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Bonds 101

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#1 ·
Bonds 101

This thread is for educational purposes only and will have no securities offered for sale. It will teach you about investing in bonds. The bond market does not receive the attention of the average investor that the stock market does. We don't have Jim Cramer and the rest of the media with all of their bells and whistles to get peoples' attention. The bond market is much larger than the stock market and should be a part of your arsenal of investment knowledge. There are great opportunities to make substantial returns in both markets and the bond market was brought to the retail investor about 20 years ago. Before then it was more of an investment tool for institutions and the ultra wealthy. There were very few middle and upper middle class individuals who owned bonds and the numbers of them that own bonds today is much lower than it should be due to simple lack of knowledge and media coverage. I believe it's so important that people learn about bonds because they have a date in the future when the issuer has a contract to return the investor's money (make sure you know about credit ratings. I'll post something later in the week). I will try to have an individual bond topic to discuss several times a week, but we'll try to stick to simple bonds. If you have any questions about bonds and fixed income please feel free to ask them here and make sure you speak with your financial advisor before you invest.

What are bonds?

A bond is a debt security, somewhat like a loan that is divided up into $1000 increments and sold to investors. When you buy a bond you are, in essence, lending money to the entity that issued the bonds. Bond issuers can be corporations, national governments, municipalities, government agencies or any other entity wishing to raise capital for operations or improvements. When you buy bonds the issuer is obligated to pay you a specific rate of interest and repay the face value (principal) when it "matures", or comes due.



There are many types of bonds to choose from: U.S. government securities, municipal bonds, corporate bonds, mortgage backed bonds, casino bonds, and many other types. Many mortgage backed bonds pay principal and interest on a monthly basis. You can receive a very strong degree of protection from the sub-prime crash by investing in mortgage backed bonds that are guaranteed by the federal government or a federal agency who guarantee on time payment of principal and interest. Beware, there are AAA rated mortgage backed bonds that are not backed by the government or a government agency that are dangerous.


Important features to consider when investing in bonds.

There are many things that an investor needs to consider before they invest in bonds: credit quality, interest rate, maturity, price, yield, call dates, and tax status. You need to use these factors to decide if a bond agrees with your financial objectives. If you're looking to buy a boat in 5 years and want to put your money to work until you're ready to visit the boat dealer, a bond with a maturity of greater than 5 years would not be consistent with your goals. If you can't afford to lose any money a bond with a high yield and low credit rating is probably not for you due to frisk of default. If you have $1 million saved for your retirement and need $50,000 a year to live happily then a bond that pays less than 5% interest is not the bond that fits your needs. These are just a few examples of how we judge whether an investment is suitable for us. There are many other considerations that you need to discuss with your financial advisor before investing in bonds. I'll post these considerations within the next week or so.
 
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#5 ·
Smart move brasos, bond holders always get their money before shareholders. If you don't mind getting stock when a companies financial condition takes a turn for the worse you might want to ask your financial advisor about reverse convertable bonds. In many cases they offer an obscenely high coupon and if the stock price drops a certain percentage from its price on the date of issue they are converted to stock. If they convert to stock your stocks will be worth less than the bonds were worth because they establish the quantity of stock you will receive on or close to the day of issue. The higher the volitility of the stock the higher the coupon on the reverse convertable bonds. This is considered a relativly risky play as far as bonds go and you can lose money as you can in the stock market, but the returns are real nice on the winners.
 
#6 · (Edited)
Here's the next episode (considerations you need to make before investing in a bond.)

Credit quality

One of many important considerations you need to make before you invest in any particular bond is credit quality. You can purchase bonds that hold credit qualities ranging from full faith and credit of the U.S. government, considered the most stable and highest credit quality in the world, All the way down to bonds that are considered below investment grade or "junk bonds". Most banks, municipalities, and many other institutions are prohibited from investing in junk bonds by their investment policies due to the higher risk of default. Long term bonds may not mature for many years, thus it is very important to look at the credit quality of a bond that you are considering. We also need to keep in mind that credit quality can change over time. Case in point: Ford. Had we bought a 30 year Ford bond 20 years ago we would have bought an investment with a high grade credit rating. Today it is considered a Junk or high yield bond. We never know where a corporation's credit will go in the distant future. There are government agencies that have been around for 70 years and have maintained the highest credit rating since their inception. If corporate bonds are an investment that you are considering, the issuer is responsible for providing information to the investor about their financial condition through a document called a prospectus or official statement. It should be provided to you by your financial advisor before you invest.

