How to Start an eCommerce Business

ByVladana Donevski
March 01,2022

The standard 9-5 work schedule definitely isn’t a good fit for everyone, so those who are brave enough to take the leap might be tempted to become their own boss and start something of their own. If you’re an entrepreneur at heart, you’ll probably enjoy the process immensely. Now, thanks to the internet and some specialist software designed to make our lives easier, running your own business definitely isn’t a far-fetched dream. 

Depending on what kind of business you’d like to start, you might want to consider eCommerce as a vehicle for success. eCommerce is a rapidly growing market in which online stores sell goods and services globally. It’s estimated that by 2023, eCommerce revenue is expected to reach $740 billion in the US. If your business does manage to become the next Amazon or Etsy, you’ll be taking home a significant portion of that. 

Of course, getting started is never easy, mainly because you have so much to think about. You need to plan and organize yourself before you dive in if you want your store to be a success.

For all these reasons, we’ve prepared this detailed guide on how to start an eCommerce business. After reading it, you’ll likely have at least the first couple of steps of your action plan pinned down. So, without further ado, let’s get started. 

Work Out What You’re Going to Sell

People who are looking into starting an eCommerce business typically already know what they’d like to sell. Some are interested in turning their hobby into a living, while others already have a brick-and-mortar store and are looking to expand, or move entirely online.

However, if you’re unsure what to sell, here is some food for thought. Typically, there are three categories of products you can sell online: physical goods, digital downloads, and services. 

Physical goods are an excellent choice if you can manufacture or source things people are looking to buy. Of course, you can always resell physical goods - you just have to buy them from a wholesale provider first or set up a dropshipping store. These processes include their own set of challenges. For example, you need to find out which wholesale provider you want to go with, how you’re going to store the items, and which shipping method won’t cost you an arm and a leg.

Selling digital downloads is an excellent way to open an eCommerce website if you don’t want the hassle of handling, storing, and shipping physical products. These could be anything that your customers can download on their devices: online courses, artistic designs, eBooks, printables, plugins, and templates, among other things. Depending on your skillset and the type of digital product you want to sell, your profit margins can vary greatly. While selling digital products doesn’t always entail the considerable initial investment you would need to provide for physical products, you might also not earn as much.  

Selling services can also be an excellent choice for your eCommerce store. This solution allows you to get started with minimum investments and earn profits fast. Still, the main thing you’re selling is your time, and you only have so many hours in a day. Expanding beyond what you can accomplish (and earn) on your own typically requires that you hire someone else. They can take on some of the workload, but that in itself carries its own set of costs and responsibilities.

Once you decide what type of product or service you’ll be selling, you should assess the viability of your idea. In other words, you want to be sure the result will be worth the effort. How can you determine that? By doing your market research first. Let’s take a quick look at how to perform that properly.  

Research Your Products and Markets

Just as you would when opening any other type of online business, you need to do your research before starting an eCommerce website. You need to find out what kind of products perform well, how much competition there is in the niche, and what type of business model can most effectively bring your eCommerce business ideas to life. 

Since you’ll be selling online, doing a bit of Google research might help you pinpoint what type of product will work. By analyzing Google’s results for a particular keyword and its relative terms, you’ll be able to gauge how popular certain options are. Look for the type of product popping up on the first page and which companies are selling it. The autofill option might also give you a couple of online business ideas. “People also ask” is another excellent section that could be helpful. 

You probably already have an idea in your mind of what you’re going to sell, so it’s time to work out whether or not that idea is plausible. You can do so by evaluating product viability. Here are a couple of things you should ask yourself about the product or service you’re thinking of selling:

  • Is there a demand for it? Is it a fad, or will I still be able to sell this in five years?
  • Are there reasonable profits to be made here? What do the numbers say?
  • Is there already a successful eCommerce company selling the same products or services?

The third question leads us to competitor research, which is a crucial component of starting a successful business. Finding out who the key players are is just the first step. The most important one is putting their business model under the magnifying glass. 

Look for anything they’re doing well and make a note of how you could emulate it. More importantly, look for any ways you’d improve on their business model; you might be able to find a gap your business could fill. At the very least, you could identify that special factor that could help you set your business apart from the competition in your niche, which is crucial when starting an eCommerce site. Remember, just because someone else is already doing it doesn’t mean you can’t do it better. 

