﻿If stocks are the 6 cylinder engine that propels you towards growing your wealth,
then bonds are like the breaks that keep the ride steady and on the road. In order to effectively
manage your investments, you need a little bit of both. Too much engine without the breaks,
and you could drive yourself off the road. Too much break without the engine, you really aren’t
anywhere. So, the big question is, then what bond should I buy? Hi, if you are new to the channel,
my name is Tae from Financial Tortoise - a channel dedicated to helping the Sandwich
Generation Master Money and achieve Financial Security. And before I go on, if you have yet to
download your free copy of “Sandwich Generation’s Guide to Financial Security - 10 Steps to Securing
Your Family’s Financial Future!” please go to my website at financialtortoise.com and do so. I send
out weekly newsletters with other great tips on mastering your money and I wouldn’t want you to
miss them. It's exciting to talk about stocks. Fortunes are made and lost with the rise and
fall of the stock market. And rightly so given that for the average individual like you and I,
stocks, more specifically, index funds serve as one of the greatest wealth building tools.
However, having only stocks in your portfolio can be a bit risky, especially if you are getting
closer to your retirement age. At various times in your investment journey, you want to add a bit
of bonds to your portfolio to smooth out the ride. And VBTLX, Vanguard Total Bond Market Index Fund,
in my opinion, is the one and only Bond Fund you need in your portfolio to help smooth out your
investment ride. At an expense ratio of only 0.05%, VBTLX has over 10,000 individual bonds
within its fund with varying credit ratings, issuers and maturity dates. So in this video
we are going to dive into bonds. What they are. What risks they come with and most importantly
why buying VBTLX is your best option for holding bonds. To begin with, you might be asking,
what are bonds anyways? And how do they differ from stocks? Simply, think of bonds as loans. When
you buy bonds, you are essentially loaning money to a company or a government agency. Ever heard of
US Savings Bonds or Corporate Bonds? Government agencies or corporations issue these bonds,
and when they are bought, these organizations are essentially getting a loan from the buyers.
Stocks on the other hand are part ownership of a company. When you buy stocks, you are buying
a piece of the company itself, not lending it money. Ok, that’s interesting and all, but
why do we want it in our portfolio? There are several benefits that bonds provide that stocks
do not. The first reason you want Bonds in your portfolio is that they make our investment road
much smoother with its lower volatility. If you were to compare the total stock market trends,
VTSAX vs. total bond market index, VBTLX the past 20 years - VBTLX has smaller overall gains,
but has much less volatility than the VTSAX. What having bonds in your portfolio will do for you,
is that durings times of market crash, where your stock investments can dip by 20-30%,
your bond investments will hold steady. Now if you are in your 20s and 30s and don’t plan on dipping
into your investments anytime soon, having the majority of your investments in stocks
is a better move. You have time on your side to ride out the ups and downs of the stock market.
However, if you are nearing retirement and want to tap into your nest egg soon, you want bonds in
your portfolio. You don’t want to be caught in a situation where you need to pull your
money from the stock market when it’s 20-30% down. Another reason you want Bonds in your portfolio is
that they act as a deflation hedge. Inflation and deflation are two big macro risks that impact our
portfolio. Inflation is when the price of goods soars and deflation is when the price of goods
spiral downward. We are currently in an inflation period, but the market has its own ebbs and flows
so we won’t know when we will enter a deflation period again. Being invested in stocks provide
us a good hedge against inflation, but we want to be prepared for periods of deflation as well
with bonds. Remember, we are long term investors, not market timers. In addition to reduced
volatility and deflation hedge, another benefit to holding bonds is that they pay interest,
providing additional income flow. And sometimes, these interests can be tax free with the right
bonds. For example US Treasury Bonds are actually exempt from state and local taxes.
