A great way for investors to build a strong portfolio is by investing in bonds. In order to build that portfolio, you need to know the various kinds of bonds that are out there and how each is different from the other. Offering a low risk in comparison to other forms of investing, government bonds, corporate bonds, municipal bonds, and zero-coupon bonds all offer great ways to diversify your portfolio.
Government bonds fall into three main categories including bills, notes and bonds and they are considered a very low investment risk. They are classified according to the length of time before maturity and are fixed income securities. Notes that mature within one to ten years are debt securities, whereas bills are considered debt securities if they mature in less than one year. Actually maturing in more than 10 years, bonds are also debt securities. Government bonds, referred to as "Treasury bills", are technically not regarded as bonds because their maturity’s term is brief. For those investors who opt to buy bonds, Treasury bills, also known as T-Bills, are considered extremely safe.
Businesses not only issue stock, but also issue corporate bonds which have more of a risk factor than government bonds and thus offer a higher yield. Corporate bonds are commonly available in various durations: short-term (less than five years), intermediate, and long-term (over twelve years). Corporate bonds are also available as callable bonds and convertible bonds. Keep in mind that corporate bonds offer higher yields but government bonds can be a more secure investment as private companies’ profits can fluctuate or take a nosedive.
Municipal bonds are often not subject to taxation. Because these type of bonds, known as "munis", have the potential to be tax-free, their yield is lower than that of other bonds. Municipal bonds can be a great investment, depending on your investment philosophy.
Zero-coupon bonds are issued at a considerable discount to par value but make no coupon payments. This is another investment option that offers the entire payment at maturity and as a result, tend to fluctuate in price much more than coupon bonds. A zero-coupon bond is basically a package of bonds that has been stripped of their coupons by a financial institution.
Excellent, how do I go about buying bonds?
Discount brokers or full-service brokers can handle most transactions. You may need to decide first on the services that best suit your needs and budget before deciding on a broker. For new investors, utilizing the services of a bond broker can be very costly and they may not have the funds to do so. Bonds can be purchased through a government agency or you may be able to go through your financial institution. However, it is a typical practice for brokers to claim they are not charging a commission, when in actuality they merely raise the price of the security to earn their commission. To be sure that the mark-up is not outlandishly high and to ensure you are charged a fair amount, you will need to research the latest quote for a specific bond.
It is true that bonds have less investment risk than stocks, but before you buy bonds you should still do your homework. Portfolio diversification is an essential goal of any investor and bonds can be a key element in diversifying your investments.