Learn how to invest in bonds for profit step by step (beginner friendly guide)from expert bond investor.Start bond investing and make money without any risk.
If you have been lately searching for different sources to invest your savings in order to make some profit, then you surely might have come across bond investing. investing in bonds is a very popular method of investment and is a very good investment in terms of return on investment.
If you are interested in becoming one among the bond investors, and if you have been recently searching on how to invest in bonds, then today we bring you a very detailed in-depth guide on investing in the bonds, investments strategies, top bonds to invest in,bonds vs stocks, risk and benefits of investing in bonds,how to become one of the bond investors and how to invest in bonds to make a high profit.
What is a Bond?
A bond is a form of lending where the person or firm investing in bonds acts as a bank. Bonds are generally issued by the government or companies to meet their expenditure or debts.
When you buy a bond from a company or a government, you are lending them money upon an agreement that the government or company will repay your entire loan amount back at the end of a period called “maturity date” that is set when you buy a bond.
Until the time of repayment reaches, you are paid a yearly interest for your bond as well.
Why Do Companies or Government Prefer Bonds?
Companies issue bonds to meet their expenditure or to settle out their debts. Governments also issue bonds in order to settle any financial deficits of the government and also to bring development.
When bonds are similar to bank loans and people who invest in bonds acts like a bank lending loans, why would companies or government directly approach the bank for loans instead of offering bonds?
There are many reasons for why issuing bonds are preferred than taking a bank loan, and below are few of the main reasons:
- The first and foremost reason why companies and government prefer issuing bonds over bank loans is that, even though an annual interest is paid to the bond investor, it is almost at all times lower than the interest rates charged by banks on loans, thus saving the government or the company some money.
- Bank loans impose certain regulations and restrictions on the lender until the loan is repaid completely. For example, if a company takes a loan from a bank, most of the banks would restrict the company from making any business acquisitions until the loan amount is repaid completely. When it comes to issuing bonds, there are no such restrictions, thus allowing the company to function more freely.
Important Keywords that every Bond Investor Should Know:
There are many unique keywords that are used frequently by companies or government bodies issuing bonds and the professionals who invest in bonds. If you are someone who is just setting the first steps into the world of bonds, then it is really important that you know and understands the most common keywords that are used while talking and transacting about bonds.
So below are some of the keywords that are commonly used while talking about bonds:
Face Value / Par Value:
The Par Value or Face Value is a term used to define the principal value of each bond, which means the amount you had paid while purchasing the bond. The amount that you paid while purchasing the bond is the exact amount that you should expect in return once the tenure of the loan is completed.
The Maturity Date of a bond is the date on which the bond validity expires and the company or government that issued you the bond should pay you back the entire Face Value or Par Value at the end of the Maturity Date.
A Coupon is the annual interest amount in percentage that you will be receiving for the Face Value of the bond. Suppose you bought a bond for $100 and the coupon is rated at 5%, then annually you will receive an interest of $5 (0.05 x 100) until the Maturity Date.
The Yield of a Bond is the percentage of annual interest that you get paid for your bond depending on the current market value of the bond you purchased.
- For example, if you purchased a bond of $1000 with a coupon value of 5%, then the annual interest paid to you is $50 (0.05 x 1000). However, if the current bond value of your bond dropped to $500 from $1000, the yield of your bond will be 10% and you will still be paid $50 as per the original agreement. The 10% yield means that the $50 paid to you annually as interest is 10% of the current bond value ($500).
- Investment Grade: Investments in terms of bonds are generally made by taking the bond investment grade into consideration. The Bond Investment Grade can be considered as the score of a company depicting how likely the company is to pay back your bond after the end of the Maturity Date.
The Investment Grade for each company is offered by different agencies such as Moody’s, Fitch and Standard and Poor In order to be considered trust-worthy for buying bonds from, any company should have at least a rating of “BBB”. The companies with “BBB” grade rating are highly likely to pay back your investment amount after the Maturity Date and are safe bond investments.
The Companies that have a rating of “BB” or lower are considered to have a “Junk Grade” and is not at all recommended while buying bonds.
How Does Bond Value Fluctuate?
As with any other investment, the main factors influencing the fluctuation in bond values are:
- The demand for the bond.
- Global economic policies (For government).
- Market (For companies).
