Bond Investing For Dummies

Russell Wild is an experienced financial advisor and writer who has been working in the finance and investment industry for more than 30 years. Russell is the principal of Global Portfolios. He is the author of Exchange-Traded Funds For Dummies and the previous editions of Bond Investing For Dummies.

Introduction 1

About This Book 2

Conventions Used in This Book 5

What You’re Not to Read 5

Foolish Assumptions 5

How This Book Is Organized 6

Part 1: A Quick Guide to the Fixed-Income Universe 6

Part 2: Bonds of Many Distinct Flavors 6

Part 3: Bonds as Portfolio Cement 7

Part 4: A Manual for Smart Bond Shopping 7

Part 5: Bonds as Good Friends of Retirees 7

Part 6: The Part of Tens 7

Icons Used in This Book 7

Beyond the Book 8

Where to Go from Here 8

Part 1: A Quick Guide to the Fixed-Income Universe 9

Chapter 1: Buying Bonds: In Your Best Interest 11

Understanding What Makes a Bond a Bond 12

Choosing your time frame 13

Picking who you trust to hold your money 14

Recognizing the difference among bonds, stocks, and cryptocurrencies 15

Why Hold Bonds? (Spoiler Alert: It Isn’t to Make You Rich) 16

Identifying the best reason to buy bonds: Diversification 16

Going for the cash 17

Investing in an Era of Low, Low Interest Rates 19

All this fuss about the Fed 20

Real (after-inflation) interest rates matter most 20

Don’t get depressed over depressed rates 21

Introducing the Major Players in the Bond Market 22

Supporting (enabling?) your Uncle Sam with Treasury bonds 22

Collecting corporate debt 23

Demystifying those government and government-like agencies 23

Going cosmopolitan with municipal bonds 24

Buying Solo or Buying in Bulk 26

Picking and choosing individual bonds 26

Going with a bond fund or funds 26

Chapter 2: Constructing Your Portfolio’s Foundation 29

Focusing on Your Objectives 30

Deciding what you want to be when you grow up 31

Picturing your future nest egg 31

Understanding the Rule of 20 (preferably 25) 32

Choosing your investment style 33

Making Your Savings and Investment Selections 34

Saving your money in safety 34

Investing your money with an eye toward growth 36

Understanding Five Major Investment Principles 38

1 Risk and return are two sides of the same coin 38

2 Financial markets are largely efficient 39

3 Diversification is just about the only free lunch you’ll ever get 39

4 Reversion to the mean — it means something 40

5 Investment costs matter — a lot! 41

Chapter 3: A (Mostly) Heroic History of Bonds 43

Reviewing the Triumphs and Failures of Fixed-Income Investing 44

Beating inflation, but not by very much 44

Serving a savoir in times of distress 45

Looking Back Over a Long and (Mostly) Distinguished Past 47

Yielding returns to generations of your forebearers 48

Gleaning some important lessons 49

Realizing How Crucial Bonds Are Today 52

Viewing Recent Developments, Largely for the Better 54

Chapter 4: Interest, Sweet Interest 57

Calculating Rates of Return — Tougher than Deciphering Babylonian 58

Cutting deals 59

Changing hands 59

Embracing the complexity 60

Conducting Three Levels of Research to Judge the Desirability of a Bond 60

Level one: Getting the basic information 61

Level two: Finding out intimate details 63

