What You Should Know About Investing In Bonds
When you invest in bonds there are a number of important factors you should look at. There are some common mistakes that bond investors make, but they can be easily avoided if you take everything into consideration. To do this you need to:
know the risks associated with bonds
know how long it is until your bond matures
The most common mistake made by inexperienced bond investors is simply not understand what exactly a bond is a how they work. Something many people do not know is that bonds can be traded at a premium. This means that when a bond has matured it may actually be worth less money than you paid for it. Under most circumstances, you should not buy bonds at a premium because you will not get your principle back.
You need to go in understand the dynamic of a bond. You want to look at its yield to maturity and purchase a bond with a higher yield to maturity. Sometimes buying a bond at a premium may actually have a good yield. Do not assume that bonds being sold at a premium are bonds that people do not want and then completely avoid them. The key is looking closely at the return over the life of the bond.
Also watch out for “high yield” bonds. You want to look closely at these just as you want to look closely at any bonds being sold at a premium. High yield bonds are higher risk although the returns may potentially be higher. The risk is often too great.
Bond Investing Factors
The first thing you want to consider when you are looking at bonds is the credit quality of the company. You want the company or institution to have good credit. This substantially decreases your risk.
Secondly, look at how long you are going to be in the bond. Whenever you are investing you should have some sort of time-frame in mind. Are you a long-term investor or a short-term investor? Do you want to see returns quickly or are you planning for something farther in the future like retirement?
Third, take a look at the bond’s yield to maturity. This is your actual return on the investment. This is especially important if you are buying on a secondary market. Yield to maturity also includes equity. You want to make sure there is market for the bond if you want to sell it down the road.
Market Factors and Rates of Return
There are two market factors that affect bonds. They are different and affect two different areas of the bond market. The Federal Funds Rate is relevant to short-term bonds. Long-term and mid-term bonds are more greatly affected by the market itself. This means they are greatly affected by supply and demand, so their prices are going to fluctuate as are their rates of return, over that period of time.