Have you ever wondered… what exactly is a bond? You’re not alone! In this week’s episode, Josh and Austin discuss the important topic of bonds. Join the guys as they dive into the complexity of convexities, the many different types of bonds, and answer the question: why would anyone want to invest in bonds? Listen in now!
Main Talking Points
[2:13] – What is a Bond?
[6:37] – Callable Bonds
[8:34] – Credit Ratings of Bonds
[13:18] – Inverse Relationship Between Bond Prices and Bond Yields
[16:19] – Government Bonds
[17:12] – Municipal Bonds
[18:20] – Asset-Back and Mortgage-Back Securities
[19:46] – Floating Rate Loans
[21:51] – Dad Joke of the Week
[22:41] – Can You Lose Money on a Bond?
[25:47] – Convexity
[28:41] – General Performance of Bonds
[34:27] – Why Would You Want to Own Bonds?
[40:01] – Inflation
[42:09] – Sequence of Return Risk
[43:43] – How Could You Invest in Bonds?
[45:53] – Should You Invest in Bonds?
[47:42] – The 60-40 Rule
Links & Resources
Ask an Advisor: College Edition Part II – The Invested Dads
Retirement Stepping Stones (ft. Tony Hixon) – The Invested Dads
ETFs vs Mutual Funds – The Invested Dads
Invest With Us – The Invested Dads
Free Guide: 8 Timeless Principles of Investing
Social Media
Full Transcript
Intro:
Welcome to The Invested Dads Podcast, simplifying financial topics so that you can take action and make your financial situation better. Helping you to understand the current world of financial planning and investments, here are your hosts, Josh Robb and Austin Wilson.
Austin Wilson:
All right. Hey, hey, hey, welcome back to Invested Dads Podcast, the podcast where we take you on a journey to better your financial future. Today, we are going to be talking about what’s probably the third most boring but hopefully helpful topic the last couple months, and that’s bonds. We’re going to answer the question, why the heck would anyone want to invest in bonds?
Josh Robb:
All right, so you said third most boring.
Austin Wilson:
Third most boring, by my calculation.
Josh Robb:
By your ranking, what else fits there?
Austin Wilson:
Yeah, I think utility stocks could be a little bit more boring.
Josh Robb:
Okay.
Austin Wilson:
But maybe not, I don’t know. Annuities, I think that was the most boring.
Josh Robb:
You think people who sell utility stocks are power brokers?
Austin Wilson:
Oh, the power broker.
Josh Robb:
Oh man, I just thought of that.
Austin Wilson:
That’s going to pick up speed next season.
Josh Robb:
That’s it.
Austin Wilson:
It has to. Who would’ve thought that you-
Josh Robb:
My joke or utilities in general?
Austin Wilson:
No, Captain America.
Josh Robb:
Captain America.
Austin Wilson:
The power broker.
Josh Robb:
Oh, the power broker. Yes, from that episode.
Austin Wilson:
Okay, so now we’re caught up. Josh has now watched the entire first season of Winter Soldier-
Josh Robb:
Winter Solider and Falcon.
Austin Wilson:
And Falcon. Now, it’s Captain America: The Winter Soldier.
Josh Robb:
Is that what they’re called?
Austin Wilson:
Yeah. They announced it at the end of the first season.
Josh Robb:
Oh, okay.
Austin Wilson:
Anyway, that’s not what we’re talking about today. We’re talking about bonds. But first, we have had some pretty special guests lately. So, Josh, run through those just in case someone wants to listen to them before they get to this super exciting bond episode.
Josh Robb:
If this is boring, you may want to jump out real quick and be woken up, there was a great episode we did in our series, Ask an Advisor. We did part two of the college edition where we had Mackenzie Murphy on who is our marketing intern. She was able to do some questions from her and her friends about things that they are interested in, which is a really good episode.
And then we just recently had co-founder of Hixon Zuercher Capital Management, Tony Hixon, on to discuss his latest book, which is called Retirement Stepping Stones, which is a great read. A really good episode. Make sure you check that out.
Austin Wilson:
Yeah, check that. If you haven’t listened to that, go back, listen to it and come back to bonds. Come back to bonds.
Josh Robb:
You can always come and listen to bonds.
Austin Wilson:
That’ll be here. It’ll be here.
Josh Robb:
Yes.
[2:13] – What is a Bond?
Austin Wilson:
So, yes, bonds.
Josh Robb:
Bonds.
Austin Wilson:
That’s what we’re talking about. They’re very different than stocks. We spend a lot of time talking about stocks. The financial news, the media spends a lot of time talking about the stock market when in reality, the bond market is actually larger than the stock market and around the world-
Josh Robb:
About three times the size.
Austin Wilson:
And, it’s important to have an understanding of what that is even though it’s not as exciting or fun on the high level.So, let’s just break down, 50,000 foot like we typically do.
Josh Robb:
Yes, start up.
Austin Wilson:
Very different than stocks. With a stock, you own Josh Robb Corp., there’s 10 shares outstanding, $10 a share, $100 market cap. It’s great. If you own one share, you own 10% of the company, you own a share of Josh Robb Corp.
So, with the stock, you own a very small portion, usually teeny, teeny, minuscule portion of a company, of a publicly traded company. So. you buy a stock for a given price and you hope the company is going to continue to grow and innovate and that their share price is going to reflect that growth and that your wealth will grow over time, right? That’s how stock ownership works, and that’s how we spend a lot of our time talking about. The key word there is own. You own a small piece of a company.
Okay, you’re a business owner. Let’s say that the business will sometimes be worth more, it will sometimes be worth less in the eyes of the market, and you are bearing the risk in hopes that it’s going to be worth more over time. Time is the key there.
Bond is different. Bonds are way different. With a bond, you don’t actually have ownership of a company. I guess we’re also going to talk about governmental entities a bit today, but you don’t actually own that.
Josh Robb:
Right.
Austin Wilson:
A piece of it. Instead, you, Josh Robb Corp, no just Josh Robb the person, you’re lending your money. So, you’re going to say, “US government, I’m going to lend you my money, and then I’m going to be promised that you’re going to give me interest in the middle,” sometimes at the end, but that’s another topic for another day, “and my money back at the end.”
Josh Robb:
Yeah. So, I’m going to charge you for holding my money and using it, and then you’re going to give me my money back at some point in the future.
Austin Wilson:
So, think of it like with stocks you’re an owner, with bonds you’re a loaner.
Josh Robb:
Not, like by yourself.
Austin Wilson:
Not, not like you by yourself. That’s a Nick Murray-ism, and we’ve referred to him before.
Josh Robb:
Yes.
Austin Wilson:
But yeah, you’re an owner with a stock, you’re a loaner, you’re loaning your money with bonds. So, let’s just briefly …
Josh Robb:
I always say, a great way to think of a bond, a lot of people who own their home have a mortgage. That concept, when you think about it, is what a bond is. A lot of people then associate with that as the bank said, “Hey, you want to buy a house? Here we’ll give you some money. You owe us interest, and you’re going to pay us all back everything we had plus that interest.”
Austin Wilson:
Yes.
Josh Robb:
That’s just the reverse of a bond.
Austin Wilson:
Exactly.
