How To Invest In Bonds: Taking Control And Avoiding The Fees

By Bill Addiss of Online Trading Academy

Friday, August 10, 2018 3:35 AM EDT

Although the bond market in the U.S. is more than twice the size of the stock market, many individuals are not familiar with investing in bonds. Those that are familiar with it often opt to invest in bond funds, but unfortunately, this usually results in incurring commission charges and ongoing annual fees that can be avoided.

With a little bit of homework and knowledge, it is VERY possible for investors to manage this portion of their portfolio and avoid the fees and lack of control. In prior articles, we have discussed different strategies for investing in bonds in today’s rising interest rate environment. Here, we will discuss some of the mechanics to investing for the individual investor.

Treasurydirect.gov

The U.S. Treasury market is the largest and most liquid of the bond markets in the world. Investors globally are attracted to it for the income and safety if affords. The US Treasury offers investments as short as 1 month to as long as 30 years. Thanks to a program entitled Treasury Direct, individual investors are afforded the opportunity to buy Treasury Bills, Notes and Bonds directly from the Treasury Department when they are newly issued. The benefits of doing so include:

NO commissions or fees
A schedule of regular offerings allowing for a variety of different maturity options
Ease: Investors can have the money automatically deducted from bank accounts to purchase the securities
Investment denominations often as low as $100
Individual investors receive the exact same price/yield as the largest institutional investors, with no additional fees or ‘mark-up’
The Federal Reserve Bank offers free custodial services (meaning they hold your securities for you), charging no fees or need for a brokerage account

It is important to note, that should the investor choose to liquidate their Treasury Securities before maturity, they must be transferred out of the Treasury Direct program, put on deposit at a broker/dealer and liquidated in the market. This could potentially incur market risk, as well as fees or commissions applied by the broker which could result in a loss. If, however, you are a traditional buy and hold investor, the securities can be kept on deposit within the Treasury Direct program, incurring no fees or expenses.

Where to buy bonds and how to manage them with low to no fees.

TIPS

The newest type of bonds the U.S. Treasury offers to investors are called TIPS (Treasury Inflation Protection Securities). These are adjustable rate bonds (unlike most bonds here in the U.S. which offer a fixed return). In the current rising interest rate environment, these securities are now particularly attractive. The Treasury Dept. issues these bonds with maturities as short as 2 years, to as long as 30 years.

The schedule of new issue TIPS can also be found on the Treasury Direct website. Additionally, like other treasury securities, TIPS can purchased via the Treasury Direct program, offering retail investors the same benefits as described above. TIPS, however, are only available in $1000 denominations.

Corporate Bonds

Investors seeking income often turn to corporate bonds. These bonds offer a bit more credit risk than Treasury bonds (because you are lending money to corporations, not the U.S. Government) However, unlike stocks, the bond market does not trade on exchanges but rather in the OTC (over-the-counter) market. This means, should investors seek to buy or sell bonds they must go through their broker/dealer.

In the past, this lack of centralization and price transparency meant that investors could not be sure they were getting a fair price. That is no longer the case. Today, individual and institutional investors alike can make sure they are getting fair prices. To explain: The Federal regulator for the U.S. corporate bond market is called FINRA (Financial Industry Regulatory Assoc.). At FINRA.org, it is now possible for investors to check and see where individual bonds are trading in the market and at what price. Through their TRACE portal, investors can also identify where bonds have traded in the marketplace as recently as 15 minutes ago! The impact of this is huge for individual investors. Now, when buying bonds directly through a broker/dealer, you the investor can go to the FINRA website, identify that bond and see where the bond has traded to assure that the price you are being offered for the bond is fair.

Municipal Bonds

Municipal bonds can be extremely attractive for many investors because they offer most individual investors tax-free income, unlike corporate bond income which is taxable. The regulatory agency for Municipal bonds here in the U.S. is the MSRB (Municipal Security Rulemaking Board). Like FINRA, they too now offer the opportunity for the individual investor to see if the bond price they are being offered by their broker is fair. At MSRB.org, investors can access RTRS (Real Time Reporting System) and identify a particular bond to see where that bond traded as recently as 15 minutes ago. This, too, is designed to give the individual investor more access to current market information.

