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3 Steps to Easy Bond Investing - Making a Market-Proof Portfolio | Investing for Beginners - YouTube
Channel: Let's Talk Money! with Joseph Hogue, CFA
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Investors miss out on so many advantages in
bond investing because they don鈥檛 understand
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the investment.
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By the end of this video, you鈥檒l have the
three keys to investing in bonds to know exactly
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how they fit in your portfolio.
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You鈥檒l be able to protect your money while
still getting a solid return and that regular
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cash flow.
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We鈥檙e talking investing in fixed income
today on Let鈥檚 Talk Money.
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Joseph Hogue with the Let鈥檚 Talk Money YouTube
channel where we鈥檙e creating the financial
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future you deserve.
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I want to send a special shout out to everyone
in the community, thank you for taking a part
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of your day to be here.
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If you鈥檙e not part of that community yet,
just click that little red subscribe button.
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It鈥檚 free and you鈥檒l never miss an episode.
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Bonds are waaayyy underrated by investors.
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The Federal Reserve found that less than 2%
of investors hold any bonds at all in their
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portfolio, despite the fact that most financial
advisors recommend holding at least 15% to
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50% of your assets in fixed income.
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That also flies in the face of two stock market
crashes in the last 20 years that wiped out
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half the value in stocks.
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Bonds provide a rock-solid safety and return.
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In fact, over the ten years through 2016,
stocks and bonds offered about the same level
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of return鈥ut bonds did it with fewer sleepless
nights.
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Now I love investing in stocks just as much
as the next person and I鈥檓 not saying you
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should ditch equities but bonds is going to
be the secret asset you add to your portfolio
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that helps reach your financial goals.
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I鈥檓 going to walk you through three steps
to investing in bonds to protect your money
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while still producing that return and I鈥檒l
show you how to find bonds in which to invest
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on any online site.
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I鈥檓 then going to share my favorite bond
investing strategy, something that will make
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all this super easy so make sure you stick
around to the end of the video.
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This is going to be a brief highlights video
of what鈥檚 in my book Step-by-Step Bond Investing.
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The book is a complete guide into bonds and
how they fit into your investing strategy.
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I鈥檒l leave a link to the book in the description
below and I鈥檓 going to be discounting the
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price for YouTube subscribers that click over
and check it out.
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But let鈥檚 get into those three steps to
investing in bonds and how you can use these
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cash flow assets to do some amazing things
for your portfolio.
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First is to simply understand how bonds work.
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These are debt issued by a company or government.
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Investors get a fixed payment of interest,
usually twice a year, and then get paid back
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the value of the bond at the end of the loan.
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So bonds are really an interest-only loan.
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Because of how bonds work, there are some
important differences with stocks or other
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investments.
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Bonds are a contract.
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Companies have to pay the debt back and if
anything happens then bond investors get paid
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before stock investors.
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So bonds are generally much safer than stocks.
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Even in so-called junk bonds which are just
companies with a little less solid financials,
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the number of bonds that don鈥檛 get paid
back is just three out of 100 on average.
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Since all the payments on a bond are fixed,
the interest and that final payment, the bond鈥檚
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price increases or decreases depending on
interest rates in the market.
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The bond鈥檚 price has to adjust or people
wouldn鈥檛 be able to sell bonds after they
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buy them.
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For example, say you buy a bond for $1,000
and it pays a 5% interest payment or $50 a
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year.
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That interest payment doesn鈥檛 change and
the bond will pay that $1,000 back at the
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end of the loan.
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Now let鈥檚 say you bought that bond when
the interest rate the U.S. government was
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paying was 3% on a Treasury bond.
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But what happens if the government raises
interest rates, now that Treasury bond pays
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4% and the rate on other new bonds goes up.
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You鈥檙e 5% bond doesn鈥檛 look so good anymore
because investors can get higher rates on
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new bonds.
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Well since those payments don鈥檛 change on
your bond investment, you would have to drop
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the price if you want to persuade someone
to buy it from you.
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Conversely if rates were to go down then your
5% bond might be looking even better.
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Other investors will be willing to pay you
more for the right to collect those payments.
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It can seem a little confusing but you really
don鈥檛 have to worry about it.
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Everyone loves to freak out about rising rates
and falling bond prices but if you hold your
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bond investments to the end of the loan, you鈥檒l
always get those same payments.
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You don鈥檛 have to worry about whether the
bond鈥檚 price went up or down while you held
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it.