Credit ratings

We have 3 major rating agencies that let us know about the credit worthiness of bond issuers. These agencies are Moody's, Standard and Poor, and Fitch. They assign credit ratings on bond issuers based on a deep analysis of their financial condition and other factors. AAA is the highest credit rating with the least risk of default. Bonds that are rated BB or lower are considered to be speculative or "junk". Under normal economic circumstances a diversified portfolio of junk bonds will have only a modest risk of default in the long run. We still need to understand that the high yield given in any single junk bond is accompanied by a high risk, low credit rating. The possibility of a default in junk bonds goes up when the economy is not doing well. You can check for credit problems that may cause a ratings change on the net at Moody's, Standard and Poor's, or Fitch's web sites.

Moody's___S&P______Fitch______________Definition

Aaa______AAA______AAA_____Prime: Maximum Safety

Aa1______AA+______AA+_____High Grade High Quality

Aa2______AA_______AA

Aa3______AA-______ AA-

A1_______A+_______ A+______Upper Medium Grade

A2_______A________ A

A3_______A-_______ A-

Baa1_____BBB+_____BBB+____Lower Medium Grade

Baa2_____BBB______BBB

Baa3_____BBB-_____BBB-

Ba1______BB+______BB+_____Non-Investment Grade (Junk)

Interest Rates

Bonds pay interest that can be fixed, adjustable, or payable at maturity or call. The interest rate that a bond pays is called the coupon. Most bonds have a fixed interest rate that is expressed as a percentage of the face value (principal amount). Different bonds can pay interest on different schedules. It can be paid monthly, quarterly, semi-annually, or at maturity. For example, a bond is worth $1000.00 with an 8% interest rate or coupon. It will pay investors $80.00 per year or $40.00 every six months if it is a semi-annual paying bond. When a bond comes to maturity or is called the investor will receive the full face amount of the bond - $1000.00 and their last interest payment. There are also adjustable rate bonds available. Rates on adjustable or "floating rate" bonds adjust at predetermined dates in accordance to a rate index, for example, U.S. Treasury bill rates. Bonds that periodically adjust to the U.S. Treasury index will also have less price volatility, bur we'll discuss pricing later. Another type of bond known as the zero coupon bonds pays interest at maturity. An example would be as follows: A $20,000.00 zero coupon bond could be purchased for $5,000.00 with a 20 year maturity. In 20 years the bond will come to maturity in 20 years and you will receive $20,000.00. That would give you a rate of return of roughly 7% per year compounded. If this is a taxable bond you will pay tax on the "accretion" or what many may think of as accrued interest. We know this as the phantom tax in the bond world. You receive no cash, but still pay the tax.

Maturities

The Maturity of a bond is a specific date in the future when the investor's principal will be repaid. Bond maturities run from very short periods of time up to 30 years. There are other features of bonds that cause many of them not to go until maturity, but repay principal early along with a last interest payment and terminate the investment contract.

Bond insurance

Many bond issuers use bond insurance to enhance their credit quality in order to make their bonds more marketable. Bond insurers guarantee the timely payment of principal and interest. The bonds will then carry the same credit rating as their insurer. The major players in the bond insurance industry in the United States are having financial difficulties at current time due to the sub prime mess and could become financially insolvent. They major players are AMBAC, FGIC, MBIA, and FGIC. They still have their AAA ratings but it is very important that you look at the underlying credit rating of a bond issuer and not rely on the insurer to make sure you get your principal back. These are insurers of mainly municipal bonds but have lately gone to insuring sub prime bonds and that's what got them into financial trouble.

Price

The price that an investor pays for a bond is based on several factors: current interest rates, supply and demand, credit quality, maturity and tax status. Bonds that are new issues typically sell close to their face value. Secondary market bonds have a price that will fluctuate with changing interest rates. Example: if you bought a bond 1 year ago that had a 2 year maturity and was giving 5% and since then interest rates had gone up substantially it would be worth less today. Today, one year after you bought your 5%, 2year bond, you can buy a bond that will give you 6% and matures in 1 year ( both bonds now mature at the same time). The bond that you bought for 100 cents on the dollar a year ago would now be worth 99 cents on the dollar. The investor today wants 6% on his 1 year investment and your old bond only pays 5% interest for the next year. The new buyer of your old bond in the secondary market will earn 5% from the interest and 1% on the principal that he will receive 100 cents on the dollar for after he only paid 99 cent on the dollar for it. Thus, he will receive the prevailing market rate for the bond that was issued a year ago. These are nice round numbers for sake of simplicity, it doesn't always work out so cleanly. A simple rule to remember, if interest rates go up the market price on your bonds will go down. If interest rates go down the price on your bonds will go up. Bonds that are farther to maturity will have greater price fluctuations than bonds that have shorter maturities.

