Investors and financial advisors use the term “bond” generically to mean any sort of investment-grade debt instrument. Bonds, however, are as unique as each of the individual investors that rely on the 6th Avenue Team for financial planning and investment advice. At a basic level, bonds do have common characteristics, but this does not mean that all investors will achieve optimum benefits by selecting any bond. We believe that the preferred strategy is to utilize bonds as part of a greater investment portfolio that is designed to serve an individual investor’s wealth management needs and goals.
Bonds are negotiable instruments that represent a debt of the bond’s issuer. As with a majority of debt, the issuer promises to repay the debt plus interest according to the terms and conditions specified in the bond’s documentation.
Some types of bonds that an investor might consider:
· Municipal bonds
· U.S. Government treasury bonds
· Corporate debentures
· Real estate investment trust (REIT) bonds
All bonds have three common characteristics:
1. A face value, which represents the principal amount of the debt;
2. A maturity date, which is when the full principal balance of the debt is due and payable;
3. A coupon rate, which reflects the interest that the bond issuer agrees to pay.
The differences among investment-grade bonds are far greater than these common characteristics. Bonds issued by some government entities and blue chip corporations, for example, are perceived to carry lower default and non-payment risks than bonds issued by thinly capitalized startup companies. Lower risk bonds generally have lower coupon rates than higher risk bonds, which need to offer a higher coupon rate to attract investors.
Some bonds include conversion features that allow a holder to convert the debt into the issuer’s equity per a defined conversion formula. Debentures are a form of bonds that are secured only with an issuer’s general promise to repay principal and interest, whereas bonds are generally secured by defined assets, such as a pool of residential real estate mortgages.
How to Buy Bonds
Investment-grade bonds are generally purchased directly from an issuer or in markets that provide a platform for bond trading. The market price of an existing bond will likely vary from its face value as a function of interest rates. As interest rates go up, bond prices decrease in order to match the bond’s yield to current rates. Similarly, bond prices will go up as interest rates go down.
Bond prices will also vary as a function of the market’s assessment of the creditworthiness of the issuer. Thus, an investor will be able to buy a bond at a large discount from its face value if the market believes that the issuer is close to defaulting on its interest and principal payment obligations. Savvy investors whose investment plans can accommodate a higher level of risk may be able to realize significant gains by purchasing discounted bonds. The key to finding those bonds is to perform an analysis of the issuer’s creditworthiness, and then to determine if the market’s assessment of the issuer is at odds with that analysis.
What Separates Good Bonds from Bad Bonds?
In a vacuum, there are no good bonds or bad bonds. Rather, what makes a bond good or bad is whether it corresponds to an investor’s financial plan and wealth management goals. A high yield junk bond will be inappropriate for an investor whose plan has little room for high-risk investments. That bond may be a fit for another investor whose plan can accommodate greater risks and who is willing to accept that risk in exchange for significant potential gains.
Within this construct, the worst bond will always be the bond that an investor purchases apart from any consideration of how that bond can serve the investor’s specific needs. Even the savviest investor can succumb to general investment recommendations that have no connection to the investor’s greater financial strategy. Bonds and other investment assets which serve that strategy will always be the investor’s best option.
The financial advisors on the 6th Avenue Team at Ingalls & Snyder, LLC in Manhattan have the in-depth knowledge and experience that is required to analyze the bond market and to identify the right bond investments that match an investor’s individual wealth management plan. We look beyond the immediate market’s assessment of a bond to determine its fundamental strengths and weaknesses and its prospects for generating the cash flow and growth that serves our clients’ needs.
Please call our New York offices for answers to your questions about bond investments and to schedule an in-person appointment with one of our investment advisor representatives.
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