You can invest in bonds by buying individual bonds, unit investment trusts or bond funds. Let’s take a look at each type of bond to understand it better.
Individual Bond
There are a wide variety of individual bonds. You can buy these bonds in the over-the-counter (OTC) market. Some bonds are also listed on the New York Stock Exchange. The OTC market is made up of banks and securities firms that trade in bonds electronically or over the phone.
If you want to buy a new bond issue, your investment advisor could get you a prospectus that will inform you about the features and terms of the bond and the risks associated with it. There is also something known as the secondary market. This is where already issued bonds can be bought and sold.
Bonds in the OTC market are usually sold in $5000 denominations. Most bond prices include a markup which is the dealer’s profit and cost. If you want a particular bond that your broker does not have, then a commission will be charged when you get it. Different brokers have different prices within the regulatory guidelines. So look around before you settle on buying bonds from a specific broker or firm.
Bond Funds
These funds are similar to stock funds. They offer you a portfolio of securities that are professionally selected and managed. You can take more risk by investing in a wide range of issues. You can also choose to have your interest payments distributed to you periodically or reinvested.
Bond funds do not have a specific maturity date as they are actively managed funds. This means that bonds can be added or taken out according to investor demands or the market conditions. With “open end” funds, you can buy or sell your share whenever you want. Be careful about that. Since the market value of bonds fluctuates, you could either make a profit or loss depending on the performance of the fund since you bought it. “Close end” bond funds have a number of shares that are traded on the stock exchange. Strategies for these bonds tend to be more aggressive as fund managers know that they don’t have to redeem these bonds at the investor’s whim. Most funds charge a management fee. So take that into consideration when calculating your expected returns.
Bond Unit Investment Trusts
These are fixed portfolios of investments in government, municipal, mortgaged-backed or corporate bonds. The investments are professionally selected and remain the same throughout the term of the trust. With this investment, you know exactly how much you will earn as the portfolio never changes. As it is not actively managed, you will not have to pay any management fee. However, you will have to pay a sales charge and an annual fee to cover expenses incurred and trustee fees. The initial investment normally starts from $1000 and can go up to $5000.
Money Market Funds
These funds consist of pooled investments in short-term securities like certificates of deposits (CD’s) and bonds issued by federal agencies or reputable corporations. They have maturities of 3 months or less and can be withdrawn at any time, which makes them highly liquid. The initial minimum investment can start from $1000 and can go up to $10,000. These funds are not guaranteed by the FDIC and so the stability of the net asset value cannot be assured.