Investors often focus most of their attention on how to buy stocks, because the stock market has produced such strong returns over the long run. Yet bonds can provide valuable benefits for investors, including portfolio diversification and a way to put money to work for shorter periods of time than would be prudent for a stock-market investment.
Many investors have difficulty with bond investing because the process of buying bonds can be different from what stock investors are used to seeing. Bonds also come with different maturities, interest rates and yields, and levels of risk, and getting information on individual bonds isn't always as easy as it should be.
In general, there are three ways you can buy bonds:
- Buying newly issued individual bonds directly from a borrower
- Buying new or existing individual bonds through your brokerage account
- Buying bond mutual funds or exchange-traded funds
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We'll look at each of these options below.
Buying bonds directly
Some bond issuers offer investors a way to put money to work directly without the need for an intermediary. The most obvious example is the U.S. Treasury, which sells a wide variety of bonds through its TreasuryDirect system. Treasury bills, notes, and bonds with maturities of between four weeks and 30 years are available on TreasuryDirect, as well as U.S. savings bonds. Some private-sector companies also make debt instruments available to investors directly.
The advantage of buying bonds directly from the issuer is that you typically avoid the fees that brokers and other intermediaries charge. Issuers often make it simple to make investments, allowing you to set up transfers from your bank account to the issuer in order to pay for the bonds you buy.
However, there are downsides to direct bond purchases. With some issuers, it's more difficult to sell bonds that you've purchased directly than it would be if you had purchased them through other means. Issuers can also add on fees of their own that can offset the savings versus what you'd pay with a broker. It's important to understand the terms under which the bond issuer runs its direct-sale program so that you're prepared for how your bond investment will go.
Buying bonds through a broker
Most brokerage companies offer individual bond trading in conjunction with regular stock trading. You can invest in newly issued bonds, or purchase existing bonds in the secondary market. Because any one company can have dozens of different bonds outstanding, searching among the universe of available bonds can be overwhelming, but it does let you tailor your purchase to exactly the characteristics you want for your portfolio.
Brokerage fees can vary widely for bond purchases, with different fee schedules for newly issued bonds compared to already existing bonds. In some cases, commissions are dramatically larger than what you'd pay for a similarly sized stock investment, so be sure to look closely at your commission schedule rather than assuming that what you'll pay will be anywhere near the brokerage company's stock commission rates.
Using bond mutual funds and ETFs
Rather than buying individual bonds, some investors prefer the diversification that a mutual fund or ETF can provide. Bond funds are available that cover the whole gamut of investing options in the bond market, ranging from all-inclusive funds that include bonds of all types within a single fund to very specific funds that focus on a particular niche of the bond market.
The primary benefit of bond funds is that you can get diversified exposure with a relatively small investment. They're also easy to trade, with ETFs able to be sold at any time during the trading day and with traditional mutual funds available for sale on a daily basis. However, you can't tailor your bond holdings quite as well to your particular needs, and the way that most bond funds work introduces a different type of interest-rate risk than holders of individual bonds face.
Look more closely at bonds
Bonds are valuable assets for those with shorter time horizons for all, or a portion, of their money, and picking the right bond investments is essential. By understanding the different ways you can buy bonds, you'll be able to make the best choice for you in your particular financial situation.