But before you think bonds are all sprinkles and fairies, they have their own set of risks that
you want to be aware of. And when you understand these risks, it will help you to realize why VBTLX
is indeed your best choice when it comes to investing in bonds. The first risk that I want to
highlight is default risk that comes with holding bonds. Like I mentioned earlier in the video,
bonds are essentially loans to the government or corporations. And responsible organizations,
like responsible individuals should ensure they meet their debt obligations. Paying back you,
the lender, regularly and on time. However, what happens if the organization is struggling
to make its payments and defaults. You as the bond holder won’t get your money
back. So in order to help investors evaluate the risks of any company or government bond
they are thinking about purchasing, various rating agencies, like the Standard & Poor,
evaluate their creditworthiness and give a grade; ranging from AAA to D. Just like school grades,
lower the rating, the higher the risk of default. Now with the higher risk bonds, like double BB
and lower, their interest rates are higher because less people would be willing to buy these higher
risk investments. So as a buyer of bonds, if you are willing to accept this higher risk,
higher the interest rate you’ll receive. Vanguard's Total Bond Index Fund, VBTLX mitigates
against this default risk by holding only investment grade bonds. There is no bond within
VBTLX rated lower than BBB. Vanguard wants to provide you good returns, but not at the expense
of unnecessary risks. Another risk that comes with owning a bond is the Interest Rate risk. This only
comes into play if you decide to sell your bond before the maturity date at the end of its term,
but it’s a factor you want to consider. Let’s say that you are looking to sell your bond before the
maturity date. If the going interest rate has changed since your purchase, the value of the
bond will change as well. For example, if the interest rate has gone up since your purchase,
the value of your bond will have decreased. Why? Because with the higher interest rate,
let’s say as an example, 6%. New bonds may be issued with this higher 6% interest rate making
your original bond with a lower interest rate, let’s say 3%, less attractive. If you want to
offload it, you’ll need to offer it at a discount. If you are holding onto a few specific bonds with
these lower interest rates, you could be at a world’s hurt whenever the interest rate changes.
But again, when you hold onto VBTLX, because its holding bonds of widely differing maturity dates,
your interest rate risk is mitigated. The third risk I want to highlight is Inflation
Risk that comes with bonds. Inflation occurs when the cost of goods is rising. If you watch any news
lately, it seems like everyone is talking about inflation given how high it is right now. In my
neighborhood, basic food like eggs and chicken are up 10 to 20% compared to what they cost last
year. So, if you are lending money by buying bonds during periods of inflation, when you get it back,
you can afford less stuff. Last year, I was able to buy a carton of eggs for $2. Now it costs
$2.50. And the bond interest rate is set by the anticipated inflation rate. Generally, short-term
bonds pay less interest because it's associated with less risk - it's a shorter time horizon and
your money is tied up for a shorter period of time. And long-term bonds pay more in interest
because of higher associated risk. I know, it can be a bit confusing, but the bottom line
is that if you decide to purchase individual bonds, you’ll need to effectively manage this
inflation risk. Anticipating what inflation will do in the future and making your associated bond
purchase for your portfolio. Again, this is where VBTLX shines because when you purchase VBTLX,
the fund already holds various bonds across a broad range of terms; short-term, mid-term
and long-term. Effectively reducing inflation risk. No need to try to predict the future with
a magic ball - because honestly, none of us can. The bottom line is that when it comes to bonds,
Vanguard’s Total Bond Index Fund, the VBTLX is really the only fund you need to hold in order
to gain all the benefits that comes with holding bonds while mitigating all the risks like default,
interest and inflation risks. VBTLX has an expense ratio of 0.05% and it’s equivalent ETF is Vanguard
Total Bond Market ETF (BND). At the time of this video, there are over 10,000 individual bonds
within this one fund. All with various credit ratings, issuers and maturity dates. I know I
probably made this video more complicated than it needed to be, but I wanted you to have all the
information so you can make the most informed decision when managing your investments. Buy
VBTLX. And start adding them little by little as you get closer to your retirement age. If
you want to learn more about Asset Allocation and why they are important for your portfolio,
check out my video here. And if you found value from this video, please do me a favor and hit
the like button below. It really helps with the YouTube algorithm and allows videos like this
to be shared with more people. Thanks again for watching and I’ll see you in my next one.