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One of the most important figures in modern finance is John Bogle. He made index funds accessible to individual investors. I am really thankful for his work and you should be too!
However some of his advice on bonds is DANGEROUS, sorry #Bogleheads
//Time for a Thread//
However some of his advice on bonds is DANGEROUS, sorry #Bogleheads
//Time for a Thread//
Up until the time of his death in early 2019, RIP, Mr Bogle continued to advocate for 60% Stock and 40% Bond portfolios. Here is a video of him talking about his investing philosophy.
Contrary to conventional wisdom bonds are RISKY right now.
Let’s talk explore why
• What are Bonds?
• Basic Components of a Bond
• Bond Valuation
• How Bond Funds Work
• Bond Risks
• Bond Alternatives
Let’s talk explore why
• What are Bonds?
• Basic Components of a Bond
• Bond Valuation
• How Bond Funds Work
• Bond Risks
• Bond Alternatives
What are Bonds?
Bonds are a financial instruments that represent debt. Corporations, Governments and Municipalities issue bonds to finance projects that they would not be able to afford out of current cash flow from operations.
Bonds are a financial instruments that represent debt. Corporations, Governments and Municipalities issue bonds to finance projects that they would not be able to afford out of current cash flow from operations.
What are Bonds? (cont)
In return for money front they promise to pay back the original principal (loan amount) plus interest.
In return for money front they promise to pay back the original principal (loan amount) plus interest.
Basic Components of a Bond
• Face or Par Value: How much the bond will be worth at maturity.
• Coupon Rate: The interest rate the bond issuer will pay on the Face Value of the bond.
• Face or Par Value: How much the bond will be worth at maturity.
• Coupon Rate: The interest rate the bond issuer will pay on the Face Value of the bond.
Basic Components of a Bond (cont)
• Coupon Dates: This dictates when the bond issuer will make interest payments. These can vary, but every 6 months is typical.
• Maturity Date: When the bond issuer will pay the bondholder the face value.
• Coupon Dates: This dictates when the bond issuer will make interest payments. These can vary, but every 6 months is typical.
• Maturity Date: When the bond issuer will pay the bondholder the face value.
Bond Valuation
A bond’s price equals the value of all the future interest payments in comparison to the interest rate paid by government debt. Another way to say it is that a bond’s price is equal to the present value of its expected future cash flows.
A bond’s price equals the value of all the future interest payments in comparison to the interest rate paid by government debt. Another way to say it is that a bond’s price is equal to the present value of its expected future cash flows.
Bond Valuation (cont)
The rate of interest used to discount the bond’s cash flows is known as the yield to maturity (YTM) or the Risk Free Rate. What is the Risk Free Rate? The current assumption is that US Government Debt is the most ‘risk free’ debt you can hold.
The rate of interest used to discount the bond’s cash flows is known as the yield to maturity (YTM) or the Risk Free Rate. What is the Risk Free Rate? The current assumption is that US Government Debt is the most ‘risk free’ debt you can hold.
Bond Valuation (cont)
The rate you use will depend on the bonds duration but in general you would us a T-Bill for a bond with 1 year or less of duration a T-Note for 1-10 years of duration or a T-Bond for 10-30 years of duration
The rate you use will depend on the bonds duration but in general you would us a T-Bill for a bond with 1 year or less of duration a T-Note for 1-10 years of duration or a T-Bond for 10-30 years of duration
Bond Valuation (cont)
If you are a math nerd like me, here is the formula
C = the periodic coupon payment
y = the yield to maturity (YTM)
F = the bond’s par or face value
t = time
T = the number of periods until the bond’s maturity date
If you are a math nerd like me, here is the formula
C = the periodic coupon payment
y = the yield to maturity (YTM)
F = the bond’s par or face value
t = time
T = the number of periods until the bond’s maturity date
Bond Valuation (cont)
Since the YTM is denominator of the equation, the lower the interest rate the more the bond is worth. Conversely, as interest rates rise the less bonds are worth .
Also the longer the duration of the bond the more sensitive it is to interest rate changes.
Since the YTM is denominator of the equation, the lower the interest rate the more the bond is worth. Conversely, as interest rates rise the less bonds are worth .
Also the longer the duration of the bond the more sensitive it is to interest rate changes.
Comparing $VGSH to $VGLT you can see how much the price of long duration bonds change compared to short duration.
$VGSH Vanguard Short Term Treasury Index ETF
-Maintains an avg maturity of 1-3 yrs
$VGLT Vanguard Long Term Treasury Index ETF
-Maintains a avg maturity of 10-25 yrs
$VGSH Vanguard Short Term Treasury Index ETF
-Maintains an avg maturity of 1-3 yrs
$VGLT Vanguard Long Term Treasury Index ETF
-Maintains a avg maturity of 10-25 yrs
So how does this play out? Example
UncommonYield, Inc. Issues two bonds, a short term bond to build a new website and a long term bond to buy a new facility.
