds, such as a bond exchange-traded fund (ETF). That can provide access to a large swath of different bonds in one trade. Bond ETFs can include a mix of corporate bonds, municipal bonds, government bonds and international bonds. Brokerage accounts offer flexibility and easy access to your money, but you'll likely be on the hook for various fees or commissions.

Retirement accounts can also be used to purchase individual bonds and bond funds. IRAs, which can be opened with an investment brokerage, generally offer more investment options than workplace retirement accounts. With a 401(k), for example, your choices may be more limited. Retirement accounts have annual contribution limits and other restrictions, but they also offer tax advantages you won't get with a brokerage account.

4. Place Your Bond Order

Buying bonds is relatively simple. Your brokerage will likely have an online portal that allows you to review your options and place a bond order in a few clicks. That involves choosing a bond, specifying how much you want to invest and confirming your order.

With a 401(k), you'll need to contact your plan administrator to clarify your investment options. They may offer a self-directed brokerage account that allows you to invest beyond your plan's standard selections.

5. Monitor Your Investments

Due to regular market activity, the values of your investments will likely change over time. That may prompt you to rebalance your portfolio, which involves buying and selling different securities to get back to your desired asset allocation. For example, if you're a long way out from retirement, you may be comfortable carrying more stocks than bonds because you have time to recover from short-term losses. Your risk tolerance and age can help you decide on the right asset allocation.

Where to Buy Bonds

A brokerage firm can serve as an intermediary between you and the bond market. They can also connect you to stocks, ETFs, mutual funds and other securities. However, it's also possible to buy bonds directly from the issuer.

Government bonds are available at TreasuryDirect.gov. Here you'll have access to T-bonds, which mature every 20 or 30 years, as well as:

• Treasury bills: Auctioned at a discount, T-bills take anywhere from four weeks to one year to mature. Interest is then paid in full.
• Treasury notes: These bonds issue fixed interest payments every six months. Term lengths range from two to 10 years.
• Series EE savings bonds: The value is guaranteed to double after 20 years, but it can continue earning interest for 30 years.
• Series I savings bonds: These savings bonds can earn interest for 30 years. The interest rate is tied to inflation and changes every six months. That can help your returns keep up with the cost of living over time.

Tips for Buying Bonds

Like any investment, bonds come with unique pros and cons. Here are some simple tips to consider before adding them to your portfolio:

• Gauge your risk tolerance. While it's unlikely that the federal government will default on its bonds, it is possible for municipalities and companies to become insolvent. Corporate junk bonds, which usually offer the highest yields, tend to carry the most risk.
• Balance returns with other investments. You'll want to consider your overarching investment strategy and risk tolerance when adding bonds to your portfolio. Bonds typically have modest returns when compared to higher-risk investments like stocks. Historically, the average stock market return is about 10% annually.
• Think about your timeline. Maturity periods can vary with different bonds. Consider when you'll ideally need the money you're investing. For example, if you're saving for a short-term financial goal, a 30-year Treasury bond probably isn't the best fit.
• Consider credit ratings. Credit ratings exist for a reason. A company with a D rating might offer a higher-than-average yield, but you'll be assuming more risk since there's a higher chance of default.
• Consider a bond ladder. This strategy involves buying multiple bonds that have different maturity lengths. When timed right, a bond ladder can provide steady, predictable returns as each term ends. And if yields rise over time, you may be better positioned to take advantage of that trend.

How Are Bonds Taxed?

Not all bonds are taxed the same way. The type of bond you have will determine your tax liability.

The Bottom Line

You can buy individual bonds or invest in bond funds with a regular brokerage account or retirement account. Alternatively, it may be possible to purchase a bond straight from the issuer. This is the case for bonds that are backed by the federal government. Either way, bonds carry less risk than more volatile investments like stocks and real estate.