Investing in Bonds For Dummies book cover

Investing in Bonds For Dummies

By: Russell Wild Published: 10-26-2015

Change up your investment strategy. Diversify with bonds!

Stock, bonds, mutual funds—are all of these elements really necessary in your investment portfolio? Yes! Investing in Bonds For Dummies introduces you to the world of bond investment—and equips you to diversify your portfolio—through the concise and approachable presentation of the details surrounding this form of investment. This engaging text offers a clear, yet thorough take on the background of bond investment, helping you understand why it's such an important part of a well-rounded portfolio. Additionally, the book explores bond returns, risks, and the major factors that can influence the performance of bonds.

When it comes to diversifying your investment portfolio, most financial advisors recommend a strategy that mixes high- and low-risk options, allowing you to protect your investment without being too conservative. Depending upon your age, financial goals, and other key factors, the percentage of your portfolio made up of bonds may vary; however, it's safe to say that bonds will play a role in your investment strategy.

  • Understand how to buy and sell bonds and bond funds, and why it's important to do so
  • Measure the returns and risks that different bonds have to offer, preparing yourself to make educated investment decisions
  • Diversify your investment portfolio by adding bonds to the mix
  • Avoid common investment mistakes when navigating the world of bonds

Investing in Bonds For Dummies can keep your investment portfolio from getting stagnant by showcasing why diversification with bonds is essential to a successful investment strategy!

Articles From Investing in Bonds For Dummies

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32 results
32 results
Investing in Bonds For Dummies Cheat Sheet

Cheat Sheet / Updated 03-27-2016

You may think of bonds as thoroughly modern financial instruments, but they have a long history. They played an important part in helping the Allies win World War II, for example. Every bond needs to be identified, which is where its CUSIP comes in. When you reach a certain age, the government requires that you begin withdrawing at least some money from your accounts, and you need to pay close attention to this, because if you don’t cash out the minimum amount, big fines are levied.

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Bond History: The Important Story of War Bonds

Article / Updated 03-26-2016

At the heart of the fundraising effort in World War II was the creation of war bonds. Even before the United States entered World War II, a massive effort was underway to raise money to build the military and support allies in war-torn Europe and Asia. In April 1941, with great fanfare, President Franklin D. Roosevelt purchased the very first such bond from Secretary of the Treasury Henry Morgenthau, Jr. Posters, radio commercials, newspaper advertisements, and newsreels in theaters spread the word that purchasing a bond was the patriotic thing to do. The government made it easy to invest by issuing cards with slots for quarters. When a person collected 75 quarters — $18.75 — he or she could bring the card into any post office and receive a $25 bond redeemable in ten years (with no actual interest payments in the interim). That worked out to 2.9 percent annual compound interest — considerably lower than prevailing rates at the time. More than six out of ten U.S. citizens bought war bonds, raising nearly $200 billion (worth about 13 times as much in today’s dollars), and Hitler and Hirohito got what was coming to them.

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Choosing Between Active Mutual Funds and Passive (Index) Funds

Article / Updated 03-26-2016

One of the hottest debates among investors — one that will never end — is whether actively managed investments are any wiser than index fund investments. The simple answer is usually no, they are not. The vast majority of index investors do better than the vast majority of active investors. Although various studies show various results, none contradicts the basic premise that indexing works, and works very well. When you look at bond funds in particular, however, things get a bit muddled. On one hand, bond index funds are way cheaper than actively managed bond funds, just as stock index funds are cheaper than actively managed stock funds. But because bond funds tend to yield more modest returns, costs are more important. A fund made up of bonds that collectively yield 5 percent that costs 1 percent to hold suddenly yields 4 percent; that's a difference in your return of one-fifth. But there's another side to the story, explains Matthew Gelfand, PhD, CFA, CFP, managing director and senior economist with Rockefeller Financial. Despite the cost/yield equation, which Gelfand doesn't deny for a second is very important, he argues that active management of bonds can make sense — in fact, it makes very good sense, because bonds are so much more complicated than stocks. "There are many, many more bonds and kinds of bonds than there are stocks on the market," says Gelfand. "The analyst coverage is much more sparse. Although more and more trading now is through electronic markets via the web, trading is still mostly over-the-counter, so bid/ask spreads remain wider than in stock markets. All this makes for a less 'efficient' market and allows for good active managers to add real value," he says. "If you can find a reasonably priced, well-managed active bond fund, it stands a better chance of outperforming a bond index fund." There's certainly nothing wrong with passively managed (index) bond mutual funds or exchange-traded funds. They can, and often do, make excellent investments. Still, handpicking the right actively managed bond fund, if you do so smartly, can juice the returns of your fixed-income portfolio, with limited additional risk.