Yield

Yield is the actual return that you earn on your bond. The yield is based on the coupon and on the price paid for a bond. Example: If you buy a bond that matures in 1 year and paid 101 cents on the dollar for it ( a premium ) and it has a 7% interest rate you will only receive a 6% yield because when you receive your principal you will get it at 100 cents on the dollar. Your yield will be higher than your coupon or interest rate if you buy your bond at a discount ( less than 100 cents on the dollar ) Again, these are simple numbers just to make it easy for me to explain. If you buy bonds at a premium or a discount the yield will also vary if the bonds are called before maturity. Make sure that you ask your investment advisor about yield to call and yield to maturity.

Tax Status

There are bonds out there that offer tax free status. Treasury bonds can only be taxed by the federal government. You have to pay no state or local taxes on them. Many municipal bonds are exempt from state and federal tax. You will receive a lower rate on these bonds than you would if you were to invest in taxable bonds of the same credit quality and maturity but often it ends up being less after paying taxes. If the tax equivalent yield on a tax free bond is higher than the yield on a taxable bond then you should consider the tax free bond. Here's how to figure out the tax equivalent yield on a tax free bond.

Tax Equivalent yield = Yield / (1 - your tax bracket)

I'll go over tax free municipal bonds later.

Within the next week I'll post more on bond investment considerations.
 
#7 · (Edited)
Here's the final post on bond investment considerations

Redemption Features

Though maturity is a good gauge as to when you will get your principal back, there are calls, puts, and structures that can greatly shorten the life of an investment.

Call provisions

Some bonds have a feature called a call schedule. Issuers of bonds reserve the fight to refinance their debt just as we reserve the right to refinance our mortgages at a lower rate. Bonds are normally called after the Federal Reserve has lowered rates substantially. When a bond is called, the investors' principal is returned and the last interest payment is made. This leaves the investor with cash that will often times need to be reinvested at a lower rate. Thus, it is called "call risk". An early call on a bond that is purchased at a premium (more than 100 cents on the dollar) will cause the yield on your bonds to go down. If you purchase a bond at a discount (less than 100 cents on the dollar) and it's called early your yield will go up. Before you buy a bond you need to ask your financial advisor what the yield to call is and what the yield to maturity is. Bonds that are callable will usually give the investor a higher return in exchange for the call risk.

Puts

Some bonds have puts, which allow the investor to require the issuer to return their principal. Investors usually exercise their put options when interest rates have risen and they have the opportunity to reinvest at a higher rate. Some bonds have what is called a Death Put. This allows the bond holder's estate to require the issuer of the bond to return all principal on the bond holder's death.

Here's a strategy move: I had a client that was diagnosed with a terminal illness and given four months to live. I found bonds with a low credit rating (junk bonds) that had a death put provision on them. A death put allows the holders estate to put the bonds back to the issuer upon the holders death. I knew the company was not going to default on their bonds over the next year and probably not even after that. Here's the kicker, the bonds were selling at 70 cents on the dollar due to drops in credit quality and rises in interest rates. When the client passed away several months later, his family was able to "put" the bonds back to the issuer at 100 cents on the dollar or par. That's a 30% gain on bonds over a period of a few months. It's not all the time that you can find these bonds at such a discounted price, but it is something you should check into if you know someone who has been diagnosed with a terminal illness during a rising rate economic environment. Investors don't have to die to get that kind of yields but we'll get into other strategies later.

Prepayments of principal and average life

Mortgage backed bonds are typically priced off of their average life. If a mortgage backed bond is made of 30 year mortgages the chances of it maturing in 30 years are small. As the mortgage holders pay down the principal on the mortgages backing the bond that principal is passed through to the investor each month and that pro-rata portion of the bond has matured. There are several factors that cause prepayments on mortgage backed bonds. First we'll go over the 4 D's: Death, Default, Divorce, and Destruction. If a mortgage holder dies, the home usually sold by the estate and the current mortgage is terminated, returning that portion of principal to the investors. If a mortgage holder defaults, the home is sold by the bank and the investor receives that portion of the principal. Be careful with this one, if the bond is backed by the U.S. government or a government agency you have little to worry about when it comes to the return of your principal. Government agencies guarantee on time payment of outstanding principal and interest. If it is a mortgage backed bond that is not backed by the federal government or a government agency, you are subject to the whims of the real-estate market and the value the bank can get for the home. In the sub prime era, its best to stick with the government and government agency mortgage backed bonds. Divorce commonly causes the sale of a home and the investor gets their principal back at that time. In the event of destruction, the insurance company pays off the mortgage and the bondholder receives their principal. Another very large factor of prepayment on mortgage backed bonds is refinancing. If a homeowner refinances their mortgage, the existing mortgage contract that backs the bond is terminated and the investor receives their principal back. Of course, these bonds begin to pay down faster in falling interest rate environments because the holders of the mortgages backing the bonds have the opportunity to refinance at a lower rate. There are thousands of mortgages backing some of these bonds and the average American family lives in a home for 7 years before they move. Chances are very slim that these bonds will go out 30 years.

