How to Purchase Bonds

Bonds are fixed-income securities representing a loan or debt, usually from a government or corporation. When an investor buys a bond, they become a creditor, lending money to the issuer. In return, the issuer promises to pay interest regularly and repay the principal at maturity. Investors purchase bonds as part of a diversified investment portfolio to reduce risk and ensure steady returns. However, where and how to buy bonds depends on the type of bond you are interested in.

Various types of bonds are available, and most can be bought through a bond broker, either via full-service or discount brokerage channels, similar to how stocks are bought from a stockbroker. Bonds can also be purchased as part of Exchange-Traded Funds (ETFs) or mutual funds, which are convenient ways to gain bond exposure. Government bonds are sometimes available directly from the issuing government, though brokers or funds also provide access.

Although the advent of online brokerage services has lowered the cost of investing, some retail investors might still need to find bond brokers more affordable due to the fees involved.

Key Takeaways

• Bonds are fixed-income securities representing loans or debts, making the bondholder a creditor to the issuer.
• Many brokers now offer individual investors the ability to purchase bonds directly online.
• An easy way to invest in bonds is through a mutual fund or ETF focused on bonds.
• Government bonds can be bought directly from government websites or as part of funds, offering flexibility in their access.

Purchasing Bond Funds

Bonds are an investment asset with distinct characteristics compared to stocks. While bonds tend to be less volatile and are generally considered less risky than stocks, they also deliver lower returns over time. A well-diversified portfolio, including stocks, bonds, and cash, can help balance risk and reward.

Bond funds—such as mutual funds or ETFs that hold a portfolio of bonds—offer a more accessible way to invest. This is particularly beneficial for those new to investing or who wish to simplify the process. Bond funds provide diversification at a lower cost and allow investors to skip the complex research in selecting individual bonds, empowering them to make informed investment decisions.

When buying or selling bond funds, it is essential to understand that these transactions occur on the secondary market. This means you purchase bonds from another investor, not directly from the bond issuer. A notable drawback of bond funds is that you may need to learn the maturity dates of all the bonds in the portfolio, as they change frequently. Therefore, bond funds might only suit investors looking to hold bond maturity.

Most bond funds invest in corporate bonds or municipal bonds, also known as munis, issued by local governments. Knowing what type of bond fund you’re investing in is essential before purchasing.

Buying Government Bonds

Purchasing government bonds—like U.S. Treasury bonds or Canada Savings Bonds—offers a flexible process. Many financial institutions offer clients the option to purchase government bonds through regular investment accounts. If this service isn’t available, you can still purchase government bonds directly from the issuing government, giving you control over your investment decisions and peace of mind.

In the U.S., for instance, TreasuryDirect, run by the U.S. Department of the Treasury, allows investors to buy, sell, and hold various Treasury securities, including Treasury Bills (T-bills), Treasury Bonds (T-bonds), Treasury Inflation-Protected Securities (TIPS), and Series I and E.E. savings bonds. There are no fees or commissions, but you will need a U.S. Social Security number or Taxpayer Identification Number, a U.S. address, and a U.S. bank account to open a TreasuryDirect account.

How to Purchase Bonds in the U.K.

Gilts

Government bonds in the U.K. are referred to as gilts. Like U.S. Treasuries, gilts are considered safe investments because they are backed by the government. This safety, while it may come at the cost of lower returns, provides investors with a sense of security and confidence in their investment choices.

You can buy gilts directly from the U.K. Debt Management Office’s purchase service or through the secondary market, which is accessible via brokers or banks. Prices are quoted per £100 face value but can be traded in smaller units. Alternatively, investors can buy funds specializing in gilts or those that include a mixture of government and corporate bonds.

Corporate Bonds

Corporate bonds issued by U.K. companies can be bought on the secondary market through online brokers. Most brokers offer detailed information about the bond, including the UK rate, maturity date, and price. For retail investors, purchasing individual corporate bonds can be expensive, so many opt to invest in ETFs or mutual funds that provide exposure to a wide range of corporate bonds.

The Cost of Buying Bonds

Purchasing bonds through a brokerage involves fees. Some specialized bond brokers have minimum deposit requirements, often around $5,000, and charge account maintenance fees or commissions on trades. Depending on the bond type and transaction size, broker commissions typically range from 0.5% to 2%. It’s important to factor in these costs when planning your bond investment.

Bond funds tend to have lower expense ratios than stock funds, and passively managed bond ETFs, which track bond indexes, generally have the lowest fees. An expense ratio is a measure of the cost of operating a fund, expressed as a percentage of the fund’s average net assets. It’s important to remember that while some brokers advertise commission-free trades, they often mark up bond prices, which effectively acts as a hidden fee. You can check the markup by comparing the bond’s current market price with your quoted price or using the Trade Reporting and Compliance Engine (TRACE) to monitor over-the-counter transactions.

Strategies for Buying Bonds

Modern online brokerage platforms have made buying bonds more straightforward and more cost-effective. However, choosing the right bonds is crucial based on your investment goals, tax exposure, risk tolerance, and time horizon. Many platforms offer tools that allow investors to filter bonds by credit rating, issuer type, maturity, and yield.

U.S. Treasury bonds are often benchmarks for other bond prices and yields. Any bond’s price is best understood by looking at its yield, which is the return an investor can expect from holding the bond until maturity. The yield spread, which measures the difference between a bond’s yield and that of a comparable Treasury bond, is a valuable tool for evaluating a bond’s relative value. Understanding these concepts can help you make informed decisions when buying bonds.

Treasury bonds can be a great choice if you’re aiming for a risk-free portfolio. You can minimize reinvestment risk by carefully structuring your portfolio with bonds with coupon payments and maturities aligned with your income needs.

Another popular strategy is a bond ladder. This involves buying bonds with staggered maturity dates, allowing you to reinvest proceeds regularly. This method helps reduce the risk of being locked into low interest rates for a long period.

How to Purchase Tax-Free Municipal Bonds

Tax-free municipal bonds (munis) can be bought online or from specialized municipal bond brokers. Confirm your eligibility for tax-free status based on your residency before purchasing these bonds.

How to Buy Savings Bonds for Children

If you’re interested in purchasing savings bonds for a child, you can do so online through TreasuryDirect. You’ll need the child’s name and Social Security number. You can also use your federal tax refund to purchase savings bonds.

How to Buy Foreign Bonds

Investing in foreign bonds is possible through some brokerages with access to international markets. You can also invest in international bond mutual funds and ETFs, which provide global exposure.

Can You Still Buy Bearer Bonds?

Bearer bonds, once popular due to their anonymity, are no longer widely issued because they are prone to illegal activities like money laundering and tax evasion. They are also vulnerable to theft since they belong to whoever physically holds them.

Conclusion

Investing in bonds is a valuable strategy for diversifying your portfolio, but the bond market can be complex. Today, brokers and online platforms make bond investments more accessible, allowing investors to choose between buying individual bonds or investing in bond mutual funds or ETFs. Your choice should depend on your financial goals, risk tolerance, and investment timeline. A clear understanding of each type of bond will guide you in making the best decisions for your portfolio.