When you hear the word “bond”, what comes to mind?
Sean Connery, the best Bond, duh.
Although Pierce Brosnan was pretty good too...
What about the $20 savings bonds your grandmother always gave you on your birthdays?
Oh yeah!
They’re probably gathering dust in our closet.
I guess I never cashed those in!
Well Never Say Never Again!
To be honest, I didn’t really understand what bonds were or how they worked until I
became a financial professional.
When used correctly, bonds can actually function as a bit of a middle ground between the safety
of cash and the wild swings of stocks.
Oh I like it...kind of like a Daniel Craig.
Less misogyny, but still got that swagger.
I’d like to learn more.
For Your Eyes Only, here’s the Two Cents guide to Bonds…
Savings Bonds.
Let’s start with the basics.
You’ve probably borrowed money a time or two in your life, whether it’s bumming ten
bucks from a friend or taking out a mortgage on a house.
Most of the time we find ourselves in the lendEE position, aka, the ones needing to
borrow money.
But how would you like to be the LendER, charging interest and receiving payments?
That’s essentially what being a bond investor is.
When a government or company needs to borrow money, it does so by issuing bonds.
Cities, states and counties issue bonds to build roads and schools.
Corporations issue bonds to expand or get through lean times.
Let’s say you’ve got $10,000 you want to invest.
You decide to buy a $10,000, 10 year bond at 4% interest.
So you hand over your money, and the issuer (either a Municipality, or Company) will pay
you a “coupon” of $200 every six months coming to a grand total of $400/yr.
And as long as Tomorrow Never Dies, after 10 years, you also get your original $10,000
back!
There is another bond type that works a little differently.
This is the “zero-coupon bond”, like Series EE Savings Bonds.
These are initially sold to an investor below their face value.
Those are the ones that gathered dust in our closets for so long.
Our grandmas probably paid $10 for a bond valued at $20.
The bond is guaranteed to be redeemable at that final value after a certain number of
years.
And that’s the golden word: “Guaranteed”: By default, bonds are guaranteed by the issuer
to repay both principal AND interest.
Unlike the Casino Royale that is the stock market, bonds offer a Quantum of Solace to
investors seeking predictable returns.
Less “shaken”, more “stirred.”
However, while they are less risky than stocks, you can still lose money in two different
ways; either through “issuer default” or “market changes.”
Issuer Default occurs if the company or government is unable to pay back the interest or principal.
Like when Puerto Rico defaulted on the $800 million owed to bond holders back in 2016.
The risk of this happening depends on the issuer’s “credit rating”; from AAA on
the very low risk end to sub-prime, or junk bonds, on the riskier side.
Basically, the better the score, the safer your moneypenny.
But some investors actually like companies with lower ratings.
Why?
Higher interest!
YOLT!
On average, sub-prime or “high yield” bonds with lower credit ratings pay 6-8% more
interest than investment-grade bonds.
If The World Is Not Enough for you, some sub-prime bonds can even pay interest above 100% per year.
Keep in mind that these are going to be offered by companies and institutions that are probably
on the edge of solvency.
Unless you have a Live and Let Die attitude, don’t gamble too much on this spin of the wheel.
The second way your bond can lose value is due to changes within the bond market itself.
Some bonds will be bought and sold by multiple buyers throughout their life, and what people
are willing to pay for them depends on where interest rates are, and how close to they
are to maturity.
So when the bond market is up, you might spend a $1,200 for a bond that you’d later only
be able to get $1,100 for.
Because a bond fund is comprised of thousands of individual bonds being constantly bought
and sold, bond funds go up and down, much like a stock fund.
But the waves are often half the height.
This is why it’s common to find a retired person using a substantial amount of bonds
for their income needs.
They’re less volatile, pay regular income, and come with some guarantees.
Yeah! they can’t afford for the sky to fall on them!
Get it?
Skyfall?
Too far?
But what about younger people, should they bother with bonds?
Maybe!
If you’re saving up for a short-term goal, like a car or a down payment on a house, bond
funds are a safer place to do it.
You might not be Moonraking it in, but you won’t have the Spectre
of losing it all hanging over your head.
As we’ve said before, there’s no Golden Gun to investing, and bonds are no exception.
If you’re hoping to make more money than a savings account offers but the volatility
of the stock market scares the Living Daylights out of you, bonds might be just what the
Dr. No ordered.
And that's our cents...
...Two Cents.
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If you've ever invested in bonds, let us know how it worked out for you in the comments!