INTRO: Over the past few decades,
bonds have fallen out of favor. The average person isn’t even aware of what exactly bonds are
while investors avoid them like the plague. This is quite ironic given that the biggest
companies in the world often do the exact opposite holding tens of billions if hundreds of billions
in bonds. For example, we often hear that Apple has nearly $200 billion in cash on hand, but this
is rather misleading because they don’t actually hold anywhere near this amount in cash. Apple
actually only holds $28 billion in cash. The rest of Apple’s money is held in what are called
marketable securities which are basically just bonds and other fixed income assets.
Apple currently has $23 billion in short term marketable securities and $141
billion in long term marketable securities. In fact, a few years ago, Apple was the 23rd largest
US treasury investor in the world beating out most countries. And if you take a look at the other
leading companies in the world, you’ll find a very similar story. Google, for instance is currently
holding $113 billion in marketable securities. So, here’s why these companies hold the vast majority
of their cash in marketable securities and why all Americans should be investing in bonds as well.
BONDS EXPLAINED:
Before we jump into why bonds could be a favorable investment, let’s first recap what exactly bonds
even are in the first place. Bonds are basically IOU statements handed out by governments and
corporations around the world. Whenever these entities need money to build a road or a new
factory, they’ll issue these IOU statements and they’ll promise to pay a certain amount of
interest rate until they pay back the full amount. So, you as the bond holder are basically a loaning
agency to these massive entities. Usually, the vast majority of bonds are sold to institutions
like pension funds and other countries like China, but this isn’t on purpose. In fact,
governments around the world would prefer to issue their bonds to their citizens. This way,
they’re paying interest to their citizens instead of China or Russia. Most governments actually go
out of there way to ensure that their bonds are easily accessible to the average person.
The US government, for example, guarantees that they’ll offer you atleast $5 million worth of each
bond every single time they issue bonds. In other words, you don’t have to compete with the big
institutions and countries unless you’re buying more than $5 million worth of treasury bonds on
a regular basis. It’s not just the federal governments that are issuing bonds either.
Usually, most areas will issue their own bonds to fund a local dam or highway. These are called
municipal bonds and they’re a great way to earn money while supporting your local communities.
Also, interest payments earned from municipal bonds are exempt from federal income taxes and
sometimes also state and local taxes as well. And if you live in a high tax area,
this could make the interest earned from these bonds far more valuable. For example,
if you’re taxed 40%, a municipal bond that pays back 3% would actually be equivalent to a regular
investment paying back 5%. Anyway, moving onto corporate bonds, this is where you’ll face the
most amount of competition because companies generally offer the highest interest rates and
they issue a limited number of bonds. But if you stick with large corporations like Apple
who regularly issue billions bonds, it shouldn’t be too hard to get your hands on these either.
SECURITY:
Alright, now that we’ve discussed the basic premise of bonds, let’s take a look at why they’re
worth owning. By far the biggest advantage of bonds and especially US treasury bonds
is their safety. In fact, treasury bonds are so safe that the interest earned from these bonds are
considered risk free. I mean, this shouldn’t be that surprising given that a country like the US
has virtually no risk of default because they can just print money to pay back their bond holders.
This means that you’re basically guaranteed to make money if you simply hold till maturity. And
this is why marketable securities are generally just considered cash. Now, if you try to exit your
investment early, you may be looking at a loss depending on how the bond market is doing at the
given time. But, if you hold till maturity, it’s basically like earning interest from a savings
account which is unfortunately non existent nowadays. Corporate bonds on the other hand
are by no means risk free, but one positive is that their risk is always clearly defined. You
can look at a companies annual earnings, their profit margins, and their balance sheet to get
a pretty good idea of how likely they are to pay back their debt. And, if you don’t want to
do that, you can take a look at risk ratings from reputable companies like S&P or Moody’s. Usually,
these ratings separate corporate bonds into two sections which are investment-grade bonds
and non-investment grade bonds. For our purposes, we’re mainly going to focus on investment grade
bonds. These ratings are super stringent and AAA ratings are basically never handed out. In fact,
there’s only 3 corporations in the entire world that have a AAA rating which are Apple, Microsoft,
and Johnson & Johnson. Also, Apple didn’t even join this list till the end of last year.
Something else to note is that if these companies due collapse for some reason,
you’re one of the first people who are paid out after liquidation. According to section 507 of
the bankruptcy code, the first people who are paid out are secured debt holders who have collateral.
But, after these guys are paid out, bond holders are next in line. Meanwhile,
shareholders are last in line and they’re usually not paid very much if anything. So,
if you’re looking for safety, stability, and security, bonds are definitely the way to go.
YIELD:
One of the biggest criticisms against bonds is that their yields aren’t that high nowadays,
but I don’t this is exactly true. Sure, bond yields will never be as high as stock returns,
but that’s because you’re taking on substantially more risk and volatility by investing in stocks.
