Middle-Class Investing 106: Using Bonds to Create Safe Cash Flow

As we start understanding assets, we see value in safely accumulating more things that produce money.

Just because we are middle-class doesn’t mean we can’t have access to some significant investment products.

Treasury bonds are the safest investment instruments we can buy; we can purchase them directly from the US Treasury (like large institutions).

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Welcome back to the Middle-Class Investing series (101, 102, 103, 104, 105), where we go from credit cards to cash flow.

Why are treasuries vital to our portfolio? Bonds are simple to understand. You know exactly what you will earn if you buy them and hold them to maturity.

We can use these predictable fixed-income payments to dabble into other investments later. But first, we must understand the nature of bonds. 

Bonds 101. Bonds are constantly competing with each other in the bond markets. The first thing bonds compete with is the Federal Funds Rate (FFR).

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The Federal Reserve sets the FFR depending on certain economic factors, mainly the employment rate and inflation. 

The Federal Funds rate determines how much banks pay to borrow money. From here, the rate also influences rates for credit cards, certificates of deposit, savings accounts, mortgages, auto loans, and bonds.

The FFR affects the coupon interest rate on our Treasury Bills, Notes, and Bonds. For example, if the FFR is 3%, the interest rate on my 30-Year Bond maybe 5%.

However, we buy our Treasury Bonds at auction. We don’t see the auction; however, it affects our yield. For example, I may buy a 5% bond at a discount. Therefore, my effective interest rate could be 5.5%.

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Tracking bond interest rates. We want to follow the interest rates (here) on Treasuries because it will lead to better returns. Our goal is to lock in some excellent yields for a long time.

I consider 4% yield a reasonable rate on a 30-Year Treasury. Yes, inflation may spike over the next 30 years, but historically, 4-6% is an excellent long-term rate. 

You must decide what interest rates you consider suitable for holding your long-term bonds. Can you imagine having 12% bonds from the 1980s?

Bonds create safe cash flow. So why bonds and not certificates of deposits? Holding 30-year bonds can help us make a mountain of secure cash flow.

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Bonds pay semi-annually. If you buy bonds year-round, you will receive payments in February and August and then in May and November.

You can keep stacking your bond income to create recurring cash flow that you can trust. Fixed income is terrific for building generational wealth.

There is one more step. As fun as it is to spend passive income from our bonds, there is one more step—high-yield bond reinvestment.

Bond traders use multiple calculations to determine the value of bonds. One factor to consider is bond reinvestment—using coupon payments to buy more securities at the same interest rate.

However, what if we instead used the payments to buy high-yield products like preferred shares and closed-end funds?

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We can turn our 4% interest payments into monthly-paying dividends yielding 10%. High-yield bond reinvestment is a great way to juice our returns safely. 

Selling your bonds. I am a buy-and-hold bond investor. I have never sold a Treasury bond. However, there may be times when it is advantageous to sell some bonds.

Think of bonds like fashion design. Sometimes there are hot designs that fade over time. However, they make a roaring comeback and become all the rage.

Bonds have a similar ebb and flow. For example, I have a couple of 30-Year bonds that yield 4%. Currently, the going rate is around 4% for bonds.

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However, what happens if the FFR suddenly drops to 0%? That turn of events could result in 30-Year bonds yielding 2% or less.

Now, my 4% bonds look like rock stars. Bond investors will pay a premium to obtain my 4% bonds. Instead of selling at par (100), they could sell for 120.

I wouldn’t buy bonds with the express intent to sell them. However, there may be times when it just makes sense to sell at a massive profit. 

You can roll this new cash flow into higher-yielding products. Bonds are not as emotional as stocks; thus, you should slowly follow interest rates throughout the economy.

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Bonds outside of Treasuries. The bond market is much larger than the stock market. However, it is tough to access bonds outside of Treasuries.

Some types of bonds are municipals, corporates, junk, and mortgages. The best way to access these types of bonds is through bond exchange-traded funds (ETFs).

These Bond ETFs trade on the stock market, which means they are subject to being emotionally traded. Bond ETFs are nice to have but always go straight to the source (US Treasury via TreasuryDirect).

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As long as you don’t sell your bonds, you will redeem them at face value at maturity. You won’t lose money. You can’t say the same about Bond ETFs.

Conclusion. Bonds play a vital role in getting you the safe cash flow you desire. Ensure you are buying bonds that meet your interest rate threshold.

I bought a lot of 30-year bonds during the pandemic. These bonds have interest rates between 1.3% to 1.8%. They are garbage, but I was buying them on auto-pilot. Dollar-cost averaging with bonds is not wise.

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Stick to buying bonds over 4%, and you should do well over 30 years. If the Federal Funds rate drops to 0% or 1%, it may be an excellent time to sell some of your positions. 

Bonds are far less emotional than stocks. You can predict most of what is happening to a small degree. Bond markets are said to be much more intelligent than stock markets, so it is good to follow bonds.

I recommend reading “The Bond Book” to get an in-depth look at how bonds can change your life. They have helped me build some decent, safe cash flow. I then can reinvest into my favorite type of passive income, high-yield dividends. Good Luck!

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