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So you鈥檝e got the bond basics down and now
you need to decide which types of bonds you
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want to buy.
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We鈥檒l be talking about three types of bonds
though there are a few more you might want
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to check out in the book.
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Treasury bonds are loans to the federal government
and you pay no state taxes on the interest.
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The interest rate you get is the lowest of
the three bond types but there is virtually
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no chance the U.S. government will not pay.
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Corporate bonds offer the highest return but
you have a little more risk depending on the
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company.
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Just like the credit bureaus that rate your
credit history and calculate your credit score,
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there are rating agencies that tell investors
how risky a company is on its loans.
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These ratings range from C to triple A with
the A鈥檚 being the safest.
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Again, looking at these ratings can be a little
misleading because you see words like Junk
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Bonds and poor quality but the fact is that
even these lower-rated bonds are still much
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safer than stocks.
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Bonds rated double-B by S&P default at a rate
of less than one out of 100.
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Once you get into the C-rated bonds, defaults
start creeping up but the others are very
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safe.
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Finally here are municipal bonds which are
loans to states, cities and local agencies.
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Now you鈥檝e probably been spooked by stories
about Puerto Rico and Michigan defaulting
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on bonds but this is also more hype than anything.
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Listen, the 24-hour news networks need something
to call news.
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They鈥檒l make anything as sensational and
shocking as they can if it means they can
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sell more commercial space.
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The fact is that muni bonds can be a great
investment鈥or the right investors.
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You see, municipal bonds are free from federal
income tax and if you buy muni bonds issued
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in your state, you probably won鈥檛 have to
pay state taxes on the interest income either.
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That means for investors in the higher tax
brackets, then it usually makes more sense
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to invest in municipal bonds rather than corporate
bonds and pay that federal income tax.
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It鈥檚 going to depend on your tax bracket
but it鈥檚 usually around 24% where municipal
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bonds start making more sense than corporates.
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So anyone paying that federal income rate
of 24% or higher, start thinking about investing
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more in munis.
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Each of these three bond types has its advantages.
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Treasuries are super-safe while corporates
are generally the highest return.
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Munis give the rich folk a special gift鈥ecause
the rich need all the help they can get, right?
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Now before we get to the last step to investing
in bonds, I want to ask a question for future
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videos.
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What do you think is the best asset class
for investing between bonds, stocks or real
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estate and why?
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Which is the investment you鈥檙e counting
on to reach your financial goals?
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Our last key to bond investing before we walk
through an example is going to be deciding
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on a time horizon, that鈥檚 the length of
loan you want to invest in, or whether you
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want to invest with a ladder strategy.
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Just like any loan, bonds are issued for different
time periods but most of what you鈥檒l be
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looking at will be from five to 30 years.
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Investors locking up their money for longer
want a higher return so those longer-term
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bonds usually offer higher rates.
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One of the great things about bonds and this
is almost always overlooked by investors is
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the ability to match up your investments perfectly
with your financial needs.
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For example, if you need to pay for college
tuition costs in 15 years, your savings for
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this isn鈥檛 something you want to totally
leave in stocks.
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So you can put that money in bonds with 15-years
left.
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You鈥檒l collect interest during that time
and can reinvest it and then you get the lump
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sump payment at the end.
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A popular bond investing strategy, especially
for people living off their investments is
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called bond laddering.
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This is where you match up your near-term
expenses with very short-term bonds, ones
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maturing in a year or two so you have that
cash flow, but then you use the rest of your
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investment to buy longer-term bonds that pay
higher rates.
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The reason it鈥檚 called laddering is because
you invest in bonds that mature in different
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years.
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You invest in enough bonds for each year over
the next five or ten to cover expenses in
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that year.
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If you have don鈥檛 spend all the interest
or money from the bonds each year, you buy
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another year鈥檚 worth of bonds with a later
date.
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Let鈥檚 look at how to put this all to work.
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I鈥檓 going to show you how to find individual
bonds in which to invest and then I鈥檒l get
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to that favorite bond investing strategy.
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I鈥檓 going to be using my ETrade account
but any online investing site is going to
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be similar.
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You鈥檙e first going to look for the bonds
section or maybe it鈥檚 called bond screener.
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You鈥檒l usually find a comparison of rates
on different types of bonds and different
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maturities.
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So here we see that we can get a 2.94% on
U.S. government treasury bonds for 10 years
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or we can get 3.9% if we invest in A-rated
corporate bonds.