Josh Robb:
We’re giving out our money to an entity, whether it’s a company or the government, so that they can use it for whatever they want. In turn, they’re going to promise to pay us back an interest and our initial thing we loaned out.
Austin Wilson:
Absolutely. Perfect. So, let’s give one-sentence definitions for some key terms.
Josh Robb:
All right.
Austin Wilson:
Number one, duration. Josh, explain duration in one sentence.
Josh Robb:
Duration.
Austin Wilson:
Yeah.
Josh Robb:
Duration is really the length of time that you’re going to have your money being lended out.
Austin Wilson:
Yeah, absolutely.
Josh Robb:
So, if the duration is five years, for five years-
Austin Wilson:
Your money is locked up.
Josh Robb:
They’re going to have my money, and they’re not obligated to pay it pack until the end-
Austin Wilson:
Yeah, absolutely.
Josh Robb:
… of that duration.
Austin Wilson:
Coupon is another word, and that is just the periodic interest payment, and that’s in dollar terms. The coupon will be in dollar terms. Now, when you flip the table, you can look at yield. Yield would be the percentage usually of par or what the bond was issued at that you are getting as a percent of your interest payment. So, two different terms there. Yield to maturity, Josh?
Josh Robb:
Yes, so that’s the yield you’re going to get if you wait all the way until it comes back to you too. So, that duration. So, the yield to maturity takes that coupon payment. Let’s say it’s a five-year bond and they pay it twice a year, and so you’re going to get 10 payments over that five-year period. And they’re saying, okay, if you’re paying $100 per payment, this is how much you’re going to earn. That’s the yield for that timeframe.
[6:37] – Callable Bonds
Austin Wilson:
Right. So, before we get to yield to worst, because that’s another key one, we have to talk about what a callable bond is because that’s typically the big difference there.
Josh Robb:
Yes.
Austin Wilson:
So, callable bond. Call, meaning the right to buy. It’s like an option, and this is an option on a bond that the issuer has in place when they issued the bond. So, say Walmart issues $100 million of 4% coupon bonds, 10-year bonds, whatever, if it’s a callable bond, they have the right to buy it back between whatever time period they specify or from a period on.
Therefore, the yield to worst is a common term there. That could mean the earliest time that that bond could be either called; or if there is no call option, that’s going to be maturity at that point. If they call it early, you’re going to get less yield because there’s less coupons after they would have called it. So, it’s going to be a different yield calculation that way.
Josh Robb:
Yeah. And when you’re looking to invest, if there is a callable bond, you have to take the worst-case scenario into factor so that yield to worst, let’s just say, okay, if I were to buy it now and it’s a five-year bond but in three years they have the ability to call it back, I need to know, that’s my worst case return and I could get out of it, am I comfortable with that? It may go all five, but I don’t want to be upset if that’s my end point and I didn’t figure that in. That’s a yield towards.
Austin Wilson:
And it’s probably also worth pointing out that typically if you’re buying a callable bond, you are compensated with a bit of additional yield to make up for the risk that they could call it back in advance. The bond market is very transparent on how it works.
Josh Robb:
Yes.
Austin Wilson:
It’s just math. So, pretty much, if there’s a put one way, and there’s a take somewhere else and it all works out in the end.
Josh Robb:
Yeah. So, if you have two five-year bonds, one is non-callable and one is callable, your yield to maturity is going to be higher for that callable because you’re taking a risk that you may not get there.
Austin Wilson:
Yeah.
Josh Robb:
And so, yeah.
[8:34] – Credit Ratings of Bonds
Austin Wilson:
So, credit rating. Something we should probably talk about. First of all, to confuse you further, Standard & Poor’s and Fitch are two major rating providers. They use the same system. That’s great. Moody’s is another, and they use their own.
Josh Robb:
Yes.
Austin Wilson:
So, that’s just going to confuse people further. But I’m going to go through them in order from very highest credit rating to very lowest credit rating.
Josh Robb:
Yeah, so not only do you have multiple people rating them, which is good, because then you don’t have just one company and it gets confused.
Austin Wilson:
Absolutely.
Josh Robb:
But they don’t use the same rating scale.
Austin Wilson:
No, they do not.
Josh Robb:
Because why?
Austin Wilson:
Why would you do that?
Josh Robb:
Yeah.
Austin Wilson:
That’d be too easy. So, we’re going to go to the top.
Josh Robb:
Yes.
Austin Wilson:
Number one, so best credit rating you can have according to S&P and Fitch, AAA.
Josh Robb:
AAA.
Austin Wilson:
Then you go AA+, AA, AA-.
Josh Robb:
These are the batteries, yes.
Austin Wilson:
A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, C, D.
Josh Robb:
All right, so you just drew a lot of alphabet at me.
Austin Wilson:
Yup.
Josh Robb:
Pretty much it’s, if you think of grading, if I go to school, I get a grade.
Austin Wilson:
Very similar.
Josh Robb:
AAA is all by itself, right? There’s only AAA. There’s not plus or minus there. But after you get past AAA, it’s the plus then the regular then the minus. That’s it. So, A+, regular A, A-. Just think of grades. That’s how it works.
Austin Wilson:
Exactly.
Josh Robb:
Pretty easy.
Austin Wilson:
Taking away letters if you’re repeating them.
Josh Robb:
The fewer the letters then … yeah. Yeah, so-
Austin Wilson:
So, wait, and I’m sure we’re going to talk-
Josh Robb:
We are.
Austin Wilson:
… about this in a little while. But at some point, we get to the term junk bond. As you’re working through that scale, throw a real quick, where is that line?
Josh Robb:
Below BBB?
Austin Wilson:
Yeah. So, like that, BBB is your threshold.
Josh Robb:
Right, because BBB is kind of like the investment grade, threshold.
Austin Wilson:
Yes. And then down from there as well, you may hear the term junk bond.
Josh Robb:
Yes, or high yield.
Austin Wilson:
Junk or high yield, they’re interchangeable. It just means the rating is lower. You get compensated higher because you’re taking a risk.
Josh Robb:
You get more yield but there’s more risk because of a default risk, which is something we’re going to talk about.
Austin Wilson:
So that’s that, the BBB is that threshold.
Josh Robb:
Yes.
Austin Wilson:
So, Moody’s changes that up a little bit, and theirs makes a lot less sense. They have a mix of uppercase and lowercase letters for one, but I’m going to call them AAA. You have AA1, AA2, AA3, A1, A2, A3, BAA1, BAA2, BAA3, BA1, BA2, BA3, B1, B2, B3, CAA1, CAA2, CAA3, CA and C.
Josh Robb:
That’s though.
Austin Wilson:
So, if I was to choose, I would just go with the S&P and Fitch system of credit ratings, but-
Josh Robb:
It’s a lot easy, in my mind, a lot easier to understand-
Austin Wilson:
I think the people were-
Josh Robb:
… because you grew up with a-
Austin Wilson:
Great scale.
Josh Robb:
… great scale that has a similar thing.
Austin Wilson:
I think that the people were awfully moody when they wrote the Moody’s list.
Josh Robb:
Well, it sounds like farm animal noises for some of those.
Austin Wilson:
Baa.
Josh Robb:
You get BAA1 and BAA2. I don’t know, that’s crazy.
Austin Wilson:
So, another one we’re going to mention and come back to is convexity.
