Almost all investors who buy bonds buy them because they are generally safe investments. However, except for bonds from the federal government, bonds carry the potential risk of default, no matter how remote that risk might be. Whether it is a high-yield corporate bond or a bond sold by the sovereign commonwealth of Virginia, there is always a chance that the entity that borrowed the money will not be able to make the interest payment.
Bond ratings were developed as a way to indicate how financially stable the issuer of the bonds really is. Developed by third parties such as Standard and Poor's and Moody's, bond-rating services give bonds letter or mixed letter and number ratings based on the financial soundness of the bond issuer. To complicate things, the rating agencies use entirely different rating systems, making it very important that you check what the ratings mean before you make any assumptions. The higher the rating, the higher the quality of the bond, with Treasury bonds being rated the highest and "junk" bonds being those with the lowest ratings.
Depending on the bond, it can either trade very frequently at a low commission or it may be very difficult to find a buyer or seller and involve large transaction costs. "Liquidity" is the term used to describe how easy it is to sell something. Highly liquid bonds include U.S. Treasuries and debt issued by large, blue-chip corporations. Illiquid bonds would include the bonds of a company viewed as close to bankruptcy. Because it is no longer a safe investment, only those speculating that there will be a corporate turnaround are willing to buy those bonds, meaning they trade a lot less frequently. Liquidity has a direct effect on the commission you pay to trade a bond, which unlike stocks, rarely trade on a fixed commission schedule.
Use a brokerage. The most common way to buy bonds, much like stocks, is to use a brokerage account. You can either use a full-service (or full-price) broker or a discount broker to execute your trades. You will learn more about the ins and outs of brokerages and how to pick one in our Broker Center. Bond commissions vary widely from brokerage to brokerage, so it does not hurt to shop around a little before making your decision. Through a brokerage, you can buy anything from a 10-year Treasury to a one-year junk bond issued by a corporation on the edge of bankruptcy. You can either participate in the direct offering of the bonds or pick them up in the secondary market, depending on your brokerage.
TreasuryDirect. In an effort to make it easier for citizens to buy U.S. government bonds, the Bureau of the Public Debt started the TreasuryDirect program. This program enables individuals to purchase bonds directly from the Treasury, completely avoiding a brokerage. Investors can establish a single TreasuryDirect account that will hold all of their Treasury notes, bills, and bonds. Investors are issued account statements periodically. Interest and the repayment of principal are made electronically via direct deposit to a bank or brokerage designated by the account holder. As long as the investor has enough money, he can buy any type of Treasury security he wants. Additionally, you can transfer bonds to and from your account as you desire. To learn more, visit TreasuryDirect.gov.
Mutual funds. One of the easiest ways to purchase bonds is through a mutual fund. You can invest small amounts (sometimes as little as $25 at a time), sign up for an automatic investment plan (which transfers money from your checking account to your investment account), and achieve instant diversification (since a mutual fund owns thousands of bonds from hundreds of issuers). In fact, for small amounts, bond funds are usually the best bet for investors. However, they do have drawbacks, such as ongoing expenses and a potential loss of principal. For more information, read Bonds Vs. Bond Funds.
If you're looking for an income stream, but you'd like to look beyond bonds, you're in luck. There are other ways to get a check in the mail.