Investing in bonds provides low-risk cash flow for your portfolio. You can invest in various types of bonds.
Corporate bonds give you access to companies. These bonds come with higher risk but also higher interest rates.
Cities, states, and local governments issue municipal bonds. These bonds come with fewer risks and, therefore, lower rates.
The Federal Government also issues bonds. Their Treasury bonds come with the least risk.
This structure translates into the lowest interest rates.
Each of these bonds can bolster your portfolio. However, knowing the types of bonds only presents a starting point. Gaining additional insights will help you make smarter investing decisions.
Want to learn how to invest in bonds? This article will cover everything you need to know.
How to Invest in Bonds
You can either invest in bonds via a broker or ETF. Brokers let you buy individual bonds in increments of $1,000.
Brokers give you access to corporate, municipal, and treasury bonds. You can also purchase treasury bonds directly from the government’s website.
You cannot spend $100 or $1,400 on individual bonds. You must invest $1,000 at the minimum.
Not everyone likes the high entry point for bonds. Bond ETFs offer a reliable solution. Instead of buying bonds, you buy a basket of bonds.
You can purchase fractional shares of an ETF instead of entire shares. You can get started with an ETF of bonds for as little as $1.
Can the Issuer Pay off the Bond?
When you buy bonds, you must consider an issuer’s ability to make interest payments. Higher risk translates into higher interest rates. This phenomenon explains why treasury yields are so low.
You can make more money with non-defaulting corporate bonds. Review a company’s balance sheet to see if it can cover interest payments. A company’s obligations and growth potential impact its ability to cover the debt.
Establish Your Risk Tolerance
Not every bondholder invests in corporate bonds. Some investors believe these bonds carry significant risks not worth the risks. These investors will focus on Treasury and municipal bonds.
Other investors believe T-bills and municipal bonds carry insufficient potential. They don’t want to park their money for years in exchange for a low return. These investors will take on riskier assets such as corporate bonds.
Before investing in bonds, assess your risk tolerance. Your risk tolerance determines how much risk your portfolio can bear.
Risk tolerance is personal for each investor. Your personal budget plays a critical role in determining which assets you select.
Younger investors often invest in riskier assets. They have more income potential and time to weather downturns.
Older investors tend to pick low-risk assets that produce minor gains. Growth is better than no growth for these investors. Some of them have their eyes on retirement and don’t want to rock the boat.
Bond maturities indicate how long a company has to pay off the principal fully. Bonds with higher maturities take longer to pay in full.
Issuers reward long-term bondholders with higher interest rates. A 5-year bond will have a higher interest rate than a 2-year bond.
Higher rates will increase your cash flow. However, it takes longer to receive your principal.
Bond investors should also review inflation rates. A bond yielding 2% will lose money because inflation outpaces the yield.
This issue always concerns bondholders. However, today’s inflation growth makes it more glaring.
You can get higher returns with corporate bonds and stretched-out maturities. Some investors buy into a combination of short-term and long-term bonds.
This strategy gives them access to some of their initial principal each year.
Bondholders often reinvest their principal proceeds into other bonds. They will do the same with interest payments.
If interest payments do not provide enough cash flow to buy a bond, you can buy Bond ETFs.
Selling Bonds to Realize Your Gain or Loss
You do not have to wait for the maturity date to cash out on your bond. Some investors prefer to sell their bonds before the maturity date.
They realize the gains or losses upon selling. Profits will increase your taxes, while losses count as tax deductions.
Bonds are highly liquid assets. You can quickly sell a bond, realize the proceeds, and shift to another asset. Some bondholders switch up their holdings to capitalize on better opportunities.
Why Some Investors Pick up Bond ETFs
Some bondholders prefer to own individual bonds. They want to pick the best bonds and outperform the market.
Other investors opt for bond ETFs. They don’t want to try and beat the bond market.
These investors prefer to mirror the market and reap average cash flow. Nothing is wrong with achieving average returns.
Exchange-traded funds require less work than researching individual bonds. You review an ETF’s holdings and invest if you like their assets.
You don’t have to monitor your bonds. The ETF will do that for you.
Funds buy and sell bonds based on risk tolerance and the fund’s stated objectives.
ETFs provide a passive approach to bond investing. You can contribute any amount you desire and automatically reinvest the proceeds.
Stay up to Date With Finances
Learning how to invest in bonds only represents the beginning of your journey. Strong financial habits will give you more proceeds to invest in vital assets.
Mastering your finances early in life helps with retirement in the future. Your savings will compound as you earn and save more money.
Staying on top of the best news and tricks will help with your goals. Our magazine provides expert commentary and articles to help you master your money. Read through our issues today.