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How Much Money Do You Need to Invest in Individual Bonds?

Original post by Slav Fedorov of Demand Media

The amount of money you need to invest in individual bonds depends on bonds' minimum prices, as well as your risk tolerance level, tax bracket and goals. You can start with as little as $1,000 but, obviously, the more you have, the more you can do with bonds and the more flexible and secure your bond portfolio can be.

Contents

Minimum Bond Prices

U.S. Treasury securities and corporate bonds trade in $1,000 denominations; municipal bonds trade in $5,000 denominations. A U.S. Treasury zero-coupon bond can be bought for less than $1,000. You can buy U.S. Treasury securities direct from the Treasury with as little as $100, in multiples of $100.

Risk Factor

Interest on and the principal of U.S. Treasury securities is backed by the full faith and credit of the U.S. government; corporate and municipal bonds carry varying degrees of risk depending on the issuers' ability to repay. All bond prices fluctuate in the secondary market, but U.S. Treasury securities are considered virtually risk-free if you hold them to maturity. Corporate and municipal bonds can and do default. The lower a bond's credit rating, the higher the interest and the higher the risk.

Diversification

To protect against the risk of default, investors buy bonds from several issuers to diversify their bond holdings. Since all U.S. Treasury bonds are issued by the U.S. government, there is no need to diversify: one Treasury bond of any amount is as safe as 10 or 20, so a U.S. Treasury bond investor can start with as little as $100 by buying direct from the Treasury. Corporate and municipal bond investors need at least three to five high-quality bonds for minimum diversification, more if they want to buy lower-quality bonds for higher income. The more corporate or municipal bond issuers in a portfolio, the safer it is.

Tax Considerations

Corporate bonds are fully taxable; municipal bonds are free from federal, and in some instances, state income taxes. The higher an investor's tax bracket, the more he will benefit from tax-free municipal bonds.

Laddering

Laddering is buying bonds in equal denominations that mature at regular intervals. For example, an investor can buy five $1,000 bonds maturing every six months or every year, for a total of $5,000. Laddering helps alleviate the uncertainty of interest rates. Shorter-term bonds pay less interest but are more liquid, while longer-term bonds pay higher interest but the money is locked in for longer periods. An investor who wants to construct a five-year ladder with U.S. government bonds that mature every year would need to buy five bonds.


                   

Resources

References

  • "PassTrak Series 7: General Securities Representative License Exam"; Dearborn Financial Services; 2003
  • "The Wall Street Journal Guide to Understanding Money & Investing", Kenneth M. Morris, 2004

About the Author

Based in San Diego, Slav Fedorov started writing for online publications in 2007, specializing in stock trading. He has worked in financial services for more than 20 years, serving as a banker, financial planner and stockbroker. Now working as a professional trader, Fedorov is also the founder of a stock-picking company.


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