Do you buy individual bonds?

[jIM_Ohio]

Hmmm. I seem to have hit on a knowledge vacuum here. We own I-bonds also but those weren't the kind I was talking about. I meant munis or corporate bonds.

For years, I've listened to Suze Orman tell everyone to never invest in bond funds, only individual bonds. Dave Ramsey says the same thing (actually he doesn't invest in bonds at all but defnitely not bond funds). Particularly in an environment of rising rates, bond funds are more risky since you can't hold something until maturity and get a fixed rate.

When I first started investing in a bond fund, we didn't have the asset base to buy individual bonds but we do now and I'm thinking about transitioning over. I would prefer to keep the money at Vanguard. I know they sell bonds and have a slew of online resources for learning about them. I was just hoping someone could share some real life experience.

Steve, see the forest through the trees... you are onto something, there are a few things to consider. Focus on the risks, and you have your answers.

Suze Ormon has wealth most people could only imagine, just because it is wise for her does not mean it is the best path for 75-95% of America.

The risks, consider the following:
Interest rate risk- what does that mean to you?
Principal risk- what does that mean to you?
Default risk- what does that mean to you?
Liquidity risk- how does this apply to investments, rebalancing, and the securities owned?

Then apply all 4 of these to bond funds (default risk goes away, as does liquidity risk) and apply all these terms to the individual securities (interest rate risk looks different and principal risk looks different).

Is one of those more appealing to you?

[jIM_Ohio]

A couple of commission comparisons...

Scottrade has a $5000 minimum on newly listed munis and corporates and doesn't charge a "commission" but acts as principal and will markup the price (how much exactly I don't know but probably 1-3%).
On secondary corporates they charge a $35 fee + $3/bond with a $1000 minimum.

Vanguard (as I'm sure you've looked already) doesn't charge a "commission" on newly offered corporate's either but will probably mark them up as well and has a $10k minimum. They charge $2 per $1000 face amount (i.e. one bond) for "Standard and Voyager Clients" with a minimum of $1000 on corporate's and $5000 on munis. The thing to keep in mind with minimums however is sometimes minimum quantity is more like 5 bonds.

As far as how to pick them, it depends on what you're looking for. If you want to invest in "investment grade" corporate's look for anything with an S&P rating of BBB or Moody's rating of Baa3 and above. Maybe in your tax bracket it would make sense to look at some NJ munis. To find the equivalent taxable rate just the munis yield and divide it by (1-your tax rate) to get a comparison. When buying munis, there are two types...revenue and general obligation bonds. Revenue bonds pay from the revenue they receive from the project (i.e. water treatment plant, hospital, etc...) a general obligation bond is paid from tax revenue of the municipality. General obligation bonds are usually considered the safer of the two.

I'd say the most important thing to look at (besides ratings and maturity date), especially if you're planning on holding the bond to maturity, is the Yield to Maturity (YTM). That'll tell you how much you will really make annually on the bond. People tend to focus on the coupon and not take into consideration that they've may have bought the bond at a premium and if they hold it to maturity they won't get back all of what they've paid for it.

There's also Yield to Worst (YTW) which would give you the annual yield you'd get if the bond were to be called but in this rate environment I can't see many recently issued bonds being called.

Another thing to keep in mind is that there can also be a pretty substantial spread in bond prices when compared to stocks since corporate bonds usually aren't traded very often.

Bonds are purchased in $1000 increments, which will help others understand the minimums described.

The markup could be as simple as a $950 bond being sold for $970 (with the 20 point difference going to the broker).

[kv968]

Bonds are purchased in $1000 increments, which will help others understand the minimums described.

The markup could be as simple as a $950 bond being sold for $970 (with the 20 point difference going to the broker).

Thanks for the clarification. Forgot to mention that.

[scfr]

The only individual bonds I own are Treasuries, purchased through Treasury Direct. I know you said that is not the type of bond you are looking at, but one thing to keep in mind is that Series EE bonds are guaranteed to double in value if held for 20 years. That translates to 3.5% which isn't fantastic but not horrible either.

Ages & ages ago when I spent a lot of time researching the possibility of buying individual bonds of the type you are considering (which I ended up not doing), I had decided to go with the Zions Direct Bond Store. At the time I must have felt it was the best option; I do not know if they are now, but it may be one place worth at least checking. My plan at the time was to buy only initial offerings and hold to maturity, and was not interested in trading.

[humandraydel]

The "safe principal" argument is exaggerated and largely just a scare tactic. Just because you hold an individual bond to maturity doesn't mean it isn't marked down in the market. It's marked down to reflect the opportunity cost of holding the bond to maturity. By holding to maturity and getting your "principal" back, you are just exchanging the opportunity cost of higher interest rates (on newer bonds that bond funds are constantly purchasing) for the emotional attachment to your principal.

Consider a 20 year bond that you purchase today ($1000) at an interest rate of 3%. 2 years from now, interest rates are up to 5% and the market has marked your bond down to $800. That's simply because the expected return on the 2 investments is the same - paying $800 for a $1000 coupon bond at 3% or paying $800 for an $800 bond at 5%.

Note that I made the numbers up, but it illustrates the point.

[Helpmeplease]

If it is a muni bond linked to the state, then you will always have your original principal unless the state itself goes bankrupt. In a bond fund you can lose your principal.

[kv968]

If it is a muni bond linked to the state, then you will always have your original principal unless the state itself goes bankrupt. In a bond fund you can lose your principal.

Ask the people who held Detroit bonds if they're going to get all of their principal back.

[FirstTimer90]

Ask the people who held Detroit bonds if they're going to get all of their principal back.

The user above mentioned cities that are linked in a way to their states so the states will not let the bonds fail unless the state fails. So I don't think your Detroit argument holds water in this case.

[feh]

If you invest in individual bonds, tell me about it. Where do you buy them? How do you pick them? What are typical commissions and fees?

Came across this thread today and thought you might be interested:

http://www.bogleheads.org/forum/viewtopic.php?f=10&t=129370

[disneysteve]

I just read something interesting in Money magazine. There are 2 new ETFs that consist of a diversified portfolio of bonds with a defined maturity date. So you could buy shares today in a fund of bonds that all mature 3 or 5 or 6 years from now, for example. At the end date, your original investment is returned and there is an income stream between now and that date. This eliminates some of the issues with traditional bond funds. It also eliminates the difficulty of building a diversified portfolio of individual bonds on your own. Also, you can ladder maturities by investing in several different ETFs with different maturity dates. For those who are concerned about rates but don't want to be picking individual bonds, this might be the answer. Guggenheim and iShares are the ones selling this product currently.

[feh]

I just read something interesting in Money magazine. There are 2 new ETFs that consist of a diversified portfolio of bonds with a defined maturity date. So you could buy shares today in a fund of bonds that all mature 3 or 5 or 6 years from now, for example. At the end date, your original investment is returned and there is an income stream between now and that date. This eliminates some of the issues with traditional bond funds. It also eliminates the difficulty of building a diversified portfolio of individual bonds on your own. Also, you can ladder maturities by investing in several different ETFs with different maturity dates. For those who are concerned about rates but don't want to be picking individual bonds, this might be the answer. Guggenheim and iShares are the ones selling this product currently.

What's the expense ratio?

[disneysteve]

What's the expense ratio?

Looks like 0.10% for iShares and 0.24% for Guggenheim.