Assessing Risk

Virtually all investments have some type of risk. When you're investing in bonds you need to remember. The greater the return, the higher the risk.

I'll post some information on safe issuers of bonds within the next or so.
 
#9 · (Edited)
Why Invest in Bonds?

Many bonds have a predictable stream of payments, repayment of principal and people invest in them to preserve and increase their wealth. Other people invest in bonds for their retirement income or to help grow savings for large purchases in the future. They are not like stocks or funds that could go down in value and not come back for a very long time. Though the value of bonds floats up and down during their life, they have a date in the future when the investor receives their principal investment back.

Bonds will follow a simple set of rules. Certain circumstances will occur and the investor will have certain things happen with their bonds according to those rules. The stock market and funds have a very complex set of rules. The rules for bonds are simple compared to the rules of the stock market. A bond's rules are like a game of checkers and the rules that apply to the stock market and funds are more like a 3 dimensional game of chess. Case in point -Enron- where high level forensic accountants took years to figure out something was up. Take a look at the stocks for Lowe's and Home Depot. We just went through the largest period of home building and home improvement in the history of the United States. Those who invested in Lowe's did well, while the investors in Home Depot did poorly because the CEO took a huge sum in bonuses and a large golden parachute. There was no way for the investors Who planned on profiting from the housing boom to know that this was going to happen before they bought into Home Depot. I'm not here to bash the stock market, there are some great opportunities to make money there and if you're making money there I urge you to continue. The point I'm trying to get across is that the bond market is a larger yet simpler market. It still has its hidden pitfalls (subprime mortgages) just not as many as the stock market.

Strong credit quality is a must in this economy

In an economy that looks to be headed for recession we need to make sure that we are not investing in bonds with low credit quality. Right now I'm sticking with Full faith and credit of the U.S. Government, or a government agency.

Genie Mae is a Corporation that is wholly owned by the U.S. government. It was given full faith and credit status in 1969 by then attorney general William Rehnquist. They buy VA and FHA mortgages from banks in order to provide the banks with liquidity so that they can continue to make mortgage loans. Any bonds issued by Genie Mae have the same credit quality as a U.S. treasury bond or a CD that is FDIC insured. They hold the strongest credit quality in the world.

Fannie Mae and Freddie Mac are two government agencies that have held AAA ratings, the highest credit rating since their inception. They are stockholder owned corporations that were formed by congressional mandate and perform the same function that Genie Mae performs but they don't buy VA mortgages per the norm. Both Freddie and Fannie bonds are invested in by every municipality, School district, port authority, toll road authority, and most pension plans in the country. If Freddie or Fannie were to go belly up we would have a huge disaster. Every municipality, School district, port authority, toll road authority, and most pension plans would also go bankrupt. A very large portion of our property tax money is invested in very short Fannie and Freddie bonds until the municipality or school district is ready to spend it. We consider the credit quality of these bonds to be on par with that of the federal government and it's often referred to as "implied full faith and credit of the U.S. government". The federal government would probably have no choice other than to bail them out if they were to fail.

Simple Bonds

A simple bond would have a maturity date and a coupon. This bond will give you x percent of interest per year paid to the investor on specific dates until the bond matures and gives the investor their principal back so that it can be reinvested. This type of bond is great for people who are saving money for a specific period of time to accomplish a specific financial goal. This type of bond, if it is of very high credit quality, is also good for people to retire on and live off of the interest.

Simple bond + 1 rule

If you take a bond that has the same rules as the bonds above, a maturity and a coupon, add in a call date or series of call dates, the yield will go up because the investor will now have an extra risk to deal with. If the investor's bond is called by the issuer they will receive their last interest payment and the return of their principal investment before the bond matures. This will leave them with money to reinvest, probably at a lower interest rate.

Add in a few more rules for a higher yield

I saw a bond the other day that was Full faith and credit of the U.S. government that was giving investors 7 ½%. The issuer was Genie Mae. How can you get a bond that has the same credit quality as a U.S. Treasury Bond yet yields almost twice what treasuries do. We add in a few more rules. We know that we have to take more risk to get more yield, so what gives? There are bonds with structures that allow us to take risks other than the risk of loosing our money. This particular bond will give us 7 1/2 % until the fed raises rates to 7%. After the fed raises rates to 7% or more the interest earned on the bond goes to 0%. It's been quite a while since rates have been there (December 1990) and the fed is currently lowering rates. I'd say this one would be a good way to get 7 ½% on your speculative money with out the risk of losing it as long as you hold the bonds to maturity. This is not the type of bond that you would invest your entire retirement fund into because if rates do go over 7% then you could find yourself without income. If you are looking to make more money in an investment than you can on typical AAA rated bonds or CD's this is a great way to do it. I would much rather invest in this type of bond than junk bonds.