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How Exactly Does the Federal Reserve Move Interest Rates?

Article / Updated 03-26-2016

The U.S. Federal Reserve has three "magic" powers with which to expand or contract the money supply, or move interest rates. They are open market operations, the discount rate, and reserve requirements: Open market operations: This term means nothing more than the buying and selling of Treasury and federal agency bonds. When bonds are sold (and the public's money is funneled into government hands), the money supply is tightened, inflation tends to slow, and interest rates tend to rise. When bonds are purchased back (and the public's money is returned), the economy is given a boost and interest rates tend to fall. The discount rate: This term refers to the interest rate that commercial banks must pay for government loans. The more the banks have to pay, the more they tend to charge their customers, and interest rates tend to rise. Reserve requirements: The reserve is the amount of money that banks must hold on hand as a percentage of their outstanding loans. The higher the reserve requirements, the tougher it is for banks to lend money, and interest rates tend to rise as a result.

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Buying a Primary or Secondary Bond Issue

Article / Updated 03-26-2016

All bonds are traded through brokers. But some bonds available for sale are new or primary issues. Others are secondary issues. Yes, it's something like buying a new versus a used car — except the used bond isn't necessarily any cheaper. In fact, according to Bill Conger (a principal and senior portfolio manager with Red Hook Management in Morristown, New Jersey), bonds that are just issued, especially in the municipal-bond arena, quite often offer juicier deals. You still need to be careful and follow all the rules, but all things being equal, the odds of a broker nailing you with a ridiculously excessive markup are less in the primary market. That's because new issues are almost universally issued at the same price for all buyers, says Conger. "If the broker tried to mark up the price of the bond too much, it's doubtful that the bond issue would sell." Bottom line: Ask your favorite broker — and your favorite broker's competitors — for a listing of all new issues. Then compare and contrast the yields on the newbies versus the oldies. You may be impressed. The mechanics of buying a primary issue differ from one brokerage to the next, but generally, you can place an order at a specific price and yield. If the price goes up and the yield goes down between the time you place the order and the bond goes to market, you have the opportunity to back out of the deal. If you trade stocks, you'll recognize this situation as similar to a limit order on a stock.

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Minimum Required Distribution: Don't Miss It!

Article / Updated 03-26-2016

In the United States, people have the minimum required distribution (MRD) on 401(k) plans as well as regular and rollover IRAs. And woe is you if you miscalculate. Your finances will certainly be pummeled hard, but at least you won't be stoned. You should be happy to live in a country where people who break the law are given due process and, if found guilty of a crime, they'll neither have their limbs removed, nor will they be stoned to death. Of course, the calculation is easy — says the IRS. You simply take your retirement account's starting balance as of December 31 the prior year and divide that number by your "life-expectancy factor" (which is found in IRS publication 590, available on the IRS website). Don't get it wrong! The penalty for taking less than your minimum required distribution is brutal. If you withdraw less than the required minimum amount, the IRS can nail you for a sum equal to 50 percent of the MRD not taken. MRDs generally begin at age 70 and a half. If you feel uncomfortable doing the calculation yourself, a retirement specialist at the brokerage house where you have your account will help you, or you can ask your tax guru.

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Identifying Bonds: What Is a CUSIP, Anyway?