Level three: Examining the neighborhood 66

Understanding (and Misunderstanding) the Concept of Yield 69

Coupon yield 70

Current yield 70

Yield-to-maturity 70

Yield-to-call 72

Worst-case basis yield 72

The 30-day SEC yield 73

Appreciating Total Return (This Is What Matters Most!) 73

Figuring in capital gains and losses 73

Factoring in reinvestment rates of return 74

Allowing for inflation adjustments 74

Weighing pretax versus posttax 75

Measuring the Volatility of Your Bonds 76

Time frame matters 76

Quality counts 76

The coupon rate matters, too 77

Foreign bonds, added risk 78

Revisiting the Bonds of Babylonia 78

Interest short run, interest long run 79

Interest past, interest future 79

Part 2: Bonds of Many Distinct Flavors 81

Chapter 5: US Treasury Bonds: As Safe as Safe Can Be 83

Investing with Uncle Sam in Myriad Ways 84

Savings bonds as gifts or small investments 85

Treasury bills, notes, and bonds for more serious investing 90

Treasury inflation-protected securities (TIPS) 91

Easing Your Fears of Default 93

Deciding Whether, When, and How to Invest in Treasuries 94

Figuring out whether you want Treasuries 94

Picking your own maturity 97

Adding in some inflation protection 99

Entering the Treasury Marketplace 99

Buying direct or through a broker 100

Choosing a new or used bond 101

Tapping Treasuries through mutual funds and exchange-traded funds 102

Chapter 6: Getting Down to Business: Corporate Bonds 103

Why Invest in These Sometimes Pains-in-the-Butt? 104

Comparing corporate bonds to Treasuries 104

Considering historical returns 106

Getting Moody: The Crucial Credit Ratings 107

Revisiting your ABCs 108

Gauging the risk of default 110

Special Considerations for Investing in Corporate Debt 111

Calculating callability 112

Coveting convertibility 112

Reversing convertibility —imagine that 113

Appreciating High Yield for What It Is 114

Anticipating good times ahead 114

Preparing for the bad times 115

Investing in high yields judiciously 115

Chapter 7: Powerful and a Tad Mysterious: Agency Bonds 117

Identifying the Bond Issuers 118

Slurping up your alphabet soup 118

Separating federal agency bonds from GSEs 119

Sizing up the government’s actual commitment 120

Introducing the agency biggies 120

Comparing and Contrasting Agency Bonds 125

Eyeing default risks, yields, markups, and more 125

Weighing taxation matters 126

Discos, floaters, and step-ups 127

Banking Your Money on Other People’s Mortgages 127

Bathing in the mortgage pool 128

Deciding whether to invest in the housing market 128

Considering Agencies for Your Portfolio 129

Chapter 8: (Practically) Tax-Free: Municipal Bonds 131

Appreciating the Purpose and Power of Munis 132

Sizing up the muni market 133

Comparing and contrasting with other bonds 133

Delighting in the diversification of municipals 134

Knowing That All Cities (Bridges or Ports) Are Not Created Equal 136

Dealing with the rare default 136

Enjoying low risk 137

Choosing from a vast array of possibilities 138

Consulting the Taxman 139

Bringing your bracket to bear 140

Singling out your home state 141

Matching munis to the appropriate accounts 142

Recognizing Why This Chapter Is Titled “(Practically) Tax-Free: Municipal Bonds” 142