Work Out Who Your Ideal Customer Is

If you want to make sure your business will be successful, you also need to target the right audience. This means figuring out who your ideal buyers will be, which will significantly influence the steps you take.

For starters, you need to be where your target audience is and speak their language. To ensure this, you should look into your customers’ demographics and psychographics. Start with their essential characteristics; you want to know their age, gender, and income. Once you have a good picture of that, you should then try to find out more about their opinions and beliefs. 

Why is this important? Well, once you have these terms pinned down, you can clarify the approach of your eCommerce business. For example, if you want to appeal to environmentally conscious customers, you wouldn’t want to sell items packaged in lots of plastic. By the same token, Instagram isn’t the ideal platform for promoting bingo games to senior citizens.

Getting this approach right will significantly improve your eCommerce website and your overall online presence. If you’re selling software for accountants and bankers, you might consider adjusting the tone of voice on your website to avoid the slang the kids use these days. To target a younger audience, having a flashy, highly responsive website might be the most effective thing you can do. Pinning these details down will help you figure out your marketing strategy later. 

Create a Business Plan

Now that you know what you’ll be selling and to whom, you should create a business plan. It sounds daunting, but this is an excellent way to ensure you stay on track while you’re setting up an eCommerce business. Don’t overthink it - you don’t have to show that first version to anybody. It can serve as a to-do list for you as you plan each step in more detail.

However, if you need a business loan, an advisor, or a partner to help run your new business, you really need to create a thorough and professional business plan. Here are some things it should include:

  • What your business is and what you’re selling
  • How you expect your business to earn money
  • Your operational model
  • Where you plan to get your financing from
  • A list of any executives and employees (if applicable)

Since this business plan will also serve as marketing material, you should keep your target audience in mind while writing it. If you’re going to show it to your potential employees, the business plan could help them see your vision and why it might or might not work for them. Before showing it to investors, you’ll need to have every aspect of your financials and operating model pinned down. After all, you want to maximize your chances of getting their approval and funds for your new online eCommerce business

If you aren’t creating the plan for yourself, it’s advisable to look at some online templates first. These will help you keep your business plan consistent, thorough, and as detailed as possible, and will make sure you keep your goal and target audience in mind. If this is too troublesome for you, you can also consider hiring someone to write the business plan for you. 

Lastly, it’s important to stick to the 20-page rule. You want to be informative enough, but you don’t want anyone to spend too much time trying to wrap their head around your concept. 

Decide on Your Business Name and Structure

You might now have a business plan, but you still don’t have a business. This next section of our guide is about formally establishing your company.

You’re probably wondering how to start an eCommerce business step by step. First things first, you’ll need a name, a defined legal structure, all the necessary licenses, and an employer identification number (EIN). Let’s go through those steps one by one.

Picking a Name

Picking the right name can be difficult, and there are many things to keep in mind when doing so. You need a name that is distinctive, easy to remember, and clearly shows what your eCommerce business sells or does. On top of that, the name needs to be available, both with the US Patent and Trademarks Office and on websites that sell domain names.

Even if you haven’t started working on your website, it’s worth registering a domain for your business as soon as you decide on a name. After all, the availability of a domain name can heavily influence the name you choose for your business. By acquiring a domain as soon as possible, you’re preventing someone else from taking it.  

Putting in place a defined legal structure is one of the most important steps to start a business, and it requires your time and attention. Consulting with a lawyer at this point is a good idea. After all, the type of entity you choose to establish will have important legal implications for your business.

The most common types of business entities used for startups are sole proprietorship, LLC, general partnership, and corporation. Let’s give these categories a brief overview.

Sole Proprietorship

With a sole proprietorship, there isn’t a legal distinction between the business and its sole owner. That means you are personally liable and taxed for owning this type of business.  

General Partnership

If you’re not starting an online business on your own, you might consider a general partnership. These are typically conducted between two or more owners. Everyone in the partnership is equally liable, and this partnership is treated as a pass-through entity for tax purposes. 

