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I'm a new investor and have no formal business training.
I was hoping someone can give me a brief overview of how the bond market works?
I know there are a few types (corporate, government, municipal). Are junk bonds sort of a small corporate bond and therefore more risky? Also, from what I know when you are looking at the bond market its not good for the values (rates?) to increase because the bond you previously bought is now worth less?
Some people I've heard discussing bonds make them sound like they are guaranteed to make you money vs. the stock market. Are bonds safe? 100% safe?
Finally, how does a regular person invest in bonds? I have some in my mutual fund but was curious how easy or if possible to pick individual bonds yourself - the way you can pick stocks. Do people use Etrade, Scottrade, etc?
Thanks
Bonds are a loan you make to a company or agency. They pay interest until maturity then the original amount. Three risks creditworthiness, callability, and the money market. Many issuers have the right to call in (pay off) the bond, maybe after five years. Money market: it sounds counterintuitive, but bonds increase in value when interest rates decrease. Normally corporate bonds have a higher claim than stock. That is, bond holders have to be paid before stockholders. This makes them safer than stock, but with lower upside potential. Government bonds are tax exempt and thus carry a lower interest rate. This of course is the short version. Some bond trading expert can go into more sleep-inducing detail.
Last edited by pvande55; 12-19-2015 at 12:23 PM..
Reason: Add lines
I experimented with buying bonds about 3 years ago. I bought NYC and Westchester tax free municipal bonds (5% interest). I was surprised to find I was buying bonds for a lot more than the face value. I was essentially buying the bond and paying for the anticipated interest in advance. As a novice bond buyer it is difficult to track a profit over the long term.
I also was surprised to find two NYC bonds were called early which I understood could happen, but didn't anticipate. Again, the gain/loss column is difficult to understand. I staggered the bonds in a ladder and when they come due the face value shows up in my account.
It is nice to see tax free cash going into your account. I would love to find out if you can purchase a muni bond at face value. Five percent is hard to find now. My broker recently called and offered a 2%.
I would love to have the expertise to fully understand the individual bond market.
Thanks for the info.
It sounds like the bond market is probably not for someone without much experience like myself.
Still a little curious.
Do you know if you are guaranteed the interest if you hold the bond?
From what I saw online; esp with government bonds - they take a long time to mature (I don't remember seeing any less than 5 yrs).
Retired11 - 5% interest sounds good if you're not paying for it upfront like you suspected. 2% not so great esp since some online banks offer CDs for more than that.
Anyways, I guess I'll keep looking for places to put my money.
The problem is that a 5% bond, since prevailing interest rates are much lower, is going to cost you a premium over face value. If it isn't selling at a premium, it is because investors see a high risk of default. Now, if you bought such a bond in 2006, and it is not callable for another five years, you're sitting in the catbird seat.
Thanks for the info.
It sounds like the bond market is probably not for someone without much experience like myself.
Still a little curious.
Do you know if you are guaranteed the interest if you hold the bond?
From what I saw online; esp with government bonds - they take a long time to mature (I don't remember seeing any less than 5 yrs).
Retired11 - 5% interest sounds good if you're not paying for it upfront like you suspected. 2% not so great esp since some online banks offer CDs for more than that.
Anyways, I guess I'll keep looking for places to put my money.
Just FYI, junk (also known as "high yield" bonds are corporate bonds that are issued by financially weak companies. They pay higher interest rates to compensate for the higher risk of default. They're not necessarily bonds of smaller companies. Large companies can also be financially shaky.
In general, it's better to buy a bond mutual fund instead of individual bonds themselves. It's typically expensive to buy bonds as an individual investor, and you need a lot of money to have a diversified bond portfolio. The exception would be U.S. treasury bonds. Those are pretty easy and cheap to buy, I think, but they also pay very low interest rates (as do most bonds right now).
Yes, you are supposed to get the interest if you hold the bond. Of course, there is always the possibility of default. Countries like Greece and Argentina defaulted on their bonds. Corporations default on bonds. The US federal government's bonds are considered "risk free", but truth be told, nothing is risk free in this world. Of course, US government bonds pay low or very low interest rates precisely because they are perceived as very low risk.
Overall, your best bet is to buy a bond fund such as one of the following:
Vanguard Short Term Bond Index
Vanguard Short Term Investment Grade
Dodge & Cox Income
You're not going to make a lot of money on these funds. You can lose money in any given year, but it's typically not going to be much. Long term returns will be in the low single digits, maybe up to 5% if interest rates go up over the next decade (which we can't predict).
Overall, your best bet is to buy a bond fund such as one of the following:
Vanguard Short Term Bond Index
Vanguard Short Term Investment Grade
Dodge & Cox Income
Thanks for the tips. I will keep my eye on these funds.
Do you think there is an ideal time to get into a bond fund?
For example, hypothetically, lets say the Fed raises rates twice more this coming year and you suspect the economy is starting to take a turn for the worse. Your suspicion is rates will then start to be dropped to help with a pending recession. Is this the best time to buy? When rates are higher but you suspect they are dropping soon?
Thanks
I'm a new investor and have no formal business training.
I was hoping someone can give me a brief overview of how the bond market works?
I know there are a few types (corporate, government, municipal). Are junk bonds sort of a small corporate bond and therefore more risky? Also, from what I know when you are looking at the bond market its not good for the values (rates?) to increase because the bond you previously bought is now worth less?
Some people I've heard discussing bonds make them sound like they are guaranteed to make you money vs. the stock market. Are bonds safe? 100% safe?
Finally, how does a regular person invest in bonds? I have some in my mutual fund but was curious how easy or if possible to pick individual bonds yourself - the way you can pick stocks. Do people use Etrade, Scottrade, etc?
Thanks
Keep in mind that as the interest rate increases over the next couple of years existing bonds will lose money. Thus it might be hard to make money with bonds.
Individual bonds will not lose money as the interest rate increases as long as you hold then to maturity. But if the company goes out of business you can lose all of your money. Thus the default risk is less in a fund but losses due to increasing interest rates is real.
Also remember if you buy a 1,000 bond with a life of 30 years you get your 1,000 back in 30 years. Due to inflation the 1,000 may only buy 300. This is a big risk for bonds.
I would tend to stay away from bonds until you have done a lot of studying and understand the risks.
Government bonds < Investment-grade corporate bonds < High yield (junk) bonds < Stocks. Note that some stocks are less risky than some junk bonds.
There are credit ratings ranging from AAA to CCC. AAA represents the safest type of bond, including the bonds issued by Canada, Norway, Belgium, Germany and a few other developed countries. US Treasuries are one notch lower at AA+. Junk bonds are CCC.
During crises, government bonds tend to be negatively correlated to all other bonds and stocks.
I don't bother with owning junk bonds or even most corporate bonds. Better to invest in stocks and keep some government bonds as a hedge for a crisis.
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