How to Buy Bonds Safely
Submitted by user 1101 on February 20, 2012
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As an individual, have you ever taken an interest-bearing loan? Almost all large organizations have also borrowed money for various reasons. These organizations may issue bonds to raise the money that is needed by them, for example, to fund expansion projects. Bonds are a form of debt sold to the public in set increments. The lender is given a bond that mentions the amount lent, agreed-upon interest rate, and interest payment periods of the loan. There are different types of bonds and as an investor, it is imperative that you are aware of the risks and returns associated with bonds.
Bonds can be issued by the government or corporationsBonds are also known as fixed-income securities because they generate a fixed amount of income every year. The US government's Treasury Department may issue bonds of different maturities, ranging from three months to 30 years. These bonds are safe because they are guaranteed by the U.S. government and the interest paid is free of state and local taxes. In case of a bankruptcy threat, state and local governments may also offer bonds with competitive interest rates. The interest paid on these bonds may be free of federal income tax, while the local governments may also waive the income taxes on them. Corporate bonds may provide higher interest rates than government bonds, but they are riskier as the corporation may go bankrupt and eventually default on the bond.
Bonds should be purchased keeping in mind the investment objectiveAn investor usually looks for income and safety of his principal amount when making an investment. If your objective is to seek long-term growth, then bonds should not be considered for investment. Bonds should be purchased if the objective is safety of principal and earning a fixed income from the investment. This could be particularly true for retired professionals. When investing in bonds, you should look to buy bonds which have different maturity levels. This will allow you to have access to funds each year and not require selling the bond at a lower price before maturity. As an investor, you should compare bonds on the basis of returns upon maturity. However, this comparison may not provide an accurate picture for bonds with different maturities and coupons. The return on a bond's investment is linked to its credit as well as market changes. A higher return can be enjoyed on relatively riskier investments. The value of bonds may fluctuate with changes in market as their value tends to decrease with an increase in the interest rates.
Conservative investors opt for short-term bondsDepending on your investment objective, you may choose to invest in a bond with longer or shorter duration. A bond with higher duration will be more sensitive to interest rate changes. Conservative investors usually opt for bonds with a lower duration. Bonds are exposed to several risks, which include interest-rate risk (risk of interest rate fluctuation), credit risk (risk of a default on the payments) and inflation risk (risk of higher inflation). Short-term (less than 5 years) Treasury Bills and other short-term government bonds are the safest bonds. The investment decision would depend on the available funds, willingness to diversify and whether you require professional management of your investment.
Generally, individual investment in bonds is advisable if the objective is to preserve your capital and achieve diversification even at minimum investment levels.
Further reading:http://www.fool.com/investing/beginning/what-is-a-bond.aspx |