Below are detailed explanations of different factors that lead to fluctuations in bond value apart from the 3 factors mentioned above:
- The bond yield also influences the fluctuations in bond pricing. For example, a bond with 2% bond yield will be having a bond value lower than that of a bond with 5% bond yield.
- If the Maturity Date of a bond is long term, then it can also influence the pricing of the bond. Bonds that feature maturity date of a longer period will mostly require a cash flow discount rate that is higher and also features a risk of debt.
- Inflation can also affect the bond pricing. Inflation results in interest rates that are higher. As a result, a discount rate that is higher is required which in turn decreases the pricing of the bond.
- The Bond Investment Grade also affects the fluctuations in the bond pricing. If the investment grade of a bond decreases, that affects the credibility of the bond and thus the price of the bond drops and vice versa.
The above factors are only to be considered if you are about to purchase a new bond. If you have already purchased a bond of any company, then the principal value of your bond remains the same, no matter the bond pricing goes high or low.
And at the end of the maturity date of your bond, you are paid back your complete principal amount that you invested while purchasing the bond, irrespective of the current bond pricing.
How is the Bond Interest Calculated?
There are many bond interest calculator tools available online. However, we recommend you to understand the procedure of how bond interest is calculated, instead of using such bond interest calculator tools.
Below is the step-by-step guide on how to calculate the bond interest. Before following the steps below, make sure that you have read the section above on the common keywords used while talking about bonds, so as to understand the steps written below faster:
- Know the exact face value of your bond. Generally, the face value of a bond is either $1000 or a multiple of the same.
- Now, check the Bond Coupon rate percentage of your bond. The coupon rate percentage of the bond is set when the bond is bought and remains unchanged for the entire period of the bond.
- Multiply the face value and the coupon rate percentage of the bond.
- The result from Step 3 is the annual interest that you will receive from your bond investment.
For example, if the face value of the bond you purchased is $1000 and the coupon rate percentage of your bond is 5%, then the annual interest you are paid for the bond is $50. If the interest is paid to you on an annual basis, then you will receive $50 every 12 months. If the interest is paid every six months, then you will receive $25 every six months or in case the interest is paid to you monthly, then you will receive $4.16 every month.
Benefits of Investing in Bonds:
If you are interested to know more about the benefits of investing in bonds, then below are some of the key benefits :
- When compared to other modes of investments, bond investments are generally considered as a safer mode of investment. This is mainly because of the fact that the values of bonds are not as volatile as other investments, say stocks.
- The interest payment that a bond investor receives can be at times higher than the profits gained from other sources of investment.
- At the end of the maturity date, the original amount that you spent in buying the bond is completely returned to you.
What are the Risks of Investing in Bonds?
Similar to any other investment source, bond investments also have its own risks and disadvantages. It is very important that you know and understands what are the risks of investing in bonds and also the bonds level of risk and potential return before you make any investment in a bond.Learn the Bond Investment Strategies from the expert.
So, below are some of the main risks involved in bond investing:
One of the main risks involved in bond investing is the risk of reinvestment. For example, assume that you bought a bond for $1000 which had a coupon of 5% when purchased. For this bond, you are to receive $50 annually which can be reinvested in buying bonds again. Now say that the coupon rate has fallen to just 1%. The $50 that you have reinvested in bonds now only makes $0.5 annually as interest because of the fall in the coupon. This is called the risk of reinvestment.Call Risk. Call Risk refers to when the issuer of a bond calls out and retires the bond, thus buying back all the bonds from people who bought it before the maturity date has reached.
- Another risk involved in bond investing is called Call Risk. Call Risk refers to when the issuer of a bond calls out and retires the bond, thus buying back all the bonds from people who bought it before the maturity date has reached.
- Another risk related to bond investing is where the bond investor fails to pay you the interest or the face value of your bond.
- Inflation risk is also one of the key bond investment Inflation affects badly on fixed bonds. To know more about fixed bonds and also other types of bonds, do check out our detailed article on the Types of Bonds.
Bonds vs Stocks:
When it comes to investing in bonds for beginners, the main question that arises is “Should I invest in stocks or bonds?”.
Bonds vs Stocks is one of the most asked questions out there by people who are confused by the question “Should I Invest in Stocks or Bonds”. So below is the detailed analysis on Bonds vs Stocks.
