Human nature makes us do funny things, especially when it comes to money. Every human exhibits a different behavior regarding money.
Some people love to place spectacular bets at a casino, lottery, or sporting event. Others keep all of their money in a savings account, earning 0.1%.
The key to winning with money is understanding your own history, attitudes, and beliefs. Once you do that, you have a much better chance of making investments that allow you to sleep well at night.
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Exploiting your risk tolerance. Once you understand your money habits and where they come from, you can start making investments that suit your temperament.
The first step is determining how to diversify your larger portfolio. Some investment choices at the larger scale are real estate, businesses, paper assets, cryptocurrencies, commodities, and content creation (royalties).
Under the paper assets tab, we have high-yield savings accounts, certificates of deposit, money market funds, treasury bonds, index funds, dividends stocks, closed-end funds, etc.
Today, I want to dive deeper into the world of bonds. Why are bonds important to your portfolio? Should you invest in bonds in your 20s or 70s? Should you stay 100% invested in the stock market? There are lots of questions regarding bonds, so let’s jump in.
What are bonds? Bonds fall under the term “fixed-income.” They originate from a government or corporation and have a set duration, payment schedule, and interest rate.
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If you want to learn more about bonds at all levels, I highly recommend reading “The Bond Bond.” This is a quintessential guide to bonds that every investor must read.
Inside the “bonds” category, there are various levels of risk. The typical ranking from least risky to most risky is treasury bonds, mortgage-backed securities, municipal bonds, corporate bonds, and sub-investment grade bonds (junk bonds).
The power of US Treasuries. US Treasuries are the most accessible to the average person out of all the types of bonds. If you have a social security number, you can create a TreasuryDirect.gov account and purchase bonds today.
Treasuries come in different flavors, including Treasury Bills, Treasury Notes, Treasury Bonds, Series “I” Savings Bonds, Series “EE” Saving Bonds, and Treasury Inflation Protected Securities (TIPS). Please read the linked articles for more on each type of Treasury product.
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But why are Treasuries important to your investment portfolio? Indeed, buying Nivida (NVDA) or Tesla (TSLA) is sexier than owning Treasuries.
Treasuries (and bonds in general) protect your principal and income during hard times. The best way to invest in bonds is to hold them for the entire duration.
However, based on your bond’s interest rate, you can sell your bond for a profit. Selling bonds is not preferred for non-bond dealers, but it is possible.
An example of bonds in action. Let’s examine a scenario where you have $200,000 invested in 30-year Treasury Bonds (at 4.5%) and $200,000 in the S&P 500 Index Fund (SPY).
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After 30 years, your bond has produced $270,000 in income, plus the original principal. You would have a total of $470,000 in your account.
Using the standard 10% growth of SPY, after 30 years, you would have $3.5 million in your brokerage account or individual retirement account.
However, this doesn’t include if you reinvested your bond interest payments at a higher rate. Let’s say you invested your $9,000 annual income into a 10% yielding closed-end fund. That would give you $1.6 million on top of your $200,000 principal.
However, the real reason to invest in bonds is to protect your principal during a market downturn. Nothing is preventing your SPY index funds from taking a 50% haircut. If you depend on selling shares to generate income during retirement, you’ll be in a tight spot during a recession.
Overcoming Depression through Recession
You invest in bonds to prevent yourself from selling shares when the market is in a downturn, correction, or recession.
Remember that bond prices can also increase. If you have bonds at 4.5% and the Federal Reserve lowers rates to 1.5%, you can make a nice profit if you sell them.
Bonds vs. stocks. The old adage says that bond prices and stock prices have an inverse relationship. When stocks get scary, people move to bonds. When stocks are rising, people move away from bonds.
Recently, the government has provided both markets with a lot of external support (manipulation). So, the jury’s still out on the relationship. It’s best to keep an eye on both markets.
My personal rule of thumb is to purchase 30-year Treasury Bonds above 4% yields. The average annual inflation over the last 100 years is 3.3%. Therefore, I can at least keep pace with inflation at 4%.
Mortgage-Backed Securities vs. Treasury Bonds
Also, if I reinvest my bond payments at 10% yields, I stand to outpace inflation by a large margin while protecting my initial principal. You must decide what numbers work best for you.
Converting to bonds. As you age, preserving your capital becomes a much higher priority. Usually, people want to grow their wealth in their 20s and 30s.
- Bond Investing in Your 20s
- Bond Investing in Your 30s
- Bond Investing in Your 40s
- Bond Investing in Your 50s
- Bond Investing in Your 60s
- Bond Investing in Your 70s
As they move into their 40s and 50s, they may want a 50% split between stocks and bonds. In their 60s and 70s, they may want a 70% bond allocation.
However, these numbers can change with each scenario. You may feel more comfortable staying 80% in stocks if you have a pension or paid-off house.
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If you have no pension and a little social security, you may be 90% in bonds and 10% in stocks. Again, the key is knowing your money mindset and your actual situation.
I have a military pension, so I will hold around 20% of the bonds for the duration. As long as I live entirely on my pension, I can withstand a market downturn.
Other types of bonds. Many different types of bonds have higher yields than Treasuries. Of course, you assume more risk for these bonds.
For the average investor, vetting bond funds that sell on the open market is best. You can take the time to find individual bonds or invest in bond funds run by professionals.
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You can find active or passively managed funds, ones that use leverage or don’t, and an unlimited number of funds that can help you balance your portfolio.
However, bond funds cannot guarantee your principal. Conversely, it is much easier to sell bond fund shares than an individual bond on the open market.
My favorite bond funds are PIMCO closed-end funds (PDI, PDO, PTY). They are high-risk high-reward, and the managers at PIMCO are some of the best in the business.
I don’t use these to protect capital, only to generate a high level of income. I use 30-year Treasury Bonds and Series “I” Bonds to preserve capital and inflation protection.
Take The Difficult Path
Conclusion. Bonds play an essential part of your portfolio. People love high-yield savings accounts and certificates of deposit. However, these rates can disappear as soon as the Federal Reserve adjusts interest rates.
With Treasuries, you can lock in some excellent rates for 1-month to 30-years. When times are good on the stock market, it’s tough to purchase bonds.
However, bonds are your best friend during a downturn. I know I loved having my treasuries during the 2020 pandemic. All my stocks were in the red, but my bonds kept producing income.
Investing in bonds requires you to understand your risk tolerance, which can only be done by understanding your money mindset. Bonds will be your favorite assets when things turn for the worse. Good Luck!
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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. All Right Reserved Military Family Investing
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