219: Are Bonds A Good Investment?

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 The Invested Dads Podcast, a podcast where we take you on a journey to better your financial future. I’m Austin Wilson, Co-Portfolio Manager at Hixon Zuercher Capital Management.

Josh Robb:

And I’m Josh Robb, Director of Wealth Management at Hixon Zuercher Capital Management. Austin, how can people help us with our podcast?

Austin Wilson:

Subscribe if you’re not subscribed already. Hit that plus, follow, whatever that icon is on your podcast player, that way you get new episodes as soon as they drop. And we’d love it if you’d leave us a review on Apple Podcasts or Spotify or wherever you’re listening. That just helps us to be found by more people so we can help make a difference. Today, Josh.

Josh Robb:

Yes.

Austin Wilson:

We’re talking about bonds. It’s pretty exciting.

Josh Robb:

Yes.

Austin Wilson:

What they are, how they work, and how they fit into a portfolio.

Josh Robb:

Fitting into a portfolio … That’s an open-ended question because-

Austin Wilson:

It depends? Maybe?

 

[1:04] – What Are Bonds? 

Josh Robb:

Yes, that’s what I like to say. Bonds are an investment option. We’ve talked a little bit about the types of investments in the past. A bond is a debt instrument in that a business, corporate, or a country, through government bonds, lends out money, borrowing, and says, “Hey, I have a project I want to do. Can somebody give me $10,000, please?” I give money.

Austin Wilson:

They’re the borrower-

Josh Robb:

And I’m the lender.

Austin Wilson:

You’re the lender as the buyer.

Josh Robb:

Yes. And in doing so, they’re promising to pay me interest while they hold onto my money and use it for something.

Austin Wilson:

Or a zero coupon bond, which we can talk about later if you want.

Josh Robb:

And in return, I don’t have access to my cash. That’s why I’m wanting something for that.

Austin Wilson:

You’re giving up liquidity.

Josh Robb:

Yes. And then, when they’re done, set period of time, they give it back. Example. They say, “Hey, I have a five-year bond. I’m going to hold your money for five years. I’m going to give you 2% interest along the way. I’m going to pay it twice a year. And then, when you’re done, you’re going to get your money back.”

Austin Wilson:

Absolutely.

Josh Robb:

That’s a bond.

Austin Wilson:

Yes, you just did a great job. We’re going to have 10 points. You just answered number one. What are bonds? Well, bonds are debt securities issued by governments or corporations to raise capital for a use of variety … They can use it for a variety of-

Josh Robb:

Anything –

Austin Wilson:

… different things. They finance government expenditures, corporate expansions, infrastructure projects. But bonds are a loan, right?

Josh Robb:

Yes. Loan-

Austin Wilson:

As an investor, when you buy a bond, you are not the loaner. You are the buyer of the debt.

Josh Robb:

Yes.

Austin Wilson:

You are then the lender.

Josh Robb:

Yes. And you, in a sense, have a certificate that says that you’re obligated, or they’re obligated, to pay you back that money they borrowed. It’s not a gift. You’re not giving them some money for free. And you’re going to get in more detail about types and all that, but the high level is stocks are ownership. Bonds are debt.

Austin Wilson:

Loanership.

Josh Robb:

And there’s reasons for both and why both fit in a portfolio into your first part about how they fit. They tend to be less volatile than ownership because-

Austin Wilson:

Don’t look at 2022 as an example.

Josh Robb:

But even then, they were less-

Austin Wilson:

Slightly.

Josh Robb:

… volatile than the overall market. But bonds tend to be less volatile up and down. You get long-term, historically, less return because you’re taking less risk because-

Austin Wilson:

And benefits.

Josh Robb:

… the more risk, you want more payoff. Yes.

Austin Wilson:

Right? If your stocks are zigging, hopefully your bonds are zagging. And your overall-

Josh Robb:

They react to different things.

 

[3:34] – Types of Bonds 

Austin Wilson:

Or your overall portfolio can be smoother ride. Yes, we’re going to get to that later. Let’s go to number two. Types of bonds. You mentioned it a little bit, but government bonds is one of these examples-

Josh Robb:

Break these down. Yes.

