How to Purchase Corporate Bonds for Investment

A corporate bond is a debt instrument. Investors receive regular interest payments and get the principal or face value of the bond back on maturity. The advantages include diversification, steady income, liquidity and generally higher yields than government bonds. The disadvantages include the risk of default and lower prices because of higher interest rates. You may purchase bonds directly or indirectly through bond mutual funds.

Difficulty:

Moderate

Instructions

Things You'll Need

• Affiliation with a brokerage firm
• Internet access
• Adequate assets to invest

1. Allocate the proper mix of stocks, bonds and cash in your portfolio. Your investment time horizon and risk tolerance level determine the mix. Investors with a longer planning horizon (more years before retirement) and higher risk tolerance may opt for more stocks in the mix, while conservative investors may opt for more bonds.

2. Research a corporate bond before buying. In addition to the bond rating provided by Moody's and Standard and Poor's, which are the two rating agencies that rate corporate bonds, review the financial documents at the issuer's website. Invest in the bonds of companies with a strong cash flow and a consistent record of sales and earnings growth.

3. Purchase corporate bonds through your online broker. Bonds trade in the secondary over-the-counter market, usually in $5,000 denominations. Bond price quotations assume a par or face value of $100. For example, bond prices of 98 and 102 mean that the bond is trading at a discount or premium to par, respectively. Therefore, the purchase cost of a $5,000 face-value bond with a price quote of 99 is $4,950 (0.99 multiplied by $5,000).

4. Buy corporate bonds indirectly through bond mutual funds, which are professionally managed portfolios of government and corporate bonds. The advantages of these funds include risk diversification and relatively low management fees. Sources for information on bond mutual funds include financial websites and the business media. Read the mutual fund prospectus to ensure that the bond fund invests in securities matching your investment time horizon and risk profile.

5. Ladder your bond investments. This involves spreading the bond maturities over several years. The advantages of a bond laddering strategy include diversification and a dependable income stream.

6. Evaluate your corporate bond investments. Review the financial reports of the issuing companies. Do not wait for a rating agency downgrade to get out of the bonds of financially troubled companies.

Tips & Warnings

• Corporate bonds are either investment-grade or speculative-grade. Moody's rates investment-grade bonds on a sliding scale from "Aaa" to "Baa" and speculative or high-yield bonds from "Ba" to "C." Standard & Poor's rates investment-grade bonds from "AAA" to "BBB" and speculative-grade bonds from "BB" to "D."

• Money market mutual funds may also invest in high-quality short-term corporate bonds. Bond unit investment trusts are similar to bond funds, except that the bonds in a trust remain for the life of the trust unless they mature or the issuer redeems them.

• Don't expect much encouragement for this form of investments from representatives the securities industry.

References

• PIMCO; Investing Basics: What Are Corporate Bonds and What Advantages Do They Offer?; September 2007
• Securities Industry and Financial Markets Association: Investing in Bonds: Bond Basics -- How to Invest
• Wells Fargo Advisors: Bond Investment Strategies
• Bankrate: Build Your Investment Ladder With Corporate Bonds; Laura Bruce

Resources

• Securities Industry and Financial Markets Association: Corporate Market At-A-Glance
• "The Wall Street Journal": Market Data Center: Bonds, Rates and Credit Markets Overview
• Charles Schwab: Bond Unit Investment Trusts
• Fidelity: Corporate Bonds
• Yahoo! Finance: Bonds Center: Bonds Glossary