The Price of Bonds

Buying bonds is tricky. With a stock, you can pull up a quote on your computer, and -- presto! -- you have a good idea of the going price.

Generally, you're going to get the same price for a share of Coca-Cola(NYSE: KO) from a full-service broker in Hawaii as you would from a discount broker in New York. However, that's not the case with bonds.

Most bonds don't trade on a centralized exchange. And instead of charging a commission, most brokerages (discount and full-service) imbed a "markup" in the price of the bond. This makes it difficult -- if not impossible -- to know what fees you paid.

A recent issue of BusinessWeek highlighted the problem. The magazine test-drove the bond sites of five online brokerages -- Schwab(NYSE: SCH), E*Trade(NYSE: ET), TD Waterhouse, Harrisdirect, Fidelity -- and found them wanting.

While these outfits call themselves "discount brokers," the "discount" applies only to stock transactions. Buying bonds, especially smaller amounts, can be expensive. BusinessWeek found, for example, that a single General Electric(NYSE: GE) bond that matures in 2007 would yield just 2.5% after fees, if bought through Schwab. Compare that to the 3.4% yield on a Treasury note maturing in the same year, which is considered a safer investment.

Additionally, the markup on a bond may not be disclosed. Schwab and TD Waterhouse charge a minimum markup of around $50 per purchase, and will reveal the actual markup to customers who ask. E*Trade and Fidelity won't reveal their markups and charge transaction fees of $40 and $50, respectively, on smaller orders. Harrisdirect, on the other hand, tells investors up front that it charges a flat $45 fee on purchases of 15 corporate bonds or less.

What's a fixed-income investor to do? Here are some ideas:

  • Avoid buying bonds in small quantities.

  • Bond funds can be cost-effective, but they have their own problems. Look for short to intermediate maturity bond funds. The shorter the maturity, the less the value of the funds will react to the whims of interest rates.

  • There is no need to buy Treasury securities from a broker or through a mutual fund. You can buy them from Uncle Sam, commission-free, at TreasuryDirect.

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