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Investing in corporate bonds

The riskier the company, the higher the interest rate.

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Corporate bonds come in many shapes and sizes and can act as a diversifying asset in your portfolio — but some bonds are safer than others. Review the bond rating and company history before making a purchase.

What are corporate bonds?

A corporate bond is a debt obligation issued by a company and sold to an investor. A bond acts as a type of loan: the investor funds the bond and the company uses the capital as it sees fit. In exchange for funding the bond, the investor receives regular interest payments until the bond matures, at which time the principal is repaid in full.

Corporate bonds start at $1,000 and increase in value in minimum denominations of $1,000. This is called the face or par value of the bond. Terms can vary widely, from short-term bonds lasting three years or less to medium- and long-term bonds lasting upwards of 10 years.

Interest rates may be fixed — which means the amount of interest you receive over the life of the bond remains unchanged — or floating, which means the bond’s interest rate may periodically reset in response to market interest rates.

How do they work?

Before a corporate bond is issued, it’s reviewed by a US rating agency and assigned a rating based on the issuing company’s creditworthiness. The higher the rating, the safer the bond, but bonds with higher ratings tend to offer less competitive interest rates.

Once a bond has been reviewed, the corporate entity issuing the bond typically uses an investment bank to underwrite the bond. When this process is complete, the bond can be marketed to and purchased by public investors.

After an investor purchases and funds a bond, they receive regularly scheduled interest payments to their brokerage account until the bond’s maturity date, at which time the bond is repaid in full.

A bond may be repaid ahead of schedule if it carries a call provision that allows for early payment. Investors may also sell a bond before it matures, but won’t receive the face value of the bond. What you receive for selling a bond ahead of its maturity date depends on the number of payments left on the bond.

How are corporate bonds rated?

Corporate bonds are reviewed by at least one of the following US rating agencies: Standard & Poor’s Global Ratings, Moody’s Investor Services or Fitch Ratings. After it’s reviewed, a bond is issued a rating based on its creditworthiness from “AAA” — the most creditworthy with the least risk — to “C” or “D,” also called junk bonds, which are the least creditworthy with the highest risk.

Bonds with higher ratings are less likely to default, but carry lower interest rates. Junk bonds, on the other hand, compensate investors for greater risk with more attractive interest rates.

Moody’sStandard & Poor’sFitchGradeRisk
AaaAAAAAAInvestmentLowest
AaAAAAInvestmentLow
AAAInvestmentLow
BaaBBBBBBInvestmentMedium
Ba, BBB, BBB, BJunkHigh
Caa/CaCCC/CC/CCCC/CC/CJunkHighest
CDDJunkIn default

Benefits and risks of corporate bonds

Corporate bonds are a viable portfolio addition for all kinds of investors. Consider the following benefits and risks before you invest.

Benefits

  • Ratings. Corporate bonds are reviewed and rated for their creditworthiness so investors can better gauge their investment risks before making a purchase.
  • Reduced volatility. Unlike the value of stocks, which can fluctuate wildly, corporate bonds are considered a more stable investment.
  • Accessible. You can invest in a corporate bond simply by holding a self-directed brokerage account with a platform that offers access to the bond market.
  • Consistent income. Like dividends, bond interest payments can act as a form of consistent income for your portfolio.

Risks

  • Default. Even bonds with strong ratings may fail — there’s no guarantee you’ll receive a return on your investment. And if your bond goes into default, you may lose your principal entirely.
  • Market risk. The longer a bond’s term, the greater its market risk: the risk that the bond’s value will be negatively affected by shifting market interest rates.
  • Inflation. Rising rates of inflation may reduce the purchasing power of a bond’s interest and principal.
  • Call risk. If the bond you purchase has a call provision, the company may be able to pay off the bond before it matures, robbing you of the potential capital you would have earned had the bond stayed in your portfolio.

How to invest in corporate bonds

Interested in a bond investment? To start, you’ll need a self-directed brokerage account. Here’s what to expect of the process:

  1. Compare platforms. When comparing online brokerages, make sure the one you select offers access to the bond market and can cater to your level of trading experience.
  2. Open an account. To open a self-directed brokerage account with an online broker, you’ll need to fill out an application and fund the account with an external transfer from an existing bank account.
  3. Find a bond. Many online platforms are equipped with a stock screener: a research tool that can help you filter your bond options. You can also explore third-party stock screeners equipped to analyze bonds, like those offered by Finviz and Yahoo Finance.
  4. Submit your order. Once you’ve found a bond you want to purchase, submit the order through your brokerage account.
  5. Monitor your investment. Log in to your account to track your investment.

Compare bond brokers

To invest in corporate bonds, you’ll need a brokerage that offers access to the bond market. Review your options below.

Name Product Annual fee Government bond trade fee Corporate bond trade fee
Worthy
0%
$0
$0
Earn a 5% fixed return on bonds that support American small businesses.
TradeStation
$14.95
A platform built for all kinds of traders and all styles of trading
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Compare up to 4 providers

How much do corporate bonds pay?

Interest rates on corporate bonds vary by the creditworthiness of the bond and its issuing company. Bonds with a higher credit rating tend to have interest rates between 2% and 4%. High-yield junk bonds, on the other hand, may have interest rates as high as 6% to 8%.

Are corporate bonds taxed?

You may encounter any of the following forms of taxation when buying and selling corporate bonds:

  1. Interest. Any interest you earn on a corporate bond is subject to both federal and state income tax.
  2. Capital gains. Any income you earn from the sale of a bond prior to its maturity date is subject to capital gains tax.
  3. Issue discount. While less common than taxes on interest and capital gains, you may also be taxed when purchasing a bond priced below the par value. This is called an issue discount and is subject to taxation.

Types of corporate bonds

There are many options for investors interested in adding corporate bonds to their portfolio:

  • Investment-grade. Any corporate bond with a rating of “BBB” and above is considered an investment-grade bond and has a lower risk of default.
  • High-yield. Also known as non-investment grade or junk bonds, these are bonds that receive a lower rating but typically offer higher interest rates.
  • Convertible. Convertible bonds can be exchanged for stock of the issuing company.
  • Zero-coupon. This bond doesn’t pay interest over the term of the bond but is offered at a discounted rate. Investors purchase the bond and receive a single payment at maturity, typically including interest.
  • Callable and puttable. These bonds carry call and put options, where either the issuing company or the investor has the right to buy or sell the bond before a set date prior to the bond’s maturity.
  • Step-up and step-down. Interest on these bonds is fixed up until the bond’s call date, at which time the rate may rise or drop depending on whether the bond is called.
  • Fixed-rate coupons. These are corporate bonds with fixed interest rates.
  • Floating-rate. These corporate bonds have an interest rate that changes based on how other market benchmarks perform, like six-month treasury yields or commodity prices.
  • Variable-rate. The interest rate of these bonds is typically tied to a long-term interest rate benchmark and resets on an annual basis.
Disclaimer: The value of any investment can go up or down depending on news, trends and market conditions. We are not investment advisers, so do your own due diligence to understand the risks before you invest.

Bottom line

Corporate bonds offer consistent income from ongoing interest payments and are less volatile than stocks. But no bond is risk-free and some are safer than others. Explore your brokerage account options across multiple trading platforms to find the account that best fits your needs.

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