Josh Robb:
Convexity.
Austin Wilson:
That’s Josh’s favorite thing in the world.
Josh Robb:
Google that, convexity formula.
Austin Wilson:
Not if you’re driving.
Josh Robb:
And see what cool formulas come up with that.
Austin Wilson:
Yeah. So-
Josh Robb:
Good times.
Austin Wilson:
Something to talk about is that debt rating determines yield. The more risky the debt issuer, the more likely an issuer is to default. Default, meaning go out of business, be unable to pay what they owe, and that’d be what they owe in you, the investor money, or other investors.
That is going to be compensated through a higher coupon, a higher yield on their debt to compensate for that additional risk. That happens as you move further away from risk free. So, risk free, think of it like a US Treasury bond. It is essentially risk-free as long as the government is around, they’re going to pay their debt.
Josh Robb:
Right. Yes, sure.
Austin Wilson:
That’s what they say.
Josh Robb:
Debt ceiling?
Austin Wilson:
That’s what they say. That’s what they say. And then, there’s zero risk that you won’t get paid the way it’s discussed. So, in theory, that’s the way. However, in practicality, to be determined down the road.
Josh Robb:
When it comes to investments, that’s as risk free as you get in the bundle.
Austin Wilson:
So, as you work away from risk free, away from AAA, then your interest payments were going to increase, your interest yield is going to increase, but so does default rate at the same time.
Josh Robb:
Yeah. And again, it comes back to, the same is true with stocks. Again, when we’re talking about investing, a lot of the underlying concepts are the same, right? The more risk I’m going to take, the more I want compensation for that risk.
Austin Wilson:
Right.
Josh Robb:
You see that with stocks is that you get a higher price point or a different P/E ratio. If I’m going to take risk, I want a-
Austin Wilson:
Higher return, yeah.
Josh Robb:
… be compensated with a higher potential return-
Austin Wilson:
Potential.
Josh Robb:
… here on this side, bonds. If I’m going to take a higher risk of the company defaulting, meaning not paying me back, I would like you to offer me a higher interest rate to borrow my money.
Austin Wilson:
Yes.
Josh Robb:
Same concept.
[13:18] – Inverse Relationship Between Bond Prices and Bond Yields
Austin Wilson:
So now, we’re going to talk about the inverse relationship between bond prices and bond yields.
Josh Robb:
Okay.
Austin Wilson:
Now, we’ve talked about this before on the show, so we’re not going to go too much into detail. But in general, think of it like this, have you heard that stocks and bonds are often thought to be negatively correlated?
Josh Robb:
Yes.
Austin Wilson:
That’s kind of a common thinking. So, here’s how this works. As people are bullish on the economy, they buy stocks.
Josh Robb:
Yes.
Austin Wilson:
What did they do to buy those stocks? Generally, they’re going to sell bonds. So, they want to participate in the profits, the economic growth that’s going on, and the selling of those bonds causes bond prices to fall and bond yields rise because the coupons are fixed. It’s similar to how a dividend yield work. If the company holds their dividend flat but the stock price dips, their dividend yield goes up.
Josh Robb:
Right.
Austin Wilson:
Right?
Josh Robb:
Because what you pay to get that is less, but you get the same thing for it.
Austin Wilson:
Yeah, or the other way around. As the stock goes up, if the dividend stays the same, the yield will go down.
Josh Robb:
Right.
Austin Wilson:
That’s kind of how that works. It works the other way for bonds too. When investors get fearful, they then turn around and sell their stocks. That obviously is putting pressure and causing the stock market to drop. They go then and buy bonds. So then, the buying of the bonds sends the bond prices up, which causes bond yields to fall. So, similar to what we just talked about.
Josh Robb:
Right.
Austin Wilson:
So, that is about the inverse relationship between bond prices and bond yields, and really how they correlate with stocks.
Josh Robb:
Yeah. And we should be very clear. When we talk about an inverse relationship, that usually they move in opposite directions.
Austin Wilson:
Yeah.
Josh Robb:
But in real life, there are times where they move the same direction. Like in 2008, 2009, there was a lot that was going on and both fixed income and stocks were down for a while. It doesn’t mean just because stocks are down bonds are up. There are normally very little correlation between the two.
Austin Wilson:
True.
Josh Robb:
Normally, in a normal market, they are oppositely or negatively correlated, it’s not a guarantee in that-
Austin Wilson:
And how often are we in a “normal” market.
Josh Robb:
Right. So, just keep that in mind when we’re talking about this, is normally, again, go back to just straight math and how that works. That’s usually the case. But again, when you apply economics and things going on, sometimes they move the same direction. Last year when interest rates were being adjusted by the Fed, that put pressure on the fixed income world at the same time there was pressure on the stock market.
Austin Wilson:
Absolutely.
Josh Robb:
Two different things causing pressure; but from a price movement standpoint and returns, they were moving in a similar direction.
Austin Wilson:
Yeah. So, let’s break down just at a high level some different types of bonds.
Josh Robb:
Yes.
[16:19] – Government Bonds
Austin Wilson:
Because when you say bond, it’s very different. Just like there are tons of different kinds of stocks out there, we understand that. There are different types of bonds, and this is a very short list. There’s even a much bigger list. This is just a short list.
So, first of all, US Treasuries or government bonds generally from an issuing government around the world, similar sort of thing. German boons, whatever these kinds of things. They are they official, they’re often thought of as “risk-free debt.” Because of that low risk, you’re obviously going to be compensated very low in terms of yield, but you have very little risk when that happens.
Josh Robb:
And depending on the type of government bonds, and I know we’ll talk about some of them in a minute, but there was war bonds back in the day. There’s different types, and they offer some incentives too. If the government is trying to motivate those purchases, they, being the government, can say, hey, this bond is tax free.
Austin Wilson:
Yes.
Josh Robb:
You’ll see those periodically, different types of bonds. There’s some educational bonds out there, some EE bonds and things like that, all have different structures based on what they’re trying to accomplish for people investing in them.
[17:12] – Municipal Bonds
Austin Wilson:
So, speaking of tax-free bonds, municipal bonds. Think of a municipal bond issued from a municipality, and that could be either a state or local government. They can issue-
Josh Robb:
Or school or-
Austin Wilson:
Or school, yeah. They can issue bonds to then use that funding to build roads, update a town, build a new building, anything like this. The unique thing about those is that they’re not risk free, for one.
Josh Robb:
Right.
Austin Wilson:
They have different credit ratings. You can buy them insured or not insured. There’s a lot of variables when it comes to munis and there are different areas of the country that are better for munis than others. Some places have run their finances a little bit more conservatively than others in the past, and you can buy ones that are funded based on tax dollars or whatever. So, there’s all kinds of different munis out there but the key differentiator is that the income that you’re getting from them, the coupons, that is federally tax free.
Josh Robb:
Yes. And some are state and local tax free depending on how they’re issued.
[18:20] – Asset-Back and Mortgage-Back Securities
Austin Wilson:
Yes. So, that’s a unique thing. So, if you have a high tax situation in your life, this could be a way to get some federally tax-free income, potentially more. So, that’s a unique experience there. Corporate bonds, these are just bonds issued by corporations. Very, very common all around the world.