Austin Wilson:

Issued by national governments. The US government is the biggest example of this. The US treasury can issue US treasury bonds, which are loans to the US government. They’re usually considered no-risk, but we would say caveat. Very, very, very, very, very, very, very, very low risk that the government entity will not pay you back because the government is ultimately the one who is taxing people and bringing in revenue all the time and growing, ideally, over time.

It’s unlikely they’re going to default, right?

Josh Robb:

Yep.

Austin Wilson:

Very low risk. Generally lower return. Lower yield. Because of that, you’re getting less of an interest payment. They can go very long on interest rate payments. Sometimes as much as-

Josh Robb:

30 years.

Austin Wilson:

… 30 years in the US. There are some places in Europe, I think, that are 50 and 100-year –

Josh Robb:

Wow.

Austin Wilson:

Pretty crazy. And those longer term bonds, and we’re going to talk about this a little bit more, can be very sensitive to interest rate movements, but we’re going to talk about that soon.

Next bucket, corporate bonds. Corporations, right? We live in Findlay, Ohio. Marathon Petroleum Corporation also headquarters itself here in Findlay, Ohio. Marathon can issue bonds. They can issue debt. People can buy that debt, and they typically offer higher yields than a government bond because there’s a little bit more risk there and varying different levels of credit risk depending on how quality a company’s financial health is and how high their credit rating is, but corporations can use that for expansions, projects, or just generating cash flow, whatever they want to do, just like government bonds. It’s very similar.

Josh Robb:

Now, do you see some sectors do more bond issuing than others?

Austin Wilson:

Yeah. The biggest one’s financials.

Josh Robb:

Banks and ventures, companies, and –

Austin Wilson:

Financials and banks but in general … They are the number one kind of companies that issue a lot of debt, and that’s because they have a lot of capital on their balance sheet. It’s very easy to use that as collateral sometimes to have favorable debt treatment and stuff like that. A lot of financials do that. Energy companies do that a lot of times as well, but you can buy technology companies and consumer discretionary and industrial bonds just like that as well. That’s bucket number two.

Bucket number three. Municipal bonds. Kind of like government bonds, but these are state and local governments. And they can issue bonds to finance. These could be public projects like schools, hospitals, infrastructure. And a couple of different ways they can pay these out. General obligation, meaning it’s just backed by the full faith and credit of the issuer. Or by revenue. These projects bring in revenue. Those are the ones that are backing it then. But what’s really key about municipal bonds is the tax treatment. And often, they have not always, but usually the case … They are tax-free in the municipality that they are issued in. If you’re buying a state municipal bond, tax-free to the state. It’s kind of nice.

Josh Robb:

You still have to pay federal tax, but no state tax on the income.

Austin Wilson:

Yup. Or wherever the municipality essentially is.

Josh Robb:

As an example-

Austin Wilson:

They’re usually waiving that. Those are the types of bonds.

 

[6:32] – Calculating Bond Returns 

Austin Wilson:

Now, where it gets nitty-gritty is number three, bond returns. How do we calculate these? Let’s talk about price versus yield. Bond prices fluctuate based on changes in interest rates. When interest rates go up, bond prices go down. When interest rates go down, bond prices go up. And perceptions of risk in terms of how likely you are or are not to get paid can often drive the price, which inversely-

Josh Robb:

And that drives through all three types of those. And so, you have a government bond, corporate bond, or municipal bond. They’re then rated for risk. And that’s where you hear the term A-rated bond all the way down to what they call junk bonds, right?

Austin Wilson:

Yes.

Josh Robb:

Can you explain that? Why would I buy junk?

Austin Wilson:

The higher rating, the lower the risk, right? This company or this government entity is very, very, very, very likely to pay you back, so they don’t need to give you a lot of compensation for that. And so, your yield is going to be lower, but then you can go down the credit rating scale into lower levels of investment grade, is kind of the upper bucket. And those are still good but a little bit more risky down to what you’ve mentioned as junk. Junk would be anything that’s not investment grade. Triple B or below typically is kind of where you would land there.

Josh Robb:

That’s a break point.

Austin Wilson:

And that’s the break point. And those are … They’re I wouldn’t say extremely risky. A lot of times, you’re seeing default rates in the 2% to 4%. 2% to 5% range. It’s pretty likely you’re going to get paid, but you get a nice chunk interest higher. It’s viewed as more risky. By taking on more risk, you get a better yield.

