Bond Basics: Buying Cheap Bonds

Buying cheap bonds is one of the great joys of investing. But most people miss out on this growth and income play because they cling to the myth that bonds do not fluctuate in price.

They do! Bonds drop in value if the underlying fundamentals of the company that issues them take a hit.

Municipals drop in value if the city’s, county’s or state’s tax base or revenue base that pays the interest and principal weakens.

And all bonds will drop in value when interest rates go up, some more than others.

Buying bonds below par (less than $1,000 per bond) gives the buyer a higher interest rate than the coupon (current yield, yield/price) and capital gains (the difference between the market price and $1,000 at maturity) – often before maturity.

Nothing feels better than paying pennies on the dollar for a bond and getting double-digit yields. You got a bargain, and you’re often beating the stock market by a significant margin.

Picking Which Cheap Bonds to Buy

Buying bonds on the cheap is an art, but it’s not brain surgery.

The first step is to ignore all the fundamentals and technicals for a moment, and ask yourself this: Is this company in a death spiral, or is this just a temporary setback from which it can recover?

It’s usually best to consider only companies that you know or industries that you understand. Taking wild guesses and buying the cheapest bonds with the highest yields is almost always a mistake.

During the oil crunch a few years ago when the Saudis were manipulating the oil market, survivability was easy to answer. The market was being artificially forced down, and it was obvious the well-managed companies would be fine.

Excellent oil companies’ bonds were available at $0.15 and $0.25 on the dollar and paid 30% and 40% returns to maturity. All of the ones that I followed made it!

That’s what cheap bonds can do for you.

Looking at Key Metrics

But we aren’t always handed a market like that one. Those are rare. So it usually comes down to management and fundamentals.