The stock market can be a dangerous minefield for beginners. The process of getting starting can be intimidating because of the absolutely absurd amount of information out there. I personally believe it is this way so that most people will have to rely on pricey financial advisors. But I am here today to tell you that you can invest and control your own finances throughout your lifetime. Today we are going to focus on stocks, bonds, and why you will need both on your path to financial independence. Let’s start with some quick definitions.
Stocks- Equity shares of a publicly-traded company. Stocks usually give owners voting rights inside the company. Some of these companies pay portions of their profits, which are called dividends.
Bonds- Debt repayment instruments used by companies to raise capital. Bonds do not give owners a voting right. However, they are higher on the debt repayment totem pole than stocks. That means that if the company goes under, bond owners will receive a payout before stock owners. Because of this higher safety, bonds usually pay lower interest payments. Bonds are also known as fixed-income instruments.
Electronic traded funds- ETFs hold baskets of securities. This means they can hold a basket of stocks, a basket of bonds, or a combination of both. Usually, the title of the ETF tells you what types of securities it holds. For this article, I will mainly refer to the Total Stock Market ETF (VTI) and the Long Term Bond ETF (BLV). These are my personal go-to ETFs.
Government Treasuries- It is also a good idea to invest in government bonds that do not trade on the stock exchanges. This way you have something that you can redeem that is not tied directly to the stock market. You can invest in government treasuries at the www.TreasuryDirect.gov website.
Stocks and Bonds are both ways for a company to raise capital for various needs. Bonds don’t require the company to give away ownership stakes and stocks (shares) are not guaranteed to pay dividends. Both ways have pros and cons but that is outside the scope of this article. Let’s see how stocks and bonds correlate to one another.
As I said earlier, bonds are fixed income. They are a very safe way to earn a return on your investment by being paid interest over a fixed amount of time. If you buy bonds from the government and/or strong companies, your money is almost guaranteed. If you want a higher return, you may buy bonds with a company that is in a riskier position. The general rule is that as you get older you want less of your money in the stock market and more of your money in fixed income instruments, mainly bonds.
The reasoning is that as you age you are using your investments to pay for your lifestyle. You don’t want to be fully invested, and dependent, on stocks that can be extremely volatile. If you need a fixed amount of income per month, it would be safer and more reliable to get this money from bonds. However, since bonds pay less in interest payments (2-5%), you would need a lot of money to get a high fixed income directly from them.
This is where the strategy starts to formulate. So we know that we need a lot of money invested in bonds in order to get a nice safe return and consistent payments. However, we also know that our money isn’t going to grow very quickly if invested only in bonds. We need to use stocks to grow our wealth, and then convert them to bonds, to maintain our wealth.
People usually convert their capital gains (when stock prices go up) into bonds once the stock market prices start to decline. This is why as stocks go down, prices of bonds go up. The investors may stay on the sidelines (invested in bonds) until they feel the market is safe again. As this happens the price of bonds go down (because people are selling), and stocks go up (because people are buying).
Let’s do a quick example to help drive home this point. Our trader bought into Telsa at $50 and the price is now $800. Every day he is nervous about taking his gains off the table. Traders and investors have different mindsets. Traders are looking for capital gains and investors are looking to buy long-term, appreciating assets. Most people are traders. We want to think like an investor, which means for the long-term.
Back to the example; he feels that Telsa is going to decline soon, so he takes his profits. He then moves all his money, $800 (minus taxes paid later), into our BLV bond fund. He then stays invested in BLV until he has found another viable trade for himself. Now think of this happening with all traders doing this in unison. I remember in April 2020 when the only green (positive) security I had was BLV. Everything else was red (negative). In fact, BLV was near its highest point of the year.
How do we leverage stocks and bonds as investors? I will give you my techniques. These are the techniques I use because I know my risk tolerance. You will have to use your own techniques because your risk tolerance is your own and may be different from mine.
My overall retirement plan and income strategy are based on my military retirement, my income investment portfolio, my rental income, and my business income. Stocks and bonds fall within my income investment portfolio. Inside my investment portfolio, I have high yield savings, bonds, real estate funds, and stocks.
I invest in government bonds from the TreasuryDirect website. I buy 30-year bonds every month, along with some I and EE bonds. I receive a little income from my TreasuryDirect bonds, but they are mainly there for security. I consider them like mini savings accounts. You can redeem them with only a small penalty (3-month interest) and have your money returned in 2-3 days.
Inside my stock portfolio, I buy individual stocks, real estate investment trusts, mutual funds, closed-end funds, electronic traded funds, and preferred shares. All this is to say that I am diversified, to the extreme. Some might say that I am losing out on huge gains because of my diversification, but I say good riddance. I am not investing in the stock market to make huge gains. I want my money to grow between 8-10% annually, and that is split between capital appreciation and dividends.
As you can see, I have my money working for me across many asset classes, outside of the stock market and inside the stock market. This allows me to not have to sell my stocks for capital gains. I buy VTI and BLV equally. Remember, I have bonds outside of the stock market and I buy individual stocks outside of VTI. BLV and VTI are only part of my overall stock market strategy.
As the stocks go up, I can buy more bonds because they will be at great prices. When bonds go up, that means that people are fleeing from stocks. You will literally be able to see this happening in the stock market, so there is no need to guess. On normal weeks and months, I just buy both equally. I am in it for the long term.
In a perfect world, when I am in my 60s, I will have an even split between BLV and VTI. I would be living off my dividends from BLV and watching as my VTI continued to raise. My whole goal is to buy and hold. Whether that is my businesses, real estate, or stock market investments. I want to buy and create investments for the long term.
Knowing the correlation between stocks and bonds can set you up for future success. It is one of the early indicators of where the stock market is at, and what the market is feeling. It is also part of many trends and analysis that you will learn along the way. Hopefully, this wasn’t overwhelming. Remember, that this was just my technique on how to leverage stocks and bonds. You may be in a completely different risk tolerance position.
Government Bonds may be your preferred method of investing. You may want 100% of your money invested in the stocks. It is all up to you. Be able to answer these questions for yourself. Why am I investing this way? What is my end state? Am I a trader or investor? What is my risk tolerance? What portfolio allows me to sleep well at night?
Your homework assignment, should you except it, is to go to the yahoo finance website. Pull up the 2020 charts for BLV and VTI. Screenshot the charts and put them side by side. When were stocks at their highest? When were bonds at their highest? These questions are important for your financial education and eventually your financial independence. You may one day be living entirely from your stock market investments, so it is great that you are taking an interest early on. This is how fortunes are built.
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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