How to Methods of Bond Investing

Trouble understanding the murky world of bonds? Want to invest in bonds but not sure what you are paying? Read here to understand some of the fundamentals associated with the cost of bonds and how to evalute the differences.

Instructions

Difficulty: Easy

Things You’ll Need:

• calculator or spreadsheet

1. IDENTIFY THE OPTIONS - You can invest in bonds in a variety of ways, including 1) buying individual bonds yourself, 2) buying a bond fund, or 3) hiring a bond manager in a separately managed account (SMA)
2. UNDERSTAND COST COMPONENTS - Each method of bond investing comes at a cost.
   
   For individual bonds, you will normally pay your brokerage firm (be it a discount or full service firm) a "mark up" when you purchase. Many investors do not realize there is a cost embedded in the price of their bond, and you should evaluate your net return net of mark-ups / commissions / concessions etc.
   
   Bond Funds - have their own expense ratios just like any mutual fund. The fund manager pays mark-ups when he purchases bonds (just like you would) but because he buys in bulk he will have lower costs than you. The trade off is that you have to pay his management fee. You are also exposed to interest rate risk because if interest rates rise your bond fund value will decline, and vice versa.
   
   SMA Accounts - these accounts often require a minimum investment of $100K to $500K. The bonds are selected by a professional manager but are purchased specifically for your account and will appear on your statement. The most popular form to pay for SMA services is "fee based", meaning you pay the manager a percentage of the assets you are investing. You will normally not pay any additional mark-ups or commissions and you should make sure this is the case before investing - get it in writing!
3. EVALUTE YOUR SKILLS AND COMMITMENT - Unless you are going to seriously spend time understanding bonds and their components, you should probably stay away from buying your own bonds. Let the pros do it and pay their fee.
   
   However, if you have the time and inclination, you shoudl buy a book on the subject and get to understand the animal you are dealing with - treasuries, TIPS, GO's, Revenue Bonds, junk bonds.
   
   If you are going to hire out and have less than $100K for bonds, you are probably best off in a bond fund. However, realize that you will be subject to interest rate risk - that's ok if you plan to invest long term and can ride out multiple interest rate cycles, say over 5-10 years.