Limited Liability Company (LLC)

LLC is one of the most common types of businesses out there. With an LLC, you and any other members have only limited liability and are typically taxed as a pass-through entity.

Corporation 

As an entity, a corporation is entirely separate from those who run it. That’s because a corporation is considered a legal person, meaning that the people controlling it have no liability. It’s owned by its shareholders and governed by its directors. Corporations aren’t the right choice for single entrepreneurs, but this legal structure works perfectly for large businesses. 

If you’re still not sure which business structure is right for you, consulting with an experienced professional might be the best course of action. Once you decide on a suitable business model, they’ll help you file the necessary papers. 

Applying for an EIN

The next step is to apply for your EIN. Depending on what type of business entity you opt to establish, this nine-digit number may or may not be required. Regardless, it’s a great way to help you separate your business and personal finances. For this reason, getting an EIN is highly recommended for everyone looking to start an online business.

You can apply for an EIN for free online or via mail, fax, or phone. If you choose the online route, you’ll likely receive your number immediately. 

Getting a Business License

Every business, whether online or offline, needs a business license. Depending on the state your business is located in, you might need to get yours sooner than later. Some regions allow you to sell up to a certain threshold before getting your license, while others require you to have it beforehand. All this information is neatly listed on the SBA website, together with which licenses are required in your state. You’ll likely be able to obtain your license online, although again that can vary by state.

Find or Create the Products You’re Going to Sell

Once you’ve done everything required to set up your online eCommerce business, it’s time to stock up on your product. If you’re selling digital products created by someone else, stocking up might be relatively simple. However, if you want to sell something you create yourself, you’ll need to do much more preparation for your launch, as the production process will probably involve a lot of work. When prepping for your grand opening, make sure you don’t compromise on the quality of what you’re offering.  

If you plan to resell, you should contact wholesalers to work out how you can put together your inventory efficiently and cost-effectively. You need to select your inventory carefully and make sure you’re satisfied with what’s on offer in your store, taking industry trends into account. If you’re considering dropshipping, now’s the time to make the appropriate deals with suppliers and manufacturers.  

Create Your Website

Now that you have all the data, products, and paperwork figured out, it’s time to start working on your eCommerce website

Your website is your online storefront, and you should dedicate the same amount of time and effort to building it as you would to setting up a brick-and-mortar store. After all, this is what your customers will see, browse through, and use to have your products delivered to their doorstep. It’s up to you to make that experience as pleasant and convenient as possible. 

We’re assuming that by this stage, you’ve already selected and purchased your domain name. The next step would typically be finding a hosting provider, but that doesn’t really apply here; you’ll have to decide which eCommerce platform to use, and you’ll get hosting as part of that package. Here’s a quick overview of some of the popular eCommerce software options out there:

Shopify

Probably the world’s most popular eCommerce platform, Shopify is an excellent choice for anyone looking to open their own online store. Shopify accounts start at $29 per month and allow you to create and customize your store to an impressive extent. 

WooCommerce

If you decide to create your website on WordPress, you should definitely opt for WooCommerce as your eCommerce provider. With its most basic package, this plugin allows you to create an online store for free; all you have to do is download it and enjoy its multitude of features. Just be aware that if you’re not familiar with WordPress, WooCommerce might present a bit of a learning curve.

Magento

Magento allows you to customize your new eCommerce site to the fullest. It’s free to download and offers many more options than any other solution on the market. The potential problem is that you need to be quite tech-savvy to get the most out of it. 

As such, it’s not the best option for new eCommerce entrepreneurs with a DIY approach. However, if you can find the money to hire a developer, you can use Magento to open up a world-class shop that will put your competitors to shame. 

Squarespace

Squarespace is another excellent solution for making an eCommerce website, especially for beginners. It’s famous for its easy-to-use shop templates that will get you started in no time. As is the case with Shopify, Squarespace allows you to set up shop without having to know how to write a single line of code. It’s also relatively cheap - the basic plan that includes eCommerce capabilities starts at $18 per month. Still, Squarespace is more of a website builder than a full-blown eCommerce platform. As such, it’s somewhat limited in terms of the tools, features, and add-ons it offers. 

