Baby Bonds

Malcolm Berko
Tue, 15 Jan 2019 21:00:00 -0800
Lifestyle

Dear Mr. Berko: Every three months, I receive patent royalties. Last year, I received $3,877, $3,206, $2,135 and $3,440. I've had to buy low-paying certificates of deposit because the minimum corporate bond purchase is $5,000 and I never seem to get that much at one time. Now I have 14 different CDs paying between 1.1 percent and 2.3 percent. I know I could get 4 to 6 percent with good common stocks, but I don't want to own stocks because they are so unpredictable. I lost several thousand dollars investing in three oil master limited partnerships and two real estate investment trusts, which I was told would be safe high-income stocks. I even bought 75 shares of General Electric at $20, which was supposed to be a bargain, and now it's about $9 a share. Please tell me about corporate bonds and baby bonds. — TF, Fort Walton Beach, Fla.

Dear TF: A corporate bond is a debt obligation — like an IOU — issued by a company in thousand-dollar increments and is evidence of a debt owed to the bondholder. The borrowing company issuing the bond uses the money for various reasons — e.g., expansion, inventory purchases, equipment, acquisitions, marijuana and stock buybacks. Investors who buy bonds receive regular payments from the issuing company until the bond matures. A corporate bond has a fixed interest rate, a specific maturity date and a face value of $1,000 when issued, which is the amount that's repaid when the bond reaches its maturity. However, because few bonds trade transparently like a common stock (commission costs are embedded in a bond's purchase price), it's difficult to know how much you've enriched your broker. For small purchases — those under $25,000 — 2 to 4 percent of the maturity value is the usual fee. That's $500 to $1,000 on a $25,000 face-value bond.
Updated: Wed Jan 16, 2019

Dear Mr. Berko: Every three months, I receive patent royalties. Last year, I received $3,877, $3,206, $2,135 and $3,440. I've had to buy low-paying certificates of deposit because the minimum corporate bond purchase is $5,000 and I never seem to get that much at one time. Now I have 14 different CDs paying between 1.1 percent and 2.3 percent. I know I could get 4 to 6 percent with good common stocks, but I don't want to own stocks because they are so unpredictable. I lost several thousand dollars investing in three oil master limited partnerships and two real estate investment trusts, which I was told would be safe high-income stocks. I even bought 75 shares of General Electric at $20, which was supposed to be a bargain, and now it's about $9 a share. Please tell me about corporate bonds and baby bonds. — TF, Fort Walton Beach, Fla.

Dear TF: A corporate bond is a debt obligation — like an IOU — issued by a company in thousand-dollar increments and is evidence of a debt owed to the bondholder. The borrowing company issuing the bond uses the money for various reasons — e.g., expansion, inventory purchases, equipment, acquisitions, marijuana and stock buybacks. Investors who buy bonds receive regular payments from the issuing company until the bond matures. A corporate bond has a fixed interest rate, a specific maturity date and a face value of $1,000 when issued, which is the amount that's repaid when the bond reaches its maturity. However, because few bonds trade transparently like a common stock (commission costs are embedded in a bond's purchase price), it's difficult to know how much you've enriched your broker. For small purchases — those under $25,000 — 2 to 4 percent of the maturity value is the usual fee. That's $500 to $1,000 on a $25,000 face-value bond.

Baby bonds are usually issued by utilities, real estate investment trusts and financial firms in increments of $25 rather than $1,000. They trade like common stocks (e.g., $23.50 a share or $26.10 a share), so you could invest those small royalties in 161 shares, 217 shares, 329 shares — whatever the market price dictates. Quality bonds earn 4 to 6 percent. The commissions would cost you $4.95 at Charles Schwab. Baby bonds' fixed rates range from 3 percent to nearly 11 percent (highly speculative) and are paid quarterly until the bonds mature. And because most "babies" trade on the New York Stock Exchange, you can access prices frequently during the day if you know the ticker symbol. For example, Stanley Black & Decker's baby (SWJ) is rated BBB+. That's on the lower end of investment-grade. SWJ has a 5.75 percent coupon, trades at $24.37 (and therefore pays a dividend of about $1.40 a share) and yields 5.9 percent. This baby was issued in 2012 and is callable anytime at $25. Your most recent royalty check of $3,440 could have purchased 141 shares.

Baby bonds have higher yields, some 0.25 to 1.25 percent higher, than their companion bonds. That's because in the event of a default, payment to traditional bondholders takes precedence over payment to holders of baby bonds. It's also because most babies are called within five years after their issuance. So baby investors won't earn that higher yield for as long as they'd like. But that doesn't seem like much of a risk in an uncertain-interest-rate environment. Meanwhile, the IRS treats quarterly distributions from babies as interest income rather than dividends. Ergo, in some instances, investors would be wisely advised to keep their babies in tax-advantaged accounts. Hence, consider babies if you want to invest $3,877 or $3,206 or $2,135 or $3,440 for three to eight years and earn a righteous return. You can access a long list of babies on several websites. Quite a few have 6 to 11 percent current yields. Some trade above par, and some trade below par. Ask your broker to show you the websites, and have him select several for you.