Understanding How to Buy and Sell Bonds

As briefly mentioned above, bonds here in the U.S. do not trade on exchanges, they trade in the Over-The-Counter (OTC) market. This means there is no centralized marketplace or exchange to buy or sell bonds. Therefore I might suggest, when working with a broker to buy or sell bonds, you might consider the following:

Contact a broker you have an account with to explain your needs and get bond suggestions and prices from them.
Check the price at which they are offering the bonds to you (or willing to buy bonds from you if you are selling) using TRACE for corporate bonds, or RTRS for municipal bonds, as explained above.
If there is a disparity between the prices shown in those systems and the price you are getting from your broker, shop your business to other brokers.
Important to remember: Because of the nature of the OTC, it is almost always advisable to shop different brokers to compare prices. This is certainly a bit more time consuming but can be well worth the effort!

Also, due to the nature of the OTC market, many (if not most) broker/dealer firms maintain a daily inventory of previously issued corporate, municipal and government bonds which they willingly offer to their retail and institutional clients alike. As a potential buyer of bonds, check with your broker/dealer, but always remember to check the accuracy of their offerings using TRACE or RTRS.

As this article highlights, it is VERY possible for retail investor to buy individual bonds and reduce, if not avoid, the fees they would have to pay a money manager or fund manager. Granted, a bit more homework may be required, but for those investors seeking to take control of their investments and minimize or even avoid any fees, the opportunity is here.

Disclosure: I understand that Online Trading Academy instruction will prepare me to actively trade securities and/or other financial instruments for my own account at an appropriate financial firm which utilizes the Electronic transmissions of securities and other financial instruments orders to execute trades for its customers. I understand that this course is not preparation to be a Licensed Broker in the financial industry and will not help me get a job.

Online Trading Academy Training Program should not be construed as a recommendation or an offer to buy or sell any security or the suitability of any investment strategy for Student. The purchase, sale, or advice regarding any security, other financial instrument or system can only be performed by a licensed Industry representative; such as, but not limited to a Broker/Dealer, Introducing Broker, FCM and and/or Registered Investment Advisor. Neither Online Trading Academy nor its representatives are licensed to make such advisements. All purchasers of the Online Trading Academy Training Program or other Online Trading Academy products are encouraged to speak with a licensed representative of their choice regarding the appropriateness of investing/trading or of any particular investment/trading strategy.

Online Trading Academy training centers are independently owned and operated and each location may set its own fees for classes.

A Note About Terminology Used on our Website

As used on this Website and in our communications, the word "professional" or "Professional" is used as an adjective to describe the exceptional quality of our education and the high standards we require of our instructors and personnel in all our Centers. None of our courses will provide education to become a Licensed Broker in the financial industry, or licensing in any other profession, and no course of instruction will lead to any job, employment or professional certification.

As used on this Website and in our communications, the word "Graduate" or "graduate" means any person who has experienced our Core Strategy Courses (previously called Professional Trader Part 1 and Part 2) and any person who has experienced any other combination of classes which total at least seven full days of our trading and investing education.

We Help You Minimize Trading Risk

At Online Trading Academy, we understand the risks involved in short term trading and emphasize risk management in our classes. Enroll in one of our free seminars to find out more!

Understanding Trading Risks

Electronic active trading involves special risks and may not be suitable for everyone. Electronic active trading may also involve a high volume of trading activity. Each trade generates a commission and the total daily commission on such a high volume of trading can be considerable.

Electronic active trading accounts should be considered speculative in nature with the objective being to generate short-term profits. This activity may result in the loss of more than 100% of an investment, which is the sole responsibility of the customer. An electronic active trader should understand the operation of a margin account under various market conditions and review his or her investment objectives, financial resources and risk tolerances to determine whether margin trading is appropriate for them. The increased leverage which margin provides may heighten risk substantially, including the risk of loss in excess of 100% of an investment.

STATEMENT BY CHAIRMAN ARTHUR LEVITT SECURITIES AND EXCHANGE COMMISSION CONCERNING ON-LINE TRADING
JANUARY 27, 1999

Chairman Arthur Levitt today issued the following statement to investors:
The Internet and other new technologies are in many ways transforming how our capital markets operate. There are clear benefits to these changes including lower costs and faster access to the market for investors. I believe that investors need to remember the investment basics, and not allow the ease and speed with which they can trade to lull them either into a false sense of security or encourage them to trade too quickly or too often.

