How to Buy Bonds: A 3-Step Guide

January 9, 2024 Collin Martin Beginner
Shopping for bonds? The bonds you choose should align with your risk tolerance and goals. Discover what to consider before buying any bond.

Wondering how to buy bonds? The bonds you choose (and in which proportions) will depend largely on your risk tolerance and goals. And you'll want to shop around since each broker often charges their own fees on top of the bond's price. Here are three steps to consider before buying bonds.

1. Determine your risk tolerance

Knowing what type of investor you are can help you determine how much of your total portfolio to allocate to bonds. While each individual investor's goals and objectives should determine the actual allocations, the percentages shown below should serve as a good starting point when considering how to invest in the bond market.

  • Conservative investors seek current income and stability while being less concerned with growth: 50% bond allocation
  • Moderately conservative investors seek current income and stability with only a modest need for portfolio growth: 50% bond allocation
  • Moderate investors seek long-term growth but want less volatility than the overall stock market: 35% bond allocation
  • Moderately aggressive investors seek long-term growth and can handle a fair amount of volatility: 15% bond allocation
  • Aggressive investors seek long-term growth and are comfortable with high volatility in exchange for potentially higher returns: 0% bond allocation

2. Consider your goals

Once you decide on your bond allocation, think about your strategy behind investing in them. Your goals will play a key role in the types of bonds to include in your portfolio. (For reference, bonds with terms of less than four years are considered short-term; bonds with terms of 4 to 10 years are considered intermediate-term; and bonds with terms of more than 10 years are considered long-term.)

If your goal is to protect investment principal from losses, consider:

  • Short-term U.S. Treasury bonds
  • Short-term investment-grade corporate bonds
  • Short-term investment-grade municipal bonds

If your goal is to diversify your portfolio and add income, consider:

  • Short- and intermediate-term U.S. Treasury bonds
  • Short- and intermediate-term agency bonds
  • Short- and intermediate-term international developed-market bonds
  • Short- and intermediate-term investment-grade corporate bonds
  • Short- and intermediate-term investment-grade municipal bonds
  • Mortgage-backed securities

If your goal is to maximize interest income, consider:

  • Long-term Treasury bonds
  • Long-term corporate bonds
  • Long-term municipal bonds
  • Preferred securities
  • Emerging-market bonds

If your goal is to minimize taxes, consider:

  • U.S. Treasury bonds
  • Municipal bonds

3. Shop for the best prices

Finally, don't hesitate to comparison shop for bonds. "Many investors simply don't realize different firms charge different prices for the exact same bond," says Kathy Jones, managing director and chief fixed income strategist at the Schwab Center for Financial Research.

Bonds don't trade on centralized markets like stocks, which makes their true cost difficult—if not impossible—to ascertain. Instead, most are purchased "over the counter" through a brokerage firm that buys the bond on your behalf. The firm then tacks on a fee, or markup, that can range from a fraction of a percent to several percentage points, depending on factors such as bond liquidity and the firm executing the trade.

"Too many brokerages not only charge far too much but also conceal such costs from investors," Kathy says. So before you buy your next bond, ask yourself these important questions:

  • What's the market price?
    This will reflect the actual price it costs your broker to buy a bond from another dealer (which may include fees paid to the dealer).
  • What's the markup?
    A markup refers to the difference between the market price of a bond and the price a broker-dealer charges to sell it. A markup is generally wrapped into the price—and may or may not be disclosed.
  • Are there additional fees?
    In addition to markup, brokers may charge miscellaneous fees to cover administrative services, clearing fees, overhead, etc.—which they may or may not be required to disclose.
  • What's the accrued interest?
    When you buy a bond between coupon payment dates, you'll owe the seller any accrued interest since the last payment date. This cost has nothing to do with your broker but does factor into the total cost.​​​​​​​
  • What's the overall cost?
    This will include all of the above: the market price plus any markup, additional fees, and accrued interest.

"Be wary of firms that fail to give you direct answers about their fees," Kathy advises. "They're probably being opaque for a reason." 

Even seemingly small differences in markups can mean giving up hundreds, if not thousands, of dollars in total returns over time. It pays to shop around.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Mortgage-backed securities (MBS) may be more sensitive to interest rate changes than other fixed income investments. They are subject to extension risk, where borrowers extend the duration of their mortgages as interest rates rise, and prepayment risk, where borrowers pay off their mortgages earlier as interest rates fall. These risks may reduce returns.

Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security's tax-exempt status (federal and in-state) is obtained from third parties, and Charles Schwab & Co., Inc. does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

Preferred securities are a type of hybrid investment that share characteristics of both stock and bonds. They are often callable, meaning the issuing company may redeem the security at a certain price after a certain date. Such call features, and the timing of a call, may affect the security's yield. Preferred securities generally have lower credit ratings and a lower claim to assets than the issuer's individual bonds. Like bonds, prices of preferred securities tend to move inversely with interest rates, so their prices may fall during periods of rising interest rates. Investment value will fluctuate, and preferred securities, when sold before maturity, may be worth more or less than original cost. Preferred securities are subject to various other risks including changes in interest rates and credit quality, default risks, market valuations, liquidity, prepayments, early redemption, deferral risk, corporate events, tax ramifications, and other factors.

In the bond market, there is no centralized exchange or quotation service for most fixed income securities. Prices in the secondary market generally reflect activity by market participants or dealers linked to various trading systems. Bonds available through Schwab may be available through other dealers at superior or inferior prices compared to those available at Schwab. All prices are subject to change without prior notice.

Schwab reserves the right to act as principal on any fixed income transaction. When Schwab acts as principal in a secondary market transaction, the bond price includes our transaction fee (as outlined in the Charles Schwab Pricing Guide), and may also include a markup that reflects the bid-ask spread and is not subject to a minimum or maximum. When trading as principal, Schwab may also be holding the security in its own account prior to selling it to you and, therefore, may make (or lose) money depending on whether the price of the security has risen or fallen while Schwab has held it. When Schwab acts as agent, a commission will be charged on the transaction.

The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager) to help answer questions about specific situations or needs prior to taking any action based upon this information.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.