How to Invest in Bonds

Knowing that some portion of your asset allocation should contain bonds is fine and dandy, but the question remains, “How to invest in bonds?” When investing in bonds you should use a bond index fund and not individual bonds. A bond index fund is the same as a stock index except it tracks a specific type of bond. The exact type of bonds the index tracks depends on the index and its overall purpose. In today’s investment universe an index exist to track just about every type of bond.

Owning a bond index has many advantages over owning individual bond issues. The most important of which is probably the diversification benefit that comes with owning an index versus individual bonds. If you wanted to purchase individual bonds you would have to purchase a great multitude in order to be diversified. On the other hand a bond index holds multiple issues and is diversified and hence you will be as well. Commissions are another reason you want to stay away from individual bonds. If you purchased individual non-Treasury bonds you will most likely use a broker who will charge you a heavy commission.

Individual bonds do have some advantages going for them. If you purchase individual bonds you are guaranteed the full return of your principle at maturity. This means you will not lose money if you plan to hold the issue to maturity and the bond issuer does not default. Also, after you have purchased individual bonds you no longer have any ongoing expenses. However, these slim benefits do not outweigh the benefits of a bond index.

In order to purchase a bond index fund you have to first decide what bond index you wish to purchase. After you have decided on the particular index you should find either a mutual fund or ETF that tracks that particular index. When looking at these funds pay close attention to the fees charged. Have you decided how to invest in bonds?