Chapter 5: Intro to Bonds and Fixed Income
Bonds can be simply explained as a loan you provide, similar to the ones banks give to you. When you buy a bond, you are essentially lending your money for a specified period. In return, you receive interest on that loan.
After the loan period has ended, you get your initial money back and keep the interest earned.
So to the important question: How much can you earn?
Bond ratings
The first factor that affects how much you earn from bonds is the bond rating. This rating acts like a credit score for the entity issuing the bond, or if you're from Europe and don’t know what a credit score is, it serves as a risk rating that indicates how likely they are to repay you.
These ratings range from AAA down to D. AAA is the safest, followed by AA, then A, and so on. Essentially, the higher the rating, the safer the bond. The key thing to understand is how these ratings relate to the amount of money you earn, also known as the yield, which you can see on the chart.
Lower rating=Higher Yeild but also Higher risk
Time
By time, we mean the duration you loan your money to the bond issuer. Common time frames are 1, 3, 5, and 10 years, but there are also longer periods. Generally, the longer you bind your money, the higher the yield you will receive.
There are some situations where a longer time span can give you lower yields. This typically occurs during recessions or times of fear of a recession, as interest rate decisions can be very unpredictable.
4o
When could buying bonds be the right move?
-
If you want to earn more yield than a regular bank account but don't want to commit to a long-term investing strategy, you could buy a short-term bond. This option helps keep up with inflation and is unlikely to drop in value during the short period.
-
Bonds are among the safest income sources available, but they often offer a relatively low yield. Because of this, they perfectly fit the needs of retirees who want to be even safer than with dividends and have a decent-sized portfolio, so the low yield doesn't bother them.
-
Another option for bonds is to use them as a hedge against short-term drawdowns if that is a personal concern for you.