And you would do that because, well, it’s different type of bonds. If you’re trying to diversify your bond portfolio, you can hold some treasuries. You can hold some corporate investment grade and maybe some high yield. Really diversify that. But you can also often get better returns in the high-yield space, but they are more correlated to equities because they’re more risky, and equities are more risky. Something to consider there, for sure. That’s kind of how price and yield go there.

There’s also something where you never really buy a bond often at par. Par is what the bond’s issued at. Usually be viewed as a $100 or whatever. And then what happens is, if yields move down, that bond price goes up because that yield is set at a higher rate and vice versa. You often buy bonds at the prevailing yield of the market. Their price has adjusted up or down, depending on where yields are at that current time, to match where they are-

Josh Robb:

Because the bond can’t change its interest rate once they set that bond. The only thing that can change … They have some variable, but in general, usually if they say, “Hey, it’s a 5% interest, five-year bond,” that’s set. The only thing that can move is the price.

Austin Wilson:

If interest rates move down to four or three, then that bond, that 5% bond, will trade at a premium-

Josh Robb:

It’s worth more

Austin Wilson:

… because it’s worth more. You can’t buy a 5% bond anymore. That’s why prices move. For example, in 2022, when interest rates go up, bond prices go down. Inverse relationships.

Josh Robb:

You can buy a new bond paying more interest so the bond that’s already out there is worth less because it’s paying less interest.

Austin Wilson:

And if you think of why, inflation. Inflation was what was driving bond prices down and interest rates up in 2022. Well, these are fixed-income vehicles. Well, if the income is fixed, and inflation is hot, they’re going to be worth less, right?

Josh Robb:

Yep.

Austin Wilson:

That’s kind of why we saw that.

Another interesting way to look at these things is interest rate sensitivity. This kind of very much can impact your bond returns. Bonds with longer maturities, and we would call this duration … The longer the maturity of the bond, the more sensitive it is to interest rate changes. And shorter-term bonds have a lot less interest rate sensitivity. Understanding this relationship can really help you gauge your overall risk of your bond.

If you’re buying 30-year treasuries, there’s a lot of things that can happen in the next 30 years. There’s a lot of risk, and a little bit of move in interest rates can really impact a 30-year treasury. But a two-year … Not that big of a difference. The longer you go out in duration, the more risk you take on.

That also can help you when it comes to returns. If your longer duration and interest rates start falling, well, you’re going to pick up more price appreciation as prices go up.

The opposite side is also the case. If your longer duration and interest rates are going up, your price is going to go down more. Something to consider there.

 

[10:52] – Factors Impacting Bond Yields 

Austin Wilson:

Number four, factors impacting bond yields. Central bank policies. The Fed, in our case, can and does impact bond yields in general. Short-term interest rates are what the Fed’s setting. They’re essentially setting the overnight lending rate to big financial institutions. But then what their policy rate happens, it extrapolates all the way out through the yield curve. If the Fed increases interest rates, the short, short, short end goes up a little bit, but all other interest rates in some way, shape, or form also are being extrapolated based on that as well.

Josh Robb:

It’s like a ripple effect-

Austin Wilson:

It’s a ripple effect.

Josh Robb:

… works outward.

Austin Wilson:

Now, that really impacts the shorter end of the curve. Longer-term interest rates or longer end of the yield curve interest rates are impacted by other things as well, and those things can certainly be what’s going on in the economy. That can be, is economic growth projected to be high or low? Or inflation expectations. Geopolitical events. All kinds of things. These all impact bond yields over time. And obviously, we’ve talked many times, and we’re going to continue to say price and yield move inversely when it comes to bonds.

 

[11:58] – Diversification Benefits 

Austin Wilson:

Now, where it comes to your portfolio, we can talk about diversification, and we hit on this a little bit, but number five is diversification benefits. Portfolio stability is something that people like when you invest in bonds. They often, not always … Again, 2022 … It was pretty volatile, but they often exhibit lower volatility than stocks which can provide some stability during market downturns and balance your overall portfolio risk. It’s talking overall here.

You got a bucket of stocks. You got a bucket of bonds. Together, you put those things together. They’re going to be less volatile together. Then either one of them would be by themselves, and that’s why we like them in portfolios. And also, historically, bonds over long periods have a negative or less-correlated uncorrelated relationship with stocks, meaning that your overall volatility is coming down, which really enhances your risk-adjusted returns because of that diversification.

