how to bond investing

3 Steps to Easy Bond Investing

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Bonds offer the best protection from a stock market crash and three bond investing secrets are all you need

Investors miss out on so many advantages in bond investing because they don’t understand the investment.

It's too bad because bond investing is your single best investment to protect your money when stocks crash and finding great bonds isn't as difficult as you might think.

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.

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Why Everyone Needs to Invest in Bonds

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.

An Easy Bond Investing Strategy to Get Started

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.

best bond investing books 2017This 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.

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.

How Do Bonds Work?

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.

how to bond investingEven 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.

What Types of Bonds Should You Buy?

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.

bond rating scale

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?

What Bond Strategy is Best for Your Needs?

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.

bond ladder investing strategy

How to Find Bond Investments

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.

how to find bond investments
How to find bond investments

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.

How to Invest in Bond Funds

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.

best bond fund for beginners

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.

best high yield bond fund

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.

Investing in bonds doesn't have to be complicated and can be your best protection against a stock market crash. Follow these three steps to bond investing to find great cash flow investments that will help reach your long-term financial goals without the ups-and-downs of stocks.

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