Things to Consider When Buying Bonds

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Things to Consider When Buying Bonds

Bonds are generally more conservative than stocks but may be riskier than certificates of deposit or money market accounts. They are not designed for making your money grow rapidly, but they can help to diversify your portfolio. Most traditional bonds may be able to provide a relatively stable source of interest payments and a return of your principal.

Things To Know

  • Some investors place importance on the length of the bond term when choosing investments for their goals.
  • A bond’s value on the market is directly related to current interest rates.
  • A bond’s credit quality can affect the price of the bond.

What bonds are all about

The purchase of a bond is basically a loan to the issuer: a loan that must be repaid to you at maturity and in some cases periodically. Bonds differ in their maturity and scheduled payments of interest.

Maturity is the time at which a bond issuer pays you back the money you loaned. If you hold your bond until it matures, you receive the principal value of the bond, unless the issuer has defaulted. Shorter-term bonds have maturities of only several years. Long-term bonds take from 10 to 30 years to mature. In general, an investor receives greater total interest payments for bonds of longer maturity, depending on interest rates.

Bonds for conservative investing

Many investors consider the length of the bond term when investing for their goals. If the timeline of your investment is longer, you may want to consider a longer-term bond. Long-term bonds may offer a higher yield in exchange for the use of your money for a longer period.

Sometimes bonds get called

A risk common to bonds is that the bond issuer may decide to pay off a bond before its maturity date. This is known as "calling" a bond. Bonds are called because an issuer no longer needs to borrow the money, or because interest rates have fallen and the issuer wants to issue new bonds at a lower interest rate.

Keep interest rates in mind

A bond’s market value is directly related to interest rates. As interest rates go up, the market prices of bonds generally go down and vice versa. Until a bond matures, its price on the secondary market constantly changes in response to changes in interest rates. If you sell your bond before it matures, the price may be more or less than you originally paid for it, depending on current interest rates.

Keep credit quality in mind

The other factor affecting the prices of bonds is the credit quality of a bond. If a bond issuer is at increased risk for default, it will be assigned a low credit rating. Credit ratings are based on a grading system, with AAA or Aaa being the highest possible mark, all the way to a grade of C or D. Rating agencies include Moody’s Investors Service, Fitch, Standard & Poor’s, and Morningstar.