Josh Robb:

And if I remember, correlation goes from one to negative one. Zero means not a fit. Not in any way correlated-

Austin Wilson:

– the same way at all.

Josh Robb:

Negative one means they move in opposite directions. One means they move the same direction, and bonds and stocks tend to be right around that zero. They don’t necessarily move in opposite directions, but they don’t react to the same things.

Austin Wilson:

Over longer terms. Now, in shorter terms, they may be positively correlated.

Josh Robb:

Because economic situations impact both stocks and bonds.

Austin Wilson:

Or in some terms, they may be negatively correlated, but generally speaking they’re going to be less correlated than having all of your eggs in one basket.

Josh Robb:

And the more you diversify each of those baskets, stocks and bonds, the more together they’re diversified.

Austin Wilson:

Correct.

Josh Robb:

All right. We’re going to take a break. We got five in. We got five more to go.

Austin Wilson:

Five and five.

 

[13:34] – Dad Joke of the Week 

Josh Robb:

And we’re going to do a dad joke. And so, here it is. Why did the bird’s mom go to the elementary school?

Austin Wilson:

Mama bird. I don’t know.

Josh Robb:

It was a parrot teacher conference.

Austin Wilson:

A parrot teacher conference.

Josh Robb:

Yes.

Austin Wilson:

I like it. I like it. I have nothing to tie into bond with that bird.

Josh Robb:

No?

Austin Wilson:

No. Maybe the bonds hold some birds. Birds hold some bonds.

Josh Robb:

Birds hold bonds?

Austin Wilson:

Could be.

Josh Robb:

That’s a tongue twister.

 

[13:58] – Risk When Investing in Bonds 

Austin Wilson:

Birds hold bonds. Number six, Josh. Risk factors. We talked a little bit about this before, but there are risks inherent with bonds. They’re not risk-free. Even government bonds aren’t risk-free, but they’re pretty much risk-free in terms of getting your money back. But there’s price risk, right? If you don’t hold them to maturity, then the prices can move, obviously. And that maturity you’re going to get par back. That’s usually how that goes.

Josh Robb:

Your example … $100 is that par. If I bought a bond for $102 because my interest rate was better than what was currently out there, there’s a premium.

Austin Wilson:

Correct.

Josh Robb:

When it goes to mature, I don’t get $102 back-

Austin Wilson:

You get $100 back.

Josh Robb:

I get $100. But the difference … Why would I pay more for it if I’m not going to get that money back?

Austin Wilson:

You made… afford to yield along-

Josh Robb:

I made extra money on my interest than I could have got with another bond.

Austin Wilson:

The other would go the same way, where maybe you bought a bond at $98. Your interest rate would’ve been lower than the market, but you would’ve bought it at a discount. Therefore, essentially, your yield to maturity would’ve been-

Josh Robb:

You kind of look at your total. All my interest pay is plus what I got paid and got back. That’s how you compare

Austin Wilson:

If you bought it at $98, you’re still getting $100 back.

Josh Robb:

Yes.

Austin Wilson:

Which is kind of cool, but this also ties into something that I mentioned earlier, zero coupon bond. There are some bonds that don’t pay you regular interest payments along the way. Sounds crazy, right?

Josh Robb:

Why would I do that?

Austin Wilson:

Why would I do that? And that’s because you’ll buy that bond at $80, and you’re going to get $100 back at the end, but you’re not getting any coupon payments along the way, and that’s a zero-coupon bond. You get it? Zero coupon.

Josh Robb:

But you still get a return.

Austin Wilson:

Exactly.

Josh Robb:

You just don’t get any interest along the way.

Austin Wilson:

Duration risk. Huge risk factor. We talked about that longer duration bonds more sensitive to interest rate changes. Shorter-duration bonds less risky in that. But then we have credit risk. You’re going to get compensated more down the quality spectrum, I guess you could say. Junk bonds which are going to get a higher yield than investment grade, than treasury. All of these things here-

Josh Robb:

And this is true on all investing. The more risk you take, the more you should expect to be compensated for taking that risk.

Austin Wilson:

It’s the same with stocks. If you think about what is a … What’s a risky part of the stock market?

