Investing in Bonds For Dummies. Russell Wild

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СКАЧАТЬ plan to hold it for 20 years. If you sell it before it matures, you may lose a bundle. Bond prices, especially on long-term bonds – yes, even Uncle Sam’s bonds – can fluctuate greatly! I discuss the reasons for this fluctuation in Chapter 2.

      I also discuss the very complicated and often misunderstood concept of bond returns. You may buy a 20-year U.S. Treasury bond yielding 3 percent, and you may hold it for 20 years, to full maturity. And yes, you’ll get your principal back, but you may actually earn far more or far less than 3 percent interest on your money! It’s complicated, but I explain this phenomenon in Chapter 2.

      Introducing the Major Players in the Bond Market

      Every year, millions – yes, literally millions – of bonds are issued by thousands of different governments, government agencies, municipalities, financial institutions, and corporations. They all pay interest. In many cases, the interest rates aren’t all that much different from each other. In most cases, the risk that the issuer will default – fail to pay back your principal – is minute. So why, as a lender of money, would you want to choose one type of issuer over another? Glad you asked!

      Following are some important considerations about each of the major kinds of bonds, categorized by who issues them. I’m just going to scratch the surface right now. For a more in-depth discussion, see Chapter 3. In the meantime, here are the basics:

      ✔ Supporting (enabling?) your Uncle Sam with Treasury bonds: When the government issues bonds, it promises to repay the bond buyers over time. The more bonds the government issues, the greater its debt. Voters may groan about the national debt, but they generally don’t see it as an immediate problem.

      In Chapter 3, I explain all of the many, many kinds of Treasury bonds – from EE Bonds to I Bonds to TIPS – and the unique characteristics of each. For the moment, I merely want to point out that all of them are backed by the “full faith and credit” of the federal government. Despite its huge debt, the United States of America is not going bankrupt anytime soon. And for that reason, Treasury bonds have traditionally been referred to as “risk-free.” Careful! That does not mean that the prices of Treasury bonds do not fluctuate.

      ✔ Collecting corporate debt: Bonds issued by for-profit companies are riskier than government bonds but tend to compensate for that added risk by paying higher rates of interest. (If they didn’t, why would you or anyone else want to take the extra risk?) For the past few decades, corporate bonds in the aggregate have tended to pay about a percentage point higher than Treasuries of similar maturity. Since 2008, this spread has broadened, with ten-year corporate bonds paying about a percentage point and a third more than their governmental counterparts.

      ✔ Demystifying those government and government-like agencies: Federal agencies, such as the Government National Mortgage Association (Ginnie Mae), and government-sponsored enterprises (GSEs), such as the Federal Home Loan Banks, issue a good chunk of the bonds on the market. Even though these bonds can differ quite a bit, they are collectively referred to as agency bonds. What we call agencies are sometimes part of the actual government, and sometimes a cross between government and private industry. In the case of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), they have been, following the mortgage crisis of 2008, somewhat in limbo.

      To varying degrees, Congress and the Treasury will serve as protective big brothers if one of these agencies or GSEs were to take a financial beating and couldn’t pay off its debt obligations.

      ✔ Going cosmopolitan with municipal bonds: The bond market, unlike the stock market, is overwhelmingly institutional. In other words, most bonds are held by insurance companies, pension funds, endowment funds, and mutual funds. The only exception is the municipal bond market.

      Municipal bonds (munis) are issued by cities, states, and counties. They are used to raise money for either the general day-to-day needs of the citizenry (schools, roads, sewer systems) or for specific projects (a new bridge, a sports stadium).

      Buying Solo or Buying in Bulk

      One of the big questions about bond investing that I help you to answer later in this book is whether to invest in individual bonds or bond funds.

      I generally advocate bond funds – both bond mutual funds and exchange-traded funds. Mutual funds and exchange-traded funds represent baskets of securities (usually stocks or bonds, or sometimes both) and allow for instant and easy portfolio diversification. You do, however, need to be careful about which funds you choose. Not all are created equal – far, far from it.

      I outline the pros and cons of owning individual bonds versus bond funds in Chapter 11. Here, I give you a very quick sneak preview of that discussion.

Picking and choosing individual bonds

      Individual bonds offer investors the opportunity to really fine-tune a fixed-income portfolio. With individual bonds, you can choose exactly what you want in terms of bond quality, maturity, and taxability.

      For larger investors – especially those who do their homework – investing in individual bonds may also be more economical than investing in a bond fund. That’s especially true for investors who are up on the latest advances in bond buying and selling.

      Once upon a time, any buyers or sellers of individual bonds had to take a giant leap of faith that their bond broker wasn’t trimming too much meat off the bone. No more. In Chapter 4, I show you how to find out exactly how much your bond broker is making off you – or trying to make off you. I show you how to compare comparable bonds to get the best deals. And I discuss some popular bond strategies, including the most popular and potent one, laddering your bonds, which means staggering the maturities of the bonds that you buy.

Going with a bond fund or funds

      Investors now have a choice of well over 5,000 bond mutual funds or exchange-traded funds. All have the same basic drawbacks: management expenses and a certain degree of unpredictability above and beyond individual bonds. But even so, some make for very good potential investments, particularly for people with modest portfolios.

      Where to begin your fund search? I promise to help you weed out the losers and pick the very best. As you’ll discover (or as you know already if you have read my Exchange-Traded Funds For Dummies), I’m a strong proponent of buying index funds – mutual funds or exchange-traded funds that seek to provide exposure to an entire asset class (such as bonds or stocks) with very little trading and very low expenses. I believe that such funds are the way to go for most investors to get the bond exposure they need. I suggest some good bond index funds, as well as other bond funds, in Chapter 5.

      The Triumphs and Failures of Fixed-Income Investing

      Picture yourself in the year 1926. Calvin Coolidge occupies the White House. Ford’s Model T can be bought for $200. Charles Lindbergh is gearing up to fly across the Atlantic. And you, having just arrived from your journey back in time, brush the time-travel dust off your shoulders and reach into your pocket. You figure that if you invest $100, you can then return to the present, cash in on your investment, and live like a corrupt king. So you plunk down the $100 into some long-term government bonds.

      Fast-forward to the present, and you discover that your original investment of $100 is now worth $11,730. It grew at an average annual СКАЧАТЬ