If you have any questions please feel free to ask them in this forum.
 
#10 ·
Adding risk to the rules.

The last bond that we discussed was giving us 7.5% until the 1 month U.S. LIBOR was raised to 7%. 1 month U.S. LIBOR very closely tracks Fed Funds. It's the overnight rate that European banks use to lend each other U.S. Dollars. The investor is taking this risk in order to get the higher yield without putting his principal at risk as long as he holds his bonds to maturity. The next bond that we will discuss has the same type of risk, interest rate risk, but will give us a much higher coupon. It holds a higher perceived interest rate risk than the previous bond we discussed. They have a coupon, or interest rate to the bond holder that will go up X% for every 1% the Federal Reserve lowers interest rates. The coupon also goes down that same X% for every 1% that the Fed raises rates. Your risk being that you can have a bond that performs poorly or not at all in a rising rate market. Due to the fact that bond values fluctuate opposite interest rates, the value on these bonds will fluctuate substantially.

The fed is scheduled to meet tomorrow, March the 18th. There will probably be a large interest rate cut, 75 to 100 basis points. Last week I placed some of these bonds that float up 6% for every 1% that the 1 Month U.S. LIBOR goes down. Let's not forget that the 1 month U.S. LIBOR tracks fed funds and the Fed is poised to make a large cut. When I placed these bonds in portfolios they were giving 16% interest, if we get a 1% rate cut tomorrow they will be giving 22% to the investor. 16 and 22 percent are great numbers for an AAA rated government agency bonds. As you can see we've added another rule to a bond that offers us another way to take risk, and our coupon goes up substantially. The end game on taking this type of risk is, if the investor is wrong about where interest rates are heading and everything goes wrong, the investor gets their money back at maturity. If investors are wrong about a stock, there's no date in the future when they get their money back. All they can do is wait and hope that the stock price goes up in the future. Before you invest in this type of bond make sure you ask you advisor about all of the risks involved.

We'll discuss these bonds in greater detail in the future, or if you have any questios you want answered sooner feel free to ask them here.
 
#11 ·
Capital Gains with bonds.

When you're looking to achieve capital gains with bonds, the government and government agency backed inverse floating rate bonds described in my last post are the best bonds I can think of. Due to the fact that the coupons on some of these bonds float up as much as 30% for every 1% that the fed lowers rates or down 30% for every 1% the Fed raises rates they have extreme price volatility. Once rates have gone up you can find some of these inverse floating rate bonds for as little as 50 cents on the dollar. If the fed lowers rates 1% the price could go from 50 cents on the dollar up to par, or 100 cents on the dollar, in a very short period of time. We have made capital gains plays with this strategy often earning investors 40 or 50% on their money in a matter of months. This can also be done with bonds that have lower levers than 30%. A lever is determined on a bond before its issue. When you invest in one of these bonds you will know exactly how much the coupon will move up or down when the Fed moves. Many times people who originally wanted to sell a bond for a capital gain decide to hold onto it rather than sell because the coupon is now so high. I am holding some of these that are yielding about 60% currently with a value of about 160 cents on the dollar. Since rates have already fallen this is a play that is off the table for now. On the next rate cycle, be sure to ask your financial advisor about this play before you decide to make it. The prices on these bonds are very sensitive and are affected by mere perceptions of inflation that could cause the fed to move rates. Another thing that will affect the outcome of these plays is whether we have a Democrat or Republican in the white house. Dems tend to raise a lot of tax revenue through capital gains. Republicans tax the hell out of us through other means. I'm not taking sides in politics, just stating the facts that will affect your investments.

Rules that give you protection

There are bonds out there that float inversely to where the Fed moves rates that have a floor as to how low the coupon can go. I use these bonds for individuals that are already retired. If you can get by on the income produced by these bonds when they are on their "floor" these would be an investment that might fit your style. When I find investors that like to buy high credit quality bonds that give them for example 6% fixed I tell them they should invest in a floor bond that will never pay them less than a 5% coupon but has the possibility of going up to 10 or 11% coupons if the Fed lowers rates. Many of my 5% floor bonds are currently sitting around 9% and will go up farther if the Fed continues to lower rates. Many of these bonds are issued by government agencies or the federal government and have the highest credit quality. Thus you have stable income from the floor, and you have the possibility of higher returns if the Fed lowers rates.

