How To Make Money From Bonds

I hope the weekend treated you well. Last week the Republican National Convention, and this week the Democrats will have their turn. I know, lots of chatter indeed.

In my political conversations with family and friends, we often talk about whether or not we’ll be any happier with a new President in office. Trust me, you don’t want to read our family emails – they are fierce!

Well, a similar line of question is raised when we think about our money. I read a NYTimes piece that scratched the surface on the linkage between money and happiness. My favorite part…

In fact, academics have a name for this [pursuit of happiness] cycle , which involves fixating on what we don’t have, actually getting that thing, not ending up any happier and then fixating on something else. They call it the hedonic treadmill. Despite all our efforts, we never get anywhere. We experience small ups and downs, but by and large, our happiness stays the same.

It’s important to keep this in mind because money is emotional and while we all need to stay focused (which we talked about last week) on our money goals, remember that you also must keep in mind why you are doing your money thing.

With that, I promised you I would share with you how to make money from bonds in case that will make you happier. Here you go.

How Do You Make Money From Bonds?

When you buy a bond, you are lending a company (like Nike) money and the company is promising to pay you back what you loaned them PLUS interest. The interest payment is typically determined from the coupon rate. So, if I bought a $100 bond with a 5% annual coupon over 3 years, at the end of the 3 years, I would get the $100 back. And, I would have received $5 at the end of the each of the three years, or $15. This assumes that I hold the bond for all 3 years.

Many people use bond investing as an income generating strategy because the company (otherwise known as the borrower) is contractually obligated to pay you back that original amount plus interest. Because of that, investing in bonds is less risky than investing in stocks, where you could lose all your money.

So, what's all this talk about bond yields and interest rates? And, how is that different than a coupon rate? In short, all of these terms are technically different but related. I won’t bore you or complicate things with the math, but all you need to understand is that interest rates directly affect bond yields in the same direction; low interest rates means low bond yields, and effectively a lower return on your money.

When bond yields are low, the price of the bond (like the $100 I mentioned above) will go up  – this is a fundamental relationship that is all you need to know.  Forget why this happens for now. What’s important for you is that the coupon rate never changes, but because the price of the bond is higher, if you sell it, you effectively earn less money ($5 over $105, or 4.6%, is lower than $5 over $100, or 5%).

Investors make investing decisions based on a bond’s yield (rather than coupon) because it effectively tells you what you can expect to receive in return more so than the coupon rate.

What's next?

Tell me how you really feel. Leave a comment below!

I want to hear from you!

3 Takeaways From What's Happened in the Bond Market

It's already mid-July and I hope life is treating you well. Well, there's plenty of news to distract me from the daily grind and my investing goals. I would suspect that you might be in the same boat. The thing I have to remind myself is that no one else is going to be responsible for my money situation except me. I need to continuously focus to make sure I keep my eye on the prize and understand the forces moving around me. What's happening in the bond market is one of the major forces that is happening around me.

Bonds are NOT SEXY (although any bond traders might disagree) and we don't talk about them as much as we talk about stocks, but they are important.

I mean, when's the last time you had a conversation about them?

I'm changing that today.

3 Takeaways From What's Happened in the Bond Market

  1. Long-term bond rates are at historic lows. I mean, over the last 227 years of rate history, they are at their lowest point.  When rates are low, bond prices are high, which means that investors are piling into bonds for safety --- flight response.
  2. The bond market is telling us that economic growth looks anemic Long-term rates help tell us about the future economy. When rates are low, it means that growth expectations are low.
  3. Relatedly, interest rates are expected to remain low for the foreseeable future. Prior to Brexit, investors were expecting interest rates to rise. But, the current interest rates tell us that this is not the case. So, it will be cheaper to get car loans, home loans, and any other financing that is priced off of rates. Pay attention!

What's next?

Digest this and leave a comment below with your thoughts on what’s happening with the bond market, and let me know if you questions. Next week, I’ll go over how you make money from bonds --- really, how do they actually work? If there are any other answers you want with respect to bonds leave a comment below. I would love to hear from you!