I always wanted to learn more about the bond market. While the stocks are pretty straightforward, bonds always have this air of mystique around them. Yields, treasury rates, bid and ask spread, ability to avoid taxation – it seems like there’s a special little market of its own. The Naked Guide to Bonds by Michael V. Brandes provides a pretty good and straightforward explanation of how the bond market operates.
US bond market lacks the degree of transparency that US stock market has, and since there’s no New York Bond Exchange, there are certain peculiarities a bond investor should consider. Some of the bond offerings are hard to sell, as they’re generally targeted towards the buy-and-hold crowd that wants fixed income, not opportunities for trading. Nevertheless, the bonds are traded, with prices determined by interest rates and market demand. Since most of the institutions in the market operate with the budget of $1 million and above, there’s actually a separate submarket for anyone trading in the lots of fewer than 1,000 bonds (pretty much all of them are priced at $1,000 to make at least one factor comparable). Effectively you might have two separate markets with two different prices quotes for the bond – a market for institutional (above one mil) and small investor (below one mil) trading. Bad news is that smaller investors get penalized, as prices for buying and selling bonds favor large institutions.
One of the reasons you might be looking into the bond market is tax-free municipal bonds, which are exempt from federal income taxes, and exempt from the state income taxes, if the bonds you buy belong to the same state you’re in. Municipal bonds, typically with lower yields than corporate or agency bonds, typically include the buyer’s income tax bracket in calculating the total rate. The bad news is, as mentioned above, most of the municipal bonds are issued for the period of 20 years, and if you need to sell them before the deadline arrives, you might be stuck with an offer, on which you’re losing the money, since the market is not that saturated. It’s also important not to make a mistake of getting municipal bonds for an IRA account – you’re giving up high yields for no income taxes, but since IRA income is already not taxed, tax-free municipal bonds generally do not belong in retirement accounts.
The book is easy reading. Not light, but definitely straightforward if you’re paying attention to what has been described in the previous chapters. The author then discusses some strategies that might be applicable to the reader, and talks about the common pitfalls, such as chasing the yield, or having no sense of direction in the bond market. Among online resources worth checking out, InvestingInBonds is perhaps the most well-known official resource. Yahoo! Finance also runs a bonds center with basic market data and some tutorials on bond trading. Bloomberg bonds center offers some news feeds for the market. MunicipalBonds is also a great site for researching one particular subset of the bond market, providing both research and news on new offerings.