Today I’m talking about how to invest in bonds and became a good investor. Bonds are not the biggest in popularity among the securities, but they sure have a lot of people loving them.
Because one of the biggest advantages of buying bonds is that you can get your principal back. I’m going to take your hand and give you a tour in this blog post about bond investing for beginners.
From what are bonds and where to invest in bonds to types of bonds. Here in this introduction to bonds, you can find everything you need to know.
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As I always say, the first thing we do when want to learn something is look for the definition on the internet.
Bonds are considered to be the less risky of the two choices: Stocks and Bonds.
Yet, understanding exactly how bonds work is an interesting concept. Unlike stocks which you buy into the company, with a bond you actually are lending the money – you are the bank!
That’s simple right? And that’s what a bond is in finance. But if you still have doubts about what is a bond, here is this. It’s a loan that’s given to a company or government by an investor. When a company issue a bond, they are borrowing money from investors. On the other hand, investors will get paid interest on the money they loaned.
Companies and governments are always making new bonds. Whenever they have a new project or to cover expenses. People usually see bonds as a way to keep their saved money and also an opportunity to generate profit.
By giving you the definition of what is bond you should get a glance at how do bonds work but here’s an example. Everything is better with an example.
When a company or a city needs money, they will let people issue a bond. For example, New York wants to create a new Central Park. So they decide to issue a bond to raise the money for it. The New York City says each bond is a loan for $2.000, and they will pay it back in ten years. To make it look more promising they will give you 5% of profit wich here is called the coupon rate in bonds. Once the bond terms are explained you can proceed to operate.
How often do bonds pay interest? Each year the city will give you 5% in return which is, in this case, $100. Once the ten years pass, the placeholder (the city) will give you back your principal investment.
Many people think bonds have no risk, and they’re wrong. Bonds have LESS risks than stocks, but the bond market investment still has its risk.
One of the biggest risk a bond investor face is the default risk. This happens when the bond issuer defaults the capital. Usually, the higher the coupon rate is, the higher the bonds investment risk will be. A bond risk depends on the financial stability the issuer has. Governments are well-known issuers and generally cataloged as stable. Companies and corporations have a bigger risk since they can go in bankrupt at any time.
Bonds can be traded on the open market, so this means there’s always someone buying and selling bonds. If you buy a bond and later on need the money for an emergency or whatever you need it for. You can sell the bond to another investor. This is how bonds are traded.
So investment bonds are explained now, we can move to the types of bonds.
3 Types of Bonds for Investing:
This is when businesses and corporations are looking for lenders. They don’t want to go public and sell their shares or parts of their company public, but they do need money to borrow. It’s when they can’t get money from banks. They hire financial professionals to help with this public lending.
Corporations will borrow for a certain period of time. And then pay a yearly interest rate on the loan until the bond matures.
This is considered the riskiest of them all because you don’t know if the company will pay you back, or they can fold. As with all higher risks, the rewards are much higher.
This is when the United States Government is borrowing money from people. Considered to be the safest investment out there. There are a few benefits to this bond buy – the greatest of all is that it’s tax-exempt. You don’t pay any taxes on its gains.
The way these are purchased are usually in par value denominations ($1,000 bulk).
This is local governments asking for IOU’s with interest rates. This is paid via the taxpayer’s money that comes into the local areas. The downside is that they are not guaranteed by the local government. The main benefit of this sale is that they are tax-exempt too. Plus, if you’re buying into a certain project, let’s say money is needed for a new toll road. You are pretty much guaranteed you will get that money back since it’s a toll road and will not lose the money.
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The company, government, or municipality pays back in different time frames. This is called coupon rate or coupon yield. Some can pay monthly, bi-year, yearly, or at the end of its maturity. This information is known to the public when you buy, and you make the decision.
The risk is much lower, thus the rewards are lower. But if you buy well, you will always make your money back!
Knowing this you sure will want to add bonds to your trading portfolio. A lot of investors likes to have some investment in stock and others in bonds. This is a good way to diversified your portfolio.
I just give you a glance of what are a bond and how to invest in bonds. Like any security they are complex, but you sure can make a nice income from bonds.