Investing in Corporate Bonds - dummies

Investing in Corporate Bonds

Oh sure, the strength of our economy and the vigor of our industry rely much on the progress of science, the foundations of democracy, and the labors of a motivated and educated workforce. But what really moves our economy and bolsters our industry, the single most driving force in capitalism, without which we’d all be living in huts and eating cold gruel, is OPM: Other People’s Money.

New businesses start every day, with the initial funding typically coming from the savings of an intrepid entrepreneur or the good graces of a supportive mom and dad. But to move a seedling of a business from the garage (where Bill Gates started) to the storefront on Main Street to the malls or industrial parks of America requires OPM. And OPM comes to a business mainly from two sources: selling shares of the business to stockholders and borrowing money from bondholders.

By becoming a corporate bondholder, you can help drive our economy and our society to new heights and spare the masses from having to eat gruel. That’s perhaps an overstatement, and possibly, it’s beside the point. Forget about society and gruel for the moment and just consider what corporate bonds can do for your personal wealth.

To put it bluntly, corporate bonds can be something of a pain in the pants, especially when compared to Treasury bonds. Here’s what you need to worry about when investing in corporate bonds:

  • The solidity of the company issuing the bond: If the company goes down (or even just limps along), you may lose some or all of your money.
  • Callability: There’s a chance that the issuing company may call in your bond and spit your money back in your face at some terribly inopportune moment (such as when prevailing interest rates have just taken a tumble).
  • Liquidity: Will someone be there to offer you a fair price if and when you need to sell? Will selling the bond require paying some broker a big, fat mark-up?
  • Economic upheaval: In tough economic times, when many companies are closing their doors (and the stocks in your portfolio are plummeting), your bonds may decide to join in the unhappy nosedive, en masse.

So why even mess with corporate bonds?

Ah . . . that is a question that some of the world’s most prominent investment experts have also asked, and they don’t all come up with the same answer. Some argue that corporate bonds are indeed worth all the hassle and doubt because the higher rates of interest they pay make them preferable to Treasuries. Others argue that the difference in interest rates between corporate bonds and Treasuries (known as the spread) isn’t worth the potential trouble of holding corporates. But when it comes to adding stability to a portfolio — the number one reason that bonds belong in your portfolio — Treasuries and investment-grade (high quality) corporate bonds are your two best choices.