How To Create A Bond

The New Investor's Guide to Buying Bonds Online

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As a beginner investor, you might have heard that bonds are a great investment but have no idea how to invest in them. This guide shows you all the information you need to know before buying a single dollar's worth of bonds, as well as how to buy bonds online.

The bond market is incredibly diverse. It consists of the following main types of bonds:

Treasury bonds from the U.S. government, also known as T-Bills
Other government bonds
Municipal bonds
Corporate bonds
Junk Bonds
Mortgage-backed bonds
Foreign bonds

Each of these bond types has a different risk profile associated with it. In addition, different bond types will yield different investment income. Typically, the higher the risk associated with the bond, the higher its theoretical return. Almost all of the bonds can be bought online, either from an underwriter, a broker or, in some cases, the issuer of the bonds.

Understanding the Bonds Investment Process

You can buy bonds from companies that issue bonds directly, such as large corporations like Apple or Microsoft. This approach, however, is not open to all investors. It is much more efficient and less time-consuming for a large company to sell its entire issue of bonds to a single large institutional investor. This institutional investor takes on the upfront risks associated with the bond, then attempts to share them to members of the investing public. This will include other institutional investors as well as individual investors, large and small.

The original investor that takes on the initial investment risk is known as the underwriter of the bond issue. Underwriters are typically large investment banks, investment houses, and bond trading firms. Once the issue is available through an investment bank, you can then buy these bonds from the market. Bonds on the market, if the issue was successful, will be available at a marked up price from that for which the underwriter got them.

Where to Buy Bonds Online

Electronic bond trading sites allow you to buy and sell bonds that have been issued successfully. Buying through an electronic bond trading site is easier for the small investor since the minimum required can be as low as $100.

The U.S. government has a direct trading website for Treasury bonds. The website, named TreasuryDirect, enables investors to buy treasury bonds directly on the website. When it comes to selling Treasury bonds acquired through TreasuryDirect, you will first need to transfer the bonds to a financial house that allows selling of Treasury bonds. This financial house can be a broker, investment bank or another dealer. They can then sell the bond for you and give you the money.

Some brokerages you can use to trade bonds online include ETrade, Tradeweb, Bloomberg, and Charles Schwab. Selling and buying bonds through brokers and other intermediaries will come with trading commissions.

Investing in Short Term Bonds

Trading in short term bonds typically involves less yield, but they can be a safer investment than long term bonds. To understand why, you must look at the risk profile of a longer-term bond. For example, if you invest in a 30-year corporate bond, you have to solve a much harder prediction problem than if you invested in a two-year or three-year bond.

Buying a 10-year or 30-year bond means you are taking the risk that the market could move against you in that long time period. If interest rates rise, for example, your bond could lose its value. If you sold it, it would be at a discounted price, meaning that you get back less than you paid for the bond.

Short term bonds like municipals allow you to sidestep this time risk. Some of the best short term bonds to look at include:

Des Moines Iowa GO Refunding Bond Series 2005E
Central Utah Water Conservancy District GO Refunding Bond Series 2004

Investment Performance of Bonds

While we've covered the mechanics of buying bonds, you will want to know something about measuring returns from bond investments. Perhaps the key lesson is that bonds can be an exciting investment, but they return less on average than stocks.

In 99% of trading periods lasting 30 years, bonds underperformed stocks when it came to average returns. The flip-side is reassuring, however. Even though bonds make it harder to make spectacular returns, they are generally less volatile.

The performance of the bond market today mirrors much of what has happened over the last century of bond investing. Thanks to the highly mathematical and precise nature of bond structures, it's much easier to ascertain fair market value. As a result, you can make much better investment decisions when allocating your capital into bonds.