How to generate income from bonds?
In the modern economy, you’re pretty much guaranteed to have some kind of loan at some point; it’s pretty much unfeasible to have no lines of credit throughout your entire life. However — did you know that the federal government, local municipalities, and even companies do the same? And they do it by issuing bonds! Interestingly enough, you can use this to generate some income on your own. This is why we’re going to explore how to generate a passive income from bonds right here!
Bonds 101
Basically, bonds represent one of the ways that organizations are able to raise funds for their investments and other projects. If the bonds are being issued by a government — that means that the government is asking you to make a certain monetary investment. And in exchange for that initial investment, the government becomes obliged to pay you back that sum, plus interest; of course, over a previously specified time period.
So, considering this — how can you actually make money and generate income from bonds? Well, there are two ways. The first, and most obvious one, is to hold onto the bonds for the duration of the agreed-upon time period. That way, you can collect your payment (and profit) when the maturity date passes and you get your interest. Generally, this interest is paid twice each year, but that’s subject to change in specific circumstances.
However, there’s something else that you can do — namely, you can also sell these bonds at a higher price than the one you initially paid for them, thus making a profit right away.
Bond funds
There are also bond funds that you should know about. Generally, these entail gathering money from a variety of people and organizations willing to invest in bonds and then allowing a professional fund manager to handle it. In turn, the manager will proceed to assess the bond market and purchase a wide range of individual bands.
By sharing the risk and diversifying the range of bonds that you invest in, you would be making a far safer investment than going with individual bonds whose ownership you’re managing yourself.
Different kinds of bonds
If you’re going to generate income from bonds, you should learn the basics of what kind of bonds there are out there. As we’ve mentioned above, bonds can be issued by a number of different organizations — and this is what determines the specific type of bond that you’re dealing with. Considering this, you should familiarize yourself with:
- Treasury bonds
- Municipal bonds
- Corporate bonds
Treasury bonds are those that are issued by the treasury of the United States government. On the one hand, they bear no risk of default because they’re guaranteed by the government; on the other hand, they don’t yield nearly as high-interest rates as you’d get from other sources of bonds.
Next up, there are the municipal bonds — usually issued by local governmental entities, such as cities or states. They’re generally used for the funding of specific public services or projects. If a city wanted to construct a new bridge or other significant portion of the infrastructure, one of the sources of the funds could be municipal bonds.
Finally, there are the corporate bonds — the riskiest, but also those with the most attractive interest rates. Of course, the risk stems from the fact that corporations are far more likely to default on their debts than governments.
Buying bonds
Contrary to the stock market, you’ll find that the majority of bonds aren’t traded on a public market — instead, their trades are conducted “over the counter”. In other words — you will need to use a broker. This is true with the exception of treasury bonds; which are purchased from the United States government directly, and with no necessary middlemen.
The fact that bond transactions don’t happen in a centralized system means that investors don’t always have a way of knowing if they’re getting ripped off or not; there’s always the chance that a certain broker might decide to sell a specific bond above its actual face value.
On the other hand, you can also count on the FINRA (Financial Industry Regulatory Authority) to provide at least minimal oversight in bond transactions; primarily by publicly releasing transactional prices when the data is made available.
Pros and cons of bond investments
One of the biggest advantages of investing in bonds is that you’re probably conducting a safe investment; stock prices are far more volatile than bonds. Considering that, you’re creating a far more predictable source of income — with fixed interest rates that you get at certain points throughout the year.
Also, if you’re so inclined, you can choose which bonds you invest in; thus helping the local medical or school systems, while also making a profit. And if you have other kinds of financial investments, you can use bonds to successfully diversify your investment portfolio, thus reducing the level of financial risk you’re undertaking.
Conversely, there are some drawbacks of bond investments as well. For instance, you will be dealing with less cash on hand; after all, investing in bonds means locking away a portion of your money until the maturity date passes. Also, while this does not happen often in practice — there’s also the chance of your issuer could default — thus negating you any future interest payments or even the repayment of your principal.
You should also know that the bond market offers less transparency compared to the stock market — which is why there are brokers selling bonds at ridiculous premiums to unwitting investors. And lastly — the bond market may be less volatile, but it gives fewer returns than the stock market, so your focus depends on your priorities. We hope that this article was useful to you and that you’ve learned something new on how to generate income from bonds. Make sure you are staying safe in these times we are all going through and have a good one, guys!