Article / Updated 03-26-2016

All bonds have a CUSIP that identifies the bond in the same way that a license plate identifies a vehicle. CUSIP stands for Committee on Uniform Securities Identification Procedures, which is a part of the American Bankers Association. Although it's often referred to as a CUSIP number, that is something of a misnomer because a CUSIP typically contains both letters and numbers. The first six characters of the CUSIP identify the issuer, the next two characters identify the issue itself, and the ninth digit is called a check digit, its sole purpose to make computer readers happy. Here's a CUSIP for a General Electric bond: 36966RXR2. Here's one for a Fannie Mae bond: 31396CVP2.

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What Are the Best Corporate High-Yield Funds?

Article / Updated 03-26-2016

High-yield bonds return more than other bonds, but you can lose your money in times of recession when shakier companies start to default on their loans. iShares iBoxx $ High Yield Corporate Bond Fund (HYG) Contact: 800-474-2737; iShares Type of fund: Exchange-traded fund Types of bonds: Corporate high yield Average maturity: 6 years Expense ratio: 0.50 percent Minimum investment: None This fund opened in April 2007. Its first full year in operation, 2008 (a bad year for corporate high-yield bonds), the fund lost 17.19 percent. The next year, it came back with a return of positive 28.74. This is obviously not your typical sedate bond fund. Vanguard High-Yield Corporate Fund (VWEXH) Contact: 800-662-7447; Vanguard Type of fund: Actively run mutual fund Types of bonds: Junk bonds, but not enormously junky Average maturity: 4.9 years Expense ratio: 0.23 percent Minimum investment: $3,000 This is a long-time leader in junk bond investing. Since its inception in late 1978, this fund has returned 8.7 percent, but not without some bumps in the road. In 2008, shareholders lost 21.3 percent. If you have $50,000 to invest in this fund, choose the Admiral Shares version (ticker VWEAX), which carries an expense ratio of only 0.13 percent.

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What Are the Best All-in-One Bond Funds?

Article / Updated 03-26-2016

Rather than picking and choosing, perhaps you'd like to buy up a representative sampling of the total bond market? Then consider these options. T. Rowe Price Spectrum Income (RPSIX) Contact: 800-683-5660; T. Rowe Price Type of fund: Actively managed mutual fund Types of bonds: Anything and everything in bonds, with a smattering (currently 12 percent) in stocks Average maturity: 7.6 years Expense ratio: 0.69 percent Minimum investment: $2,500 ($1,000 in an IRA) This has been an industry leader since 1990. Vanguard Total Bond Market ETF (BND) Contact: 800-662-7447; Vanguard Type of fund: Exchange-traded fund Types of bonds: All higher credit quality, both government (about two-thirds) and corporate Average maturity: 7.7 years Expense ratio: 0.08 percent Minimum investment: None Introduced to the market in April 2007, this fund brings new meaning to low-cost, well-diversified bond investing. "BND is a great core bond holding," says Ron DeLegge, host of the Index Investing syndicated radio show and publisher of ETFguide. If you prefer mutual funds to ETFs, this fund comes in mutual fund version, as well: With $3,000 or more, you can invest in the Vanguard Total Bond Market Index Fund Investor Shares (VBMFX), which carries an expense ratio of 0.20 percent; with $10,000 or more, you can invest in the Admiral Shares class (VBTLX), which carries an expense ratio of 0.08 percent, same as the ETF.

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The Risk of Being Too Conservative in Bond Investing

Article / Updated 03-26-2016

Added longevity means, all things being equal, is that it behooves you to invest a wee bit more aggressively than did your grandparents. Lifespans have increased. If you are now 65, there's better than a 50/50 chance that either you or your spouse will still be alive at age 90. If you plan to retire at age 65, that means you need a portfolio that can provide cash flow for at least 25 more years. Two and a half decades is a long time. It allows for inflation to eat up a good bit of your savings. (Consider how much gasoline, a chocolate bar, or a loaf of bread cost 25 years ago.) How aggressively should you invest? That depends on many factors and whom you ask. There is, unfortunately, no firm consensus among financial professionals. Just like the amateurs, each has a certain bias. Most financial pros have moved well beyond the old adage, held dearly for years, that the percent of your portfolio held in bonds should be equal to your age. (By age 60, you should be 60 percent in bonds; by age 70, 70 percent; and so on.) Some say that the formula is as antiquated as the crossbow — and, potentially, just as dangerous.

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