« This Week’s MoneyBlogger Podcast | Main | I Had to Upgrade my Cell Phone »
Day 7 – Investing in Bonds
By JLP | February 8, 2006
Moving right along. I’m running a little behind on this series due to the fact that I was sick this past weekend. I’m feeling much better now. I hope to be back to normal blogging tomorrow. Now, on to Investing in Bonds!
Bonds represent a loan that you make to a business or government entity. For instance, a company may need to raise a million dollars for a project. They might choose to issue one thousand 10-year bonds with a $1,000 par value and a 6% coupon in order to fund the project. After doing your research, you decide that this is a good bond so you buy 10 bonds for a total of $10,000.
For your $10,000 investment, you will receive $600 per year in income in the form of coupon payments. As long as this company stays in business and pays their bills, you are pretty much guaranteed to get your $600 each year. At the end of 10 years, you should also expect to get your $10,000 back.
Bonds really aren’t that hard to understand in a perfect interest rate environment. It’s when interest rates change that makes things confusing. For instance, using the example above, let’s say that after one year you decide that you want to do something else with your money. You need to sell your 10 bonds. How much are they worth? Well, the answer depends on what current interest rates are. If interest rates have fallen since your original purchase, then your bonds are probably worth more than $1,000 each. So, you could recieve a capital gain from selling them. However, if interest rates have gone up since your purchased your bonds, then your bonds are worth less than your original price. This brings us to this rule:
The next time you listen to a report from Wall Street and they tell you that bond prices increased during the day, then you will know that interest rates must have decreased. The reason for this is simple. Think about it. If you have a bond that is paying you 6% while every other bond is paying 4%, you will demand a higher price for your bond. The opposite is true. If you are shopping for bonds and you find a bond with a 6% coupon but interest rates are 4% everywhere else, you will have to pay more for that 6% bond. Make sense?
If you are interested in buying bonds, it is probably best to find a good bond investment advisor. Most of the big investment firms have pretty good bond trading desks. If you aren’t interested in buying individual bonds, then a good bond mutual fund from Vanguard or some other mutual fund family will work.
This is far from all there is to know about bonds. I plan on writing more about this topic in the future. For now, you might want to check out these posts from other bloggers:
Canadian Financial Stuff:
Musing Money:
FreeMoneyFinance:
Expenses, Taxes and Size Matter in Choosing Bond Funds (And Stocks too!)
Topics: Uncategorized | 2 Comments »
February 8th, 2006 at 1:18 am
[...] JLP’s new series, 24 Days of Better Finances is moving right along now that he’s feeling better from the cold. There’s quite a bit of good stuff there, each day of the series consist of a specific topic along with links to other resources. [...]
March 3rd, 2006 at 6:26 am
Yeah, bonds are ok. But the interest is often so low it’s not really worth the resources. But if you’re nearing retirement it’s probably a good idea to stock up on bonds. Good post. I like your 24 Day theme.