Investing Archives

Bond Basics: How Bonds Work

Whenever you drive down one of America’s highways, or see a factory expanding in the city where you live, you’re seeing bonds in action. The fact is, bonds are used by both the federal government as well as local and state governments, and private enterprise, to generate the funds they need for expansion, development and long-term infrastructure projects.

What most people don’t realize is that the bond market in the United States is even bigger than the stock market, and that it plays a huge role in the global economy as well as in the lives of practically every American. For example, while the NYSE, NASDAQ and AMEX stock markets have an average trading volume of around $110 billion, the US Bond Market has average trading volume of almost $850 billion.

When you see a bridge being built, you can bet that bonds are what paid for it. New transportation systems that move us around, power plants that give us electricity and sewer systems that bring water to our homes and take waste away are all financed with bonds. In fact, if it wasn’t for bonds, many of the systems and infrastructure that we all take for granted would eventually break down and fall into disrepair.

So, how do Bonds work, exactly?

Bonds start when a government entity or private enterprise issues a bond in order to raise money. They are the borrower and make a legally bound promise to repay the amount of money that they borrow back to the bondholders at a specific time in the future. The amount borrowed is known as the principal or face value of the bond and the payoff date is known as the redemption or maturity date.

The best part however is that the bondholder doesn’t just get their money back, they also get interest, which is known as the coupon rate or coupon, twice a year (in most cases).  In effect, the interest that is paid to the bondholder is the compensation that the government entity or private enterprise is paying in order to borrow the money they paid for their bonds.

Bonds that are issued by the United States government are usually bought directly by the investor but almost all others are purchased indirectly through broker – dealers at either banks or brokerage houses. These are known as the “underwriter” and they act as the intermediary between the issuer of the bond and the buyer/investor.

New bonds are purchased on the primary market and, if someone purchases a bond but wants to sell it before its maturity date, they can sell it on the secondary market.

Over the last few years the pricing of bonds has become much more transparent due to better industry regulation, and investors can see real bond prices on websites like www.investinginbonds.com and others. If you have any questions about purchasing bonds, or selling bonds that you already own, please let us know and we’ll get back to you with info and advice ASAP.

Should You Invest in Bonds Near Retirement?

Even though many consumers are putting off retirement further and further these days, the fact is that you should still be planning for the inevitable day that you can’t work any longer, whether by choice or not.

One thing to keep in mind, as retirement gets closer, is that the “investment horizon” you have gets smaller, meaning that you want to invest in things that are less risky. For this reason many financial advisors suggest that consumers in their 50s and even in the early 60s dedicate at least 50% of their portfolio to Bonds.

One of the best reasons to invest in bonds is that they offer many different choices and sectors, giving you the ability to diversify your portfolio quite nicely. Many bonds can only be purchased for a $5000 minimum investment however, meaning that you need to have significant assets in order to put together a portfolio that includes different issuers, different market sectors and different maturities of bonds.

For that reason, you might wish to consider bond funds, unit trusts or exchange traded funds. That will make it a bit more convenient to diversify your portfolio, and more affordable as well. One caveat however is that they don’t offer the same promise of a specific maturity date that a single bond will give you.

Depending on the tax bracket that you happen to be in, it might be more advantageous to purchase tax advantaged bonds that are issued by either federal, state and/or city governments. The reason is simple; any interest that is paid to you on US government securities will, in most cases, be exempt from both state and local income tax. If you live in a state where taxes are high, this can be crucial. Interest that you get on municipal bonds is exempt from federal income tax and, in many cases, exempt from state and city income tax also.

One excellent way to invest in bonds is called “laddering”, which along with diversification lowers your risk. An example is to purchase bonds with different maturities that are staggered over 1, 3, 5 and 10 years, reaching maturity at those times and making sure that, no matter what interest rates are in effect at the time, your bonds still deliver a good return. The reason is that, if interest rates are rising, your short-term bonds that are maturing will let you reinvest at a higher rate and, when rates are dropping, your longer-term bonds will still be paying you with their higher coupons.

If you have any questions about investing in bonds, or about personal finance in general, please let us know by commenting or dropping us an email, and we’ll get back to you with advice and answers ASAP.

5 Excellent Tips for Beginner Investors

If you’re brand-new to investing and possibly just starting to do your online research, good for you!   One of the best things that you can do if you’re just getting into investing is teach yourself first, before you start risking any of your hard-earned money.

Today’s blog looks at 5 Tips that will get you started on the right foot, with basic but important information that you need to keep in mind so that the investments you make are sound and will pay off. Enjoy.

