Happy holidays to you and yours! The holidays are an excellent time to connect with friends and family and bond over what is most important in life. All this thinking of bonding got me thinking about bonds. What bonds us together? Indeed, it's not a short list, but one of the bonds is money. While family bonds are great, you should be familiar with another type of bond: bonds that facilitate lending to entities like governments, corporations, etc.
Recently, bonds have been a focal point of investment portfolios. With rates going up and down, bonds have experienced a uniquely difficult time, leading to challenges for investors, especially more conservative investors. With the spirit of bonding in the air, let's go over the basics of bonds.
At their core, bonds are just loans. While you may go to a bank to ask for a mortgage and submit your financials, large organizations borrow money through bonds. Usually, they are raised in increments of $1,000, but not always. The interest rate paid based on the face value is set at the issuance of the bond. So, if you buy a bond for $1,000 and the coupon rate is 5%, you will likely get two payments a year, each $25, totaling $50 or 5% of the "par value" of the bond. While your mortgage has an amortization schedule that indicates how much interest and principal you pay each month, bonds are a little simpler. They generally pay interest first, and you get the principal, $1,000, with the last interest payment.
While the mechanics of bonds are somewhat easy to grasp, some of the risks are not. You may think, "Well, if I can just collect a predetermined interest rate, that is the way to go!" As many learned in 2008-09 and 2022, there are many risks to consider. The most apparent risk is credit risk - the chance the loan can't be paid back. Similar to how people have credit scores, bonds are typically rated by a few different groups to indicate the type of credit risk an investor looks at. Also, similar to people, the better the credit, the lower the interest rate. The other main risk is interest rate risk, which investors experienced in 2022. This is the underlying price of the bond moving based on the changing interest rates.
Lastly, there are different types of bonds to consider, from the federal government to local municipalities and corporations domestically and abroad. Like many things, what starts as a simple idea can become awfully complicated. That's why it is essential to consider all risks, fees, and objectives before investing. There is always a risk of loss, and investors should consider all of their options carefully. This brings me to my last point: an excellent bond to have is one with your financial advisor! Because you're entrusting your assets and financial planning needs to someone, having a deep bond centered on trust is critical! We would love to explore that bond with you; reach out to us today!