If you have any questions please feel free to ask them here. I'll get something up on simple tax free bonds next week.
 
#12 ·
After this I think we should all be over the erroneous myth that you can't get enormous returns on AAA rated bonds just as you can in the stock market. No, you can't make Google money, but how many of us were able to get into that at the right time. You can make very healthy returns, and you have a contractual agreement from the bond issuer to give you all of your money back when the bonds come to maturity. In the stock market you could make big money one month, and lose big money the next. No contract to return your initial investment.

Tax Free Municipal Bonds

There are many investors out there who pay no taxes on the majority of their retirement income. This is done with Tax free municipal bonds that we'll go over in this segment. The laws apply to tax free municipal bonds as follows. If you buy a tax free municipal bond that is issued by an issuer in your state of residence you pay no state or federal income tax. If you buy a bond issued by an issuer outside of your state you will pay no federal income tax, but you will have to pay state income tax. If you have no state income tax in your state then you have free reign as to where your bond issuer is located. Be careful, most but not all municipal bonds are tax free. Make sure your advisor checks.

There are two major types of municipal bonds: general obligation bonds, and revenue bonds. General obligation bonds are issued by issuers with taxing authority. The principal and interest payments on these bonds are made from tax dollars. Revenue bonds have principal and interest that is paid from revenues from a public use facility or infrastructure. If you buy coliseum bonds they would be revenue bonds. If you buy toll road bonds they would be paid for by the revenues from the tolls paid by drivers using that toll road. Revenue bonds generally give a slightly higher yield than general obligation bonds because they are perceived as slightly more risky due to the lack of taxing authority to back them. A municipal bond will hold the same rating as it insurer. You need to ask your financial advisor what the underlying credit quality of the issuer is. At this point in time many of the municipal bond insurers are having solvency problems because they decided to insure billions in sub-prime mortgage backed securities. You need to make sure that the underlying credit of the issuer is strong because you can no longer count on an insurer to cover a default on the municipalities' part. If you are looking for the strongest credit quality in municipal bonds you would be looking for insured by Texas Permanent School Fund (PSF). PSF insured bonds are considered the strongest credit quality in the United States as far as municipal insurers are concerned. Unfortunately if you live in a state that has a state income tax you will have to pay your state's income tax on PSF bonds, or move to Texas.

If you are in one of the higher tax brackets, these bonds make sense for many people who seek strong credit and a reliable source of interest checks. Here's how to find out if a tax free bond will give you a better yield than a taxable one.

Tax Equivalent yield = Yield / (1 - your tax bracket)

If you are in a lower tax bracket you will be better off investing in taxable bonds and giving Uncle Sam his cut. Tax free bonds will generally give a lower interest rate than a taxable bond of the same credit quality and maturity. Their after tax yield will many times be higher to an individual who is in a high tax bracket after taxes are paid on the taxable bond. Use the formula above to find out if they're right for you and as always talk to your financial advisor before you invest in anything. If you have any questions please feel free to ask them here.
 
#13 ·
Here's a blog posting by Eddy Elfenbein I found on long term returns on bonds vs stocks. This guy is just comparing a group of long term corporate bonds to stocks. I'd be willing to bet that he's not using any of the higher yielding higher credit quality government and government agency backed derivative bonds. If we look at the Dow as a whole, we have no return since 2000. The nasdaq as a whole is at a loss since 2000.​

Eddy's post:​

April 9, 2008 Stocks Against Bonds I recently received the latest Ibbotson Yearbook in the mail the other day. If you're not familiar with it, the book is a great source for long-term returns of different asset classes (click here for more info).

What I find interesting is that the spread between the returns of stocks and bonds really isn't that much. I think would surprise many investors that boring bonds have held their own. Over the last 40 years, stocks have beaten bonds by a final score 10.5% to 8.4%.

The difference is theoretically due to greater risk for stocks. (Note: This is different from the usual equity risk premium which looks at stocks versus T-bills. Here I'm looking at stocks and long-term corporate bonds.)

Here's a chart I made of stocks and long-term corporate bonds. The only difference is that I stretched out the bond returns by 2% a year.



These two lines have tracked each other remarkably closely. In the 1970s, bonds took a big lead over stocks, and in the late 1990s, stocks shot ahead of bonds. Besides that, it's been pretty close. You can also see that the market rally of the 1980s really wasn't much of a bubble, nor is today's market out of whack by historical standards.

Let me add that I do not think this is a good way to time the market.

