Your investment options are almost limitless. Unfortunately, it’s a little trickier to figure out where to stash your money because there are so many options. Determining which direction you’d like to go might require an in-depth risk and goal evaluation on your part. Here’s an avenue to consider — why not add corporate bonds to your portfolio? Learning how to buy corporate bonds can help you and your business diversify.
What are Corporate Bonds?
Corporate Bonds are debt instruments issued by companies and corporations to raise money from investors. When an investor buys a corporate bond, they lend their money to the company in exchange for a fixed rate of interest payments over a specified period of time. At the end of this period, the company repays the original amount borrowed — known as the principal — along with accrued interest payments.
Investors are attracted to corporate bonds because they tend to carry higher interest rates than other types of debt, such as government bonds. This feature can be beneficial to investors looking for a steady stream of income or those wanting to diversify their investment portfolios. Corporate bonds can provide stability and potential capital gains if the company’s credit rating improves over time. However, they are not without risk.
How to Buy Corporate Bonds: A Step-By-Step Guide
A bond is a debt obligation, or in less-fancy terms, an IOU. When you buy a bond, you lend money to the corporation that issues them. The corporation then makes a legal commitment to pay interest on the principal when the bond comes due or matures. When a bond matures, you should receive the principal plus interest on the bond.
Corporations might issue bonds to fund capital improvements, expansions, acquisitions, research and development, pay shareholder dividends or refinance debt. They are one of the largest sectors of the U.S. bond market, which also includes U.S. Treasury bonds, other types of government bonds and municipal bonds.
If you’ve read through the bond classifications, consider the nuances of risk. evaluated your risk tolerance level and understand why you’d be interested in adding corporate bonds to your portfolio, you’re ready to buy. Take just a few steps to get that accomplished.
Step 1: Set Up a Brokerage Account
You can choose to work with an online brokerage, bank, bond trader or broker to buy a corporate bond. Benzinga reviewed dozens of brokerages and narrowed down the best online brokerage to buy corporate bonds. You can review the full rankings for the best online brokerages or take a quick look at the favorites below.
Step 2: Narrow Your Bond Choices
Research sector, growth and performance and use Benzinga’s Best Bond Funds to choose the right option for you. Even if you already know how to buy corporate bonds, you need to consider your options carefully.
Step 3: Check Your Narrowed List for Bond Ratings
Use one of the two biggest ratings firms — Standard and Poor’s and Moody’s to check financial stability, debt and other risk factors. Look for bonds with letter grades that range from AAA or Aaa to BBB or Baa, which are considered investment grade. Bonds with a BB or Ba rating or below are junk bonds. Steer clear of these because they’re issued by companies with liquidity problems.
Step 4: Place Your Order
You’ll find bond prices quoted as a percentage of the face value of the bond. Some corporate bonds trade on the over-the-counter (OTC) market as well.
Why Should You Buy Corporate Bonds
Investing in corporate bonds has benefits for those seeking income security. Corporate bonds require repayment, offering more protection than stocks in case of financial difficulties. Bondholders receive interest payments and principal back before equity investors in liquidation. Investors have a range of choices, buying new issues or exploring the secondary market. Bond funds provide diversification, spreading risk across various bonds. This flexibility accommodates different investment amounts for investors of all sizes. Corporate bonds deliver income, safety, and versatility, making them a smart investment choice.
Risks of Buying Corporate Bonds
Investing in corporate bonds carries several significant risks that can influence an investor’s decision-making process.
- Default Risk: Default risk is the chance that the company may not meet its financial obligations, leading to potential losses for investors.
- Interest Rate Risk: Changes in interest rates can impact bond prices negatively, causing existing bonds to potentially decrease in value, resulting in possible losses for investors who choose to sell before maturity.
- Inflation Rate Risk: The challenge of inflation risk is the potential decrease in purchasing power of fixed interest payments from corporate bonds, making them less attractive compared to alternative investments.
