Individual bonds typically offer investors fixed income payments, lower costs, and a potentially higher yield than bond funds. Individual bonds provide the flexibility to customize the portfolio to address specific tax considerations and credit risk concerns. The following list comprises the most common types of individual bond:
• Treasury bonds: issued by the United States government to pay for operations and fund the national debt.
• Corporate bonds: issued by corporations, these bonds generally offer higher returns, with a greater risk than government bonds.
• Municipal bonds: debt securities issued by states, cities, counties, and other governmental entities to fund day-to-day obligations and to finance capital projects, such as building schools, highways, and sewer systems. Generally, to encourage investors to invest in municipal bonds the interest on municipal bonds is exempt from federal income tax.
• Agency bonds: security issued by a government-sponsored enterprise or by a federal government department other than the United States Treasury. Entities such as the Federal National Mortgage Association, Federal Home Loan Mortgage, Federal Farm Credit Banks Funding Corporation, and the Federal Home Loan Bank, are all issuers of agency bonds.
• Mortgage-backed securities: bonds secured by home and other real estate loans. The mortgage-backed securities pool is usually sold to a federal government agency like Finnie Mae or a government-sponsored enterprise, such as Fannie Mae or Freddie Mac, or to a securities firm to be used as the collateral for the new mortgage-backed securities. Mortgage-backed securities simply share home loans sold to investors. The bank lends to a borrower to buy a house and collects monthly payments on the loan.
Investors can buy individual bonds through a broker or directly from an issuing government entity. One of the most popular cases for buying individual bonds is the ability for investors to lock in a specific yield for a set period of time. This strategy offers stability, whereas the yield on a bond mutual fund or fixed-income exchange traded fund ETF fluctuates over time.
It’s important to keep in mind that investors who want to purchase an individual bonds must purchase them as a whole. Most bonds are issued in increments of 1,000 USD, so an investor needs to fund his account balance with at least that amount to get started. Note that while United States Treasury bonds have a face value of 1,000 USD, the minimum bid is 100 USD and they are sold in 100 USD increments. United States Treasury bonds can be purchased through a broker or directly at Treasure Direct.
Whether you’re exploring how to buy municipal bonds, corporate bonds, or treasuries, the basics of buying an individual bond remain the same. An investor can purchase any individual bonds as new issues or on the secondary market. When buying individual bonds, some investors want to manage their interest rate risk by spreading out the maturity dates for the bonds they hold. This is referred to as bond laddering. Fixed-income investors use bond ladders to provide additional flexibility when adjusting their holdings to changing market conditions.
For example, an investor might have 15,000 USD to invest in bonds. He or she could spend it all on a single bond with a 10-year maturity date, but his or her capital would be tied up for a decade. The disadvantage of this is that there may be change in markets in ten years; however, with a simple bond ladder, an investor would purchase three 5,000 USD bonds with staggered maturity dates of one year, two years, and three years, for instance.
As each bond comes to maturity, we encourage investors to reinvest the principal in bonds with the longest term they chose at the outset. With this simple bond ladder, investors would have 5,000 USD to reinvest each year. If interest rates are higher, investors gain the advantage of better yields. If they’re lower, the ladder still includes maturities locked in at higher yields. Plus, investors can stagger coupon payments to improve cash flow.