A zero coupon bond is an investment instrument that does not pay interest throughout the life of the bond, but accrue interest during the life of the bond, and reinvest it at the same interest rate. The principal and interest are payed out to the investor upon the bonds maturity date.
Zero coupon bonds are regarded as a more conservative investment that other asset classes such as stocks if you hold onto them until they mature, although they do not come without risk. These types of bonds are purchased at a deep discount which is much less than their face value at maturity.
It is important to understand how these bonds work, to carefully consider your time frame for investing, and your unique investment objectives prior to committing any capital. Online brokerage ETrade offers their Bond Center to help you with how to buy zero coupon bonds, including education, research, and purchasing.
How To Buy Zero Coupon Bonds
While these bonds are not 100% risk-free, buying zero coupon bonds is a considerably less risky alternative to investing in stocks or other assets. These types of securities are more predictable than other investments, as if you are able to hold onto your bond until it matures, you will receive a lump-sum payment.
Zero coupon bonds should be seen as a long-term investment, and your risk can be reduced by keeping these bonds until they mature. Zero coupon bonds are excellent investment for long-term goals such as a child’s education, or the purchase of a new home.
How to buy zero coupon bonds. You can postpone paying federal taxes on income from your bonds by buying zero coupon bonds through your retirement account. The interest on this type of bond is charged in the current tax year, although you do not receive it in the same year as the interest is reinvested. By purchasing a zero coupon bond through your retirement fund, you do not have to pay taxes on the profits until you reach retirement.
How To Buy Zero Coupon Bonds: Tax Advantages
You can avoid paying federal taxes all together on your earnings from a zero coupon bond when you invest in municipal zero coupon bonds, which are tax-free. These bonds are issued through local agencies such as counties and states, and you usually receive tax-free interest payments with these types of securities.
The more you pay for a bond, the lower your yield is. As an example, if you pay $500 for a bond that is worth $1000 when it matures you know that the interest earned on the bond will be $500 when it matures. If the bond is purchased for $700 you would make $300 in interest when it matures.
How to buy zero coupon bonds. You can purchase these bonds through discount brokerages such as ETrade, or through your full-service broker. Markups and commissions will vary in cost, although the face value will be the same, so it pays to shop for the best rates and commissions.
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