Even though Stocks and Bonds are two popular modes of investments, they are different from one another.
Stocks in simple terms mean the shares of a company. When you buy a stock, then you are directly becoming an investor of the company. However, as large number of shares are created for a company, owning a few shares does not entitle you for any powers in the functioning of the organization. But any fall or rise in the net worth of the company will directly affect your shares in the company and you will end up gaining or losing money in the process.
Bonds basically mean debt issued by a company or government. Government bodies do not issue stocks and hence issue bonds. When you buy a bond in a company or organization, you are lending them money with a promise to pay you an annual interest and also to return back the whole amount that you lent in the first place, at the end of the bond period. Even if you own a bond in a company, you do not own any part of the company as you are merely lending money for its functioning.
Should I Invest in Bonds or Stocks?
Now let us answer the key question when it comes to Bonds vs Stocks, that is to whether to invest in bonds or stocks.
In simple terms, bonds mean you are lending and shares mean you are becoming a part. This definition translates when it comes to the return from stocks and bonds as well.
If you buy stocks in a company and the profit and revenue of the company start climbing, you will be able to make a huge profit from your investment in the stocks of the company, but in case the company falls in revenue, your shares also take a hit and you will lose money.
In the case of bonds, as you are just lending money to the company or government, you are actually not becoming a part of it and hence the investment you made in terms of bond is not affected by the rise or fall in the company’s value and at the end of the maturity date, you will receive back the amount you invested while purchasing the bond.
Bonds have their own disadvantages as well and some of them are mentioned above in this article.
Even though the risks are high when it comes to stock investments, the profits are also high. However, if you are looking for a safer mode of investment, then bond investment must be your choice as investing in bonds poses low risk compared to stocks. But before investing in bonds, do make sure to assess the grade of the company whose bond you are about to purchase to make sure your investment is returned once the maturity date is reached.
An ideal investment ratio would include both stocks and bonds. So you can begin by investing in bonds to be safe of your investment and once you start receiving interests from the bonds, you can try investing them in stocks to understand if stocks are meant for you.
What are the Top Bonds to Invest In?
Knowing about the top bonds to invest in is as important as knowing the types of investment costs for bonds.
If you are seeking for the best bonds to invest in 2018, then below are some of the top bonds for investment in 2018.
- Vanguard Short Term Investment Grade (Symbol is VFSTX):
The duration of this bond is only 2 years and 6 months with a current yield of 1.7 percent. The Vanguard Short Term Investment Grade features an investment grade score of “A”, which means that this is one of the lowest risk bonds you can invest in.
- Vanguard Limited Term Tax Exempt Investor (Symbol is VMLTX):
Another variation of the VFSTX bond listed above is the Vanguard Limited Term Tax Exempt Investor which makes investments in bonds of municipal bodies. With an investment grade score of “AA”, this is yet another low risk bond for investment and features a current yield of 1.2 percent.
3. Metropolitan West Unconstrained Bond (Symbol is MWCRX):
This bond has a maturity date of 1 year and 4 months and has a current yield rating at 2.4 percent. With a “BBB” investment grade score and higher rates, this bond is very unlikely to make any sort of huge losses during its maturity period despite its lower rating than the two bonds mentioned above.
4. Osterweis Strategic Income Bond (Symbol is OSTIX):
With an investment grade score of “B”, the Osterweis Strategic Income Bond is one of the junk bonds out there. However, what makes this bond different and more preferable compared to other junk bonds is that the maturity period of this bond is just of 1 year and 5 months and has a yield of 5.5%. Moreover, this is not a pure junk bond as the managers are more cautious and flexible by seeking better opportunities.
The bond investment options listed above are based on the top rated bonds to invest in 2018 and proper research has to be made on the current investment grade score and yield rate of the bond before making any investment.
Hope the step by step guide on how to invest in bonds written above helped you in gaining some quick insights on to all the major topics related to investing in bonds strategies.
Bond investments, like any other investment, requires proper research. Therefore, be sure to refer all the articles related to investing in bonds written on this website to have a clear view on bond investments.
Also, before you make any investments in bonds, make sure to ask us any questions you have so as to make a safe and secure investment in bonds.
We hope our investing in bonds beginner to advance guide help you to stat bond investing in 2018.It’s your turn to be good bond investor and start making money.