Josh Robb:

What?

Austin Wilson:

Small caps.

Josh Robb:

Small caps?

Austin Wilson:

Small caps.

Josh Robb:

Micro caps.

Austin Wilson:

Micro caps.

Josh Robb:

Oh, man.

Austin Wilson:

Small caps are a inherently risky area of the stock market, but actually over a long period of time they’ve done better than large cap, but they often have way bigger drawdowns-

Josh Robb:

And you have more defaults and all the things that go along with it-

Austin Wilson:

There’s a lot more risk, but you are compensated over the long term with a little bit higher return.

Josh Robb:

And I was even thinking between … If you look at the high-quality dividend stocks versus the more growth stocks, you usually get, in the long term, a good growth stock versus a good high-quality dividend stock. You get more out of the growth stock.

Austin Wilson:

Recently, anyway.

Josh Robb:

In the long term because you’re getting paid for that risk you’re taking,

Austin Wilson:

But you do take on those … It’s the volatility that is huge, and you see bigger drawdowns in more risky assets. That would also be very true here in bonds. And that … Credit risk. If you’re buying bonds, say you’re buying … You could look at municipals. You could look at corporates. Treasuries. Really, you kind of know what the credit rating is there.

Josh Robb:

They’re all the same.

Austin Wilson:

But you can look at companies like Moody’s or Standard & Poor’s who assign credit ratings to these companies, to these municipalities, and you can buy more or less risky credit opportunities. And they’ve looked at, how are the growth outlooks for these companies? How are they going to be likely to pay their debt? Or how healthy is the municipality in terms of their tax obligations? And all this stuff. And then, you can kind of take on more or less risk because you can know what these credit opportunities are.

Josh Robb:

I think it’s interesting, too, that every bond … Not every bond. Almost every bond is rated by them. There’s some-

Austin Wilson:

Major …

Josh Robb:

The big ones are.

Austin Wilson:

The big ones are.

Josh Robb:

And it’d be interesting if they also gave a scale to stocks. That would just be interesting. This is a different type of investing in that straight-up front they tell you, “This one’s more risky than that, and we’ll pay you differently because of that.” It’s very interesting when you look at the bond world.

 

[18:01] – Pros of Investing in Bonds 

Austin Wilson:

It is. Number seven, why would you want to invest in bonds?

Josh Robb:

Why would you?

Austin Wilson:

Pros of investing in bonds. Number one, income generation. If you’re not buying zero-coupon bonds, you’re buying bonds that are paying you interest payments. And that is regular income through periodic coupon payments, which makes you really … Makes them attractive for people like retirees who want some predictable cash flow, some income stability over time, and you can play the tax game and do that with municipals or whatever and really kind of fine-tune your income needs.

Number two, capital preservation. Generally, bonds are better at protecting principle if held to maturity than stocks, which is really appealing to conservative investors which prioritize that asset preservation over to just trying to grow their money.

Josh Robb:

Especially when you mentioned holding to maturity because everything you talked about interest rate sensitivity … If you’re holding to maturity, all those price movements along the way are really irrelevant to the holder of the bond at maturity because they get that par back. Even if the day before it happened and matured, interest rates moved, and the price moved, doesn’t matter. I get par back.

Austin Wilson:

You may have paper losses. Suppose you buy a bunch of bonds, $1 million bond portfolio, and then yields shoot up. You’re not going to lose money unless you sell your bonds because, when the yields go up, the bonds are going to go down in value on paper.

Josh Robb:

The price moves down.

Austin Wilson:

The price is going to go down in value, but you actually don’t lose … You’re not going to lose money if you hold them all to maturity because you bought them with a positive yield to maturity, and you’re going to get positive returns over time. That’s interesting. It’s just something … I guess technically-

Josh Robb:

Preservation. You’re right.

Austin Wilson:

Technically, if you buy a bond at a premium, you’re going to lose your slight premium, but you’re going to pick it up in terms of yield.

Josh Robb:

Yes.

Austin Wilson:

You’re going to make money as long as you’re buying bonds with a positive yield to maturity, no matter what price you buy them at-

Josh Robb:

The interests they’re going to pay you is more than the premium you paid.

Austin Wilson:

You’re going to make money on it-

Josh Robb:

You’re positive.

