How to Buy Bonds: A Guide for New Investors
Think of a bond as a loan: You, the investor, are loaning a company, city, state, or even country money. At the end of the loan term, they agree to pay you that money back, plus interest. Because of this structure, bonds are typically less risky than other investment options, and they are a smart investment for people who "have cash needs, a shorter time horizon before expecting to withdrawal funds, or a low risk tolerance," says Lori B. Poole, CFP, a wealth advisor at Bartlett Wealth Management. If you'd like to buy a bond, here are three ways to make the purchase.
Buy an actively managed bond mutual fund.
"Bonds can play a role in virtually any portfolio," says Lauren Zangardi Haynes, owner of Spark Financial Advisors. And one of the easiest ways for an investor to add them to her portfolio is by buying bonds in a mutual fund. Buying bonds in a mutual fund allows you to "buy a diversified basket of bonds with a smaller amount of money," says Poole. "Most of these funds have an investment manager that is actively putting together a bond portfolio based on market factors."
You can purchase a bond mutual fund at investment companies such as Fidelity and Vanguard. And "many people can buy bond mutual funds in their retirement plans, which is a good idea if you're closer to retirement and will need to live on the funds in the near term," explains Poole.
Buy an indexed bond mutual fund or Exchange Traded Fund.
Indexed bond mutual funds and Exchange Traded Funds (ETFs) aren't actively managed—but that usually means they have lower fees and costs associated with purchasing them. And just like managed funds, index bond mutual funds and ETFs offer a basket of different bonds, according to Poole. "An investor might be interested in adding ETFs to their bond portfolio for diversification," she says. You can also purchase these kinds of bond mutual funds through investment companies.
Buy a single bond, directly.
Rather than buying a collection of bonds through a mutual fund, you can purchase a single bond directly through its issuer. If you have a specific need, Poole recommends you work with your bank to buy a "Certificate of Deposit (otherwise known as CD) or other short-term bond that will mature exactly when they anticipate needing the cash." You can also work with an investment manager to buy a bond. In either case, you'll know exactly who has your money, says Haynes. But she warns this purchasing strategy has risk, too: If the holder defaults on the bond, you will lose all your money.
She also warns against single bonds that look too good to be true. In this case, "it probably is," says Haynes. "If you see a bond fund manager who has incredible performance versus their benchmark, lift up the hood," she adds. "There's no free lunch. Remember that [the term] 'high yield bonds' is marketing spin for 'junk debt.' People don't like to buy things called 'junk bonds, but they do like the idea of 'high-yield bonds,' so that's how those bonds tend to be marketed."