Asset-backed securities, mortgage-backed securities. Really, when there are loans, mortgages for example, a lot of times … You’re going to think of 08 and 09 when I’m talking about this, but that’s kind of what caused a lot of this thinking, but banks could bundle together millions of dollars’ worth of mortgage debt and sell it to an investor. So, an institution likely would be the investor that would buy that, and they would … Previously, before the global financial crisis, make killer returns on this kind of stuff. It’s very-
Josh Robb:
The payments being paid into those mortgages were then packaged into as interest payments.
Austin Wilson:
Absolutely.
Josh Robb:
Yes.
Austin Wilson:
And back then, interest rates were good, risk was low. Then the global financial crisis hit and there was not a good place to be for a while. However, now it’s a pretty good place to be. The banking system has stabilized, we have a lot of rules and regulations in place to protect people. So, mortgage-backed securities, asset-backed securities, they’re coming back. They’re very popular and they are a good way to get an additional yield on top of what you can get through a treasury or even a corporate bond.
Josh Robb:
Yes.
Austin Wilson:
Another option, and we’re going to talk about it a little bit more later, TIPS is what they’re called, Treasury Inflation Protected Securities. It’s a treasury, but it’s a treasury with an adjustment for inflation. We’ll talk about how inflation and fixed income work together now that is actually kind of risky-
Josh Robb:
Can’t wait.
[19:46] – Floating Rate Loans
Austin Wilson:
Later. That’s Josh’s favorite topic in the whole world. Another one is floating rate loans. So, think smaller loans-
Josh Robb:
For boats.
Austin Wilson:
Yeah, that do not have a fixed interest payment, right?
Josh Robb:
Oh, yeah.
Austin Wilson:
So, as interest rates go up and go down, the coupon goes up and goes down for the debt holder on that. And then, I do want to point out, and we’re not going to get into it too much, but all of these are available inside and outside the United States. Through emerging markets through international developed markets, Europe, Asia and Africa, South America, everywhere.
Josh Robb:
Yeah. I mean, the concept of lending has been around for centuries. I mean, it’s not-
Austin Wilson:
It’s thousands, thousands of years.
Josh Robb:
I mean, it’s not a new concept for governments to do this, for companies to do this. I mean, the concept of, hey, can I borrow some money because I think I can use it to grow, to utilize for some opportunity I have, and I will compensate you for letting me do that.
Austin Wilson:
So, essentially, if a company can go out and borrow money very cheaply, even if they don’t need it right now, they’re often going out and borrowing it because you can borrow at 1, 2%. It’s just dirt cheap. So, they’re just going to take out all of the, you know, to get their … What’s interesting about that is that, from a personal finance standpoint, it’s very disliked. It’s not necessarily a good thing. We tend to try and avoid it if we can, we encourage clients to do the same.
Well, from a business standpoint, if you can borrow money and then invest it into projects, into acquisitions and earn more than you’re spending on it, it’s actually really encouraged to a point. To a point. Everything is to a point, but it’s a very different world than it is in the private world.
Josh Robb:
And there’s a calculation to figure that out. Again, a lot of this comes back to just straight math.
Austin Wilson:
Yeah.
Josh Robb:
It is, if my fixed borrowing cost, which is the interest I would owe, is less than my potential return on that cash I will receive, then it’s a good project and it’s worth the debt.
Austin Wilson:
Yes.
[21:51] – Dad Joke of the Week
Josh Robb:
You’re right. And that’s what businesses do, is they say, “Hey, you know what, I’m okay having millions of dollars of debt on my books because the millions of dollars I’m putting to use and earning more than millions of dollars on that investment.” So, it all equals out to be good. You’re right. Let’s take a quick pause, wake everybody back up, and do a dad joke of the week.
Austin Wilson:
Wooo, dad joke of the week. Bring it on.
Josh Robb:
Did you know you can throw an envelope as far as you want-
Austin Wilson:
Time out. Is it envelope or envelope?
Josh Robb:
Envelope.
Austin Wilson:
Why?
Josh Robb:
Because that’s how I pronounce it.
Austin Wilson:
Okay, I’m just curious. I really want to know.
Josh Robb:
Yeah. Well, if it’s a big one, it’s an envelope. When it’s just small, it’s an envelope.
Austin Wilson:
That’s so goofy.
Josh Robb:
It is how it works. Just look it up.
Austin Wilson:
I’ve said envelope-
Josh Robb:
Where is your emphasis?
Austin Wilson:
I’ve said envelope. Where’s your emphasis?
Josh Robb:
Emphasis.
Austin Wilson:
Emphasis. I’ve said envelope my entire life, but half the world says envelope.
Josh Robb:
Envelope.
Austin Wilson:
So, I’ve just been curious.
Josh Robb:
So, if you throw one of those as far as you want, it will still be stationary.
[22:41] – Can You Lose Money on a Bond?
Austin Wilson:
Stationary? That’s good. I like it. So, Josh, the question that you’re thinking at this moment-
Josh Robb:
I’m thinking it.
Austin Wilson:
You’re thinking, so can you even lose money on a bond?
Josh Robb:
Yeah, because if they’re just paying you interest and you get your money back, you could lose that.
Austin Wilson:
How can you lose money like that?
Josh Robb:
You can lose money.
Austin Wilson:
This is a great idea.
Josh Robb:
It’s a great question.
Austin Wilson:
Okay, so considering-
Josh Robb:
We’ve cracked the code of-
Austin Wilson:
This is it. This is investing.
Josh Robb:
… eternal wealth.
Austin Wilson:
So, considering you’re loaning money and getting a fixed income stream, you may think, no, I can’t lose a dime. Right? You’d be wrong.
Josh Robb:
I would be wrong.
Austin Wilson:
You’d be wrong. So, purchase price actually has a lot to do with the total return of a bond. So, if you’re buying a bond in the market, you’re unlikely to pay exactly the issuing paramount especially if you’re buying on a secondary market.
Josh Robb:
Yes.
Austin Wilson:
So, par is the issuance price. Generally speaking, they look at it in terms of 1000 or 100 or 10,000 just to try and even it out that when they’re issued. So, if interest rates had moved up since the bond was issued, your bond is actually worth less because its interest rate is lower than the market is now. So, you may be able to buy it at a discount or, if you already held it, it’s lost value since you purchased it.
The opposite is also true. If interest rates have moved downwards since the issuance, your bond is actually worth more because its interest payment is higher than the market is now, and you may, if you’re buying it, have to pay a premium for that bond, or your bond has appreciated since you purchased it.
Josh Robb:
Yes. Pause there.
Austin Wilson:
Pause there.
Josh Robb:
So, we mentioned that you get your money back at the end.
Austin Wilson:
Yeah.
Josh Robb:
You get par back at the end.
Austin Wilson:
You get par back. You don’t get your money back.
Josh Robb:
We were intentional in that because the assumption there was you bought a new bond, a newly issued bond at par. But the idea is, so if there’s a bond out there and let’s say is trading for 110, they go in those increments.
Austin Wilson:
Yes.
Josh Robb:
Right? And I pay $110 for one bond, which is not how it works but let’s pretend it is, and then when it matures, I get $100 back.
Austin Wilson:
Right.
