Top 5 Factors to Consider When Investing in Bonds

So you’re thinking about investing in bonds? That’s a smart move, but like any other investment opportunity you should know something about the unique risks and rewards associated with bonds.

Here are the top 5 factors to consider when investing in bonds.

1. The Credit Rating of the Issuer

You’re going to buy bonds from the federal government, a municipal government, or a corporation. In any case, you want to understand the credit rating of the issuer.

Fortunately, there are companies that evaluate the creditworthiness of various issuers. Moody’s, Fitch, and Standard & Poor’s all offer credit rating services. Their ratings are available to you free of charge.

You’ll need to understand the rating system, though. The best rating is AAA. That means you can be almost certain that you’ll get your money back with interest over time. The rating drops all the way down to a C or D, often called “junk” bonds. They offer a high return, but a significant risk.

If you’re interested in purchasing savings bonds, those are bonds issued by the U.S. federal government. Since those bonds are backed by the full faith and credit of the federal government, you can be fairly certain that they’re safe.

2. Price

When bonds are initially offered on the market, they’re usually sold for $1,000 each. However, bonds are like stocks in that they can be resold to other people. It’s often the case that a bond will sell on the open market at a price different from its original price.

For example, someone can sell you a bond for $950 that he or she paid $1,000 to buy. Why would the other person do that? Well, maybe to liquidate some assets in a hurry or maybe the person doesn’t believe in the issuer’s creditworthiness any more.

3. Maturity

Every bond has a maturity date. That’s the date that you’ll receive the face value of the bond back from the issuer.

For example, if you bought a $1,000 bond from ABC Corp. with a maturity date of 12/31/2018, then you can expect to receive your $1,000 back on 12/31/18.

4. Coupon Rate

You can think of the coupon rate as the interest rate. It’s really no more complicated than that.

For example, if you have a bond that you bought for $1,000 and its coupon rate is 5%, then you can expect to receive 5% interest on that $1,000 every year until maturity. In this case, that means you’ll receive $50 per year.

5. Yield

Yield is very complicated to calculate, but it’s easy to understand. It’s basically your return on investment if you hold the bond until maturity.

It’s important to remember that yield is a function of price and coupon rate. That’s why it’s very complicated to calculate. However, it’s often calculated for you when you look at different bond offerings using your favorite online brokerage.

If you’re worried about a stock market dive, then maybe it’s time to buy bonds. However, make sure you understand bond investments before you take the plunge.