How to Buy Corporate Bonds

Your investment options are almost limitless. Unfortunately, it’s a little trickier to figure out where to stash your money because there are so many options. Determining which direction you’d like to go might require an in-depth risk and goal evaluation on your part. Here’s an avenue to consider — why not add corporate bonds to your portfolio? Learning how to buy corporate bonds can help you and your business diversify.

What are Corporate Bonds?

Corporate Bonds are debt instruments issued by companies and corporations to raise money from investors. When an investor buys a corporate bond, they lend their money to the company in exchange for a fixed rate of interest payments over a specified period of time. At the end of this period, the company repays the original amount borrowed — known as the principal — along with accrued interest payments.

Investors are attracted to corporate bonds because they tend to carry higher interest rates than other types of debt, such as government bonds. This feature can be beneficial to investors looking for a steady stream of income or those wanting to diversify their investment portfolios. Corporate bonds can provide stability and potential capital gains if the company’s credit rating improves over time. However, they are not without risk.

How to Buy Corporate Bonds: A Step-By-Step Guide

A bond is a debt obligation, or in less-fancy terms, an IOU. When you buy a bond, you lend money to the corporation that issues them. The corporation then makes a legal commitment to pay interest on the principal when the bond comes due or matures. When a bond matures, you should receive the principal plus interest on the bond.

Corporations might issue bonds to fund capital improvements, expansions, acquisitions, research and development, pay shareholder dividends or refinance debt. They are one of the largest sectors of the U.S. bond market, which also includes U.S. Treasury bonds, other types of government bonds and municipal bonds.

If you’ve read through the bond classifications, consider the nuances of risk. evaluated your risk tolerance level and understand why you’d be interested in adding corporate bonds to your portfolio, you’re ready to buy. Take just a few steps to get that accomplished.

Step 1: Set Up a Brokerage Account

You can choose to work with an online brokerage, bank, bond trader or broker to buy a corporate bond. Benzinga reviewed dozens of brokerages and narrowed down the best online brokerage to buy corporate bonds. You can review the full rankings for the best online brokerages or take a quick look at the favorites below.

Step 2: Narrow Your Bond Choices

Research sector, growth and performance and use Benzinga’s Best Bond Funds to choose the right option for you. Even if you already know how to buy corporate bonds, you need to consider your options carefully.

Step 3: Check Your Narrowed List for Bond Ratings

Use one of the two biggest ratings firms — Standard and Poor’s and Moody’s to check financial stability, debt and other risk factors. Look for bonds with letter grades that range from AAA or Aaa to BBB or Baa, which are considered investment grade. Bonds with a BB or Ba rating or below are junk bonds. Steer clear of these because they're issued by companies with liquidity problems.

Step 4: Place Your Order

You'll find bond prices quoted as a percentage of the face value of the bond. Some corporate bonds trade on the over-the-counter (OTC) market as well.

Why Should You Buy Corporate Bonds

Investing in corporate bonds has benefits for those seeking income security. Corporate bonds require repayment, offering more protection than stocks in case of financial difficulties. Bondholders receive interest payments and principal back before equity investors in liquidation. Investors have a range of choices, buying new issues or exploring the secondary market. Bond funds provide diversification, spreading risk across various bonds. This flexibility accommodates different investment amounts for investors of all sizes. Corporate bonds deliver income, safety, and versatility, making them a smart investment choice.

Risks of Buying Corporate Bonds

Investing in corporate bonds carries several significant risks that can influence an investor's decision-making process.

• Default Risk: Default risk is the chance that the company may not meet its financial obligations, leading to potential losses for investors.
• Interest Rate Risk: Changes in interest rates can impact bond prices negatively, causing existing bonds to potentially decrease in value, resulting in possible losses for investors who choose to sell before maturity.
• Inflation Rate Risk: The challenge of inflation risk is the potential decrease in purchasing power of fixed interest payments from corporate bonds, making them less attractive compared to alternative investments.
• Call Risk: Call risk occurs when a company chooses to pay off its bonds prematurely, often due to decreasing interest rates, which may lead investors to reinvest at lower yields.

These risks prompt investors to weigh corporate bonds against other investments, such as stocks or real estate. A thorough assessment of these risks is essential for determining the overall attractiveness of corporate bonds within an investment portfolio.

Bond Classification

Bonds can be classified in several different ways, including by their maturity, interest payment offerings and credit quality. Because there are so many classifications of bonds, you should not be afraid to diversify by purchasing several different types of bonds and layering them for your benefit.

Maturity

Bonds have different maturity rates, and longer-term bonds often offer higher interest rates but may contain more risk. The length of time varies, depending on the type of bond you’re considering:

Short-term Bonds

Short-term bonds mature quickly, within months to years. They are less risky than long-term bonds, appealing to conservative investors. These bonds offer predictable returns, aiding in future financial planning. Quick access to funds is a key benefit for those with imminent expenses. However, they may not be suitable for all investors. Long-term securities or equities may be better for maximizing returns over time. Investors should evaluate their goals and needs before adding short-term bonds to their portfolios.