Josh Robb:
Now, you’re, oh, you just lost $10. Why would you do that? Well, it’s at a premium because that interest rate-
Austin Wilson:
Is higher.
Josh Robb:
… is higher. And so, my collection means that when I’m all said and done, if I’m doing my job right and look at yield to maturity, my yield was positive meaning I made money on that bond. But maybe I get $100 back and I made $30 during that time. So, my total, I made $20 when you subtract off what I didn’t get back from the initial.
Austin Wilson:
Yes. It’s not a perfect relationship.
Josh Robb:
Nope.
Austin Wilson:
It’s very tricky, and interest rate movements can be very large.
Josh Robb:
Yes.
Austin Wilson:
It’s when interest rate movements are very, very large one way or the other that you can either stand to make a lot of money in the bond market or, a lot of times, lose a lot of money in the bond market.
Most of the time, interest rate movements aren’t so large and the price, as we’ll get into a little bit, the price impact from interest rate moves is not as drastic as stock market moves. So, the volatility in the bond market is a lot lower, so it is rare that you would lose a lot of money in the bond market. It is not uncommon for you to lose a little bit of money in the bond market.
Josh Robb:
When you lose a lot of money is default and bankruptcy.
Austin Wilson:
Exactly.
Josh Robb:
Yes.
[25:47] – Convexity
Austin Wilson:
So, I hinted at it. This is Josh’s favorite part of the episode.
Josh Robb:
Complexity.
Austin Wilson:
Complexity.
Josh Robb:
Convexity.
Austin Wilson:
So, like I had just mentioned, it’s not necessarily a one-for-one relationship. If yields go up 1%, the price does not go down 1%. It’s not one for one like that. Convexity is a term that kind of explains this, and I’m going to just tip my toe into this because it’s very complicated.
Convexity is a relationship between price and a change in yield. So, the higher the yield or the longer the duration, the more sensitive to interest rate movements a bond is going to be. For example, a 30-year Treasury will move more in price on a percentage basis than a 10-year Treasury for the same interest rate move.
Josh Robb:
Yeah.
Austin Wilson:
Also, a high yield, low credit rated corporate bond is going to be a lot more sensitive to interest rate movements than a US Treasury because the higher yield on the high yield bond is through the higher risk that you have on that.
So, interest rate movements affect different bonds differently like I had just mentioned. That 1% yield change is not going to be a 1% price change. There are many, many factors that go into this, but that’s not even 50,000. That’s like a 100,000-foot view of convexity. Complexity, as Josh calls it.
Josh Robb:
Complexity for convexity. So, high level. If you were to Google the formula, because I was going to actually read the formula out loud to you. There’s just so many pieces that I don’t think I could do it. Because it’s like one over the bond price, times one, plus the yield to maturity in decimal form, squared.
Austin Wilson:
Naturally.
Josh Robb:
You take that then you take the cash flow by time over that same formula, one plus yield to maturity, not squared this time, no, to the number of years, times the maturity in years, squared, plus the T or the time frame you’re using.
Austin Wilson:
Or, to throw another wrench in it-
Josh Robb:
And all of that is summed.
Austin Wilson:
… it’s a callable bond. You’re going to use the yield to worst-
Josh Robb:
Yes, yield to worst.
Austin Wilson:
… instead of yield to maturity, so there’s a lot of options here.
Josh Robb:
It depends, yeah. It’s complexity for convexity.
Austin Wilson:
Complexity is convexity.
Josh Robb:
But the high level, like you mentioned, is just a way of putting a number to give you the ability to compare, when you’re looking at different investment pieces, to say how does this factor in-
Austin Wilson:
Absolutely.
Josh Robb:
… and which one of these is a better investment for what I’m trying to do?
Austin Wilson:
Yeah, it’s really like, which one is at most risk for interest rate movements?
Josh Robb:
Yes.
Austin Wilson:
That’s really the way to look at it.
Josh Robb:
Yes.
Austin Wilson:
So, if you have, yeah, higher convexity means it’s going to be more impacted-
Josh Robb:
Yes, and we better see a higher yield-
Austin Wilson:
Exactly.
Josh Robb:
… to make that one a better choice-
Austin Wilson:
Absolutely.
Josh Robb:
… than something else. Okay.
Austin Wilson:
So, numbers are my jam. We know this. We talk about them weekly.
Josh Robb:
Oh, yeah.
[28:41] – General Performance of Bonds
Austin Wilson:
Let’s talk about performance for bonds in general, and then we’re going to compare bonds to stocks.
Josh Robb:
Okay.
Austin Wilson:
Okay? So, this is from a great NYU professor’s analysis and well respected. I’m not going to name him because he is just as smart. You know who he is.
Josh Robb:
I do not know who he is.
Austin Wilson:
I can’t really pronounce his last name that’s why I don’t want to say it.
Josh Robb:
That’s why you don’t want to say it.
Austin Wilson:
That’s right.
Josh Robb:
I can’t either, so you’re all right.
Austin Wilson:
Aswath Damodaran.
Josh Robb:
That’s close enough.
Austin Wilson:
That’s got to be close enough.
Josh Robb:
Yeah, I’m sure it’s exactly right.
Austin Wilson:
He’s so smart. He’s like the valuation guru of the world.
Josh Robb:
I think you’re on a first name basis-
Austin Wilson:
We are.
Josh Robb:
-with him anyway, so.
Austin Wilson:
Well, I prefer his first name.
Josh Robb:
Yes.
Austin Wilson:
Yeah. Okay, so, anyway, looking back all the way to 1928, so big data set we’re talking about here, all the way through the end of last year. So, end of 2020.
Josh Robb:
Okay.
Austin Wilson:
So, at three months T-bill, really short-term bond has returned annually 3.36%. Annually.
Josh Robb:
Okay.
Austin Wilson:
So, really short-term bond, 3.36% annually. Ten-year treasuries have returned 5.21% annually. Now, because you’re locking up your money longer, you get compensated in terms of more returns.
Josh Robb:
Remit to 10 years, yes.
Austin Wilson:
So, looking at a BAA rated corporate bond-
Josh Robb:
So, the lower end.
Austin Wilson:
Yes.
Josh Robb:
But not the low, low.
Austin Wilson:
But not the low, low.
Josh Robb:
Lower.
Austin Wilson:
It has returned 7.25%. So, again, annually. Now, that’s more risk and more return.
Josh Robb:
Yes.
Austin Wilson:
Continuing the theme of more risk for more return, the S&P 500 total returns, that includes dividends, over that same time period, 1928 to 2020, has returned 11.64% annually.
Josh Robb:
Wow.
Austin Wilson:
It’s a big difference.
Josh Robb:
Yeah, so you go three, just over three and a third, 5%, 7%, and then over 11.5%.
Austin Wilson:
Exactly.
Josh Robb:
And, again, the volatility, you’re getting paid for-
Austin Wilson:
For risk.
Josh Robb:
… taking the risk on for more potential for returns.
Austin Wilson:
It doesn’t even sound that big of a difference until you put dollar terms by it. So, let me check this.
Josh Robb:
He got sheet of paper for me.
Austin Wilson:
I got a sheet of paper.
Josh Robb:
Sheet of paper.
Austin Wilson:
Okay, so Josh-
Josh Robb:
Yes.
