Corporate bonds are grabbing the spotlight these days as investors grow desperate for yields above rock-bottom U.S. Treasuries, which are returning just 3 percent or so annually.
We asked one reader, Karl O. Koch, to allow us to reprint his question: How does one go about buying corporate bonds?
We'll show you the ways to buy individual corporate bonds and bond funds, the pros and cons of each, and the fees to watch out for.
Retail investors can research company bonds' risk via credit ratings. The three main agencies are Standard & Poor's, Moody's, and Fitch, as well as independent credit ratings services Rapid Ratings or Egan-Jones. S&P, for instance, rates "investment grade" corporate bonds at BBB or above; below that are known as "high yield" corporates, or junk bonds.
The higher the rating, the less risk, at least in theory. But a lower rating means potentially a higher yield - since that can result in a higher cost of borrowing. Understanding the security or collateral pledged against the obligation as well as the credit quality of the underlying issuer is key.
Think of a corporate bond as an IOU, money that companies borrow from investors at a specified interest rate over a specific time period. A good place to start tracking corporate bond prices and yields is on Bloomberg's website (http://www.bloomberg.com/markets/rates-bonds/corporate-bonds/). The FINRA/Bloomberg Active U.S. Corporate Bond Indexes are comprised of the most-often-traded corporate bonds, and these indexes can help you compare returns among them.
Investing in a high-yield corporate bond fund? Then it should have returned at least 4 percent in 2011, compared with the benchmark indexes Barclays Capital High Yield and Merrill Lynch High Yield Master II, which rose in the 4 percent to 5 percent range last year.
When examining historical performance of an individual corporate bond or fund, the most important measure is "total return," not just the amount of income the bond generates. Total return measures the amount earned by owning a security over time, incorporates the accrued interest on the bond during ownership, and coupons paid out on the bond. Total return is the most complete measure of money made.
