Introduction
Many investors decide to have a portion of their money in bonds or bond funds, and some experts say as much as 30 percent of your money should be invested in bonds.
Why? Bonds are very liquid -- easily sold -- and can be less risky than stocks, to start. They are fixed-income investments that pay interest, which means safer and more dependable income than many other investment choices.
A bond is very similar to an I.O.U. with interest. When you buy a bond you are giving money to a government, a corporation or a municipality—and it in turn issues an “I.O.U.” for the money you provided. Until that money (called the face value of the bond) is paid back to you on a specified date, you are paid interest on it.
Here are the types of bonds you can choose from: U.S. government securities, municipal bonds, corporate bonds, mortgage and asset-backed securities, federal agency securities and foreign government bonds.
It used to be hard to find information on the Web about bonds, but that’s not so anymore.
A good place to look may be The Bond Market Association site. This site has a great deal of information on bond basics as well as free bond price information on corporates, municipals and treasurys. It also has bond news and research information, and a list of bond dealers.
Bonds Online is another good source to know—it’s run by Twenty-First Century Municipals Inc., an online information- services company based in Mercer Island, Washington. It has various news sections on the fixed income market and a bond market commentary updated everyday. Price quotes and research reports can be found there, too.
You can also go to the official site for Treasury bond information, which is the Bureau of Public Debt Online. Ever wonder what that savings bond is worth? The site has a calculator to help you figure it out and will even let you buy savings bonds online. But there’s a ton of more bond information there for you to peruse.
Also, visit the mutual fund types page to find out more about bond funds.
Municipal bonds
Interested in municipal bonds? You're not alone. While a $5,000 minimum limits "muni" bond investments to mature, wealthy individuals, there are numerous muni-bond mutual funds carrying much lower initial investments.
Internet resources for researching, pricing and buying these securities are booming. The result? A market that once resembled an invitation-only country club party is turning into one that offers the variety and accessibility of an all-you-can-eat buffet.
The $1.5 trillion-plus muni bond market doesn't necessarily allow the simple point-and-click satisfaction investors enjoy with stocks and mutual funds. Among the daunting investment considerations you'll encounter are arcane credit ratings, varying durations and yields, and sometimes-complicated tax compliance issues.
Still, many investors -- especially those in search of tax shelters -- will find that the learning process is worth the effort.
Municipal bonds have two principal qualities that make them attractive to investors: They’re free from federal and sometimes state and local taxes, and their proceeds go toward projects that benefit the public -- new roads, schools, hospitals and even sports stadiums.
Even if you rely on a finance professional for investment advice, you'll find plenty of useful background on muni bonds on the Web.
Where to start: research
Investors might begin their research on The Bond Market Association’s Web site, www.investinginbonds.com.
An investor ready to take a nibble of the market rather than a bite might consider a tax-exempt bond or money market fund, says Reno J. Martini, chief investment officer with the Bethesda, Md.-based Calvert Group. His firm manages $4.8 billion in tax-free and taxable bond funds that recently earned top billing from Barron's.
A fund manager can conduct daily credit research, keep closer tabs than busy investors on the debt market and offer a variety of bonds to maximize return and weather ups and downs. Martini, whose tax-exempt funds carry a smaller $2,000 "cover charge" to get in, says his average investor is 40 to 60 years old.
"The data we are seeing (shows) that more individuals are seeking financial help" with their investments, he says.
Convertible bonds
Convertible securities are hybrid investment instruments, the most common of which are convertible bonds and preferred stocks. As their names imply, they can be converted at the user's choice into other investments, most often shares of common stock.
As a mixed breed, convertibles share the relative safety of fixed-income investments (bonds), while also being exposed to the underlying stock's potential gains. They move in sync with the stocks into which they can be converted, yet their hybrid nature makes them less volatile.
Like fixed-income investments, convertibles pay interest and principal payments as well as dividends. If it's a bond -- essentially a loan -- the company has to pay back the money with interest. If it's a preferred stock, which blends the characteristics of a bond and common share, it pays dividends and gives the investor a leg up over common stock in making claims on a company's assets in the event of a liquidation or sale.
Why convertible bonds?
A convertible bond is superior to convertible preferred stock because it's safer and the interest is paid before any stock dividends. In addition, if the company goes under, a convertible bond holder still has priority over stockholders when it comes to settling financial claims.
Investors can make money two ways: Sell the convertible when its price goes up in the market, or convert to common stock and sell the shares.
Funds even better
Convertible securities have their place in a well-diversified portfolio, said William Harding, an analyst at Morningstar, a mutual-fund rating and information company. But the exact percentage that convertibles should take up in one's portfolio depends on personal investment goals and needs.
It's suggested that the best way for individual investors to participate in convertibles is to buy into a mutual fund. Convertibles are complex securities and information about them isn't as readily available to small investors as common stocks.
For example, when buying a convertible bond, the investor has to look at several things: The bond's interest rate and yield, how many years remain before maturity, the common stock price applicable upon conversion, how it compares to a regular bond, downside risk and possible rewards in converting to a stock.
Since a bond, whether convertible or "straight" is still a loan, the investor also has to investigate the quality of the business issuing the bond to determine whether the company can pay back what it owes. Throw in the idea that the company may choose to repay the loan before maturity and you've got more homework to do than you'd probably want.
The upshot? Researching a convertible carries an extra level of complexity because you have to investigate the dual nature of this hybrid security. So stick with mutual funds, experts say.
The risks
Bonds, whether convertible or not, are only as good as the strength of the company behind it. In the past year or so, the credit quality of convertible bonds has dropped off.
Indeed, half of the convertible market comprises issues in technology and telecommunications, both of which can be volatile sectors.
Convertible funds also tend to be more expensive than domestic stock funds because most carry loads, or sales charges.
And just because a fund invests in convertible securities doesn't mean it will always be less risky than a regular stock fund.
Look at a fund's investment policy carefully. Some managers are allowed to invest a large percentage of the fund's assets in regular stocks, and, if they are chasing performance, they most likely will have investments in technology companies.
