Tips Before You Invest in Bonds

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Here are ten things to think about before investing in bonds or bond funds:

  1. Don't reach for the surrender button. Reaching for yield is the single worst error bond investors make. When interest rates are low or have just fallen, or when investors believe they are not obtaining the rate of return they need, this occurs. Don't be swayed by greater yields given by bonds with worse credit ratings, or by focusing only on prior-period profits. When purchasing a bond, yield is only one of several things to consider. Also keep in mind that a greater yield entails a bigger risk.
  2. Establish your goals. Is it your goal to save enough money to pay for your child's college education? Is it your ambition to retire comfortably? If so, how cozy is it? You most likely have a number of objectives. Arrange them all and be as accurate as possible. Remember: You'll never get there if you don't know where you're going.
  3. Take a look at your risk profile. Like stocks and stock funds, various bonds and bond funds have varying risk profiles. Before you invest, be sure you understand the dangers. It's a good idea to jot them down so that they're all visible.
  4. Take care of your schoolwork. If you've made it this far, you're off to a good start—but keep going. Read about bond investment in books and articles. Look for information on the internet or go to the library. Start watching financial news broadcasts and reading newspapers for fixed-income analysis. Make sure you know how to do bond math. You should also read the offering statement for the bond. It's where you'll discover all of the critical details about a bond, from the yield to the call schedule.
  5. Read the prospectus carefully if you're thinking about purchasing a bond fund. Pay special attention to the sections that explain the fund's bonds. A government bond fund, for example, does not include all government bonds. Pay attention to the costs as well. Prospectuses for individual bonds are derived from the indenture, a legal document that describes the relationship between the bond buyer and the bond seller. To read the prospectus or indenture, ask your broker for a copy.
  6. If you're purchasing individual bonds, choose a bond-focused business and broker. Speak with a few brokers until you locate one that you like. Ensure that your broker is aware of your goals and risk tolerance. FINRA BrokerCheck may be used to look up a broker's qualifications and disciplinary history.
  7. Inquire with your broker as to when the bond was last exchanged and at what price. This will reveal the bond's liquidity (an illiquid bond may not have traded in days or even weeks) as well as the firm's pricing competitiveness.
  8. Be aware of all charges involved in purchasing and selling a bond. Inquire about commissions, mark-ups, and mark-downs, as well as how your brokerage business and broker are rewarded for the transaction.
  9. Make a strategy for reinvesting your coupons. This permits the compounding power to operate in your favor. It's a good idea to set up a “coupon account” before you start getting coupons so you can preserve the money instead of being tempted to spend it. If you purchase a bond fund, you won't have to worry about this since the fund will take care of it for you.
  10. Avoid attempting to time the market. Interest rate speculation should be avoided. Too frequently, decisions are based on where rates have been rather than where they are headed. Stick to the investing approach that will help you attain your goals and objectives the most.

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