Austin Wilson:
… say you put-
Josh Robb:
Hypothetical.
Austin Wilson:
… a $100 into a three-month T bill in 1928.
Josh Robb:
Yes, when I was negative 400 years old, yeah.
Austin Wilson:
Yeah, the year before you were born. So, you put $100 into a three-month T-bill in 1928. What is it-
Josh Robb:
And I said, “Let it ride.”
Austin Wilson:
Let it ride.
Josh Robb:
For more than three months.
Austin Wilson:
Then keep reinvesting. So, what is that going to be worth today?
Josh Robb:
Ah, 3.36% annually. You already told me. In dollar terms, though.
Austin Wilson:
In dollar terms, that $100 has turned into $2081.
Josh Robb:
Boom. Retirement money.
Austin Wilson:
Retirement money. Okay, so suppose you take that same $100 and you put it into 10-year treasuries.
Josh Robb:
Okay, 10 years rolling.
Austin Wilson:
Since 1928. Rolling, yeah. That same $100 has turned into $8920.
Josh Robb:
Boom.
Austin Wilson:
Okay?
Josh Robb:
4x that.
Austin Wilson:
So, now we’re going to take that same $100 and we’re going to invest 1928 into corporate bond that we had just mentioned. That $100 is $53,736.
Josh Robb:
Whoo.
Austin Wilson:
We’re getting somewhere, right?
Josh Robb:
Here we go.
Austin Wilson:
Fifty-three thousand, that’s your number to remember in your head.
Josh Robb:
Fifty-three thousand is in my head.
Austin Wilson:
Or, Josh, in 1928, which wasn’t great timing, by the way.
Josh Robb:
No, things were happening.
Austin Wilson:
Yeah, things were getting pretty good before they got really bad.
Josh Robb:
Yes.
Austin Wilson:
So, in 1928 you put your $100 into an S&P 500 Index Fund and reinvested your dividends.
Josh Robb:
Okay.
Austin Wilson:
Okay?
Josh Robb:
And let it ride.
Austin Wilson:
And let it ride. You never touched it. Your $100 investment in 1928 is now worth $592,868.
Josh Robb:
Oh, wow.
Austin Wilson:
That’s a big difference.
Josh Robb:
Between 53. The most of our scenario.
Austin Wilson:
The most aggressive bond-
Josh Robb:
The most aggressive bond that people get.
Austin Wilson:
… 70%.
Josh Robb:
You’re getting 53,000 as opposed to 500,000-
Austin Wilson:
592, 593-
Josh Robb:
Yeah, almost 600,000, yeah. Crazy.
Austin Wilson:
So, that’s how it gets crazy. So, let’s look at a little bit closer the time periods here, 1971 to 2020. So, you’re looking at 50 years there. Three month T-bill, 4.51% annually, 10-year treasuries, 7.29% annually, corporate bond 9.55% annually, S&P 500 total return 12.18% annually.
Josh Robb:
A little bit higher-
Austin Wilson:
A little bit higher.
Josh Robb:
… for that timeframe.
Austin Wilson:
Now, let’s bring it really close to home. So, we’re looking at the last decade, so 2011 to 2022. Ten years. Three month T-bill, 0.51% annually.
Josh Robb:
Oh, man.
Austin Wilson:
Ten-year treasury, 4.64% annually, corporate bonds 7.44% annually, S&P 500 14.34% annually.
Josh Robb:
Oh, wow.
Austin Wilson:
Big differences.
Josh Robb:
We talk about this a lot, and we didn’t really touch on it because bonds, again, there’s a lot of complexity to it all. Not convexity, complexity to the bonds is what’s called a yield curve. What you saw here was, in the short term, having a half percent annually for the three-month and still 7.4% for the corporate bond, or even just the 4.6 for the 10-year. That curve is pretty wide.
Austin Wilson:
Pretty steep.
Josh Robb:
Pretty steep. And when you look at the longer term, they’re a little more narrow. It’s not quite as steep because you get three, then five then seven. So, yeah, that’s telling me what’s happened recently in interest rates, and especially on the short end, that you’re really losing a lot of that yield in return potential.
[34:27] – Why Would You Want to Own Bonds?
Austin Wilson:
Right. And since the 80s really, yields in the United States, and around the world, but more specifically talking about the United States, have been not down all the time, but generally the downward trend has been persistent for 40 years.
So, as we can see, bond performance has been much less favorable than stocks over time. So, Josh, the question in my mind is why someone would want to own the dang things? Why would you want to own bonds?
Josh Robb:
Yeah, because if you look at return, and we didn’t mention this, those were total return numbers. Real return is after inflation.
Austin Wilson:
Correct. And I have inflation figures if you want.
Josh Robb:
You have those in there.
Austin Wilson:
So, on average, from 1928 to 2020, you averaged to 3.02% inflation annually. From ’71 to ’20 at 3.91, and from 2011 to 2020 at 1.78.
Josh Robb:
Okay, so let’s just look at the longest one there.
Austin Wilson:
Yeah, so take-
Josh Robb:
So, 3%, rounded to 3% for inflation. Treasure build, you had a real return of about 0.3%.
Austin Wilson:
0.3%, yeah.
Josh Robb:
0.36% annually. Treasury, you had a 2% return; corporate bonds, you had a 5% return; and stocks you had a 9% return. So there, you see your real return, your growth of your money after accounting for inflation, the difference there. If you look at that shorter, the last 10 years, you’re losing money because you had a half percent for the T bill and you had a 1% inflation, right? Was that the number, one?
Austin Wilson:
Two.
Josh Robb:
Okay, 2% inflation. So yeah, you lost 1-1/2% there.
Austin Wilson:
You only made 2% on 10-year Treasuries.
Josh Robb:
Yes. And corporate bonds, you’re at 5 and the S&P, you still have a 12% return. So, why? You ask me why? Is it’s not for the long-term growth. It’s, like we mentioned before, volatility dampener.
Austin Wilson:
Right.
Josh Robb:
It reduces your short-term volatility. And so, yeah, why would you want to hold it? The reason is, is I’m uncomfortable or unable to maintain my equity exposure, experiencing the full volatility of the market.
Austin Wilson:
Right. Yeah, because on paper 100% equities.
Josh Robb:
Yes.
Austin Wilson:
That’s just the mathematical answer.
Josh Robb:
Yes, if you just do math.
Austin Wilson:
If we lived in a perfect world where emotions, where plans, where lives were not in our-
Josh Robb:
Urgencies didn’t show up.
Austin Wilson:
… in your brain. Yeah, exactly, then 100% equity is for everyone all the time. Why do you need a bond? But we don’t live in that world.
Josh Robb:
No, we don’t.
Austin Wilson:
We don’t live in that world. So, yeah, bonds serve as a way to bring down the volatility of the portfolio. So, when you combine stocks’ high volatility with bonds’ low volatility, or often negatively correlated volatility, you often get a level that most people can be comfortable with. So, you’re never going to have zero volatility unless you’re in trash. I mean, cash.
Josh Robb:
Which is?
Austin Wilson:
Cash is trash.
Josh Robb:
Yes. Right now.
Austin Wilson:
Right. But you can rein in the swings to levels that people can sleep at night with.
