Why Should You Buy Bonds?

Bonds are considered to be some of the safest investments because they are simply loans to a business, government or other institution. When buying a bond, you're essentially buying a debt that will be repaid at the end of the bond term, with monthly or annual interest paid on top of it. Bonds generally pay a fixed interest rate, and the price of the bond can be bid up or down, which alters the interest rates on the bonds.

How Bonds Work

Bonds are generally sold in $10,000 increments to investors who want to loan money to a certain business. The business will offer a fixed interest rate, then the bonds float on the exchange, which changes the interest rate over time. For example, if you were to buy a bond with a coupon rate of 10% and the bond was selling at a discount of 10%, you'd be able to buy $10,000 in debt for $9000. The interest would be paid on the initial bond sale of $10,000 so you would get a $1000 interest payment on a bond that cost you $9000. This results in an actual interest payment of 11% per year - much higher than the 10% as stated by the issuer.

Why Bonds are Safe

Bonds do not rise and fall with the company's stock. Even when the stock is falling, bonds may rise because they are based on the credit quality of the business rather than its stock price. More important to investors is the total amount of debt held by the company and the chance that the bonds will be paid to maturity. The ups and downs of the stock market are of little importance unless they are due to bad financial news or trouble brewing with the company in question. Bond investors are generally more patient than stock traders, thus the price for bonds flows more fluidly than stock prices.

How to Buy Bonds

For most investors, bond funds are the best way to get in on the bond market. Bond trading is entirely more complicated than trading stocks, and it's usually best to leave it up to a professional. Also, bonds require large initial investments, which limits diversification for small investors. Bond funds generate returns that are very similar to any basket of bonds, allowing you to benefit from a specialist rather than invest by yourself. The bond market is not as open to individual investors as the stock market is, which makes access to the market difficult to those without a sufficient amount of money.

The various types of bond funds will also allow you to pick the kind of debt you would like to invest in. There are municipal bonds, which are investments in cities which need funding for development. Corporate bonds are those that are issued by corporations, generally for expansion or to borrow money when interest rates are generally low. Then there are Treasuries, which are federal bonds issued as a way to borrow for a federal debt.

If you are looking for a relatively safe investment, consider buying corporate bonds through a bond fund, which will help you optimize your risk to reward ratio.