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Buying and Selling Municipal, Junk and Treasury Bonds

By: , dated January 25th, 2013

When purchasing bonds for your portfolio, it is important to understand your goals. These goals and your time horizon will affect the best type of bonds for you. If you are looking for capital appreciation, your best bet is to go with bonds with long-term maturities. These bonds tend to be more sensitive to interest rate fluctuations and therefore will provide greater appreciation if interest rates decrease (of course, they will also lose more if rates increase). They also usually have higher yields than short-term bonds. Alternatively, if you are looking for a more stable investment, shorter maturities will lead to decreased volatility.

For investors in a high federal tax bracket, municipal bonds provide some tax relief. Even though these bonds usually provide smaller returns than taxable bonds, investors in high tax brackets often will have higher after-tax returns. If you have a long time horizon and are willing to trade risk in exchange for higher returns, junk bonds (corporate bonds from companies with the highest likelihood of defaulting) can reward you for taking on the added risk. At the other extreme, Treasury bonds are highly liquid, federally-guaranteed investments for people with little risk tolerance.In order to include bonds in your portfolio, you’ll need to know how to trade them. Bond trading most often takes place through a full-service or discount broker. Therefore, it is accompanied by fees and commissions. The notable exceptions to this generalization are Treasury securities which can be purchased directly from the government without incurring any fees. The transaction costs for other bonds will be proportional to the ease with which they can be bought and sold (also known as their liquidity). Fees and commissions will obviously be higher for bonds that are more difficult to sell. New bonds can be purchased from the underwriter at wholesale prices, but older bonds will come with the higher transaction costs and less favorable spreads that are characteristic of the secondary market.

Instead of buying and selling individual bonds, it is also possible to invest in mutual funds that hold positions in a large number of bonds, increasing diversity and reducing the risk that accompanies owning bonds from only one company or institution. Mutual funds also eliminate problems with limited secondary markets by allowing investors to buy and sell at any time. There is no maturity date for mutual funds (since they continuously buy and sell bonds of different maturities), so some of the considerations involved with risk and time horizons differ from those associated with individual bonds. Funds may also be more accessible for some investors who cannot meet the minimum investments for some fixed-income securities.

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