Josh Robb:
From a financial advisor world, there’s an efficient frontier, meaning that there’s an asset allocation, there’s an investment group that you put together that gives you an optimal return for your goals and for your tolerance. In other words, increasing your exposure or decreasing does not provide you any return on top of what you’re getting for the volatility you’re achieving.
Austin Wilson:
Right.
Josh Robb:
So, there’s this efficiency where you say, you know what, maybe for this person, based on their goals, what they’re trying to do and their risk tolerance, 60-40, 70-30, 80-20. Who knows where it is? But there’s some efficiency where you say this is the optimal way of getting the most return with matching the volatility needed and required for it.
Austin Wilson:
Yeah, exactly. So, a perfect financial plan that allows people to rest easy and still meet their investment goals that include growth. So, for the most growth, obviously the more stocks, then therefore, volatility you can handle, the better off you’re going to be. But bonds are added to bring the volatility level to where it’s needed for comfort.
Josh Robb:
Yeah. And then, again, the other factor is what type of income do I need? If I need tax-free income, then there are municipal bonds. Like you said, there are other reasons maybe why you need certain bonds in certain situations for what you’re trying to achieve tax wise.
Austin Wilson:
That’s right. But proofs in the pudding.
Josh Robb:
Yes.
Austin Wilson:
Proof is in the … Hmm, I could go for a cup of little snack pack, little chocolate snack pack.
Josh Robb:
That’s so good.
Austin Wilson:
That would be pretty good. I like tapioca.
Josh Robb:
Ugh, gross.
Austin Wilson:
So, let’s think about 2008. Terrible year for the markets, right? Global financial crisis, housing bubble. Bad, bad, bad. Not fun. Large cup US stocks. They were down 37% for the year. Now, that’s for the year. They were down more at the bottom, but for the full calendar year down 37%. Emerging market stocks down 53%, small caps down 34, and international develop down 43. It was pretty bloody in there.
Josh Robb:
It was rough.
Austin Wilson:
Right?
Josh Robb:
It was rough.
Austin Wilson:
So, all these stock market carnage made bonds attractive, right? Bonds were actually up 5% for the year. Now, there were puts and takes in the middle, but for the year, up 5%. So, suppose you have a well-diversified portfolio with US, large and small caps, international develop, EM stocks, even 25% in bonds. While large cap stocks were down 37%, you were only down 25, and that’s only 25% you’re buying bonds there. And the more bonds you had at that point, the better relative to equities you did in that environment.
Now, we need to keep in mind that things turn around quickly. So, in 2009, having that same allocation would have generated a 25% return. Because of the way it works, it still wouldn’t quite been back to breakeven but a lot closer than an all-equity portfolio prior to that. But large cap US stocks, they were up 27, emerging market stocks up 79, international develop stocks up 33, and small caps up 27.
So, the way I like to think of it, fixed income is a parachute when the stock market is falling, but it’s an anchor when the stock market is rallying.
Josh Robb:
Oh, good word pictures there.
Austin Wilson:
I just made that up today, Josh.
Josh Robb:
That’s perfect. That’s perfect.
[40:01] – Inflation
Austin Wilson:
So, we hit on a little bit earlier when we’re talking about TIPS. Let’s talk about inflation.
Josh Robb:
You have some TIPS for me?
Austin Wilson:
I have some TIPS for you on inflation. So, inflation is a real risk when it comes to fixed income because of the nature of fixed income being fixed, unless you’re talking about TIPS.
So, bonds, collectively known as the fixed income asset class, you’re getting a steady income stream from loaning your money. Where this becomes inconvenient is when retirees have a lot of fixed income and then inflation occurs in the economy. So, your income stream isn’t changing, but the cost of things are going up. So, you have less and less purchasing power, less and less money leftover, less and less freedom.
TIPS can help with this. You get additional income adjusted to inflation in addition to the coupon. That’s one way. But stocks are really the only long-term solution from growing income especially if you look at a dividend growth focus. You need income? Buy a stock that grows its dividend. Oftentimes, you can find mature but still growing companies that increase their dividends 10% per year. That’s a rule that we like, called the 10-10 rule.
Josh Robb:
That is a rule of 72.
Austin Wilson:
That is a great rule too.
Josh Robb:
It’s a formula or a calculation to tell you how often your interest, your return, whatever percent you’re trying to calculate will double. You take that percentage and divide it into 72 and you get your number.
Austin Wilson:
Yeah, so o so
Josh Robb:
Ten percent divided by 72, 7.2.
Austin Wilson:
Seven years.
Josh Robb:
7.2 years, your income-
Austin Wilson:
Doubles.
[42:09] – Sequence of Return Risk
Josh Robb:
… is going to double. So, that’s a good way of looking at it. It’s a great solution. You know, one thing that we talked about in this whole thing factors into it is bonds reducing volatility, right? And for some people, that’s just the need to have an allocation. For retirees or people getting close to retirement, that is huge because when you make a big transition and you start drawing from your portfolio, what happens in the market in those early years of retirement is huge. There’s a thing that’s called sequence of return risk, and what that means high level is that the order of your returns, because we know the market doesn’t give you a flat return every year. You’ll get 6% per year.
Austin Wilson:
That would be called fixed income.
Josh Robb:
That would be fixed. But in real life, even with a diversified portfolio, you get ups and downs, and those first handful of years are crucial for the long-term success of a retiree. If you have bad years early on, it is harder to recover from than if you had those same bad years in the middle or near the end of your retirement. Reason for that is if you are retiring and the market is down and you have to start drawing for the portfolio, you’re taking money out at a lower starting point and you make it harder for that to recover back up since you’re taking withdrawals out of that portfolio. So, sequence of returns matters. So, sometimes having some fixed income exposure heading into retirement helps alleviate the pressure on your growing piece of your portfolio, the equities, and allows you to then let those recover if there is a downturn early on. So, we’re putting a bear market fund-
Austin Wilson:
That’s what I was … What do you call it?
Josh Robb:
We call it a bear market fund in the sense that if the stock market is down, don’t touch it. Draw out of this piece that is negatively correlated, usually, or at least very less impacted by those type of movements and live off of that and let that equity exposure recover before you start drawing from it.
Austin Wilson:
Yes.
Josh Robb:
That’s what it is.
[43:43] – How Could You Invest in Bonds?
Austin Wilson:
So, sequence of returns. Yes, very important at that late working early retirement phase of life. So, you might ask me, Austin, how could I invest in bonds?
Josh Robb:
How could you do that?
Austin Wilson:
So, first of all, you can go buy individual bonds.
Josh Robb:
Yes.
Austin Wilson:
You can buy individual treasuries, munis, corporate bonds, whatever you want to buy. You can do that, and that is a … It’s kind of a job because the bonds mature at different times. Depending on how you want the coupons, payments to come in and the maturities to line up, you can make a whole fancy spreadsheet out if you want.
Josh Robb:
You could.
Austin Wilson:
As well as the tax situation is very different. There’s a lot to keep track of there. So, a lot of-
Josh Robb:
Complexity.
Austin Wilson:
Some people do it that way. A lot of people choose to do it nowadays through ETFs, and we’ve talked about those before. We have an episode comparing ETFs and mutual funds. If you have any questions, we’ll link that in the show notes. But one common one is the iShares Barclays US Aggregate Bond ETF, ticker AGG. The most common one is the Aggregate-
Josh Robb:
Is the Aggregate bond.
