Investors miss out on so many advantages in
bond investing because they don’t understand the investment. By the end of this video, you’ll have the
three keys to investing in bonds to know exactly how they fit in your portfolio. You’ll be able to protect your money while
still getting a solid return and that regular cash flow. We’re talking investing in fixed income
today on Let’s Talk Money. Joseph Hogue with the Let’s Talk Money YouTube
channel where we’re creating the financial future you deserve. I want to send a special shout out to everyone
in the community, thank you for taking a part of your day to be here. If you’re not part of that community yet,
just click that little red subscribe button. It’s free and you’ll never miss an episode. Bonds are waaayyy underrated by investors. The Federal Reserve found that less than 2%
of investors hold any bonds at all in their portfolio, despite the fact that most financial
advisors recommend holding at least 15% to 50% of your assets in fixed income. That also flies in the face of two stock market
crashes in the last 20 years that wiped out half the value in stocks. Bonds provide a rock-solid safety and return. In fact, over the ten years through 2016,
stocks and bonds offered about the same level of return…but bonds did it with fewer sleepless
nights. Now I love investing in stocks just as much
as the next person and I’m not saying you should ditch equities but bonds is going to
be the secret asset you add to your portfolio that helps reach your financial goals. I’m going to walk you through three steps
to investing in bonds to protect your money while still producing that return and I’ll
show you how to find bonds in which to invest on any online site. I’m then going to share my favorite bond
investing strategy, something that will make all this super easy so make sure you stick
around to the end of the video. This is going to be a brief highlights video
of what’s in my book Step-by-Step Bond Investing. The book is a complete guide into bonds and
how they fit into your investing strategy. I’ll leave a link to the book in the description
below and I’m going to be discounting the price for YouTube subscribers that click over
and check it out. But let’s get into those three steps to
investing in bonds and how you can use these cash flow assets to do some amazing things
for your portfolio. First is to simply understand how bonds work. These are debt issued by a company or government. Investors get a fixed payment of interest,
usually twice a year, and then get paid back the value of the bond at the end of the loan. So bonds are really an interest-only loan. Because of how bonds work, there are some
important differences with stocks or other investments. Bonds are a contract. Companies have to pay the debt back and if
anything happens then bond investors get paid before stock investors. So bonds are generally much safer than stocks. Even in so-called junk bonds which are just
companies with a little less solid financials, the number of bonds that don’t get paid
back is just three out of 100 on average. Since all the payments on a bond are fixed,
the interest and that final payment, the bond’s price increases or decreases depending on
interest rates in the market. The bond’s price has to adjust or people
wouldn’t be able to sell bonds after they buy them. For example, say you buy a bond for $1,000
and it pays a 5% interest payment or $50 a year. That interest payment doesn’t change and
the bond will pay that $1,000 back at the end of the loan. Now let’s say you bought that bond when
the interest rate the U.S. government was paying was 3% on a Treasury bond. But what happens if the government raises
interest rates, now that Treasury bond pays 4% and the rate on other new bonds goes up. You’re 5% bond doesn’t look so good anymore
because investors can get higher rates on new bonds. Well since those payments don’t change on
your bond investment, you would have to drop the price if you want to persuade someone
to buy it from you. Conversely if rates were to go down then your
5% bond might be looking even better. Other investors will be willing to pay you
more for the right to collect those payments. It can seem a little confusing but you really
don’t have to worry about it. Everyone loves to freak out about rising rates
and falling bond prices but if you hold your bond investments to the end of the loan, you’ll
always get those same payments. You don’t have to worry about whether the
bond’s price went up or down while you held it. So you’ve got the bond basics down and now
you need to decide which types of bonds you want to buy. We’ll be talking about three types of bonds
though there are a few more you might want to check out in the book. Treasury bonds are loans to the federal government
and you pay no state taxes on the interest. The interest rate you get is the lowest of
the three bond types but there is virtually no chance the U.S. government will not pay. Corporate bonds offer the highest return but
you have a little more risk depending on the company. Just like the credit bureaus that rate your
credit history and calculate your credit score, there are rating agencies that tell investors
how risky a company is on its loans. These ratings range from C to triple A with
the A’s being the safest. Again, looking at these ratings can be a little
misleading because you see words like Junk Bonds and poor quality but the fact is that
even these lower-rated bonds are still much safer than stocks. Bonds rated double-B by S&P default at a rate
of less than one out of 100. Once you get into the C-rated bonds, defaults
start creeping up but the others are very safe. Finally here are municipal bonds which are
loans to states, cities and local agencies. Now you’ve probably been spooked by stories
about Puerto Rico and Michigan defaulting on bonds but this is also more hype than anything. Listen, the 24-hour news networks need something
to call news. They’ll make anything as sensational and
shocking as they can if it means they can sell more commercial space. The fact is that muni bonds can be a great
investment…for the right investors. You see, municipal bonds are free from federal
income tax and if you buy muni bonds issued in your state, you probably won’t have to
pay state taxes on the interest income either. That means for investors in the higher tax
brackets, then it usually makes more sense to invest in municipal bonds rather than corporate
bonds and pay that federal income tax. It’s going to depend on your tax bracket
but it’s usually around 24% where municipal bonds start making more sense than corporates. So anyone paying that federal income rate
of 24% or higher, start thinking about investing more in munis. Each of these three bond types has its advantages. Treasuries are super-safe while corporates
