As I mentioned in a few of my previous posts, one of the things I eventually want to start investing in is municipal bonds. Municipal bonds have been a good alternative to stocks historically, however as a new investor buying an individual bond can seem complicated. Today we are going to cover buying a bond on E-Trade, and show you how you can determine how much you are going to be paying up front and how much you will receive while you own the bond. With interest rates as low as they are right now bonds aren’t really paying that much, which is why many people are saying that there is no alternative to buying stocks right now.
To start looking at municipal bonds in E-Trade you will want to go to Trading > Bonds & CDs and then hit the municipals tab. Once you do that you should be greeted with a screen like this:
In this case you can see I entered 9m for the max maturity. This basically means I just want to see bonds that are going to mature within the next 9 months. You could also enter 1 here to see bonds that are going to mature within a year or a 2 to see bonds that are going to mature within 2 years. After that just hit the find bonds button and you should be taken to another screen:
As you can see it says we have approximately 11 results even though there are only 5 results displayed. E-Trade’s interface can act funny sometimes and this is one of them. Anyway, looking at the first result we can see it pays a 5.25 coupon, has a price of 102.468, a minimum quantity of 30 and the maturity date is 8/1/2021. Let’s look at the first Bond and hit the buy button on the right. Don’t worry clicking this button isn’t going to buy the bond immediately it’s just going to take you to another screen:
The one thing I want to point out on this screen is the Bond Price/Yield Calculator on the bottom left. This is actually one of my favorite things about E-Trade since it makes it very easy to understand what your cost and proceeds are going to be. After clicking that a new window will open that looks like this:
The minimum quantity for this bond was 30, but let’s see what would happen if we were able to just buy 1. To do this you just need to leave the radio button towards the left on price and then enter the green price from the previous screen (sometimes you may see a red price on that screen too but we are just going to ignore that since it’s beyond the scope of this tutorial) and then enter 1 for the quantity in the field to the right of that. Once you are done hit calculate and you should see the results on the right. In this case the amount is the price multiplied by 10. Then there’s the commission that E-Trade charges you for this which is $10. After that we have the accrued interest which you will also need to pay. Investopedia has a good article on what this is and the ‘Example of Accrued Interest on a Bond’ on the bottom of the article does a great job of explaining how this amount is calculated. Your total cost for this transaction is going to be the sum of these 3 items which E-Trade shows as the total order and comes out to $1034.97. We can see how much money we are going to get on the bottom right of the screen. In this case we are getting one coupon payment plus the principal back. The coupon was 5.25 and paid semi-annually (most coupons are semi-annual) and to calculate that amount we would take the coupon amount (5.25), divide it by 2 (since it’s a semi-annual coupon), and then multiply it by 10 (since we multiplied the price by 10 earlier):
(5.25 / 2) * 10 = 26.25
The redemption value for this bond is 100 (most bond redemption values are 100) so we would also multiply that by 10 to get 1000. Then add up the total coupon payments and the redemption value to get the total amount of money we would get from this transaction. In this case you can see that with the fee E-Trade charges we would actually LOSE $8.72. Not a very good deal. To be fair if we went with the minimum quantity and increased the quantity to 30 we would end up making a little over $8 so at least we wouldn’t be losing money. But does loaning someone $30k to get back $8 seem like a good idea? As we can see with interest rates as low as they are bonds really aren’t paying that much right now and this is why many people have said there is currently no alternative to stocks. Just for fun let’s look at a high yield corporate bond to see if we can do any better.
Corporate bonds are different from municipal bonds because you have to pay taxes on the interest payments you get. You usually get higher interest rates with high yield corporate bonds, but this is because the credit rating for the company that issued the bond is lower and there is a greater risk that they may not be able to pay you back. U.S. News & World Report has an article on their site that you can review if you want to learn more about bond credit ratings. Now that we’ve covered credit ratings, let’s take a look at a high yield corporate bond:
As you can see in this example the lowest rating I want to consider is Moody’s Ba3 and I also decided to exclude callable bonds from my search. After that just hit find bonds and you will be taken to the next screen:
In this case we got 3 results back. E-Trade also managed to get the number in the upper left part of the screen right this time. Yay E-Trade. Let’s take a look at the bond in the middle with a price of $101.625 and hit the buy button:
This bond had a minimum quantity so as you can see after we update the price and quantity fields and hit calculate we can see we would make a little more money ($49.17) on this one. This still seems like a waste of time and money to me but at least it’s better than 8 bucks.
That sums up my intro to buying individual bonds. They aren’t paying much these days, but they may make a comeback at some point. I used E-Trade as an example in this post, but you should be able to apply the calculation method we covered with any online trading broker.