Stocks and bonds are two of the most popular investments nowadays aside from real estate. Financial experts and investors have their own opinions about which investment works best for certain types of investors.
When it comes to stability, in addition to a diversified portfolio, a bond is considered a conservative and safe investment. This is because a bond refers to a type of investment that’s usually issued by corporations and governments in order to raise money to capitalize their projects in exchange for agreed fixed payments.
In this article, you will learn the common investing mistakes to avoid before you decide to buy a bond.
Good-To-Know Facts About Bonds
Bonds investing involves an investor giving a loan to a company that makes its assets as their collateral, which contributes to the stability and low volatility of bonds. To better understand what a bond is, take a look at these facts:
- Return of Investment: When you buy a bond, the corporation or government entity will pay you in return for issuing them a loan. The return of investment you will get from buying a bond includes the loan’s face value, paid on the agreed date and periodic interest close payments, which is often twice a year.
- Better Than Stocks: While the stock market performs poorly and tends to have false signals, bonds provide an investor with a predictable income stream. A bond is an excellent savings vehicle if you don’t want to risk losing your hard-earned money.
- How Bonds Work: A company issued a 15-year bond amounting to USD$20,000, with a coupon rate of 7%. The investor agreed to purchase the bond under the terms that the company will pay USD$1,400 interest yearly over a 15-year period.
Now that you know what bond investing is and how it works, it’s time to learn about the common bond investing mistakes and their solutions.
Unaware of Bond Trading Levels
Many investors don’t perform in-depth research before buying bonds. What they don’t know is that all bond transactions in the country are reported to the US Financial Industry Regulatory Authority or FINRA, which they can use to their advantage.
If only investors know that the most important information they need to obtain from the bond issuers is the Committee on Uniform Security Identification Procedures or CUSIP, which is a nine-digit alphanumeric code. Once the code is entered to the FINRA portal, investors will obtain data of the bond’s trading history.
Solution:
It’s important to be aware of the price levels of bonds being offered by corporations and governments by knowing their trading history. Otherwise, you’ll miss grabbing the best bond investing opportunities. Knowing the bond trading levels will help you determine if a bond level is fair or is only being exploited by the dealer. You can even buy bonds that are too cheap but worth it with thorough research using the CUSIP code.
Too Concerned About Increasing Rates
A lot of investors tend to set their own perception of too low and too high rates. A valid investment portfolio involves allocation of capital to equities that are unappealing in a fixed income. Some investors are also reluctant to purchase bonds because they’re afraid that their portfolio price will decline.
Solution:
Don’t be too concerned about increasing rates. The bond market has proven to always have an upward slope. As compared to investing in stocks, bonds have less price volatility because of more predictable cash flows.
Getting Extra Yield
Nowadays, it’s hard to get excited about extra yields. Still, many investors want to earn extra yields, such as buying longer dated maturities and buying lower rated debts. These bond investing practices involve huge risks.
Solution:
Before even thinking of hunting yields, keep in mind that markets tend to beat up investors when they least expect it.
Profit Margin Misunderstanding
Because the bond market is usually played by institutional investors, small-sized dealers don’t really bother large institutional dealers. Small retailers, commercial retailers, wholesalers, and manufacturers have needs in varying levels to earn. While manufacturers offer a cheap price, small retailers sell for a relatively higher price. The same approach applies to bond investing. The more hands involved in the process, the higher the price.
Solutions:
- Purchase bonds when they’re first issued. Buying bonds with different prices would mean sacrificing your yield because of the markups.
- Buy bonds with a reasonable maturity date, within 10 years.
- Buy bonds from high-quality issuers, such as corporations, municipalities, and governments.
- Hire an investment advisor with excellent institutional experience to help you in handling the complexities and challenges associated with bond investing.
Conclusion
Many investors make the same mistakes when investing in bonds, such as hunting extra yields, which is too risky. Also, a lot of investors don’t study the bond market well, are unaware of the pricing levels, and are reluctant in buying more bonds. Don’t be afraid to invest in bonds because this investment is more predictable than stocks. A well-diversified investment portfolio should have a good dispersion of maturities in order to attain a steady annual cash flow.
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