Some eCommerce website builders will offer hosting packages that cater to your needs adequately, but there’s also a chance you’ll have to figure out hosting by yourself. If this is the case, you should consider cloud hosting, which is widely considered one of the best solutions for an eCommerce site. 

You’ll also see many other options, such as shared hosting or even dedicated server hosting. Both of these are good options when you’re just starting your own eCommerce business, so it’s not something to stress too much about. Still, you should be aware that these options can be much more difficult to scale than cloud hosting. 

Whether or not you’re ready to scale depends on how well your eCommerce site is performing. You need to think about the features, usability, and customization options you need as your business grows. More importantly, you need to be conscious of the system you’ll be using to manage your day-to-day business online. For example, if integrating payment systems into your eCommerce site is as complex as brain surgery, you might not be able to scale that quickly. 

If your customers can’t navigate your site or find what they’re looking for effortlessly, it could be a dealbreaker for them. Consider hiring a UX design agency to help you create an online store and set up the basics. 

Define Your Brand

Another reason why you might not be able to scale as extensively as you'd like to is failing to attract and keep customers. For this reason, you need to pin down your brand building strategy. This starts with your eCommerce website and goes on to include your marketing efforts later. But the most important place for your brand to thrive is in your customers’ heads, so that it’s your company that comes to mind when they think about a specific product.

With all this in mind, you can see why branding is crucial when you’re building a business. After all, there’s a fair chance that when someone mentions coffee, a green Starbucks sign pops into your head. Your ultimate aim is to create that kind of instant association for the products or services you’re selling.

One of the most important aspects of branding is thinking about the design of your website, your logo, and your visuals in general. Unfortunately, selecting colors, typography, and other elements for your website is more difficult than you might expect. Don’t overthink it too much right now; you can always rebrand down the road. Finding a logo maker is one of the best ways to consolidate your brand identity when starting your own business

Testing everything before you go live is non-negotiable. You want to be sure that every inch of your website functions as intended. One way of doing this is to ask your friends to help you test the site, or if budget allows, hire a QA specialist to test it professionally. You want to make sure the website looks good on all devices, every button works, and you don’t have a single broken link. 

Add Your Products to the Site

Once you’ve done everything to set up your eCommerce store, the last step is to add your inventory. When doing so, pay close attention to categories and the overall organization of your site; you want your customers to find what they need quickly. 

Once they find the product they want, the customer will likely dwell on its description and image. For this reason, you need to provide them with high-quality visuals and accurate and detailed product descriptions. Think about what they’d like to know about each product. Excellent visuals and precise descriptions are key to unlocking more sales

It’s Time for Marketing

You don’t want your store to open to the sound of crickets; you need customers lined up in front of your virtual door and stampeding towards your “buy now” button. That doesn’t happen on its own; you need to put effort into marketing your new business on the internet.

Of course, marketing something properly is no small feat, and there’s a lot to think about. Newsletter? Social media marketing? Paid promotions? 

In an ideal world you’ll employ all of those strategies. But which will be your top priority - the one that will bring you the most customers with the least effort? To answer this, you should backtrack a couple of steps in this eCommerce startup guide to the section where we talk about analyzing your target audience. Do they use social media? If so, which social platform might they be on, and what type of groups would they be active in? Think of any correspondence you might have with your audience and the tone that would best speak to those potential customers. 

Promo codes, giveaways, and free goodies are also an excellent way to create interest and buzz about your store opening. If you’re offering services, free consultations may be the best way to get customers through the door. A free download each month could work for digital products. Listen to your audience’s feedback and you’ll quickly realize what works.

Grow Your Business 

Once you launch and sell all of your initial inventory, it’s time to grow further. Most aspects of running your business will remain the same, but on a larger scale. It could be beneficial to invest in some tools, hire someone to help, and draw from the experience you’ve gained while building an eCommerce business to find room for potential improvement in the future.

You’ll want to consider upping your current eCommerce marketing efforts. This could mean creating a lengthy email marketing list, collaborating with influencers in your niche, and focusing on SEO. 

As you gain new customers, you might consider investing in good customer relationship management (CRM) software. This kind of program is bound to upgrade your customers’ experience at your eCommerce store. CRMs do a solid job of replacing the face-to-face experience people have at brick-and-mortar stores. 