- Call Risk: Call risk occurs when a company chooses to pay off its bonds prematurely, often due to decreasing interest rates, which may lead investors to reinvest at lower yields.
These risks prompt investors to weigh corporate bonds against other investments, such as stocks or real estate. A thorough assessment of these risks is essential for determining the overall attractiveness of corporate bonds within an investment portfolio.
Bond Classification
Bonds can be classified in several different ways, including by their maturity, interest payment offerings and credit quality. Because there are so many classifications of bonds, you should not be afraid to diversify by purchasing several different types of bonds and layering them for your benefit.
Maturity
Bonds have different maturity rates, and longer-term bonds often offer higher interest rates but may contain more risk. The length of time varies, depending on the type of bond you’re considering:
Short-term Bonds
Short-term bonds mature quickly, within months to years. They are less risky than long-term bonds, appealing to conservative investors. These bonds offer predictable returns, aiding in future financial planning. Quick access to funds is a key benefit for those with imminent expenses. However, they may not be suitable for all investors. Long-term securities or equities may be better for maximizing returns over time. Investors should evaluate their goals and needs before adding short-term bonds to their portfolios.
Medium-term Bonds
Medium-term bonds have maturities of three to ten years. These bonds offer a balance between short-term and long-term investments. They provide higher returns than short-term bonds with less risk than long-term bonds. Medium-term bonds can generate steady income with reduced interest rate risk. Investors are attracted by their yields for growth and stability. To optimize returns and manage risks, investors can integrate medium-term bonds with short-term and long-term investments. One strategy is laddering bond investments by purchasing medium-term bonds at staggered maturities. This allows for liquidity and takes advantage of changing interest rates.
Long-term Bonds
Long-term bonds are debt securities with maturities over 10 years. They have risks like inflation and interest rate changes. Inflation can make future interest payments less valuable. Rising interest rates can lower existing bond values. Long-term bonds offer higher interest rates to offset these risks. If a company struggles financially, bondholders are paid before stockholders from liquidated assets. Bondholders are important for a company’s financial structure. While long-term bonds can be profitable, it’s important to consider the risks carefully.
Interest Payments
Several types of interest payments exist for corporate bonds, which include:
Fixed Rate
With this type of corporate bond, you receive the same payment each month until maturity. Interest payments are called coupon payments.
Floating Rate
This type of interest rate resets periodically, and they’re based on a benchmark, such as prevailing interest rates on a bond index.
Zero-Coupon
These types make no coupon payments. Instead, at maturity, the bond issuer makes a payment that is more than the purchase price.
Convertible
These are like regular fixed-rate bonds except you can convert them to shares of stock. Because of this option, your interest rate on convertible bonds will be lower.
Credit Quality
Bonds have different credit ratings, and it’s imperative to pay attention to the types of credit ratings. They can be considered investment grade or non-investment grade. You’ll more likely be paid on time if you invest in an investment-grade bond over a non-investment grade bond. If you do invest in a non-investment-grade bond, your interest rate will likely be higher to compensate you for your investment in a riskier bond.
Are Corporate Bonds Right for You?
Corporate bonds can be a good choice for reaching financial goals. They offer attractive income, often higher than government securities and less risky than stocks. This income can provide a steady cash flow as you work towards your financial objectives. Owning bonds can also provide a sense of security during market volatility. It’s important to keep a balanced portfolio, as over-investing in bonds could limit long-term returns. In the end, corporate bonds can be a valuable part of your investment strategy, offering income and lower risk. Just make sure to strike the right balance to stay on track with your financial goals.
Frequently Asked Questions
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Corporate bonds pay interest through a floating rate, fixed-rate or at maturity or by allowing conversion to common stock.
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Maturities range from 1 to 10 years and up.
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Yes, brokers may charge commissions or fees for buying and selling stocks. Review your broker’s fee structure before trading.