Austin Wilson:

That’s the thing is don’t be so short-sighted when you buy … If you’re buying individual bonds, don’t freak out when things go down in value because, if you hold it all the way to maturity, you’re going to get par at the end, right?

Josh Robb:

Yes.

 

[20:11] – Cons of Investing in Bonds 

Austin Wilson:

Don’t freak out. Those are the two reasons, main reasons, why people would like to invest in bonds, but why wouldn’t people like to invest in bonds? The opposite side of that, right?

Lower potential returns. Historically, bonds have generated lower returns than stocks over the long term, and that’s because they’re less risky. You get paid to take on risk, and stocks are more risky, so you get paid in more return, but you do also get more volatility that way. Bonds have lower potential returns, and that’s just because lower risk than the income-focused nature versus capital appreciation.

Number two is inflation. Inflation is a huge risk for bonds, and that’s, again, what we saw in 2022. Inflation went up. Bonds fell apart in terms of price for bonds.

Josh Robb:

Well, because, prior to 2022, interest rates were low, and you’re getting maybe 2%, 3% on a bond interest rate. And if inflation at that point was 8% in July-

Austin Wilson:

That’s a hard thing to swallow.

Josh Robb:

… you’re losing money. And you have to wait because that fixed rate is there until you buy a new bond. You can’t adjust for the higher inflation.

Austin Wilson:

Purchasing power is eroded over time by inflation, and bonds do not do a good job at keeping up or outpacing inflation. Stocks have over the long term, and that’s really why people … Again, your situation aside. Not a recommendation. People should hold as much equities as they can tolerate for the best chance of outpacing inflation.

Josh Robb:

If their goal is to grow their money and keep up with inflation.

Austin Wilson:

Absolutely.

Josh Robb:

Historically, stocks have done the best job-

 

[21:41] – Strategies for Bond Investing 

Austin Wilson:

Historically, they have. Those are really the two cons of bonds. But how would you invest in bonds? And there’s really two ways to do this. If you’re a DIYer, Josh, you want to build a bond portfolio. You could build what’s called a bond ladder. And I do this all the time.

You can go out and have a bond that matures next year and the year after and the year after and the year after for as many years as you want. A lot of times, six, eight years. Whatever you want it to be. And then you constantly have income coming in. You constantly have bonds maturing that you can reinvest and then reinvest in a new bond at the end. And you have a very stable income stream, a stable price movement thing, because you’re holding them all to maturity. That’s called bond laddering.

You can do that on your own. There’s lots of ways to do that. You can do that with the municipals. You can do it with corporates. You can do it with treasuries. That’s one way to do it.

Josh Robb:

And you can even line them up where their interest payments are spread out because most bonds pay twice a year. And you could say, “Okay, this bond pays January and July. This one’s February, August.” You could line them up so you get that constant income stream of a ladder portfolio, which is interesting.

Austin Wilson:

A lot of people actually use this to neutralize expenses too. A very wealthy person could do this where they know that they have a $10,000 tax bill coming due on April 15th. They will buy a bond that pays right before that, $10,000 coupon, and then they can kind of hack. And you’re tying up some capital, but you’re going to have income coming in to cover that payment, and they’ll do the same thing the next time-

Josh Robb:

Or insurance. I see insurance premiums. Let’s say maybe they have a long-term care policy, and they say, “You know what? I’m going to keep this policy. Premiums are X amount of dollars. I’m just going to get this cash flow and pay it when it happens.” You’re right. There are some fun ways you … Because, again, it’s a set period payments over that length of time.

Austin Wilson:

Right. You know what you’re going to get.

Josh Robb:

You know what you’re going to get at a certain price.

Austin Wilson:

That’s bond laddering. That’s a DIYer.

The other way to do this is to have an expert do this for you through an ETF for a mutual fund. You can also hire an advisor to do a bond ladder for you, but you can hire the experts. I’m not promoting any specific companies, but think of companies that have been out for a while. PIMCO comes to mind.

Josh Robb:

Well, they’re the largest bond manager-

Austin Wilson:

Largest bond manager in the world. You can pay them a certain percentage of your return it comes out of.

Josh Robb:

It’s an expense.