As your customer base grows, you’ll also likely have more inventory to handle and warehousing problems to solve. Thankfully, there are plenty of software options that can help you with inventory management. On top of that, you should keep an eye out for other things you can do to help you further optimize your processes.

As always, the best way to improve your business is to listen to your customers. You should also look out for ways to improve your back-office processes when you notice that something is unnecessarily complicated. Any improvements you make will surely help your profits down the line!

How Much Does it Cost to Start an eCommerce Business?

This is a difficult question to answer, as there are many unknowns at play. Creating an eCommerce website can be expensive, but you might have friends who are willing to lend their expertise for a percentage of your profits. On the other hand, you might have to pay for someone to help with marketing, or you might need to splash out more to get special inventory in. 

With all that in mind, we’ll try to answer this question: how much money does it take to start an eCommerce business? If you need just the basics - domain, platform, and hosting - it could cost you as little as $40 per month. On top of that, creating your business and acquiring all the permits you need can cost anywhere from $30 to a few hundred dollars, depending on your location. And while it doesn’t seem like much, this minimum investment will mean you have to do a lot of heavy lifting yourself. 

From there, hiring a website designer could cost anything from $300 to several thousand. On top of that, hiring a graphic designer to come up with a beautiful logo will likely cost you anywhere from $15 to $300. A warehouse typically costs $4 to $7 per square foot per month, and if we’re not even going to get started on the costs of marketing - there’s really no limit to how much you could spend getting your company’s name out there. Social media marketing starts off being quite affordable, but if you’re trying to reach a broader audience, you’ll also need to consider expanding your budget. 

Any additional software or service will create extra dents in your budget. Keep in mind that $5 might not sound like much, but if you have to pay that amount every month for multiple apps, it will soon add up. Still, many of those services are well worth their price, so it’s up to you to figure out what you can handle yourself and what you need help with when starting an eCommerce website. Overall, excluding your inventory purchases, you could be looking at an initial investment of around $700 to $3,000.

So, Is eCommerce the Right Business for You to Start?

Especially in this day and age, eCommerce is the best option if you’re looking to start your own shop. After all, few business owners these days want to deal with all the extra expenses and challenges that come with operating a brick-and-mortar store.

If you start an eCommerce business, you can enjoy high levels of flexibility while forking out much less cash than you would to open a brick-and-mortar shop, and you might even be able to work from the comfort of your home.

Before you get too excited, you should be aware that the niche is very competitive. Unless you’re offering a product that enough people need but can’t buy anywhere else, you’ll likely have to grind a lot to turn your store into a success. Still, the opportunity to be your own boss might just be too good to miss out on.

FAQ
How much does it cost to start an eCommerce brand?

Estimating how much it will cost to start an eCommerce business can be difficult. That calculation becomes even more complicated if you aren’t manufacturing your inventory but need to purchase it. However, there are some bare necessities that you simply must have, such as domain name, hosting, and payment processing. You can buy domains for as little as $0.99 per year. Hosting will cost you, on average, $29 per month, and payment processing will typically eat up to 2-3% of your profits.

What are the three types of e-commerce?

Typically, eCommerce can be divided into three categories depending on who the business is targeting. These categories are business-to-business (B2B), business-to-consumer (B2C), and consumer-to-consumer (C2C). Those in the first category sell primarily to other businesses - they might be wholesale websites, for example. B2C is the eCommerce business model that Amazon most famously uses. Lastly, there is the consumer-to-consumer type, for which the most famous example would be eBay. 

Is starting eCommerce profitable?

eCommerce can be arguably the best business to start if you don’t have a huge amount of time or seed money. The numbers show that in October 2021, the average salary of an eCommerce product owner was $85,453. That works out to be $1,643 per week or $41.08 an hour. 

If you’re interested in learning how to start an eCommerce business because you need to get rich fast, that goal isn’t actually unrealistic. Top-end performers in this niche could expect to make as much as $147,000 per year. However, it’s also not uncommon to find those with annual salaries as low as $20,500.

