How to Buy Bonds: A Complete Guide

You can buy bonds in several ways: directly from the U.S. government, through a bond fund or with the help of a broker. Understanding how to buy bonds starts with knowing the different types available, along with their associated risks and potential returns. While bonds can add stability and diversification to your portfolio, not all of them are as simple or predictable as they seem. Here’s what you need to know about these fixed-income investments and how to incorporate them into your financial strategy.

To can consider working with a financial advisor to see what role bonds could play in your investment portfolio or retirement plan.

How to Buy Bonds: A Step-by-Step Guide

If you’re interested in buying bonds, there are a few different options available to you. However, not all sellers are equal, as they each offer specific types of bond investments that may or may not be what you’re looking for. For instance, buying through a brokerage lets you purchase very specific bonds. On the other hand, buying through a bond fund is less specific, but much more wide-ranging.

Here are three common ways to buy bonds:

1. Buying Bonds Through the U.S. Treasury Department

You can buy new Treasury bonds online by visiting Treasury Direct. To set up a Treasury Direct account, you must be 18 or older and legally competent. You will need a valid Social Security Number, a U.S. address and an account at a U.S. bank. The Treasury does not collect fees, nor does it mark up the bond’s price.

2. Buying Bonds Through a Brokerage

Most online brokerages sell Treasury bonds, corporate bonds and municipal bonds. Brokers like Fidelity, Charles Schwab, E*TRADE and Merrill Edge offer extensive bond listings. However, the purchasing process through an online brokerage is nowhere near as straightforward as through Treasury Direct. Bond prices vary from brokerage to brokerage, thanks to transaction fees and markups or markdowns.

3. Buying Bonds Through a Mutual Fund or ETF

A bond fund is a good option if you don’t have the cash to spend on a diverse array of individual bonds. You often have to buy individual bonds in large, often pricey units. With a bond fund, you can get diversity for a lower cost. However, bond funds don’t have a set maturity like individual bonds, so you may see your interest payments vary and your income is not guaranteed.

How to Buy Bonds – Other Considerations

Bond buying can be a tricky process. This is particularly true if you’re buying used bonds or if you aren’t buying a bond directly from the underwriter. To ensure you’re getting a good deal, here are the main things to take note of before buying a bond:

• Credit Ratings: The biggest factor to look out for is whether the company can actually pay its bonds. You can figure this out by looking at the credit ratings issued by rating agencies like Moody’s, Standard and Poor’s and Fitch. The safest rating, which goes to Treasury bonds, is AAA.
  
• Duration: You should also note a bond’s duration, which Vanguard explains “represents a period of time, expressed in years, that indicates how long it will take an investor to recover the true price of a bond, considering the present value of its future interest payments and principal repayment.” A bond’s duration is an indicator of how sensitive the bond will be to changes in interest rates. A longer duration translates to greater fluctuation when interest rates change. When interest rates rise, the value of a bond falls. If you want to ensure that you get your set interest rate and the full payout, you’ll need to hold onto your bond until its set maturity date.
  
• Fees: You should always be aware of the fees that a brokerage can tack onto a bond’s cost if you aren’t buying directly from the underwriter. You can make sure you’re getting a fair deal by taking advantage of publicly available data on the pricing of bonds you’re looking to buy, or bonds with similar maturities, credit ratings and interest rates.

Before buying any investment, including bonds, it’s important to consider talking to a financial advisor to get personalized investment advice.

How to Buy Bonds – Choosing a Bond for Your Portfolio

Selecting bonds for your investment portfolio hinges on several key factors, such as your risk tolerance, tax considerations and investment timeline. When you’re looking at how to buy bonds, here are two things to take into consideration.

1. Diversify with Different Bond Types

A well-rounded bond allocation often includes a mix of corporate, federal and municipal bonds. This diversification strategy helps to spread risk and protect your principal investment. By including various bond types, you can also stagger their maturities, which is a smart way to manage interest-rate risk over time.

Building a diversified bond portfolio can be challenging due to the typical $1,000 increments in which bonds are sold. This requirement can make it difficult for investors with limited capital to achieve the desired level of diversification. However, there are alternative strategies to consider…

2. Simplify Investments with Bond ETFs

One effective solution is to invest in bond ETFs, which offer diversified exposure to different bond types without the need for a large initial investment. These funds allow you to mix and match various bond categories, providing flexibility and reducing the risk associated with concentrating your investments. By broadening your exposure through bond ETFs, you can effectively manage risk while working towards your financial goals.

Who Issues Bonds and What Are They For?

There are several categories of bond issuers, from companies to federal and state governments. How safe a bond is largely depends on who the bond issuer is. That’s because bonds are typically backed by the entity that issues them.

Below is an overview of the usual bond types and issuers on the market:

• Corporate Bonds: Companies issue corporate bonds. Corporate bonds’ safety varies a lot, depending on the company’s credit ratings. Companies with excellent to low credit ratings issue investment-grade corporate bonds, which have lower interest rates because of the safety of the investment. Companies with lesser credit ratings issue high-yield bonds, or junk bonds. These bonds have higher interest rates to reflect that riskiness, so if the company makes good on the bond, there’s a larger payout.

• Agency Bonds: Government-sponsored enterprises like Fannie Mae or Freddie Mac issue agency bonds. Agency bonds aren’t quite as safe as Treasury bonds. However, because the agency bond issuers are guaranteed by the federal government, these bonds are generally considered safer than even the safest corporate bonds.

• Municipal Bonds: States, cities and local governments issue municipal bonds. The safety of these bonds varies. In some instances, a municipal bond may be insured. In that case, an insurance company will have to make good on the bond if the municipal defaults.

• Treasury Bonds: The U.S. Treasury Department issues Treasury bonds. These bonds are the safest of the safe types of bonds and are considered very long-term investments. Treasury bonds pay interest every six months until they mature, which happens in 30-year terms.

Bonds vs. Stocks

Bonds are generally a far safer investment than stocks. This is because the future performance of a company is hard to predict, whereas the terms of bonds are much clearer. That doesn’t mean bonds are risk-free, though. There’s always the chance that a bond issuer will default and not pay the debt.

While bonds’ lesser risk diminishes the chances of unexpected failure, it also lowers the chances of unexpected success. Because a stock’s value varies after you buy it, you’ll always have the chance of seeing a stock’s value soar. This can’t happen with a bond.

Having a mix of bonds and stocks in your portfolio is a great way to take advantage of the benefits of diversification. In short, your portfolio will contain both the relative safety and stability of bonds, while taking potential money-making risks with stocks.

Bonds might be a safer investment than stocks, but they’re certainly not foolproof. Be mindful of the bond issuer’s credit rating and the bond’s duration before putting money out. If you’re buying bonds from a brokerage, do your research to avoid excessive fees. Though it’s not advisable to build an entire portfolio of bonds, bonds can be a good passive investment to make while you manage riskier investments.

Tips for Building a Financial Portfolio

• A financial advisor can assess your entire financial situation and determine which investments are truly best for your portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• Diversify. Don’t put all your eggs in one basket. The healthiest portfolio boasts a variety of investments across market categories. That way, if one of your investments suffers a downturn, your entire portfolio won’t suffer.
• Invest for the long term. You should avoid acquiring investments that you won’t want to keep for long. Instead, opt for investments that you’re confident will grow more valuable over time.

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