1) KISS. This is an acronym for Keep It Simple, Stupid. Many beginner investors focus on either irrelevant points or, even worse, try to predict the unpredictable, something that almost always ends in failure. If you focus on strong companies that have a history of excellent returns, and learn to “tune out” all of the noise that you will hear about which stocks to buy and sell, your odds of success will increase significantly.

2) Don’t expect too much or too little. As a beginner, many consumers believe that stocks will be the key to quick riches. The reality however is that, aside from extreme luck, investing rarely makes any investor a windfall of money. In almost all cases the best returns are achieved by patient investors who have the time to wait for their investments to grow, research the companies that they invested and have the proper expectations of what their returns will be.

3) Prepare yourself to hold on to your stocks for a long time. Here’s a fact that most new investors either don’t know or overlook; in the short run, stocks can be quite volatile, bouncing up and down like a ping-pong ball. If you try to protect what the market will do in the short term, you can literally drive yourself crazy.

In the long run however, stocks have been shown through the decades to be a very good investment choice, with stable and consistent returns. What this means is, as above in number 2, you need to be patient. You also need to focus on the fundamental performance of the company who’s stock you own, knowing that, in time, the market will recognize the best and reward you for your patience.

4) Ignore the market noise. Today there are a ridiculous amount of media outlets competing for your attention as an investor. Most of these talking heads focus on daily price movements in various markets and try to justify why they have gone up or down. The fact is however that it’s extremely rare that daily price change will mean any long-term change in a stock’s value.

The worst thing that you can do is listen too closely to all of this noise and let it control your choices, investment wise. Let’s put it this way; a baseball player never got better by looking at statistics but instead by practicing relentlessly. As an investor the more research you do and the better you know a company whose stocks you own, the more success you’ll have.

5) Act like you own the place. Lastly, remember this one fact; if you own stock you actually are part owner of the company. If you were to buy a business, you would act like a business owner, yes? You would read and analyze financial statements, weigh the strengths and weaknesses of the business and not act impulsively about changes. If you own stocks, you need to be able to do the same thing if you want to be successful.

Let’s face it, you can certainly hire a financial advisor to help you choose your investments, but most of them sell high-priced investments on commission or charge incredibly high fees for managing your assets. If you’d like to avoid those charges and fees, below are some of the pros and cons of 4 types of investments and/or advisors so that you can make the choice yourself. Enjoy.

#1: Asset Allocation Funds

These are designed to be a type of “one-stop shop” where you can get everything from bonds and stocks to alternative investments like commodities and real estate.

The Pros: It’s easy because you simply need to pick one, set it up and then forget about it. You can choose between balanced funds, tactical funds and target date funds, all of which have slightly different investments, and different proportions of those investments.

The Cons: With an asset allocation fund, the mix of investments you get won’t be specifically tailored to your needs. The fees might also be higher since they are composed of actively managed funds rather than passively managed. Lastly, since all of the investment types, regardless of their tax efficiency, are included in an asset allocation fund, there’s no way to minimize taxes across both taxable and tax-sheltered accounts.

#2: Robo-Advisors

If you want an online program that will give you both specific and customized recommendations about investments, and manage your portfolio as well, a robo-advisor may be your best choice.

The Pros: There are a number of different Robo-Advisors available both for retirement plans and outside accounts, and they offer recommendations based on a number of factors like taxes, investments in your employer retirement account and so forth. In the very near future Charles Schwab will be introducing a new, free, robo-advisor her called Schwab Intelligent Portfolios.

The Cons: With most robo-advisors you’re going to pay a fee for the service, and also be limited by the investment options that are included in whatever program you choose. Also, it takes quite a bit of time to enter all of your information into the program at the beginning.

#3: Discount Brokerage Firms

The Pros: Ff you want to talk to someone local that can help you choose your investments, a discount brokerage firm like Fidelity, Scotttrade and Charles Schwab is a great choice.

The Cons: The help that these discount brokerage firms can give you is quite limited unless you pay an extra fee. Also, the advice and help you get can vary drastically from one representative to another.

#4: Fee Only Advisors

The Pros: If you want to avoid high asset management fees, as well as conflicts of interest, hiring a fee-only advisor is a good idea, one who charges either an annual retainer or hourly fee. They can provide a comprehensive financial plan as well as excellent investment advice and, in some cases, tax preparation services also.

The Cons: Usually, fee-only advisers are the most expensive option for handling your investments.

No matter what choice you make, what you need to focus on is that your portfolio is well diversified based on both your time-frame and your risk tolerance. You also want to keep costs under control, including taxes, fees and trading costs.

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