Posted by edelfenbein at April 9, 2008 1:31 PM



Copyright © 2008 Eddy Elfenbein | Design by Callisto Design Studio | Hosting by InvestorPlace Blogs
 
#14 ·
Structured CDs and Notes

Everyone knows that we can go to our bank and buy a CD that will give us 3 - 4% depending on how long we want to have our money invested and from which bank we buy the CD. What most of us don't know is that we can buy an FDIC insured CD that will give us 7 - 8% as long as the 30 year treasury is greater than the 10 year treasury. Most of these CDs will accrue interest on the days the 30 year is greater than the 10 year and not on the days that they are inverted. If we look at the number of days in the last 15 years that we've had an inversion from the 10 year to the 30 year we can see that it's hardly enough to affect our overall annual yields. This is, of course, not something that you would want to throw your entire income producing retirement savings into. If you did throw all of your eggs into 1 basket and the 10 year to 30 year did go inverted for a long period of time, you could end up with no income. This is a great way to get full faith and credit of the U.S. government behind an investment that will give you 7 - 8% on money set aside for growth. There are many structures available in CD form that will give you a higher coupon than those you see at the bank. Ask your investment advisor about them.

Structured notes are a little different. We don't have full faith and credit of the U.S. government behind them, we have to look at the credit quality of the issuer. There are plenty of AAA rated issuers that will give you a nice rate. An investor can buy these notes linked to many different indexes, commodities, and stocks. If you believe that the price of corn is going to go up over the next 5 years, you might be able to find a note that is linked to the price of corn. For example: The investor invests in 5 year corn linked notes, the price of corn goes up 50% and the investor gets 150% of their initial investment at the end of 5 years. If the price falls by 50% the investor gets 100% of their money back at the end of 5 years. It's a good way to get some of the upside in different commodities, markets, and indexes while you get the protection of a bond behind the investment. If you want to invest in commodities and are a bit apprehensive about the possibility of losing money this might be something you might want to try. As always before you make any investment, speak with your advisor first. Be carful with notes. There are many AAA rated issuers and many junk issuers. If the underlying commodity, index, or stock goes up and the junk rated issuer goes broke you will lose your money. Make sure you stick with the issuers who have the higher credit ratings.
 
#18 ·
BondBroker,

Within Texas municipals, I prefer PSF over the insurers as well. I believe PSF is 3x covered by the oil reserves, mostly in west Tx. I've never had a muni default, but I assume the PSF would kick in to cover in the same way a solvent insurer would, correct?

I was taught AAA, AAA rating, A or better underlying rating, GO bonds versus Revenue, and try to avoid hospitals, prisons and nuke plants. Sound like a reasonable short guage for screening munis?
 
#19 ·
Flatscat,

PSF is definitely some of the strongest credit quality out there when it comes to bond insurance. AMBAC, FGIC, and most of the other municipal bond insurers out there made a big mistake and decided to insure sub prime mortgage-backed bonds and this was a huge mistake. They are now in danger of becoming financially insolvent. I don't really think that we would want to say that PSF would kick in the same way a solvent insurer would. Many of the private insurers have not paid a claim on defaulting municipalities even when they were in good financial condition. GO bonds versus the revenue bonds are definitely seen as safer but there are some strong revenue bonds out there. Large toll road authorities are usually viewed as safe revenue bond investments. You are right about the underlying credit. Since the insurers (except for PSF) are most likely not going to pay you in the case of default the underlying credit score is very important. I see airport bonds all the time that are CCC rated, I'd say you're right about that, Washington power supply had bonds on a nuclear plant default in the 80's, and I've never looked at a prison bond. One more thing you might want to look at if you're looking for safety in municipal bonds is bonds that are pre-refunded. This means that the money to pay the principal has been set aside. Very difficult for a bond to default when the issuer already has the money to pay the debt.
 
#20 ·
Building a bond ladder

A bond ladder is an investment strategy that is used to attempt to keep cash flow and income at a certain level rather than subjecting the investor to a large degree of reinvestment risk. If an investor has $100,000 to invest in a bond ladder they would invest it in many different maturities rather than one single maturity. If an investor invests in one bond that matures in 5 years giving them 5% interest they may find themselves having to invest the money at a lower rate in the future if prevailing market rates have gone down. When building a bond ladder they may invest in a series of bonds that would stager the maturities out over a number of years. $100,000 may be invested in 10 different maturities that will give them an over all 5%. The investor may invest in one $10,000 dollar face amount that is one year to maturity and another at 3 years. The rest of the ten $10,000 increments could be invested in maturities that are 5 years and out. This way if prevailing rates are down from where they were when the initial investment was made they will only have to invest $10,000 at a lower level instead of the entire $100,000. Chances are, they will be able to invest other $10,000 increments at higher levels in the future when they come to maturity.