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If we want to invest longer then we can get
about 3.1% on 30-year treasury bonds or 4.2%
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on the same maturity A-rated corporate bonds.
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Remember when you鈥檙e looking at the municipal
bond rates, you don鈥檛 pay taxes on those
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so maybe it鈥檚 a better deal than the corporate
bonds.
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Usually, if your tax rate is around 24% or
higher then it starts making sense to invest
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in municipal bonds instead of corporates.
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You鈥檒l also see here that we can search
for individual bonds.
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So let鈥檚 try this out.
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Let鈥檚 search for corporate bonds that have
a maturity of at least 20 years, that are
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A-rated or higher and pay 4.5% or more a year.
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We have 190 bonds to choose from with some
very tempting yields.
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Here we have an A-rated bond issued by South
Carolina Electric and Gas that pays a 5.1%
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yield every year through 2038.
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Now before I go to buy a bond, I would look
at the company and do some fundamental analysis.
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I would look at thinks like how much balance
sheet debt it owes and how much interest payments
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are each year.
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You want to make sure EBITDA (that鈥檚 basically
operating earnings adding back depreciation)
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is at least four or five times the interest
payments.
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You also want to look for consistent growth
in sales and no runaway expenses that might
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put those earnings at risk.
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If the company looks fundamentally sound,
like it won鈥檛 have trouble meeting those
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debt payments, you can buy the bond.
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Since bonds usually have a face value of $1,000
that鈥檚 the minimum you can invest for one
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note.
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Now just like picking individual stocks, I
like to invest in individual bonds but I also
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have a favorite way to invest that makes it
all so much easier.
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For the amount of my portfolio I want to invest
in bonds, I usually split it with a third
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for individual bonds and two-thirds in bond
funds.
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A bond fund is just a group of bond investments
managed by a professional investor.
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You pay an annual expense fee but it鈥檚 usually
so low that it鈥檚 almost negligible.
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You pay just one commission to get hundreds
or thousands of bonds in your portfolio so
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that鈥檚 instant diversification so a default
on one bond doesn鈥檛 wreck your investments.
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Now don鈥檛 worry, you didn鈥檛 just waste
your time learning all those keys to bond
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investing.
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It鈥檚 still a good idea to know the basics
of bonds and you can still invest some of
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your money in those individual bonds.
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I just like the simplicity of bond funds.
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So I鈥檓 going to highlight two of my favorite
bond funds that you might consider.
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First here is the iShares Core US Aggregate
Bond ETF, ticker AGG.
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This is probably one of the safest and most
diverse bond funds with two-thirds of its
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holdings in government or government agency
debt but it still has some corporate bonds
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to increase that interest rate.
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You see that the fund has taken a hit since
late 2017 because of those rising interest
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rates but that just means the yield has gone
up.
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You鈥檙e getting an interest rate of almost
2.9% on a super-safe collection of bonds here.
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The next bond fund I like is the iShares High
Yield Corporate Bond ETF, ticker HYG.
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This is a group of almost 1,000 of those bonds
from companies with less than perfect credit
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but guess what, it鈥檚 still a safe investment.
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With the investment spread across a thousand
companies, even with the 2008 crash, the fund
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has returned more than 6% annually over the
last decade.
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There are hundreds of bond funds and you can
get into things like international debt, emerging
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markets and some other interesting choices
but these two funds are what I use for most
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of my investment.
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If you want to see those other bond funds
and get more detail into bond investing and
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how it fits in your investing strategy, check
out that book Step-by-Step Bond Investing.
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I take you through everything you need to
know in a way that鈥檚 easy to understand
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and give you the tools to protect your money
while still getting the return you need.
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So look for that link in the video description
below.
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If you have any questions about bond investing
or even investing in general, be sure to scroll
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down and leave it in the comments.
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I always read all the comments; good, bad
and the ugly and love the interaction with
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you in the community.
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Don鈥檛 forget to answer our community question,
what鈥檚 the better investment; stocks, bonds
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or real estate there in the comments.
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Join us in the Let鈥檚 Talk Money community
by clicking on that subscribe button.
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Don鈥檛 forget to tell us your biggest reason
or hesitancy in crowdfunding down in the comments.
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We鈥檙e here Mondays and Wednesdays with the
best videos on beating debt, making more money
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and making your money work for you.
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If you鈥檝e got a question about money, just
scroll down and ask it in the comments and
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we鈥檒l answer it in a video.
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