Want Steady Income Without the Stock Market Roller Coaster? Try This Underutilized Asset

For a relatively low-risk investment that can help you generate income, consider corporate bonds. Available through popular online brokerage firms, these fixed-income investments are offered by companies that want to raise capital and can help you diversify your portfolio. In this article, we look at different corporate bonds, why you should buy them, the associated risks, and how you can invest in them.

What Are Corporate Bonds?

A corporate bond acts like an IOU from a company. When the company wants money, it can borrow it from investors by selling corporate bonds. In exchange, the company offers investors (or bondholders) interest at regular intervals and the full balance (the principal balance) on the maturity date.

Companies issue bonds for different reasons:

• To raise capital when they want to expand their operations, launch a product or service, pay off debt, make an acquisition, or buy equipment
• To avoid share dilution and giving up control by issuing new equity
• To borrow at cheaper rates when market interest rates are low, which makes it more affordable than borrowing from a bank or other lender

Why Should You Buy Corporate Bonds?

Corporate bonds offer a steady source of predictable income in the form of interest—called coupon payments—usually every six months.

Bonds are typically less risky than other assets, including stocks. This means they are less susceptible to market volatility and swings. If the issuing company is in financial distress and goes bankrupt, bondholders get preference over stockholders. After secured creditors are paid, bondholders are next in line.

Adding corporate bonds diversifies your portfolio and spreads out the risk across different asset classes. Any losses you realize in other holdings (like your stocks) can be offset by the gains in your bonds.

Types of Corporate Bonds

Corporate bonds come in various shapes and sizes. They vary based on the type of security, the risk they carry, and the features they offer:

• Investment-grade bonds: These are high-quality and low-risk. Companies that issue them are creditworthy and unlikely to default, according to credit rating agencies. Conservative investors, such as pension funds and insurance companies, often choose investment-grade bonds for stable returns.
• High-yield bonds: Bonds with higher yields are rated lower than investment-grade bonds because they come with a higher risk of default. That’s why they’re commonly referred to as junk bonds. As the name implies, these bonds offer a higher return as long as you’re willing to overlook the higher risk.
• Secured bonds: Secured bonds are backed by specific assets owned by the issuing company. Mortgage bonds are one example of secured bonds. These bonds are relatively safe and provide investors more protection than unsecured bonds. If the company defaults, investors may have a claim to the collateral.
• Unsecured bonds: As the name implies, these bonds aren’t backed by collateral. Rather, they are simply insured by the company’s promise to repay, which means there’s no guarantee that the company will repay the debt if it goes under. Investors tend to buy these bonds because they trust the issuing companies and because they may get higher returns.
• Convertible bonds: Investors get the benefit of regular bonds, including fixed income and coupon payments, with the option to convert them into a predetermined number of common shares. Convertible bonds offer higher returns than common stock, but they’re typically lower than other bonds.

Some Risks to Consider

Corporate bonds tend to be less volatile than company stock, but they still have risks you should consider before you invest in them:

• Interest rate risk: This risk occurs when the value of your bond drops because interest rates rise. This can happen even when the issuing company is profitable. Keep in mind, though, that the inverse can happen: If rates drop, the value of your bond can increase.
• Default risk: This risk occurs if the issuing corporation has financial problems and can’t repay its debts. If the company goes bankrupt, you may get only a portion of your investment back. In some cases, you may get nothing at all.
• Inflation risk: The fixed interest from your bond starts to lose purchasing power when inflation rises. Let’s say inflation is at 4% but you’re only earning 3% from the bond, you’re losing buying power in the end.
• Liquidity risk: This is the risk that you may not be able to easily sell the bond before the maturity date if you need cash. Certain corporate bonds can be hard to sell, especially those issued by smaller companies.

How to Start Investing in Corporate Bonds 

Investing in corporate bonds is almost as easy as investing in stocks. Follow these simple steps and you’re on your way:

1. Open a brokerage account. Research the firm, including its reputation, fees, investment options, and support. Make sure it gives you access to corporate bonds and offers you a broad range of bond research tools.
2. Choose your investment approach. Will you choose bond funds or individual corporate bonds? Bond funds give you access to a basket of funds. Individual funds require time, research, and a higher minimum investment amount.
3. Do your research. If you choose funds, review their focus, fees, and performance. If you choose individual bonds, research their minimum investment requirements, ratings, coupon rates, yield-to-maturity (YTM), and maturity.
4. Decide how much you’ll invest. In some cases, you’ll have to make a minimum investment.
5. Place your order.

The Bottom Line

Corporate bonds are a great way to diversify your portfolio while earning steady income with limited risk. As with any other investment, make sure you do your research to ensure that corporate bonds align with your investment style and goals. If you’re uncertain, speak with a financial professional who can guide you in the right direction.