INVESTMENT LEVEL: ALL
Do You Want to Earn More Interest?
If you have seen the extremely low interest rates at the banks, you have probably wondered if there is a way to earn more interest on your money. The answer is yes! It is possible to get paid higher interest on your savings. This strategy is not for everyone, but may be for you if you meet the following profile:
- You have adequate liquidity to meet your everyday needs
- You would be willing to invest money and leave it invested until the maturity of the investment
- You find the idea of earning a higher rate for investing for a longer period appealing
If you answered yes to all of the statements above, then you may wish to consider investing in bonds. Bonds are investments in which you loan money to an entity in exchange for a series of fixed interest payments and then repayment of principal at the bond’s maturity.
So, what is a bond? Bonds are issued by many different types of institutions including:
Types of Bonds
- The United States Government – treasury bonds, notes and bills
- State and local governments – tax free municipal bonds
- Other countries – sovereign government bonds
- Domestic and foreign corporations – a variety of corporate bonds including investment grade corporate, high yield, and convertible bonds
Important Bond Considerations
There are several factors which influence investors who wish to purchase bonds. Among the items that bond investors need to consider are:
- How long will it be before my principal is paid back (the bond’s maturity)?
- What are the risk factors involved with this bond?
- What is the interest rate the borrower will be paying on the bond?
Bond issuers will generally have to pay higher amounts of interest for bonds that will take a longer time to mature. You can expect that a bond issuer will pay you more interest if you lend them money for a ten year loan than they would for a two year loan.
There are many factors involved in bond risk. Among the risk factors are default and interest rate risk. One of the most important things to understand is the financial strength of the issuer of the bond, because this is what will determine their ability to pay you interest and return your principal. Information may be obtained through a variety of sources, including a prospectus about the bond, or independent research done on that particular bond issue.
Interest rates generally depend on the borrower’s perceived ability to pay back interest and principal that is being borrowed. Bond issuers with the highest credit ratings can expect to pay lower interest rates to bondholders than those who have lower credit ratings. Makes sense right? It works the same way for us when we borrow money. If you have a better credit score you have easier time borrowing money and can borrow at lower rates.
How Do You Invest in Bonds?
Once you have done your homework and are convinced that bond investing is for you, you are ready to try to find the right type of bond investments for you. You can invest in bonds two ways:
- Purchase Individual Bonds
- Purchase Bond Mutual Funds
Some of the advantages to buying individual bonds are that you are locked in to the bonds interest rate until maturity and you will pay no mutual fund management fees. Some disadvantages to owning individual bonds are lack of diversification and you have to do all of the research and select the bonds yourself.
Some of the advantages to investing in bond mutual funds are immediate diversification, there is automatic reinvestment of interest and principal paid to your account and experienced professionals select the bonds to buy. Some of the disadvantages are that you will pay a management fee, and possibly pay sales charges. The rate of interest earned in a bond mutual fund will fluctuate and there is no set maturity date for your bonds since the fund continually accepts new money in to the fund and will continuously buy and sell bonds to meet the needs of the mutual fund portfolio.
Before you decide to invest make sure you do your homework. This article is just meant to serve as an introduction to investing in bonds and not a bond investing guide. Bond investments will fluctuate in value and you can lose money investing in bonds. Past performance does not predict future results.