Medium-term Bonds

Medium-term bonds have maturities of three to ten years. These bonds offer a balance between short-term and long-term investments. They provide higher returns than short-term bonds with less risk than long-term bonds. Medium-term bonds can generate steady income with reduced interest rate risk. Investors are attracted by their yields for growth and stability. To optimize returns and manage risks, investors can integrate medium-term bonds with short-term and long-term investments. One strategy is laddering bond investments by purchasing medium-term bonds at staggered maturities. This allows for liquidity and takes advantage of changing interest rates.

Long-term Bonds

Long-term bonds are debt securities with maturities over 10 years. They have risks like inflation and interest rate changes. Inflation can make future interest payments less valuable. Rising interest rates can lower existing bond values. Long-term bonds offer higher interest rates to offset these risks. If a company struggles financially, bondholders are paid before stockholders from liquidated assets. Bondholders are important for a company's financial structure. While long-term bonds can be profitable, it's important to consider the risks carefully.

Interest Payments

Several types of interest payments exist for corporate bonds, which include:

Fixed Rate

With this type of corporate bond, you receive the same payment each month until maturity. Interest payments are called coupon payments.

Floating Rate

This type of interest rate resets periodically, and they’re based on a benchmark, such as prevailing interest rates on a bond index.

Zero-Coupon

These types make no coupon payments. Instead, at maturity, the bond issuer makes a payment that is more than the purchase price.

Convertible

These are like regular fixed-rate bonds except you can convert them to shares of stock. Because of this option, your interest rate on convertible bonds will be lower.

Why Invest in Corporate Bonds?

Investing in corporate bonds can be a good option for both experienced and new investors. Corporate bonds are debt securities issued by companies. Companies use them to raise capital for various purposes, like expansion or operating expenses. Unlike stocks, corporate bonds do not represent ownership. Instead, they offer fixed income through regular interest payments. At maturity, investors receive their principal back. Corporate bonds often provide higher yields than government bonds. This makes them appealing for those wanting to increase their income. There are many types of corporate bonds available, from investment-grade to high-yield options. Investors can choose bonds that fit their risk tolerance and financial goals. Overall, corporate bonds can be an important part of a diversified investment strategy.

Higher Yields

Corporate bonds usually offer higher yields than Treasury or municipal bonds of the same maturity due to the extra credit risk investors assume. To draw in investors, companies need to provide higher coupon rates compared to government bonds, which carry minimal credit risk. The difference in yields, referred to as the "corporate bond spread," can indicate market sentiment and perceived risk in the corporate sector, providing investors with a relatively appealing income stream compared to other fixed-income choices.

Historical Long-Term Returns

Corporate bonds have generally provided solid returns over the long term. Since 2003, when coupons are reinvested, corporate bonds have surpassed the benchmark U.S. 10-year Treasury bond in cumulative returns while exhibiting comparable volatility. In shorter rolling periods of one to 15 years, corporate bonds still demonstrate better performance, indicating their potential for consistent long-term growth and stability across different economic conditions.

Diversification

Corporate bonds add diversification to an investment portfolio. They offer positive expected returns and manageable volatility. Additionally, they have a low correlation with stocks. From 2003 to now, corporate bonds have shown a 0.37 correlation with the overall U.S. stock market. This low correlation can provide meaningful diversification benefits. By incorporating corporate bonds, investors can achieve a more balanced risk profile. This may help reduce overall volatility while improving return potential.

Considerations of Corporate Bonds

Investing and corporate bonds involves several important considerations. These factors can greatly affect returns and risk exposure. Corporate bonds are loans that investors provide to corporations. They can differ significantly based on credit quality, yield, maturity, and the financial health of the issuing company. Interest rate changes, market conditions, and the broader economic climate are key to bond performance. It is also vital to understand the priority of claims if a company goes bankrupt, as this affects the bondholder's risk. Investors should assess the trade-offs between yield and risk. This evaluation can help guide decisions based on their financial goals. By examining these factors, investors can make more informed choices within the corporate bond market.

Credit Rating

Corporate bonds are divided into two categories: investment-grade and non-investment-grade. Investment-grade bonds are rated BBB or higher by Standard & Poor’s and Baa or higher by Moody’s. These bonds carry lower risk but provide more modest yields. Non-investment-grade bonds are also known as "junk" or "high-yield" bonds. They have credit ratings below BBB or Baa, indicating a higher risk of default and greater volatility. While these bonds may offer higher yields, they are also more sensitive to economic downturns, which increases their risk.

Market Risk

Corporate bonds can be subject to market risks, especially in times of economic downturns or market crises. Historical events like the 2008 Great Recession, the 2020 COVID-19 Crash, and the 2022 bond bear market have shown that significant losses in corporate bond values can occur. In these situations, the creditworthiness of the issuing companies may be assessed more closely, leading to a decline in prices and affecting the overall returns for bondholders.

Duration

Corporate bonds with longer maturities are significantly affected by changes interest rates, which is measured by "duration." As bond prices decrease when interest rates rise, longer-term corporate bonds can see larger drops. Therefore, it is important for investors to take duration into account when evaluating the interest rate situation and how it may impact their bond investments.

Callability

Some corporate bonds include a call provision, which permits the issuer to repay the bond before it matures. This can pose a challenge for investors who depend on consistent, long-term income, as companies may choose to call these bonds when interest rates fall below the bond’s coupon rate. When this happens, issuers can refinance their debt at lower rates, potentially interrupting the expected cash flows for investors who rely on these bonds for income.

Frequently Asked Questions