Disclaimer: This article is for educational purposes only and not meant to be used as advice. How you invest is based on your own unique situation.
Recently I was perusing Reddit when I came across the subreddit r/bonds. One redditor posed the question of which bonds to buy. In answer, a few people advised against buying bonds and to instead go all in on crypto. It made me realize many of us are scratching our heads wondering – what is a bond? And beyond that, what is a bond coupon?
Its not that I am 100% against crypto (I have a whopping $75 investment in Ethereum) , however, they’re two completely different investment strategies. It comes down to the age-old balance between risk and reward. Bonds are low risk, crypto is high reward.
So wtf is a bond and why would you buy such a low-return asset? Furthermore, where does one get bonds? And while we’re throwing this finance jargon around, what is a bond coupon?
For me, I always envisioned them as old-timey slips of paper that I would keep locked away in a safe while they slowly accumulated value.
It’s time to explore this oh so unsexy investment strategy!
The basics of Bonds and Coupons
The simplest way to explain a bond is that it’s buying debt. For example, if I ask my friend to loan me $5, she now owns my debt – kind of like a bond.
This is different from a stock in that with a stock you are buying equity – re: partial ownership of a public company. It’s not like my friend now owns part of my bike.
Bonds are also referred to as a fixed income security, which is an umbrella term. I think it’s really just annoying jargon to make investing confusing for the average person.
The bond coupon is the rate that you will charge the entity which you are hold the debt for – but more on that later.
Types of bonds and Bond Coupons
There are 3 major types of bonds – corporate, high yield, and municipal bonds. Corporate bonds are buying company debt, high yield is buying high-risk debt (think of shitty mortgages circa 2007) and municipal just means government.
Frankly, I have zero interest in corporate or high-yield bonds. I fail to see why I would want to own corporate debt when I can have corporate equity. Sure, sure returns and all that, but if I’m going to take risks I’d rather buy some Tesla.
The same goes for high-yield bonds. Why play with risk when it comes to bonds? Again, I’d rather take a risk with equity – that’s where crypto might come in.
Which leads us to Treasury bonds. These are the ones I’m interested in. Treasury bonds are debt issued by the US government, the most trusted borrower in the world.
You know how politicians will shut down the government so they can fight over debt? Well, that debt they’re fighting over is what we’re buying when we buy treasury bonds. The interest rates set by the Fed are what defines the return we get on that debt we purchase.
Why would I buy bonds?
6 months ago I was hanging out with a friend who was telling me about her investment strategy and how she put a percentage of her savings into bonds. I balked, why would anyone under the age of 65 buy up something with such low returns?
Here’s where I eat my words, I completely disagree with my original assessment after having dug a little deeper on the topic.
The current rate of return on a 30-year treasury bond is 2%, with a coupon rate of 2.38%. The coupon rate just means the percentage they’ll pay you each year. With 2021 inflation rates at 5.4%, this means bondholders this year lost money.
Again, why the f*ck would anyone want to lose money buying bonds? Because they’re safe. Contrary to the ups and downs of the stock market, bonds pay a previously agreed amount each year.
What is a Bond Coupon?
If you decided to add bonds to your investing strategy, you’ll come across a variety of terminology. One of the most common is bond coupon. In my humble opinion, this is a nonsense phrase meant to confuse people.
A bond coupon is simply the rate of return you’ll get on your bond purchase. If you want the financy, confusing definition, here’s what Wikipedia says:
In finance, a coupon is the interest payment received by a bondholder from the date of issuance until the date of maturity of a bond.
Bonds, Bond Coupons and You
The point of buying bonds isn’t the returns, it’s to keep your money somewhere safe. Then, when the market inevitably dips, you pull that money out of bonds and throw it at the market. Then you sit back and watch your returns roll in as the market recovers.
Imagine if you had 20% of your portfolio in bonds when the market crashed hard at the beginning of the Covid pandemic. You could have dumped money back in just to see it grow exponentially very quickly.
On the flip side, people who seek high rewards and keep their money solely in stocks and crypto are left vulnerable to the volatile market. They may not have anything left aside to capitalize on the opportunity to buy low.
Finally, you might be asking yourself why bonds and not a savings account? Well, 2.38% might be peanuts but it’s still a whole world better than the 0.06% you’d get in a savings account.
This handy dandy chart from Charles Schwab shows how investing in bonds reduces both the lows and highs of an investment portfolio
Ok cool, so which ones?
This is the question I’m noodling on right now as I’m about to put roughly ~10% of my IRA into bonds. A market correction (dip in the overall value of the stock market) could come at any time and I want to be ahead of the game in keeping my money safe.
I know I don’t want to buy direct from the treasury. I have no interest in being locked in for a set amount of time. Which means I’m going to buy a bond fund. I also don’t have a ton of interest in going much deeper into bond expertise. My goal is simply to keep my money safe, not to squeeze out extra percentages of returns. With a bond fund, I pay 0.04% to let an expert do the hard work of managing for me.
It does mean I end up with a variety of types of bonds, but again, I get to leave that strategizing to the experts.
I did some research and landed on the Schwab US Aggregate Bond ETF. Part of this is because I have my IRA with Schwab so I can avoid any fees that might occur with buying bonds managed by other brokerage houses. The other part is that the price is lower right now and since returns are already so paltry I want to avoid buying a fund that is high right now.
Note that it hurts me to my very core to sell off my high return investments and buy this bond ETF. I know it will hurt more to see my whole account shit the bed if the market declines. I’m going to go for it.
Final Word…
You can see my thinking process for bond purchasing throughout this article. Ultimately, how you manage your investments is up to you and unique to your goals and current financial situation. Always do plenty of research before you make any decision! What’s right for me probably looks very different from what’s right for you.
