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How to Invest in Bonds

By David Luhman on Mon, 05/11/2009 - 23:19

How to Invest in Bonds

Investing through bond mutual funds

Buying your own bonds

Investing through bond mutual funds

For most people, investing in bonds through bond mutual funds is probably the best way to go

By investing in a bond mutual fund you get

  • Professional management to manage difficult issues like call risk and credit risk
  • Cost advantages that come with volume buying through the fund
  • Wide diversification and reduced risk
    • Not so important when investing in US Treasury bonds
    • Very important when investing in junk bonds

Especially when it comes to bond investing, invest in funds that have low expenses

Bond fund name Yield on US Treasuries Expenses After-expense yield
Thrifty US Treasury bond fund 6.5% 0.3% 6.2%
Expensive US Treasury bond fund 6.5 1.5 5.0

US Treasury bonds and high-grade corporate bonds are almost like commodities

It's very difficult for an expensive manager to add value to these commodity products

Remember that bond mutual funds will complicate your taxes relative to bank certificates of deposits if you don't use a retirement account

Buying your own bonds

Probably should avoid buying individual bonds unless you have a fair amount to invest

Perhaps $100,000 required to build a diversified portfolio

The one exception is investing in US Treasury bonds

  • Can buy directly from the Treasury for very little cost
  • US Treasury bonds face almost no credit risk

But don't buy US EE Savings Bonds

  • Offer low interest rates
  • You can lose up to six months in interest if you redeem them at the wrong time
  • Savings bonds offer minor tax advantages, but these come with strings attached

You also might want to avoid bond funds for double-exempt municipal bonds

Unless you live in a large state, most double-exempt bond funds available to you are expensive in terms of loads

Still, probably need $100,000 to invest

Try to buy original issues to get the best yield possible

You'll usually not get a great deal if you buy or sell a municipal bond in the secondary markets

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