Investment Bond Basics
Investment Bond Basics
Scott Leonard, CFP (President, Leonard Wealth Management, Inc.) gives expert video advice on: What are the pros and cons of investing in bonds?; Are bonds always safer investments than stocks? and more...
What are the pros and cons of investing in bonds?
The pros and cons when it comes to investing in bonds is that the biggest reason you do it: a bond is a very safe investment, especially if you're going to stay with high-quality lenders, whether it's a big corporation or a government. The likelihood of you losing your money at the end of that bond investment cycle is very, very small. That's the positive. The cons with bonds, or the concerns with buying bonds, is, because they are so safe, you really aren't getting a big return on the bonds. If you were to take inflation into consideration, and taxes that you'd pay on the yield on those bonds, seldom do your bonds actually make you much money long-term.
Are bonds always safer investments than stocks?
My gut reaction is that bonds are of course safer investments than stocks. But it depends what we are investing for. If we look at twenty year histories, there's never been a twenty year period in our history where a diversified stock portfolio has done worse than a bond portfolio. In other words, if twenty years is our time frame, stocks have always done better than bonds. Where is the risk? The risk is really in the short term. The short term stocks are very volatile. Are stocks or bonds riskier than each other? I think it's really a function of what's your goal. What are you saving for? And personally, what is your appetite for risk?
What is a "bond swap"?
A bond swap is simply the selling of a bond and then the buying of another bond of similar credit quality and maturity.
What is a "bond rating"?
A bond rating is a rating of the credit worthiness of the company or government that is issuing the bond. The higher the credit quality, the higher the rating of a bond. A higher bond rating reflects a higher likelihood that that company is going to be able to meet its obligations and pay back the value of the bond at the end of the term.
What is "Moody's"?
Moody's is an independent firm that goes out and rates the credit quality of companies. It will look at a company, look at its balance sheets, look at its debt, and make a determination on what is the likelyhood that this company is going to be able to pay back its debts. Then it puts a rating on that company that relates to that company's bonds. Moody's is really going to rate bonds, like you get grades in school. It's going to start with A, AAA being the highest quality, then it's going to go down from there. Single A, then it's going to go into B and different things. There are categories in there we would consider investment grade, and we would consider junk, as it relates to the quality rating of bonds.
What is bond 'yield'?
Yield is the interest rate that you're earning from a bond. You want to look at a bond's yield to maturity as opposed to the yield that the bond might have had when it was issued. The actual dollar value that you get when that bond makes a coupon payment, when it actually pays out money, is never going to change. The yield is really the value of that dollar payment relative to the purchase price of the bond. We want to look at yield to maturity when we're looking at buying bonds.
What is "after-tax yield"?
An after tax yield is really going to tell us what our yield is. What is that percentage rate we're going to earn on that bond after we pay taxes on that income? An after tax yield is going to be different for individuals based on their tax brackets and the states that they live in, too. Combine your tax rate. After tax yield is just going to be the money you earn after you pay taxes on that income.