Finance for Non-Finance People, Issue #3
Word is bond
This’ll be a quick one:
What the H are bonds? Bonds are debt.
As the word indicates, a bond is a promise to repay a debt at a certain rate over a certain period of time.
National and state and city governments go out on the bond market and ask for a loan from other countries, from corporations, and from you, Jane Q. Citizen. There are all manner of complicated ways to lend out your money to governmental entities, but in general I would recommend you ignore them and keep it simple with a fund of short-term Treasuries (recall my recommendation for doing so here).
Corporations do the same. This is what the money people mean when they talk about “leverage,” or a company being “levered up.” The more that the company has issued bonds to raise money, the more leverage it has—the more it is indebted to its bondholders.
Corporate bonds are a lot like people and households:
Some companies are allergic to debt and have very clean balance sheets.
Some companies are heavily saddled with debt and when there’s a recession and they’re making less money, they’ll go bankrupt because they can’t make their payments. (This is one way ordinary people can lose money in the stock market: buying shares of fragile companies that go to zero.)
Some companies, on the other hand, are very savvy with debt—they take it out at low rates with long terms of maturity, then they lever that cash to make a bunch of money and easily repay the debt with all those profits.
All these entities want to borrow money from you so that they have cash now, with the promise that you’ll get repaid that cash with interest.
The more creditworthy the issuer of the bond, the lower the interest rate, or coupon. The less creditworthy, the higher the rate.
There’s a billion overwhelmingly complicated facets of this—interest rates, liquidity, taxes, credit ratings, blah blah blah—but as a regular person, you can pretty much ignore all that: it all goes in the “too hard” pile.
What you need to know is that bonds can be a way of generating a guaranteed fixed income (“guaranteed,” so long as the bond issuer doesn’t go belly up).
Conventional wisdom is that, as you get closer to retirement, you want to have more and more money in that fixed-income bucket and less and less in the (theoretically) more volatile stocks.
Back in the day, retirement accounts were supposed to be 60% stocks and 40% bonds, then it was 70/30, then 80/20, then it was age-adjusted (start 80/20 when you’re young and move towards a smaller and smaller percentage of stocks), then it was TINA (“There Is No Alternative” to stocks), and now… well, now it depends who you ask.
But anything you have (with TIAA, Schwab, etc.) that is in one of those robo-adviser accounts, or those asset allocation deals that are designated “aggressive” or “moderate” or “conservative,” is all defined by that mix of broad stock-market investments and fixed-income/bonds/debt/Treasuries.
If you are fortunate enough to have one of those accounts, you should just let it ride, despite the fact that—as I am forever Cassandra-ing about—you are infinitessimally fractionally invested in things you abhor.
But if you don’t, and you are legitimately just starting from scratch or are starting very late, I would urge you to remember that fixed income doesn’t have the ability to compound the way that boring and durable stocks do, and I would advise you to start with those instead, and only start converting those assets to bonds when you are actually at the point of retirement. Otherwise you risk collecting a nice little coupon on a bond that cannot come anywhere near to the level of returns you can get on stocks over the long term.
Big picture for my MFA people:
Bonds are income, therefore…
Bonds are great for retirees.
Bonds don’t have the ability to compound the way stocks do, therefore…
Bonds are not great for young people or people just starting to invest for retirement who need as much time as possible for compounding to happen.
That said, a specific-to-you percentage of your total assets allocated to short-term Treasuries can be a great way to hold cash and to weather volatility if you are prone to freaking out about volatility.
(Just don’t try to get fancy with munis, corporate debt, junk bonds, or any complicated financial instruments out there.)
And that’s my word.
P.S. Can I just say for the record that, Five Percenter goofiness notwithstanding, I miss Brand Nubian so much? “Word is Bond” isn’t one of their all-time classic tracks, but even here, on a just-pretty-good track, they do it way better than most.
P.P.S. Peace to the Gods and the Earths and the positive people of the universe!