Bonds are sometimes thought of as a safer investment than stocks -- and maybe even stodgy. While bond prices tend to fluctuate less than stock prices, however, bonds are not without risk. Depending on the kind of bond you buy, they can have some pretty cool features, including tax advantages and the potential for capital gains. Bonds also provide a predictable stream of current income, but if you want to get a monthly check, you'll need to get creative.
Interest represents the cost of borrowing money. When you buy a bond you become the lender, and the bond's issuer is the borrower. In exchange for using your money, the issuer agrees to pay back the face value of the bond on a specific date -- in addition to interest. How much interest is involved and when the bond will mature are determined by the bond's indenture. In most cases, bonds earn a fixed rate of interest and make interest payments twice per year, but as with most rules there are exceptions.
Some bonds offer quarterly or monthly interest payments, although this is not the norm. Other bonds, sometimes referred to as zero-coupon bonds, don't make any regular interest payments at all. They are sold at a deep discount to their face value, and you get the full amount once the bond reaches maturity. While most bonds come with a fixed coupon, or interest rate, the interest on some bonds varies. For example, the interest rate on Series I U.S. savings bonds is adjusted every six months based on changes in the inflation rate.
Creating Monthly Income
If you are looking for a way to create a steady stream of income with bonds, you'll typically need six different bonds. Look for those with similar interest rates but different payment schedules. Since most bonds pay interest twice per year, figuring out the schedule is simple. A bond that makes an interest payment in January will also pay in July. A bond that pays in February will pay again in August. By creating a portfolio of at least six bonds, each with payment schedules in different months, you'll generate a predictable stream of monthly income.
All bond investments involve some level of risk. There is the risk of default if the issuer can't make its interest or principal payments on time. There are market and liquidity risks if you need to sell your bonds before they mature. Even U.S. government bonds, which are backed by the full faith and credit of the U.S. government, are subject to the risk of loss of buying power if inflation rises rapidly.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.