UncommonYield, Inc. Issues two bonds, a short term bond to build a new website and a long term bond to buy a new facility.
Short Term Bond
• Face or Par Value: $1,000
• Coupon Rate: 5%
• Coupon Dates: Every 6 Months
• Maturity Date: 1 Year
• Face or Par Value: $1,000
• Coupon Rate: 5%
• Coupon Dates: Every 6 Months
• Maturity Date: 1 Year
Long Term Bond
• Face or Par Value: $1,000
• Coupon Rate: 5%
• Coupon Dates: Every 6 Months
• Maturity Date: 10 Year
• Face or Par Value: $1,000
• Coupon Rate: 5%
• Coupon Dates: Every 6 Months
• Maturity Date: 10 Year
You decide to invest and interest environment rises from 5% to 6%
Short Term Bond: $990.43
Long Term Bond: $925.61
Bonds are selling at a Discount
Short Term Bond: $990.43
Long Term Bond: $925.61
Bonds are selling at a Discount
You decide to invest and interest environment falls from 5% to 4%
Short Term Bond: $1,009.71
Long Term Bond: $1,081.76
Bonds are selling at a Premium
Short Term Bond: $1,009.71
Long Term Bond: $1,081.76
Bonds are selling at a Premium
How Bond Funds Work
Like other Index Funds/ETFs they are trying to track a Bond Index of some kind. Some examples in the bond market are for example the Bloomberg Barclays U.S. Aggregate Bond Index
Like other Index Funds/ETFs they are trying to track a Bond Index of some kind. Some examples in the bond market are for example the Bloomberg Barclays U.S. Aggregate Bond Index
How Bond Funds Work (cont)
Since Bond Index/ETF are tracking a certain basket of securities they rarely reach maturity (unless they are a short duration fund). This exposes the fund to increased interest rate risk.
Since Bond Index/ETF are tracking a certain basket of securities they rarely reach maturity (unless they are a short duration fund). This exposes the fund to increased interest rate risk.
Bond Risks
o Default Risk: The bond issuer is unable to pay the debt.
o Liquidity: The bond market is more varied and less liquid than the stock market. If you purchase individual bonds you may have a hard time selling at a fair price.
o Default Risk: The bond issuer is unable to pay the debt.
o Liquidity: The bond market is more varied and less liquid than the stock market. If you purchase individual bonds you may have a hard time selling at a fair price.
Bond Risks (cont)
o Interest Rate Risk: As I discussed earlier, the value of a bond is inversely correlated (responds opposite) to interest rates. If you have a new issue bond with a coupon rate of 5% and rates jump to 6%, the bond you hold will be worth less overnight.
o Interest Rate Risk: As I discussed earlier, the value of a bond is inversely correlated (responds opposite) to interest rates. If you have a new issue bond with a coupon rate of 5% and rates jump to 6%, the bond you hold will be worth less overnight.
Bond Risks (cont)
o Tracking Risk: Since the bond market is so much more complicated and variable than the stock market it can be difficult for funds/ETF to track the index they trying to follow. Look for how closely the funds you hold track the index
o Tracking Risk: Since the bond market is so much more complicated and variable than the stock market it can be difficult for funds/ETF to track the index they trying to follow. Look for how closely the funds you hold track the index
Why are Bonds so RISKY right now?
The US T-Bill, US 10-year Treasury, and US 30 Year Treasury are the most liquid and frequently traded bonds in the world. You can see we have gone from a high in the teens in the 1980’s to close to zero today.
What does this mean?
The US T-Bill, US 10-year Treasury, and US 30 Year Treasury are the most liquid and frequently traded bonds in the world. You can see we have gone from a high in the teens in the 1980’s to close to zero today.
What does this mean?
Why are Bonds so RISKY right now? (cont)
Bond Valuations are about as high as they are going to get. Unless we see negative interest rates it is hard to see how they go higher. Here some charts from the site below
https://www.macrotrends.net/charts/interest-rates
Bond Valuations are about as high as they are going to get. Unless we see negative interest rates it is hard to see how they go higher. Here some charts from the site below
https://www.macrotrends.net/charts/interest-rates
If you don't want to lisent to me, maybe listen to @RayDalio https://twitter.com/UncommonYield/status/1371827577397116928?s=20
So now that we have established that bonds are risky, what are some alternatives that are different than stocks.
Bond Alternatives
-Buy Individual bonds and hold them to maturity. This is kind of a pain to do, but if you want to hold bonds is a good option
Bond Alternatives
-Buy Individual bonds and hold them to maturity. This is kind of a pain to do, but if you want to hold bonds is a good option
Bond Alternatives (cont)
-Short Duration Bonds are close to maturity and are not impact as much by changes in interest rates. $VGSH is a good choice.