Austin Wilson:
Yeah. So, it’s got a little bit of every kind. There’s treasuries, there’s munis, there’s corporates, there’s everything. There’s all kinds of stuff in different weightings, but that is a way that a lot of people get exposure to that. Another one, PIMCO is a mutual fund company. They are the fixed income experts, at least around here.
Josh Robb:
That’s their expertise there.
Austin Wilson:
They know their stuff. They have a PIMCO active bond ETF, Ticker BOND. They must have got that one early.
Josh Robb:
They grabbed that.
Austin Wilson:
Yeah. So, they got that one, they roll with it. They actively manage and actively manage bond portfolio. Another one is an iShare’s National Muni Bond ETF Ticker MUB, if you would like the tax free income portion of that. Alternatively, mutual funds are way you could get into this theme. The Vanguard Intermediate Short-Term Investment Grade Fund, the VFICX. Vanguard typically very cheap, good way to get exposure there. DoubleLine Total Return. DoubleLine, another great bond company, bond management company. DLTNX is the ticker there.
The Invesco. It used to be Oppenheimer Senior Floating Rate Fund if you’re looking at floating rate exposures. If you want to ride interest rates rising or whatever.
Josh Robb:
Or ride them when they fall.
[45:53] – Should You Invest in Bonds?
Austin Wilson:
Then you’re going to go down. Yeah, that’s when you don’t do good. OOSYX is that one. So, I’m not saying any of those are recommendations. Always, every situation, talk to your advisor. If you don’t have one, hey, give us a call. We are happy to talk to you about your financial situation. You can also check out the Invest With Us tab on our website. So, Josh, the question then is should you invest in bonds?
Josh Robb:
Well …
Austin Wilson:
And we kind of just answered it, but-
Josh Robb:
It depends.
Austin Wilson:
I don’t think we can say it too much.
Josh Robb:
Yes. It really depends on what your long-term goals are and what your volatility acceptance is. How much can I experience without reacting negatively to my portfolio determines what your asset allocation should be. And also, again, depending on where you’re at in your career, there may be some times to have some extra fixed income exposure to eliminate that sequence of return risk as you head into retirement. So, as always, what should you do?
Austin Wilson:
Yeah, talk to your advisor.
Josh Robb:
Talk to your advisor.
Austin Wilson:
So, some general rule of thumbs for asset allocation as it relates to stocks and bonds. Generally speaking, if you can stomach it based on your personal volatility-
Josh Robb:
Yeah, tolerance.
Austin Wilson:
… 100% equities earlier in your career is going to give you the best chance of good growing money over time. Then, as you get closer to that retirement point, as Josh had kind of mentioned, not putting any numbers on it, but you can generally start adding in a little fixed income exposure to take the sequence of return risk down. And then, actually a lot of people don’t think about this, but as you’re in retirement and you get comfortably into it for a while, you can actually start adding more stock exposure because you’ve taken some of the sequence of return risk from the front end out. You can just focus on growing and giving. That’s a pretty cool thing.
Josh Robb:
Yeah. I think, high level, there is no perfect asset allocation. There’s not one out there that says this is the ideal way.
Austin Wilson:
A hundred percent Bitcoin.
Josh Robb:
Maybe that is the perfect allocation. The ideal is you need to know what your goals are and what’s the highest chance to meet those goals, and that’s the allocation, as long as you can stomach it, that you should be targeting.
[47:42] – The 60-40 Rule
Austin Wilson:
Right. So, Josh, there’s this term that I had heard and is industry standard, 60-40. 60-40 portfolio is the perfect balance of stocks and bonds forever. You never need to change it, you never need to touch it. Is that true?
Josh Robb:
So that’s what’s referred to as a balanced portfolio?
Austin Wilson:
Yeah.
Josh Robb:
Auto retirement planning is based off of that type of asset allocation historically. The problem is, like we just showed in your numbers, interest rates are at all-time low. And the anticipation is we’re going to be low interest rates for a while. We’re not going to be seeing those high interest rates we saw in the prior decades.
So, that 60-40 rule is actually being relooked at and they’re recommending a higher equity exposure to get the same results of a 60-40 portfolio you used to get because interest rates are not providing their returns into that equation like they used to.
Austin Wilson:
So, it’s like 70-30 is the 60-40 now?
Josh Robb:
That’s kind of the general consensus, 70, 75. The reason is you’re just offsetting what you’re missing out on from those interest payments you were getting.
Austin Wilson:
Yeah. Another reason that that shift is occurring is low interest rates are a boost for stocks.
Josh Robb:
Yes.
Austin Wilson:
Because they make stocks more attractive, they make the valuations of stocks more attractive, and they make bonds not attractive.
Josh Robb:
Right.
Austin Wilson:
That’s why that shift is occurring. And like we’ve mentioned before, that shift has been occurring for 40 years. We’ve been working towards this towards where we’re at now. Wow, bonds. Can you believe we just spent a lot of time on bonds? Doing it again sometime?
Josh Robb:
I had so much fun.
Austin Wilson:
My favorite episode ever. Not the third worst, maybe the third best.
Josh Robb:
That’s right.
Austin Wilson:
All right, well two reminders. Number one, it’s not too late to enter our second half stock draft competition. You would start with a fresh 100,000-
Josh Robb:
You’d be beating me, still.
Austin Wilson:
… you’d still be beating Josh. And you can buy bond ETFs and stuff-
Josh Robb:
You can.
Austin Wilson:
You sure can.
Josh Robb:
Yeah, do it.
Austin Wilson:
Yeah, it’s your choice if you want to do that for the next, until December 31st. As always, number two, check out our free gift to you. It’s a brief list of eight principles of timeless investing, overarching investment themes, and to keep you on track to meet your long term goals. It’s free on our website. Check it out. Josh, how can people help us grow this podcast?
Josh Robb:
Yeah, make sure you subscribe. That way, you get our most recent episode sent directly to you every Thursday, and leave a review on Apple podcasts. And if you have any questions about bonds, shoot us an email.
Austin Wilson:
Shoot Josh an email.
Josh Robb:
Yes, I would love to respond to it, at hello@investeddads.com. Or if you have a cool topic you’d love us to cover, we always love doing that. Those are our favorite topics to do, knowing someone is interested in it. And then also, if you know somebody who’s in love madly with bonds, share this episode with them. I’m sure they would appreciate it.
Austin Wilson:
Sounds good. Well, until next Thursday. Have a great week.
Josh Robb:
All right, talk to you later. Bye.
Outro:
Thank you for listening to The Invested Dads Podcast. This episode has ended, but your journey towards a better financial future doesn’t have to. Head over to the investeddads.com to access all the links and resources mentioned in today’s show. If you enjoyed this episode, and we had a positive impact on your life, leave us a review. Click subscribe and don’t miss the next episode. Josh Robb and Austin Wilson work for Hixon Zuercher Capital Management. All opinions expressed by Josh, Austin or any podcast guests are solely their own opinions and do not reflect the opinions of Hixon Zuercher Capital Management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Hixon Zuercher Capital Management may maintain positions in the securities discussed in this podcast. There is no guarantee that the statements opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic their performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.
