How to Buy Individual Bonds

Buying individual bonds eliminates the substantial fees charged by closed-end and open-end bond funds. Bonds are sophisticated instruments, and close attention should be payed to the details of coupon, maturity and call features. This article is applicable to treasury, foreign, corporate and municipal bond issuance.

Difficulty: Moderate

Instructions

Things You'll Need:

• Internet access for online bond calculators
• Internet access for online bond accounts

Minimum Requirements for Buying Bonds

1. Buy bonds from either a broker or an online trading website. Try to buy new issues of bonds, as the price will generally be close to market returns. This usually requires the use of an off-line broker. For online purchases, compare bonds of similar quality and maturity. Understand the functioning of call features that cause bonds to be redeemed at the issuer's decision prior to stated maturity.

2. Buy individual bonds when you have $50,000 available to invest. To achieve diversification, you will need to purchase at least 10 different credits in different industries and market sectors. Diversify by maturity, rating and coupon. Trading bonds is relatively expensive. The all-in charges can easily exceed 4 percent of the face value. Buy bonds to hold to maturity.

3. Buy individual issues not less than "A" rated by one of the three rating agencies: Moody's Investors Service, Fitch, and Standard & Poor's. Ratings are available on their websites, at any library and in many periodicals. An "A" rating designates investment grade. Ratings below "A" have a higher tendency for default, much greater volatility and higher commissions if they need to be sold. A, AA and AAA bonds have better liquidity if the securities must be sold.

4. Vary the coupon choice of the bonds you purchase. Purchase zero-coupon bonds for shorter maturities and eliminate some call risk. Purchase par bonds or bonds trading close to their maturity value to maximize income and interest rate risk. Purchase premium bonds as a hedge against interest rate risk and to gain the additional yield advantages of a bond priced to call.

5. Invest in bond purchases where the maturity does not exceed 10 years or the first call date, whichever comes first. Be certain to know all the call dates of a bond, as there are usually several. There is a great risk of capital loss in bonds with maturities longer than 10 years due to adverse interest rate movement. Know that 80 percent of the maximum yield of a 30-year issue is purchased with half the risk when you purchase a 10-year bond.

Tips & Warnings

• Don't try and time the market. Buy short maturities during a recession. Buy longer bonds during expansion.
• Avoid noninvestment grade securities. Bonds are traded in large volume, and individual purchases of lesser grade bonds are not liquid.

Resources

• Business News and Links
• Fitch Business Rating System
• Moody's Investors Service
• Standard & Poor's Rating Service