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However, there are exceptions to this ruling, including a lack of adequate local educational programs or if the debtor is living with a disability. Understanding the Inclusions of Discharged Bankruptcy Orders When trying to work out how a bankruptcy discharge is relevant to your personal financial situation, you’ll naturally want to know what types of debt can be discharged. After all, bankruptcy discharge orders don’t cover everything. Section 523(a) of the Bankruptcy Code details a number of exceptions under each chapter of bankruptcy.  When filing a Chapter 7, 11, or 12, there are 19 categories of nondischargeable debts, while the list is a little smaller for Chapter 13. Below are a few examples: Certain tax claims  Child support payments  Spousal or alimony payments  Government penalties Guaranteed educational loans Cooperative housing fees While secured debts cannot be included, a valid lien or sale of the secured asset can be used to repay the debts, with the shortfall (remaining balance) subsequently being included in the order of discharge. It should also be noted that obligations affected by fraud or maliciousness won’t automatically be exempted from a discharge. It will be up to creditors to post an objection to these. If they do not, they will be included in the order discharging debtor responsibilities. Before filing for bankruptcy, it’s important to do your homework or speak to an attorney/financial advisor about the debts that can be discharged and the ones you would be liable to pay. Bankruptcy Closed vs. Discharged A bankruptcy discharge order doesn’t necessarily translate into a case closed. In a simple Chapter 7 bankruptcy without assets being lost, the closure should occur a few days after your discharge. When assets are being lost, any relevant litigation must be finalized before closure can occur. In cases where a repayment plan is needed, the closure won’t happen until after the trustee has confirmed the final report for payment distributions. Generally speaking, it is only the Chapter 7 bankruptcy cases involving difficult assets that are kept open for long periods. Although rare, it is also possible for debtors, creditors, or trustees to reopen the bankruptcy case if a debt hasn’t been listed or if false information has been provided. What Else You Need to Know About Bankruptcy Discharging Before thinking about bankruptcy, you must consider the impact it will have on your financial future. For starters, you will still be required to pay secured debts, while the impact on your credit score will last for up to eight years.  Many people who file a bankruptcy worry about what it means for their career, but the good news is that employers are prohibited from discriminatory treatment of debtors based on their bankruptcy status. This covers both public and private businesses. Furthermore, bankruptcy courts may permit those who file for bankruptcy to run businesses even before the discharge. That’s why it’s important to stay up to date on the best business banking options. A second discharge in a Chapter 7 case will be rejected if you have already received a discharge within the last eight years for a Chapter 7 or 11. This duration is reduced to six years for Chapter 12 and 13 cases. This is unless all unsecured debts from the previous discharge have been cleared. Finally, you will be advised to keep hold of your bankruptcy discharge proof letter in case creditors attempt to take action against you after the confirmation. Should this happen, you will be in a position to file a motion with the court. Should you lose your copy of the discharge order, it is possible to request another from the clerk at the bankruptcy court for a fee. Electronic documents may also be available via the clerk’s PACER system. Conclusion By now, you should have a solid understanding of the bankruptcy discharge meaning in law and how it can impact your future following any proposed bankruptcy. Under the right circumstances, it can be an attractive option that removes some of your financial burdens while also putting an end to annoying calls and debt collection actions.
By Julija A. · May 24,2022
Bonds are a good investment option for those seeking a return on their capital because they tend to offer a reliable and predictable income stream. In this article, we will explain what bonds are and how they work. We will also discuss the benefits and risks associated with bond investments and share tips on how to get started in bond investing. What Are Bonds, and How Do Bonds Work? Bonds are debt securities that are issued by governments and corporations in order to raise capital for projects, expansions, and other purposes. When you buy a bond, you are essentially lending money to the bond issuer. In exchange for your investment, the issuer agrees to make interest payments at regular intervals, as well as repay the principal amount of the loan when the bond matures. Investment bonds enable the issuer to secure cash flow at specified dates. From the investors' side, bonds are a low-risk investment with typically good interest rates. But not all bonds are created equal. Some are a better investment than others. Characteristics of a Bond Bonds come with a number of different characteristics, including the following: Face value: This refers to the amount that the bond will be worth when it matures. Maturity date: This is the date on which the bond will be repaid in full. Coupon rate: This is the annual interest rate paid on a bond. Yield: This is the return an investor will realize on a bond. On top of these basic characteristics, there are a couple of other aspects that define a bond. Some of the bonds are secured, while others are unsecured. Secured bonds typically have assets backing them that guarantee payment to bondholders if the company cannot meet its obligations. On the other hand, unsecured bonds are not backed by collateral and are a much riskier investment. Different bonds also have different tax statuses. Most are taxable investments, but there are some government-issued bonds that offer tax breaks. These are typically used as a way to encourage investments in specific projects, such as infrastructure development. Tax-exempt bonds normally have lower interest rates than equivalent taxable bonds.   