Income Builder - Some Thoughts on Buying Bonds and Working With Brokers |
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Back to Index Although it is now possible to purchase bonds from discount brokers as well as full service brokers, the process is quite different from buying stocks. Unlike stocks, bonds do not trade on a central exchange. (The NYSE, which has provided an exchange platform for trading bonds for many years, recently upgraded and expanded its capabilities, but trading volume there has plummeted, in part because it raised its trading fees sharply.) Without a central exchange, full service brokers have traditionally offered bonds to their clients out of their own inventories. They can often find other bonds through the interdealer market, but prices paid there can be high, since two brokers are looking to earn a profit from the sale. Bonds are quoted by bid and offer prices. The bid price is what a broker will pay; the offer price what it will sell. Often the prices are quoted in terms of yield. Actively traded markets, such as the one for U.S. Treasury bonds, typically operate with a very small spread of only 1/32 of a point or $0.31 per $1,000 bond between the bid and offer prices. However, some bonds trade by appointment only, so the bid-offer spreads can be quite high, sometimes a full point (equal to $10 per bond) or more. Besides the quote spread, many online brokerages charge a commission rate per bond. According to the Richelsons (See Recommended Reading) Fidelity charges $1 to $4 per bond; but some online brokers, such as Zion Direct and TD Ameritrade charge a flat fee. Most of the trading platforms available from discount brokers collect quotes from various brokers, but the offerings may be indications only and are not always firm. You won’t know whether an offering that you see online is firm until you place an order; so it is possible that your order won’t be filled at the indicated price. Hopefully, as fixed income trading volume through online brokers increases, this will be less of a problem. Nevertheless, it is probably best, especially if you are new to fixed income investing (and even if you are not) to work directly with a broker. Many of the larger discount brokerage firms have fixed income trading desks. If you are an active fixed income trader, it is likely that you will get to know their salesmen and traders. Alternatively, all of the largest brokerage firms and many of the large regional brokerages have active fixed income trading desks. Working directly with a salesman will not only bring you up the learning curve faster, it should also give you access to better investment opportunities over time. Still, you may want to work with more than one broker, if your portfolio is large enough, or you may want to use web-based price quotes and recent trade prices (from TRACE) as a check against your broker’s offerings. Since there are literally thousands of bond issues in the corporate and municipal sectors, you may not always be able to find the exact bond issue that you have targeted for purchase. For that reason, I believe that it is probably best to identify desirable bond issuers first, like General Mills, for example, on the corporate side, or the State of Massachusetts, say, on the municipal side. Once you have identified the target issuers, you should select several bonds of certain classes and maturities, like, say, senior unsecured notes with 4-7 year maturities, and also determine a minimum acceptable yield that you expect to earn on any bond purchased. With large issuers, you should be able to find several bonds that fit your investment parameters; but you should also check to make sure that the terms of those bonds, such as call provisions and covenants, are similar. So, you may want to buy the issuer’s 5.25% Senior Notes due 2011, but your broker may only be able to find (or may be able to get you a better price on) the 5.75% Senior Notes due 2013. Similarly, you may only want to buy 25 bonds (i.e. $25,000 face amount of those bonds), but the broker may be able to get you a much better deal, if you buy 32 of those bonds (because it would allow him to clear out an existing odd lot position, for example). Thus, you should have a firm grasp on your investing parameters, but have the flexibility to work with your broker to find the best deal. Such an operating strategy may help to ensure success in bond investing. This is the primary reason why it is useful to work directly with your broker’s representative. For more information about working with brokers, see the Richelson’s book, “Bonds: The Unbeaten Path to Secure Investment Growth.” Alternatively, you can see a summary of their comments on this subject in their article, “How to Buy Individual Bonds: A Fixed-Income Toolkit,” in the February 2008 issue of the AAII Journal, available to members of the American Association of Individual Investors at www.aaii.com. Back to Index _________________________________________________________________________________ Originally published February 28, 2008 Stephen P. Percoco © 2008 Lark Research, Inc. All Rights Reserved. Information is carefully compiled but not guaranteed to be free from error. Specific reference to any specific security should never be construed as a solicitation to either buy or sell. Reproduction without permission from the publisher is prohibited. |
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