Bond Investing

Bonds can represent an opportunity to get above average returns with lower risk than stocks. Be aware however that they can be difficult to understand and that you always have counter-party risk and the other party may default for a variety of reasons. This should be rare, but can be devastating.

Bond Terminology

One of the first things you can do to make bond purchasing safer is to understand the terminology. A bond is basically a loan you are making to another party with repayment dates. The other party is typically a government entity or a large company, both of whom you hope are likely to repay.

When you buy a bond it has a face value which is the amount you are buying it for and a coupon which is the amount you get paid in interest. It also has a maturity date which is when you will get your face value repaid. So if you have a $1000 face value bond with a 6% coupon and a 20 year maturity date you will get $60 per year for 20 years and then get your $1000 back.

Municipal Bonds

One of the most appealing kinds of bonds are municipal bonds which are issued by cities or local governments. These bonds have the additional advantage of often being tax-exempt, meaning you have to pay no income tax on the interest. Additionally, you can usually feel an added degree of confidence that municipalities will not default, thus reducing your counter-party risk.

Bond Funds

One downside of bonds is that you often have to segregate your money with bond brokers. Additionally these bond brokers often have minimum amounts that they will allow you to invest with them. One easy solution is to use bond funds. These are basically mutual funds or Exchange Traded Funds that invest in bonds that meet their specifications. Thus you can buy a share in these funds for much less than it might cost to get involved with a bond broker, and can also move your funds around more easily. You will however have to accept management fees and thus you may under perform simply buying a bond.