are generally the highest return. Munis give the rich folk a special gift…because
the rich need all the help they can get, right? Now before we get to the last step to investing
in bonds, I want to ask a question for future videos. What do you think is the best asset class
for investing between bonds, stocks or real estate and why? Which is the investment you’re counting
on to reach your financial goals? Our last key to bond investing before we walk
through an example is going to be deciding on a time horizon, that’s the length of
loan you want to invest in, or whether you want to invest with a ladder strategy. Just like any loan, bonds are issued for different
time periods but most of what you’ll be looking at will be from five to 30 years. Investors locking up their money for longer
want a higher return so those longer-term bonds usually offer higher rates. One of the great things about bonds and this
is almost always overlooked by investors is the ability to match up your investments perfectly
with your financial needs. For example, if you need to pay for college
tuition costs in 15 years, your savings for this isn’t something you want to totally
leave in stocks. So you can put that money in bonds with 15-years
left. You’ll collect interest during that time
and can reinvest it and then you get the lump sump payment at the end. A popular bond investing strategy, especially
for people living off their investments is called bond laddering. This is where you match up your near-term
expenses with very short-term bonds, ones maturing in a year or two so you have that
cash flow, but then you use the rest of your investment to buy longer-term bonds that pay
higher rates. The reason it’s called laddering is because
you invest in bonds that mature in different years. You invest in enough bonds for each year over
the next five or ten to cover expenses in that year. If you have don’t spend all the interest
or money from the bonds each year, you buy another year’s worth of bonds with a later
date. Let’s look at how to put this all to work. I’m going to show you how to find individual
bonds in which to invest and then I’ll get to that favorite bond investing strategy. I’m going to be using my ETrade account
but any online investing site is going to be similar. You’re first going to look for the bonds
section or maybe it’s called bond screener. You’ll usually find a comparison of rates
on different types of bonds and different maturities. So here we see that we can get a 2.94% on
U.S. government treasury bonds for 10 years or we can get 3.9% if we invest in A-rated
corporate bonds. If we want to invest longer then we can get
about 3.1% on 30-year treasury bonds or 4.2% on the same maturity A-rated corporate bonds. Remember when you’re looking at the municipal
bond rates, you don’t pay taxes on those so maybe it’s a better deal than the corporate
bonds. Usually, if your tax rate is around 24% or
higher then it starts making sense to invest in municipal bonds instead of corporates. You’ll also see here that we can search
for individual bonds. So let’s try this out. Let’s search for corporate bonds that have
a maturity of at least 20 years, that are A-rated or higher and pay 4.5% or more a year. We have 190 bonds to choose from with some
very tempting yields. Here we have an A-rated bond issued by South
Carolina Electric and Gas that pays a 5.1% yield every year through 2038. Now before I go to buy a bond, I would look
at the company and do some fundamental analysis. I would look at thinks like how much balance
sheet debt it owes and how much interest payments are each year. You want to make sure EBITDA (that’s basically
operating earnings adding back depreciation) is at least four or five times the interest
payments. You also want to look for consistent growth
in sales and no runaway expenses that might put those earnings at risk. If the company looks fundamentally sound,
like it won’t have trouble meeting those debt payments, you can buy the bond. Since bonds usually have a face value of $1,000
that’s the minimum you can invest for one note. Now just like picking individual stocks, I
like to invest in individual bonds but I also have a favorite way to invest that makes it
all so much easier. For the amount of my portfolio I want to invest
in bonds, I usually split it with a third for individual bonds and two-thirds in bond
funds. A bond fund is just a group of bond investments
managed by a professional investor. You pay an annual expense fee but it’s usually
so low that it’s almost negligible. You pay just one commission to get hundreds
or thousands of bonds in your portfolio so that’s instant diversification so a default
on one bond doesn’t wreck your investments. Now don’t worry, you didn’t just waste
your time learning all those keys to bond investing. It’s still a good idea to know the basics
of bonds and you can still invest some of your money in those individual bonds. I just like the simplicity of bond funds. So I’m going to highlight two of my favorite
bond funds that you might consider. First here is the iShares Core US Aggregate
Bond ETF, ticker AGG. This is probably one of the safest and most
diverse bond funds with two-thirds of its holdings in government or government agency
debt but it still has some corporate bonds to increase that interest rate. You see that the fund has taken a hit since
late 2017 because of those rising interest rates but that just means the yield has gone
up. You’re getting an interest rate of almost
2.9% on a super-safe collection of bonds here. The next bond fund I like is the iShares High
Yield Corporate Bond ETF, ticker HYG. This is a group of almost 1,000 of those bonds
from companies with less than perfect credit but guess what, it’s still a safe investment. With the investment spread across a thousand
companies, even with the 2008 crash, the fund has returned more than 6% annually over the
last decade. There are hundreds of bond funds and you can
get into things like international debt, emerging markets and some other interesting choices
but these two funds are what I use for most of my investment. If you want to see those other bond funds
and get more detail into bond investing and how it fits in your investing strategy, check
out that book Step-by-Step Bond Investing. I take you through everything you need to
know in a way that’s easy to understand and give you the tools to protect your money
while still getting the return you need. So look for that link in the video description
below. If you have any questions about bond investing
or even investing in general, be sure to scroll down and leave it in the comments. I always read all the comments; good, bad
and the ugly and love the interaction with you in the community. Don’t forget to answer our community question,
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