All assets are directly correlated to the risk they carry, so it’s not fair to say that bonds
as a whole are not worth it simply because they offer lower returns than stocks. Not to mention,
there’s plenty of bonds that offer great yields if you do your research. Likely
the most underrated bond in the entire world is I-series bonds. I-series bonds
are inflation protected bonds that are issued by the US government, and they’re
specifically designed to ensure that you make a return even after accounting for inflation.
And given that inflation is sky high right now, so are yields on I Bonds. Right now, I Bonds are
paying out a whopping 9.62% and you have up until October to buy at these interest rates.
If you didn’t notice, that’s literally higher than the average return of the S&P 500. Now of course,
if inflation goes down, so will the returns on I-bonds, but you’ll never be losing money
to inflation. In other words, this is a prefect store of value that’s backed by the US government.
The only catch is that you can only buy $10,000 worth of I-bonds every calendar year. But, for the
average person, if you’re also maxing out your 401k and Roth IRA every year and building up a
larger emergency fund, like any responsible person should do, this limit is likely more than enough.
Also, if you do want to buy more bonds, there’s plenty of solid options if you do some digging.
Take this Oracle bond for instance. This bond matures in May of 2025, and at current prices,
you can lock in a yield over 4%. And that’s just for holding 3 years. If you’re willing lock in for
a longer period like 20 years, you can buy this 2039 Oracle bond that currently offers a 5.79%
yield. Some other high yielding investment grade issuers include McDonald’s, AT&T, Boeing,
and Fedex. So, clearly, if you look deep enough, you can still find bonds that yield over 5%.
USE CASES:
One of the biggest shortfalls of most arguments against bonds
is that they almost always compare bonds to stocks or real estate. But, the flaw with this
argument is that bonds don’t have to be treated as a replacement to stock or real estate investing.
Rather, they could be treated as a replacement to cash. After all, basically every major corporation
out there holds the vast majority of their cash in marketable securities. Also, regardless of how low
bond yields go, they will always be higher than the yields offered in savings accounts. Now, I’m
not suggesting that people hoard cash just so they can invest in bonds. The number 1 thing that the
average person should be doing with excess savings is investing in S&P 500 in my opinion. However,
this doesn’t mean that there’s no room for bonds. There’s plenty of use cases in which bonds make a
lot more sense than cash. One example is saving up for a house. Right now, the median price of
a house in the US is $428,000. Let’s say this is your first house and you’re looking to buy right
underneath the median at $400,000. To come up with a 20% down payment, you would need $80,000.
There’s also closing costs, moving costs, and new furniture expenses,
so let’s say you budget out $100,000 for this new house. And to achieve this, you’re looking
to save $20,000 per year for 5 years. If you were to simply leave this money in a savings account,
you might be able to earn 0.5% per year. At this rate, you would earn about $1200
in interest by the time you buy the house. Now, what if you invested in Boeing bonds instead?
Boeing obviously isn’t going anywhere in the next 5 years, and you can earn about a 5% yield with
this Boeing May 2027 bond. This yield will slowly fall with time as we get closer to maturity.
So, while you may be locking in a 5% yield during your first 12 months of saving, you’ll probably
only be locking in 1% during your last 12 months of saving. To keep things simple, let’s just say
that you average a 3% yield throughout the next 5 years. At this rate, you would earn $7,600 by the
time you’re ready to buy your house. That itself could be enough to pay for your closing costs.
And this logic doesn’t just apply to saving for a house either. It makes sense whenever you need
money on a set date or whenever you have excess cash reserves. Maybe you have $50,000 set aside
for a car, but you’re waiting for the next model to release in 6 or 12 months. Putting this money
in reliable bonds would be way better than just holding cash. Clearly, while bonds may not be
a great substitute for stocks or real estate, they can be a phenomenal substitute for cash.
OPPOSITION EXPLAINED:
Despite all these benefits, many people including even Warren Buffett claim that bonds aren’t that
useful in the current market environment. But, the thing to note about virtually everyone who claims
this is that they’re not comparable to the average person. Warren Buffett has averaged 20.5% per year
from his stock investments since 1965. So, he’s obviously not going to be thrilled about a bond
that’s paying 5% per year. But, for the average person who isn’t a stock market genius and may
not even have any investments at all, bonds could be a great alternative to just having all of their
money in a savings account. Also, bonds could be a great introduction to investing in general.
The everyday person is usually intimated by the stock market because earnings reports and balance
sheets seem complex and hard to understand. But, bonds are extremely straightforward. You
loan money to the government or the most reputable companies in the world, and they pay you back with
interest by a certain date. As long as you hold till maturity, you don’t have to worry volatility
or fluctuating interest rates or any of that. And starting to earn money through bonds may be
exactly what the average person needs to make the plunge into stocks and take investing as
a whole more seriously. And that’s why I think all Americans should be investing in bonds, but
that’s just what I think. Would you guys invest in bonds? Comment that down below. Also, drop a like
if you think I bonds are underrated. And of course consider joining our discord community to suggest
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