Three Dangerous Myths About Bonds
Bonds are the most boring investment in the world…
At least that’s what I believed when I joined an institutional trading desk more than a decade ago.
As a stock jockey, I worked with hedge funds slinging around shares to capture a quick profit. We traded around binary events, like earnings releases and drug trial results. You know, events that really make a stock price move.
I had no interest in bonds. To me, they were conservative investments that only grandpas would buy. Sure, they offered some income and principal protection, but with no price appreciation, there was no way to make your money grow. Or so I thought…
Years later, I found out that everything I thought about bonds was wrong.
Here are three of the biggest bond myths people fall for and why it’s essential to have a portion of your nest egg in corporate bonds.
1. Savings Bonds Are the Only Kind of Bond Out There
If you mention bond investing to most people, their eyes glaze over.
That’s because they have fallen for bond myth No. 1 – the ol’ “savings bond mentality.”
They remember the savings bonds many of us bought from the U.S. Department of the Treasury when we were younger.
You buy a savings bond at a fixed price, say $25, and then hold on to it for a minimum number of years to avoid redemption penalties. Savings bonds are essentially zero-coupon bonds. They are issued at a deep discount to their face values but pay no interest.
Corporate bonds are often completely overlooked.
Corporate bonds are debt securities issued by corporations and sold to investors. They’re issued at par value, which is $1,000, and they have a coupon payment structure. Interest is paid semiannually. As long as you own the bond, you’ll receive the interest payment from the issuer until it matures.
2. Corporates Can’t Be Traded After They’re Issued
There’s no secondary market for savings bonds. They cannot be traded among investors, so the price you pay for them won’t change if you hold them to maturity.
But contrary to myth No. 2, that’s not true of corporate bonds.
Corporate bonds can be traded after they’re issued. And they are… almost every day.
They’ll move up and down in value as investors buy and sell them to each other. They fluctuate in value based on business fundamentals like stocks do, but not as much on a percentage basis.
If you buy a bond at a discount, say $900, as long as the company doesn’t go bankrupt, you’ll be paid $1,000 when it matures. That’s an extra $100 in your pocket plus all of the interest payments you receive while owning the bond. Which brings me to our third myth…
3. Bond Yields Are Your Only Return
Myth No. 3 is a doozy. It’s why so many investors don’t recognize the huge profit potential that exists in bonds.
Yield to maturity is the minimum return you can expect a bond to generate if you hold it until its maturity date.
Let me say it again: It’s the minimum.
You can often earn twice that (or more) by buying a bond below par value and selling it early at a profit.
If you don’t own any bonds, you aren’t diversified. And if you aren’t diversified, you’re putting your retirement at unnecessary risk when the stock market eventually heads south.
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