Over the last two years, particularly in recent months, the SEC has been hearing concerns about retail, on-line (Internet) investing. In fact, the number of complaints concerning on-line investing has increased 330 percent in the last year. Some of the issues raised specifically relate to on-line trading, others are generic to all investing. The majority of them can be addressed through better education and investors ensuring that they have done their homework.

Every day, more and more Americans are investing in the stock market, and many of them are doing so through the Internet. On-line brokerage accounts account for approximately 25 percent of all retail stock trades. And, the number of on-line brokerage accounts is expected to exceed 10 million by the end of the year.

While the manner in which orders are executed may be changing, the time-honored principles of evaluating a stock have not. An investor's consideration of the fundamentals of a company-net earnings, P/E ratios, the products or services offered by the company-should never lose their underlying importance.

Investing in the stock market-however you do it and however easy it may be-will always entail risk. I would be very concerned if investors allow the ease with which they can make trades to shortcut or bypass the three golden rules for all investors: (1) Know what you are buying; (2) Know the ground rules under which you buy and sell a stock or bond; and (3) Know the level of risk you are undertaking. On-line investors should remember that it is just as easy, if not more, to lose money through the click of a button as it is to make it.

In recent months, we have begun to identify a number of issues every on-line investor should be aware of. First, investors must understand the issues and limitations of on-line investing. You may occasionally experience delays on these new systems. Demand has grown so quickly that many firms are racing to keep pace with it. In the meantime, you may have trouble getting on-line or receiving timely confirmations of trade executions. You should not always expect "instantaneous" execution and reporting. There can and will be delays in electronic systems. You should investigate and understand options and alternatives to executing and confirming your orders if you encounter on-line problems.

Second, investors may sometimes be surprised at how quickly stock prices actually move. For example, many technology stocks have recently had dramatic and rapid price movements. When many investors attempt to purchase (or sell) the same stock at the same time, the price can move very quickly. Just because you see a price on your computer screen doesn't mean that you will always be able to get that price in a rapidly changing market. You should take precautions to ensure that you do not end up paying much more for a stock than you intended or can afford.

One way to do this is to use limit orders rather than market orders when submitting a trade in a "hot" stock. The result for investors that do not limit their risk can be quite surprising. Say an investor wanted to buy a stock in an IPO that was trading earlier at $9.00 and failed to specify the maximum they were willing to pay using a limit order. That investor could end up paying whatever price the stock has moved to at the time his order reaches the market -- $60, $90 or even more. If, on the other hand, the investor submitted a limit order to buy the stock at $11.00 or less, the order would only be executed if the market price had not moved past that level. Investors should understand the risk associated with trading in a rapidly moving market and make sure that they take all possible actions to control their risk.

Third, I am concerned that investors buying securities on margin may not fully understand the risks involved. In volatile markets, investors who have put up an initial margin payment for a stock may find themselves being required to provide additional cash (maintenance margin) if the price of the stock subsequently falls. If the funds are not paid in a timely manner, the brokerage firm has the right to sell the securities and charge any loss to the investor. When you buy stock on margin, you are borrowing money. And as the stock price changes, you may be required to increase the cash investment. Simply put, you should make sure that you do not over-extend.

Fourth, while new technology available to retail investors may resemble that of professional traders, retail investors should exercise caution before imitating the style of trading and risks undertaken by market professionals. For most individuals, the stock market should be used for investment not trading. Strategies such as day trading can be highly risky, and retail investors engaging in such activities should do so with funds they can afford to lose. I am very concerned when I hear of stories of student loan money, second mortgages or retirement funds being used to engage in this type of activity. Investment should be for the long-run, not for minutes or hours.

Millions of new investors have taken advantage of the unprecedented access and individual control the Internet provides. But, new opportunities present all of us with new responsibilities, challenges and risks. The SEC will do everything it can to protect and inform investors during this time of great innovation and change. But, investor protection-at its most basic and effective level-starts with the investor. I say to all investors-whether you invest on-line, on the phone, or in-person-know what you are buying, what the ground rules are, and what level of risk you are assuming.

Important Information about trading Foreign Exchange.

Trading foreign exchange is not for everyone. Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.

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