Reckoning with the AMT tax 143

Capping your capital gains 143

Introducing the fully taxable muni 144

Buying Munis Made Easier 144

Chapter 9: International Bonds and Other Seemingly Exotic Offerings 147

Traveling Abroad for Fixed Income 148

Dipping into developed-world bonds 148

Embracing the bonds of emerging-market nations 152

Bond Investing with a Conscience 155

Having faith in church bonds 155

Adhering to Islamic law: Introducing sukuk 157

Sustainability-linked bonds 158

Playing with Bond Fire: Potentially Risky Bond Offerings 161

Rocking with Bowie Bonds 161

Cashing in on catastrophe bonds 162

Dealing in death 162

Dancing in the Flames: Derivatives and Default Bond Products 163

Daring to delve into derivatives 163

Banking on losses with defaulted bond issues 164

Catching a fallen angel 166

Evaluating Exchange-traded Notes 167

What are they? 167

Should you invest? 168

Part 3: Bonds as Portfolio Cement 169

Chapter 10: Return, Risk, and Realism 171

Searching, Searching, Searching for the Elusive Free Lunch 172

Making a killing in CDs yeah, right 172

Defining risk and return 173

Appreciating Bonds’ Risk Characteristics 173

Interest rate risk 174

Inflation risk 175

Reinvestment risk 176

Default risk 176

Downgrade risk 177

Tax risk 178

Fear-of-missing-out (FOMO) risk 178

Regarding all these risks 179

Reckoning on the Return You’ll Most Likely See 181

Calculating fixed-income returns: Easier said than done 181

Looking back at history: An imperfect but useful guide 182

Investing in bonds despite their lackluster returns 184

Finding Your Risk-Return Sweet Spot 187

Allocating your portfolio correctly 187

Tailoring a portfolio just for you 187

Chapter 11: The Art and Science of Portfolio-Building 189

Mixing and Matching Your Various Investments 190

Dreaming of limited correlation 190

Seeking zig and zag with Modern Portfolio Theory 192

Translating theory into reality 192

Appreciating Bonds’ Dual Role: Diversifier and Ultimate Safety Net 194

Protecting yourself from perfect storms 194

Eyeing a centuries-old track record 195

Recognizing Voodoo Science 197

Comparing actively managed funds to index funds 197

Forecasting the future — and getting it wrong 198

Ignoring the hype 199

Chapter 12: Slicing the Pie: How Much Should Be in Bonds? 201

Why the Bond Percentage Question Isn’t As Simple As Pie 202

Minimizing volatility 203

Maximizing return 204

Peering into the Future 205

Estimating how much you’ll need 206

Assessing your time frame 206

Factoring in some good rules 206

Recognizing yourself in a few case studies 207

Noticing the Many Shades of Gray in Your Portfolio 212

Bonds of many flavors 213

Stocks of all sizes and sorts 213

Other fixed income: Annuities 214

Other equity: Commodities and real estate 215

Making Sure That Your Portfolio Remains in Balance 216

Tweaking your holdings to temper risk 217

Savoring the rebalancing bonus 217

Scheduling your portfolio rebalance 218

Chapter 13: Making Your Preliminary Bond Choices 219

Reviewing the Rationale behind Bonds 220

Making your initial selection 220

Following a few rules 221

Sizing Up Your Need for Fixed-Income Diversification 222

Diversifying by maturity 222

Diversifying by type of issuer 222

Diversifying by risk-and-return potential 223

Diversifying away managerial risk 224

Weighing Diversification versus Complication 225

Keeping it simple with balanced funds (for people with less than $2,000) 225

Moving beyond the basic (for people with $2,000 to $4,000) 225

Branching out (with $4,000 or more) 226

Finding the Perfect Bond Portfolio Fit 226

Case studies in bond ownership 226

Seeking out the more exotic offerings 232

Part 4: A Manual for Smart Bond Shopping 233

Chapter 14: Planning Your Bond Buys and Sells 235

Discovering the Brave New World of Bonds 236

Finding fabulously frugal funds 236

Dealing in individual bonds without forking over a fortune 237

Deciding Whether to Go with Bond Funds or Individual Bonds 239

Calculating the advantages of funds 239

Considering whether individual bonds or bond funds make more sense 241

Is Now the Time to Buy Bonds? 246

Predicting the future of interest rates yeah, right 247

Paying too much attention to the yield curve 248

Adhering — or not — to dollar-cost averaging 249

Choosing between Taxable and Tax-Advantaged Retirement Accounts 250

Positioning your investments for minimal taxation 250

Factoring in the early-withdrawal penalties and such 252

Chapter 15: Diving (Carefully!) into the Individual Bond Marketplace 253