-Short Duration Bonds are close to maturity and are not impact as much by changes in interest rates. $VGSH is a good choice.
Bond Alternatives (cont)
-Floating Rate Bond Funds go up and down with an interest index. Because of this they do not incur interest rate risk. Check out $FLOT
-Floating Rate Bond Funds go up and down with an interest index. Because of this they do not incur interest rate risk. Check out $FLOT
Bond Alternatives (cont)
-Dividend Stocks, specifically REITs and MLP, throw off tons of cashflow. If you were interest in bonds because of their yield look into dividend stocks. This guide has helped me pick the best ones https://gumroad.com/a/819074163/CSdwG
-Dividend Stocks, specifically REITs and MLP, throw off tons of cashflow. If you were interest in bonds because of their yield look into dividend stocks. This guide has helped me pick the best ones https://gumroad.com/a/819074163/CSdwG
Bond Alternatives (cont)
-You can use Options SAFELY. If you have 100 shares of a company you can sell Covered Calls and create YIELD even if there is no dividend. Here is a recent trade I made https://twitter.com/UncommonYield/status/1373599483691417605?s=20
-You can use Options SAFELY. If you have 100 shares of a company you can sell Covered Calls and create YIELD even if there is no dividend. Here is a recent trade I made https://twitter.com/UncommonYield/status/1373599483691417605?s=20
Bond Alternatives (cont)
-Covered Calls aren't the only safe Option plays. I’ve been making 1-2% per week using Cash Secured Puts. Here is a recent trade I made. https://twitter.com/UncommonYield/status/1379411984257589252?s=20
-Covered Calls aren't the only safe Option plays. I’ve been making 1-2% per week using Cash Secured Puts. Here is a recent trade I made. https://twitter.com/UncommonYield/status/1379411984257589252?s=20
Bond Alternatives (cont)
-You can make 7.4-10.51% yield on stable coins which represent CASH. If you want to learn more I wrote a thread https://twitter.com/UncommonYield/status/1377349900472582144?s=20
-You can make 7.4-10.51% yield on stable coins which represent CASH. If you want to learn more I wrote a thread https://twitter.com/UncommonYield/status/1377349900472582144?s=20
Bond Alternatives (cont)
- @CathieWood has said bitcoin may replace bonds “You think about the traditional 60/40 stock-bond portfolio, but look what’s happening to bonds right now. If we are ending a 40-year secular decline in interest rates, that asset class has done its thing..
- @CathieWood has said bitcoin may replace bonds “You think about the traditional 60/40 stock-bond portfolio, but look what’s happening to bonds right now. If we are ending a 40-year secular decline in interest rates, that asset class has done its thing..
Bond Alternatives (cont)
...What’s next? We think crypto could be the solution.” https://www.marketwatch.com/story/bitcoin-may-replace-bonds-cathie-wood-says-11614276934
...What’s next? We think crypto could be the solution.” https://www.marketwatch.com/story/bitcoin-may-replace-bonds-cathie-wood-says-11614276934
Bond Alternatives (cont)
-@GreggFoss outlined on @PeterMcCormack ‘s What Bitcion Did Podcast how #Bitcoing could act as investment insurance https://www.whatbitcoindid.com/podcast/bitcoin-as-investment-portfolio-insurance
-@GreggFoss outlined on @PeterMcCormack ‘s What Bitcion Did Podcast how #Bitcoing could act as investment insurance https://www.whatbitcoindid.com/podcast/bitcoin-as-investment-portfolio-insurance
Bond Alternatives (cont)
If you want to learn more about #bitcoin
this guide was really helpful to me. http://gumroad.com/a/615126131
If you want to learn more about #bitcoin
this guide was really helpful to me. http://gumroad.com/a/615126131
Bond Alternatives (cont)
-Unlike Bond Funds, Whole Life Insurance companies usually hold bonds until maturity. The returns are less, but if you want a stable slow growing place to put money this may work for you. https://twitter.com/UncommonYield/status/1344646102843326464?s=20
-Unlike Bond Funds, Whole Life Insurance companies usually hold bonds until maturity. The returns are less, but if you want a stable slow growing place to put money this may work for you. https://twitter.com/UncommonYield/status/1344646102843326464?s=20
So did I convince you? Are you going to stop investing in bonds? If you don’t link bonds like me are you are going
Resources (cont)
Kahn Academy Bond Basics
Kahn Academy Bond Basics
Resources (cont)
Kahn Academy Bond Valuation
Kahn Academy Bond Valuation
Resources (cont)
Bond ETF Basics
Bond ETF Basics
