THE CASE FOR LOW-COST funds, including index funds, is especially compelling when it comes to bonds. But you might do even better—by buying newly issued Treasury, municipal and corporate bonds, and then holding them to maturity.
That way, there’s typically no commission involved, you pay the same offering price as everybody else, including institutional investors, and you don’t have to worry that the dealer has marked up a bond’s price excessively. In the secondary market, where already issued bonds are traded, individuals often pay 2% or 3% more for bonds than institutional investors, and the markup (or markdown if you’re selling) could be as much as 5%. The secondary market can be an especially rough place for retail investors in municipal bonds.
To purchase new Treasury bond issues, check out TreasuryDirect.gov. Many new municipal bond issues have a so-called retail order period, which allows individuals to place orders ahead of institutional investors. One problem: Your brokerage firm may not have access to the muni issues you’re interested in. Similarly, it can be difficult to get your hands on new corporate bond issues. It may pay to work with a broker or brokerage firm that specializes in these bonds.
The biggest drawback with purchasing individual bonds is the lack of diversification. This isn’t an issue with Treasurys, where a default is highly unlikely (though it may not always seem that way amid all the political wrangling in Washington). But with munis and corporates, the risk of default is real. Unless you have huge sums to invest, you may not be able to buy enough different bond issues to protect yourself against the financial impact of one or two rotten bonds.
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