How Bonds Actually Work versus How Industry Confuses Us
"People in bonds lost everything in 2008"
"People who retired with bonds during COVID took a major hit"
These false statements come from confusion between bond market value, bond yield, and how bond coupons work. It's no surprise that many are confused. The financial industry stratigically creates confusion on bonds so people stay in their funds or their incentivized new growth stocks they aim to pump and dump.
Financial articles often paint a dismal picture by headlining "Bond's Yields Fell Sharply" like it's a bad thing. The gut response is "I'm glad I'm not in those". Rather, if bond yields went down, the person's Net Worth went up! It's amazing how the industry tries to frighten you away from bonds with their constant barrage of misleading headlines.
Now, it is very true that bonds can be traded just like stocks. You can definitely buy high and sell low - which is crushing. However, with Investment Grade (AAA) bonds, selling on a stop-loss is never a wise strategy. Instead, bonds provide a way to get a fixed income and lock it in for a target number of years. You only get "crushed" if you decide to sell them. Even then, you have to sell them when the market has them priced lower than when you bought them.
If you need the money within in a year, then be sure to find a block of bonds that meets that duration. Many folks "ladder" across 5 years so they score the coupon and get some principal back every year to re-evaluate where they should next invest based on the current market climate.
If the Fed is actively lowering the rates in the future, it's good to go for the long haul as your market value will increase and you'll lock in a good coupon rate for a long time, say 10-20 years. If the Fed rates go way low, you will be positioned to sell for an easy double digit gain. In such a climate, panic stock sellers are ditching their stocks at a loss and you could use your bond profits to pick up some major dips. You'd then get explosive gains on the other side of the recession in equities. This is simply old school "rebalancing". Patience pays. It's the reason so many of the silent generation have 3X their original nest egg they leave to their children.
In 2024, both stocks and bond yields reached 20 year highs and the Fed announced lower interest rate goals. This was a great opportunity for anyone in the red zone to lock in fixed income to cover their expenses prior to receiving social security.
To help clear up any confusion, let's look at some bond related definitions:
Yield: The income return on a bond, expressed as a percentage. It is calculated as the interest payments (coupon) divided by the bond's current market price.
Duration: A measure of a bond's sensitivity to interest rate changes. It reflects the average time until a bondholder receives all cash flows (interest and principal) from a bond.
Credit Rating: An assessment of the issuer's creditworthiness, provided by rating agencies like Moody's, S&P, or Fitch. It indicates the risk level of a bond defaulting.
Face Value (Par Value): The amount the bondholder receives when the bond matures. Bonds are typically issued with a face value of $1,000.
Coupon: The periodic interest payment made to bondholders during the life of the bond. It's usually fixed and expressed as a percentage of the bond's face value.
Those who have been tricked by Big Finance will think that the Coupon goes down when they hear that bond yields are down. The coupon payout DOES NOT go down with market yield shifts. The coupon is a percentage of the purchased bond's face value and never changes throughout the duration of the owned bond. You can count on the coupon to land in your account typically twice a year. For US Treasuries, just hold and you are guaranteed to make the coupon rate and be handed the face value back at maturity.
Now, corporate bonds, like Microsoft and Apple, are investment grade bonds as well - darn near as risk free as US Treasuries. Companies pay their bond holders first before dividends, too. So, stock dividends would get cut before you'd see you bond coupons at risk. US Treasuries are the least risk, though, which is where I like to stay.
In sum, bonds, particularly US Treasuries, are an awesome passive income source. If you work long enough to accumulate enough cash to purchase bonds at a high yield, you can be set for life. My strategy was to get enough US Treasuries to have $10K more than living expenses at age 52. This covered annualized inflation on the living expenses until my pensions kick in. My stock portfolio could then go through otherwise nightmarish cycles and I'd never lose sleep. And - I'll never sell a single bond or stock share from my retirement nest egg throughout my retirement.