What are Baby Bonds?
Bonds are some of the safest investment products out there, and they’re a spectacular option for anyone seeking passive income. Unfortunately, many bonds have high face values that make them prohibitive to retail investors. For defensive investors who don’t have thousands and thousands of dollars at their disposal to invest in bonds, baby bonds are an option.
Baby bonds are a nickname for any bond issued with a par value under $1,000. They’re designed to attract retail investors by offering a lower barrier to purchase alongside coupon rates that are ideal for generating passive income. They’re relatively common and can be a great addition to conversative portfolios or those seeking to mitigate risk through investment debt instruments.
Here’s a closer look at baby bonds and why they’re such a popular investment for fixed-income investors and retail investors seeking bond exposure.
A Closer Look at Bond Face Values
The appeal of baby bonds is their low face (par) value. They’re issued for less than $1,000, which makes them lower than virtually every other debt instrument investment option. By comparison, institutional bond par values are as follows:
- Corporate bonds traditionally sell for $1,000 par values
- Municipal bonds generally have a $5,000 face value
- Federal bonds can have par values as high as $10,000
Baby bonds can range from as low as $25 up to $1,000, with most coming in denominations of $100. This low par values makes them accessible to investors. For example, an investor with $5,000 may only have purchasing power for five corporate bonds with a par value of $1,000 each. However, they could instead also invest in 50 baby bonds with par values of $100.
Where to Find Baby Bonds
Baby bonds are a product of either corporations or municipalities issuing debt to fund new initiatives. Many times, they come in the form of municipal bonds—called “muni bonds.” Like treasuries, they’re tax-exempt. However, they’re also often zero-coupon bonds, which negates their purpose as passive income investments. Muni bonds tend to have a maturity of 8-15 years.
Many corporations also issue baby bonds. They’re a common product of utility companies, investment banks and telecoms who need to fund new ventures or kickstart new revenue streams. Corporate baby bonds are often callable, which means they tend to have a high coupon rate: as much as 5-8%. These are the bonds fixed-income investors tend to pursue.
What is the Purpose of Baby Bonds?
Baby bonds are specifically useful for small-to-midsized projects that might not otherwise garner a lot of attention from institutional investors. The issuer releases baby bonds as a way to drum up interest from retail investors.
For example, a $5 million corporate project might usually yield 5,000 bonds with par values of $1,000. This is typically too small of a quantity to attract institutional investors. Instead, the company might issue 10,000 baby bonds with a par value of $500, to make it more accessible to retail investors. Moreover, 10,000 bonds allow for more investment opportunities in the public markets.
From an investor standpoint, baby bonds can serve several purposes. Corporate baby bonds with high coupon rates are great fixed-income investments. On the flipside, muni bonds are virtually risk-free and make a great addition to balanced portfolios. In either case, the purpose of these accessible bonds is to mitigate risk.
Important Considerations for Investing in Baby Bonds
These bonds are very appealing to retail debt investors, and they’re generally seen as safe investments. However, there are a few particulars to stay apprised of:
- Almost all baby bonds are callable. Keep that in mind when building a high-yield income portfolio. While they generate a handsome fixed income through high coupon payments, a so-called bond ceases to provide passive income.
- Credit rating matters when it comes to corporate baby bonds. Companies with sub-prime credit ratings may use baby bonds as a way to entice investors; however, risk of default is still a pervasive force. Take credit rating into account before investing.
Like any investment, careful consideration for the integrity of the issuer and the presence of risk is an important step in exploring these bonds.
Other Meanings for “Baby Bonds”
The term ‘baby bonds’ is something of a colloquialism when it comes to bonds with a par value under $1,000. The term has actually been used by politicians when talking about several different policies.
- In 2010, economists William Darity and Darrick Hamilton proposed a policy where every American child receives a publicly funded trust account at birth. This “baby bonds” policy aimed to reduce racial and socioeconomic wealth gaps. It never passed.
- In the United Kingdom, the now-defunct Child Trust Fund (CTF) program was also called the “baby bonds” program. This initiative was also designed to help close the poverty gap starting at birth. Junior ISAs replaced the CTF in 2011.
These programs and several others used the term, but investors shouldn’t confuse them with low par value bonds. The policies mentioned above were not related to commercial investment products.
Are Bonds a Good Investment?
For retail investors, particularly passive income investors, baby bonds are a wonderful opportunity to gain bond exposure. Their low par values make it possible to purchase in volume, and to reap the benefits of higher coupon rates and the passive income that comes with them. For those interested in muni bonds, they’re a way to hedge against risk, inflation and volatility. Purchased from an entity with a good credit rating, baby bonds are a smart addition to defensive, conservative and fixed-income portfolios.
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