How To Purchase Corporate Bonds Directly

How To Purchase Corporate Bonds Directly – My Money Blog partners with CardRatings and Credit-Land for select credit cards and may receive a commission. Any opinions expressed are solely those of the author and are not provided or endorsed by any of the companies listed.

One thing I’m interested in is on the same table you shared, corporate bonds rated BBB are about 6% for 5 years. Can you write about this? What are the pros and cons?

How To Purchase Corporate Bonds Directly

This is my thought process. Yes, we “retail” investors can also buy individual corporate bonds through major brokerages with a fixed income division like Fidelity. (Bond trading is rare in newer trading apps like Robinhood.) The bonds are rated by different rating agencies and usually separated by their rating. Right now I’m looking at a BAA3 rated corporate bond from Moody’s with 5 years to maturity and paying 6.78% interest (click to enlarge):

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However, corporate bonds are not part of my circle of knowledge. The special thing about every US Treasury bond is that they are all fully backed by the US government. Same with an FDIC-insured bank CD or NCUA-insured credit union certificate. It’s like comparing all 16 oz. JIF brand peanut butter jars; I know they are all the same so I can just buy by price.

Once you venture into the world of corporate bonds, things get much more complicated. There is a wide range of potential credit risks of the issuing company. If the business fails, you cannot get your original principal back. There is a call risk of callable bonds where the issuer can redeem your bond early (to their advantage), not to mention various other early redemption wrinkles such as “full call”, “sinking fund protection” and “special optional repayments”.

Bonds with a Baa3 and BBB rating are still technically “investment grade,” but they are only one notch above “below investment grade,” or “junk,” also known as “high yield” bonds. Here’s a quick table of bond ratings from Investopedia:

If you take a closer look at the available bonds above, you’ll see that only one bond pays more than 6.7% and it doesn’t even have an S&P rating, which means something funny might be going on. Rates are quickly moving back into the 5.XX% range.

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Do I know why one bond has to pay 6.7% interest to attract a buyer, while another only has to offer 4.8%? I have to admit I really have no idea.

Bonds are for security. Plus, I have to remember why I hold bonds. They are my security blanket. It’s my expenses for the next 10 years that are guaranteed to be there, even if bad things happen. What if Russia bombs a NATO country tomorrow? The US would be forced to go to war. China may then feel that it should support Russia. Who knows Hope for the best. Prepare for the worst.

Stocks are meant for growth and upside potential. Let’s take the bottom-ranked bond: a corporate bond from Ally Financial with a yield of 5.6% over the next 5 years. Ally Bank is familiar to me and I have been a customer for a long time. Why don’t you buy that bundle? If I were to buy that bond, the most it will ever pay me back is the bond’s face value and interest. Worst case, Ally still goes bust and I lose all or most of my investment and end up with zero. This has happened, and with much bigger companies than Ally.

Until 6 days before its final collapse, Lehman Brothers had an A investment grade rating. The final recovery on their bonds was 21 cents on the dollar.

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However, I was also able to buy shares of Ally Financial (ticker ALLY). It currently trades at just a P/E ratio of 4.72 and even pays a dividend yield of 3.54%. In five years I could be on a total return of +50% or +100% or +200%. In other words, if you want to take risk for higher returns, compete with stocks. There is constant debate about including high yield bonds in a portfolio, but I prefer to take risks with stocks and keep my bonds as safe as possible.

Consider a low-cost, diversified mutual fund or ETF. The advantage of holding riskier corporate bonds in a mutual fund/ETF is that a corporate bankruptcy does not destroy you. You can be diversified across hundreds of companies. Now you no longer have such tight control over the term, you still lose returns on management costs and you still run interest rate risk. ​​​​If you own the Vanguard Total Bond Market ETF (BND) or a Vanguard Target Retirement Fund, you already have corporate bonds in a fund.

To buy corporate bonds and wanted a stream of higher income without a reckless amount of credit risk, I would consider the Vanguard High-Yield Corporate Fund Investor Shares (VWEHX, $3k min) or Vanguard High-Yield Corporate Fund Admiral Shares (VWEAX, $50,000 min .). VWEHX has an expense ratio of 0.23% and a 30-day SEC yield of 6.71% as of 7/18/2022. VWEAX has an expense ratio of 0.13% and a 30-day SEC yield of 6.81% as of 7/18/2022.

You buy a basket of nearly 700 bonds that straddle the line between investment grade and below investment grade. This is a bond fund I would have for the income stream, not if I needed the entire amount in cash quickly, as it can drop quite a bit in times of market stress. The expense ratio of this Vanguard fund is much lower than the industry average. Just a suggestion for further research. I do not own this fund. In fact, I have no corporate bonds at all.

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Disclosure of User Generated Content: Comments and/or comments are not provided or ordered by an advertiser. Comments and/or responses have not been reviewed, approved or otherwise endorsed by an advertiser. It is not the responsibility of an advertiser to ensure that all messages and/or questions are answered. Corporate bonds offer higher returns than some other fixed income investments, but at a price in terms of added risk. Most corporate bonds are debentures, meaning they are not backed by collateral. Investors in such bonds must bear not only the interest rate risk, but also the credit risk, the chance that the issuer of the company will default on its debt obligations.

Therefore, it is important for corporate bond investors to know how to assess credit risk and potential payouts. And while rising interest rate movements can reduce the value of your bond investment, a default can nearly wipe it out. Holders of standard bonds can recover some of their principal, but it’s often pennies on the dollar.

By yield we mean yield to maturity, which is the total return resulting from all coupon payments and all profits from a “built-in” price increase. The current yield is the portion generated by coupon payments, which are usually paid twice a year, and it represents the majority of the yield generated by corporate bonds. For example, if you pay $95 for a bond with an annual coupon of $6 ($3 every six months), your current yield is about 6.32% ($6 ÷ $95).

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The built-in price appreciation that contributes to the yield to maturity is a result of the additional return the investor makes by buying the bond at a discount and then holding it until maturity to receive par value. It is also possible for a company to issue a zero-coupon bond, whose current yield is zero and whose yield to maturity is only a function of built-in price appreciation.

Investors who are primarily concerned with a predictable annual income stream look to corporate bonds, which offer yields that will always exceed government yields. Additionally, annual coupons for corporate bonds are more predictable and often higher than dividends received on common stocks.

Credit ratings published by agencies such as Moody’s, Standard and Poor’s and Fitch are designed to capture and categorize credit risks. However, institutional corporate bond investors often supplement these rating agencies with their own credit analysis. Many tools can be used to analyze and assess credit risk, but two traditional measures are interest coverage ratios and capitalization ratios.

Interest coverage ratios answer the question, “How much cash does the company generate each year to finance the annual interest on its debt?” A common interest coverage ratio is EBIT (earnings before interest and taxes) divided by annual interest expense. Of course, since a company must generate enough revenue to pay off its annual debt, this ratio must be well above 1.0—and the higher the ratio, the better.

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Capitalization ratios answer the question, “How much interest-bearing debt does the company have relative to the value of its assets?” This ratio, calculated as long-term debt divided by total assets, assesses the degree of financial leverage of the company. This is

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