Welcome to Ameritrade Plus University |
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Lessons:
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Buying bonds How and where to invest wisely If you've stuck with the lesson to this point, you are probably interested in knowing more about how to purchase bonds. Here are the main ways: Directly from the feds. U.S. Treasuries are sold by the federal government at regularly scheduled auctions. You can buy them through a bank or broker for a fee, but why pay for something you can get for nothing? The easiest and cheapest way to participate in this market is to buy them directly from the Treasury. You can check out the so-called Treasury Direct program on the Web or by calling 202-874-4000. You also can sell bonds you already own before maturity through the Treasury's newer Sell Direct program. Through a broker. With the exception of Treasuries, buying individual bonds isn't for the faint of heart. Most new bonds are issued through an investment bank, or "underwriter," rather than directly to the public. The issuer swallows the sales commission, so you get the same price big investors pay. That's why, when buying individual bonds, you should buy new issues directly from the underwriter whenever possible -- since you're getting them at wholesale. Older bonds are another matter. They are traded through brokers on the "secondary market," usually over the counter rather than on an exchange, such as the New York Stock Exchange. Here, transaction costs can be much higher than with stocks because spreads -- the difference between what a dealer paid for a bond and what he'll sell it for -- tend to be wider. You will seldom know what spread you paid, unfortunately, because the markup is set by the dealer and built into the price of the bond. There is no fixed commission schedule. One ray of sunshine: The Bond Market Association recently began posting some muni bond prices on its website. Alas, the prices include dealer markups because dealers protested listing commissions separately. Other sites that specialize in bond information include bondagent.com and munisonline.com. If you do plan to invest in individual bonds, you should probably have enough money to invest -- say $25,000 to $50,000 at a minimum -- to achieve some degree of diversification, as we'll explain below. (If you have less, consider bond funds, also described below.) Exactly how you invest it depends largely on your objective:
The biggest drawback to bond funds -- and it's a whopper -- is that they don't have a fixed maturity, so that neither your principal nor your income is guaranteed. Fund managers are constantly buying and selling bonds in their portfolios to maximize their interest income *and* capital gains. That means your interest payments will vary, as will the fund's share price. For this reason, don't choose a fund based only on its yield. Look at its total return, which combines the income the fund paid out with any change in the value of the fund's shares. Also, look for a fund with low expenses. Because bond funds with similar investment objectives tend to hold similar types of securities, which perform similarly, there are only two ways a fund manager can goose yield: cut expenses or take on more risk. If a fund's yield is more than one percentage point higher than the average for its peers and the difference can't be explained by lower fees, the manager is probably dabbling in exotica.
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