Navigating Today’s Bond Market 254

Getting some welcome transparency 255

Ushering in a new beginning 255

Dealing with Brokers and Other Financial Professionals 256

Identifying the role of the dealer 257

Do you need a broker or agent at all? 258

Selecting the right broker or agent 259

Checking the dealer’s numbers 259

Hiring a financial planner 261

Doing It Yourself Online 262

If you’re looking to buy 263

If you’re looking to sell 264

Perfecting the Art of Laddering 265

Protecting you from interest rate flux 265

Tinkering with your time frame 266

Discount bonds or premium bonds? 268

Buying and Selling an Individual Bond: My Own Journey 269

Chapter 16: Choosing Bond Funds Wisely 273

Defining the Basic Kinds of Funds 274

Mining a multitude of mutual funds 275

Establishing a position in exchange-traded funds 276

Considering an alternative: Closed-end funds 278

Understanding unit investment trusts 279

Knowing What Matters Most in Choosing a Bond Fund of Any Sort 280

Selecting your fund based on its components and their characteristics 280

Pruning out the underperformers 280

Laying down the law on loads 281

Sniffing out false promises 281

My Picks for Some of the Best Bond Funds 282

Short-term, high-quality bond funds 283

Intermediate-term Treasury bond funds 286

(Mostly) high-quality corporate bond funds 287

Junk city: Corporate high-yield funds 288

Agency bond funds 290

Municipal bond funds: Taxes be damned 291

Taxable Muni Bonds 292

Global and International bond funds 293

Emerging market bond funds 294

All-in-one bond funds 295

Instant-Ladder, Defined-Maturity Bond Funds (Government, Corporate, Municipal) 298

All-in-one bond and stock funds 298

Target-retirement date funds (otherwise known as life-cycle funds) 300

Part 5: Bonds as Good Friends of Retirees 303

Chapter 17: Satisfying Your Need for Steady Cash 305

Reaping the Rewards of Your Investments 306

Aiming for freedom 306

Estimating your target portfolio 307

Lining up your bucks 308

Finding Interesting Sources of Interest 308

Certificates of deposit (CDs) 309

Mining the many money market funds 309

Banking on online savings accounts 311

Considering the predictability of an annuity 311

Hocking your home with a reverse mortgage 313

Recognizing that Stocks Can Be Cash Cows, Too 313

Focusing on stocks with sock-o dividends 314

Realizing gain with real estate investment trusts (REITs) 315

Taking a middle ground with preferred stock 316

Introducing a Vastly Better Way to Create Cash Flow: Portfolio Rebalancing 316

Buying low and selling high 318

Rolling bond interest back in 320

Dealing with realities 320

Chapter 18: Ensuring Financial Security in Old Age 321

Looking Ahead to Many Years of Possible Portfolio Withdrawals 322

Knowing Where the Real Danger Lies: The Risk of Being Too Conservative 323

Considering an aggressive approach 323

Easing back toward your comfort zone 324

Setting your default at 60/40 324

Allowing for adjustments to suit the times 325

Choosing my own and your ultimate ratio 326

Calculating How Much You Can Safely Tap 328

Revisiting risk, return, and realistic expectations 328

Basing your retirement on clear thinking 329

Making the Most Use of Uncle Sam’s Gifts 330

Minimizing income is the name of the game 330

Lowering your tax bracket through smart withdrawals 331

Part 6: The Part of Tens 333

Chapter 19: Ten Most Common Misconceptions about Bonds 335

A Bond “Selling for 100” Costs $100 335

Buying a Bond at a Discount Is Better Than Paying a Premium, Duh 336

A Bond Paying X% Today Will Pocket You X% Over the Life of the Bond 336

Rising Interest Rates Are Good (or Bad) for Bondholders 337

Certain Bonds, Such as Treasuries, Are Completely Safe 338

Bonds Are a Retiree’s Best Friend 338

Individual Bonds Are Usually a Better Deal than Bond Funds 338

Municipal Bonds Are Free of Taxation 339

A Discount Broker Sells Bonds Cheaper 339

The Big Risk in Bonds Is the Risk of the Issuer Defaulting 340

Chapter 20: Ten Mistakes Bond Investors Need to Avoid 341

Allowing the Broker to Churn You 341

Not Taking Advantage of TRACE 342

Choosing a Bond Fund Based on Short-Term Performance 342

Not Looking Closely Enough at a Bond Fund’s Expenses 343

Going Through a Broker to Buy Treasuries 343

Counting Too Much on High-Yield Bonds 343

Paying Too Much Attention to the Yield Curve 344

Buying Bonds That Are Too Complicated 345

Ignoring Inflation and Taxation 345

Relying Too Heavily on Bonds in Retirement 345

Appendix: Helpful Web Resources For Successful Bond Investing 347

Index 353