A bond is that scary financial thing you see headlines about sometimes but you’re like – I don’t want to click on that and read it because I’m gonna get a headache. How about clicking on the top 50 chain restaurants in the country and see which I may or may not visit? Just kidding. I’m going to try to give a brief overview of what a bond is and how to invest in one.
A bond as defined by Wall Street Journal is like an IOU companies issue to you and you’re like the bank: WSJ Link. You’re like the bank and the beauty is they have to pay you, unlike stocks which have dividends which are optional for a company to pay. Companies, cities, local governments issue bonds to raise money for different projects.
Why should I care about bonds? Because if you have an investment portfolio and it’s full of stocks, that means you’re not diversified. If you’re not diversified, you could risk losing money if the stock market crashes. According to motif investing (Motif Article), they recommend the following allocation of bonds VS stocks based on your age. Because bonds are safer it’s good to have more in your portfolio as you get older.
Buying bonds or better yet a bond fund will help you diversify your portfolio. A bond fund is like a stock mutual fund, except instead of stocks of different companies, it has bonds of different companies. You can buy many types of bond funds: from corporate companies that pay a high dividend: HYG – a corporate bond fund (more risky so pays more). Currently it pays 39 cents per month and is trading at about $87.48 per unit so if you invested $3,000 you could earn about $160 per year in dividends so it’s a high 5.3% dividend yield (.39 X 12 times paid per year / $87.48 bond unit price).
Just know that if you have a regular brokerage account, you most likely have to pay taxes on these dividends. If you invest in bonds through a retirement account than you don’t have to pay taxes until you retire and start taking money out (I’ll discuss how this works a bit more in a future post).
Or you can opt for a governmental bond fund – BIAMX – a Maryland bond fund with a four-star rating from Morningstar (less risky so pays less). Currently, it pays 5 cents per year and is trading at almost $11 per unit so with the same calculation you could earn about $13 per year in dividends so it’s a low .005% dividend yield. By the way, I’m not advertising either of these funds, rather just using them as simple examples.
Ok, so how do I buy one if I want to? Well, just like you would if you wanted to buy a mutual fund. You go to your online broker website and go to the trade button, enter the symbol, how many units you want to buy and place the order. These days the stock market is really high, so apart from diversifying your portfolio, buying a bond, for this reason, would be good too since their prices are a bit more stable. There are a lot of other types of bonds and bond funds and levels of analysis you can do to learn more about how they work and which ones to invest in. But if I got into all that, it wouldn’t be the Simple Money Man way, right? Right! 🙂