Austin Wilson:

It’s an expense ratio. But they will then … You’ll buy a mutual fund or an ETF that they are picking and choosing the most beneficial bonds to meet that portfolio’s objective, whether that be an ETF or a mutual fund. And that’s hiring someone else to do that. It also takes away the risk of you putting too many eggs in one basket because these bond managers are well diversified, and there are different bond funds or ETFs that have short duration, long duration, high-yield, muni. They can do it all. You can hire managers through the use of mutual funds or ETFs to do that for you.

Josh Robb:

Yes. And those are … Again, we talked about stocks. Stocks are the same way. You have mutual funds, ETFs, or individual. It is just a matter of, how much time and energy do you want to spend researching and building versus outsourcing that to somebody else?

Austin Wilson:

Absolutely. I guess finally a little bit more on how the Fed impacts bonds. Interest rate policy has an impact. Again, short-term interest rates. They’re influencing the short-term borrowing costs of, essentially, financial institutions.

Those bond yields and movements on the short end therefore get extrapolated throughout the rest of the yield curve and impact all kinds of bonds. Lower rates from the Fed typically reduce bond yields, which stimulates demand for higher-yielding assets, and that supports bond prices, right?

An inverse is also the case when rates go up. That typically does not stimulate demand for higher-yielding assets and therefore puts downward pressure on bond prices.

Market expectations also play a huge role in this. Bond markets, in general, react to the Fed’s announcements and look at all the economic indicators as they come in, and they reflect investor expectations for future interest rate movements and economic conditions. When you understand these, you can kind of be able to adjust your portfolio to take opportunity when you see a good one and take risk off the table when you see too much risk. But it’s very, very hard to time all this correct and accurately and perfectly all the time. I would say this is where experts earn the root keep. Especially in the fixed-income world, the markets are far less efficient than the equity markets.

Josh Robb:

And three times the size of the equity markets.

Austin Wilson:

And way larger than the equity markets. In fact, a lot of bond trading is actually still done manually, not even electronically.

Josh Robb:

That’s crazy.

Austin Wilson:

There is a lot more use, I think, in the fixed-income market for fixed-income managers to earn their keep because they can exploit market inefficiencies and outperform over time. I’m a big proponent of active fixed income, specifically. Active management in general. But specifically when it comes to fixed income, I think it’s awesome.

Josh Robb:

There’s a lot of opportunity there.

 

[26:37] – Final Thoughts

Austin Wilson:

Josh, what are your final thoughts on bonds?

Josh Robb:

You know what? I like bonds. I think they serve a purpose for certain situations and needs. And again, long-term equities, historically, have been the best thing to keep up and grow with inflation, but bonds allow people to stick with plans because, again, volatility matters, and bonds also give you that cashflow that are important. And I’ve known some people that have bought some local bonds because they actually see and experience the project right there. A school one is a great one, right? You see a lot of cool school bonds being issued and just to participate in that.

I think bonds serve a good purpose for a lot of people in diversifying and helping them achieve their goals.

Austin Wilson:

I agree. And I think that we’re in an environment now … We’re beyond halfway in 2024. We’re in an environment now where bonds are more attractive than they have been for a long time because interest rates are higher.

And a good indicator … There are a lot of studies that have proven this. A good indicator of forward returns for bonds is looking at where yields are. And if yields are higher, the overall return potential for bonds are higher. Interest rates are certainly higher than they had been for 20 years. It’s not a terrible time to be buying bonds to get return, but also they do work well in a diversified portfolio to really get your overall risk in line.

Young people often don’t think they may need bonds, and I’m not necessarily saying that bonds are the greatest thing for long-term capital appreciation, but I would also say that bonds have not been as attractive for more people than they have been right now.

Josh Robb:

Makes sense.

Austin Wilson:

All right. Well, thanks for listening. If maybe you had someone asking about bonds, go ahead and share this episode with them.

Josh Robb:

Because that topic comes up all the time-

Austin Wilson:

That topic comes … I mean, I’m thinking family dinners. This is the bomb. But share this episode with them. E-mail us any ideas to hello@theinvesteddads.com. And as always, stay invested and stick to the plan.

Josh Robb:

That’s right. And we’ll talk to you later.

Austin Wilson:

All right. Bye.

 

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 TheInvestedDads.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 the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principle. There is no assurance that any investment plan or strategy will be successful.