Knowing the difference between taxable and tax-exempt options is a critical part of understanding bonds. An investor must calculate the tax-equivalent yield to compare the return with that of taxable instruments. Most of the tax software available online can help investors with this type of math when preparing for tax season. Callable bonds can be paid off before they mature. This commonly happens with call provisions, which allow companies to retire the instrument at any point during or after its term by prepaying them for a premium amount equal in value of interest earned on reinvested payments made over time. An Example of How Bonds Work So, how do bonds generate income for investors? Here’s an example that makes the aforementioned characteristics more tangible.  Let’s say the city of Chicago is looking to build a new community center but doesn’t have the funds for the project. So, it issues bonds to raise the cash instead of going through a crowdfunding platform or a financial institution. Each community center bond has a face value of $100. This is essentially a loan each investor lends to the city of Chicago. It promises to repay the loan in 10 years, which is the bond's maturity date. However, to be able to sell as many bonds as possible, Chicago also has to entice investors to loan them the money. This is where one of the many important bond features comes in. The coupon rate is, in essence, a yearly interest rate that Chicago will pay to its investors. For this example, let's say that each bond has a 5% coupon rate - each investor will receive $5 each year. After 10 years, when the bond is due, each investor will have yielded $150. Chicago will pay back the principal of $100 as the bond matures, which, combined with $5 of fixed income over ten years, makes quite a decent investment. Benefits of Investing in Bonds There are a number of benefits associated with bonds as an investment, including the following: Stability Bond prices are generally less volatile than stock prices, which means that they can provide stability for your portfolio. The majority of bonds are issued by governments, which are typically considered stable and less likely to default. Income Bond interest payments can provide you with a source of income. While the coupon rate is rarely as generous for the smaller investment as in our example, investing in multiple bonds with a solid coupon rate can turn into a decent annual income. Diversification Every investor knows that a diversified portfolio can make all the difference. Adding bonds to your portfolio can help to diversify your investments and reduce overall risk. Types of Bonds There are many different bonds, including government bonds, corporate bonds, agency bonds, and municipal bonds. Federal bonds are issued by the Department of the Treasury. There are three different types of bonds issued by the Treasury. Also referred to as "treasuries", these have different names based on the maturity date. Those that have a year or less to maturity are called "bills", while those with up to ten years of maturity are known as "notes". Actual "bonds" are those that have over ten years to maturity. Corporate bonds are often issued by companies that need loans much larger than angel investors, VCs, or banks are willing to provide or cannot find bank loans with favorable terms. Corporations often find it more affordable to issue bonds than to go with bank loans when the interest rates and terms are taken into consideration. Municipal bonds are issued by states and municipalities to fund different projects. Investors will often find bonds with tax-free coupon income. Agency bonds are issued by organizations affiliated with the government, such as Freddie Mac or Fannie Mae. Risks Associated With Bond Investments These investments are not without risk. The biggest risk is for the bond issuer to default on the loan, which could result in the loss of your principal investment. Additionally, bonds are vulnerable to market fluctuations, which leads to price volatility. This is partly linked to the bond’s interest rate, meaning that rising interest rates can cause the price of bonds to fall. Finally, bonds are also subject to credit risk, which is the risk that the issuer will not be able to make interest payments. All in All The most important thing to learn about bonds is the different types of bonds and the risks associated with each type. You should also know your investment goals and objectives. Bonds, as fixed-income securities, can be a good addition to an investment portfolio but aren’t the right option for everyone. Finally, it is important to remember that bonds are subject to market fluctuations, so you should never buy bonds with more money than you can afford to lose.
By Vladana Donevski · May 18,2022

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