Another reason for using a bond ladder is it allows us to adjust cash flows to meet our financial needs. We can guarantee our monthly income based on monthly interest paid to us by the bonds. When doing this we need to not only pay attention to the maturities of the bonds that we put into our ladder but also the payment dates. This is very important to retired individuals that are dependant on the income from their bond ladder. We want to have a payment every month.

When creating a bond ladder we need to take the total amount we want to invest in bonds and divide it by the number of years we want to go out until maturity. This will give us the number of bonds (rungs) we will need in our ladder. The more rungs we have in our ladder the better diversified we will be. The amount of time between maturities or distance between the rungs can range from monthly to every couple of years.

The longer you make your ladder the higher your average yield should be but the more reinvestment risk you will have. If you make your rungs too small your return will be smaller but you have better liquidity.

Bond ladders can be made of many types of bonds. Some are made from municipal bonds giving investors tax free income. If the amount you have saved won't put you in a higher tax bracket, then you should go with treasury, government agency, or corporate bonds with good credit ratings. I would not make a ladder that is too long out of corporate bonds because their ratings change. You never know when a company might go broke and leave you with a ladder that is missing a rung. It's better to stick with government backed securities, muni bonds or even CDs.

 
#21 · (Edited)
Many investors should start saving now so they can pay the tax bill on a conversion from IRA to Roth IRA in 2010. In 2010 the income limit will be eliminated on Roth IRAs. Even Warren Buffet can invest in a Roth IRA in 2010. (I'm not a CPA) Any dollars converted in 2010 should be assumed, unless an investor chooses differently, if they convert in 2010 they should not have to pay the taxes on the amount converted until 2011 return is filed. The IRS is giving investors as much as 2 years to pay taxes on the conversion. An investor can pay half in 2011 and the other half on the 2012 return. Because there is a fair amount of time between now and then, investors have sufficient time to save money for the conversion.

Another change that will be affecting retirement planning is the conversion from 401k to Roth IRA. This year investors can switch their 401k plans to Roth IRAs. Unlike traditional IRAs, Roth IRAs are taxed before the contributions are made and the money then grows tax free. Investors are not required to take distributions from a Roth IRA after the age of 70 ½.
 
#22 ·
The possibility of high yields with AAA rated Bonds

We spoke before about busting the myth: "AAA rated bonds cannot give high yields". Now we'll go into depth on the subject. Government agencies like Fannie Mae and Freddie Mac have been pooling mortgages, dividing them into bonds and passing the principal and interest through to investors for quite some time. Some of these bonds have thousands of mortgages backing them. To make it more attractive to investors they guarantee on time payment of principal and interest. The credit quality of these government agencies is extremely strong and gives us a good degree of protection from the subprime market. If a mortgage holder does not make a payment for any reason -- be it default, home destruction, or any other reason, the government agency will make the payment to the investor of the bond that is backed by the particular delinquent mortgage. Most of the simple fixed rate mortgage backed bonds will pay a low interest rate that is competitive with the rate that other bonds in the AAA market are paying. In the 1980's the invention of the CMO came to be. As far as the source of funds for payment of principal and interest, the CMO is part of the Mortgage Backed family. There are many different types of CMO's out there and we will get into a few of the more interesting ones in this post. Careful, not all CMOs are backed by government agencies. Mortgage backed bonds and CMOs are composed of 15 or 30 year mortgages. Right now you are probably thinking that you don't want to have your money invested for 30 years. The truth of the matter is that most of these bonds pay off in an average time period of 7 to 12 years. If there is any event that terminates a mortgage contract the investor in the bond gets that portion of their principal back when the mortgage is terminated. There are several factors that cause a mortgage to be terminated and cause these bonds to pay off at a much faster rate than the 30 year schedule for the mortgages. If a home is destroyed, the investor receives their money for the outstanding portion of that mortgage. Divorce usually forces the sale of a home. In the case of death, a home is also sold under normal circumstances. If the borrower of a particular mortgage defaults, the investor will get their portion of that mortgage back as principal the month the home is declared in default. Another big factor for Mortgage backed bonds and CMOs paying off early is refinancing. If a homeowner refinances their mortgage the existing mortgage contract is terminated and the investor of the bond backed by that mortgage is paid their principal. The average American family lives in a home for only 7 years before they move. Thus, the maturities on these bonds are usually 7-12 years though they do hold the risk of going out quite a bit longer because they are, after all, made of 30 year mortgages. When investing in these bonds we look at average life to try and predict when a bond will give us our money back. There are several factors that an investor looks at when predicting maturity on their mortgage backed bonds or CMOs. One of the things that we look at is the average interest rate paid by the homeowner on their mortgages. Homeowners with a 6.5% mortgage are currently thinking about refinancing their mortgages causing the investor in the bond backed by those 6.5% mortgages to receive their principal more quickly. There are certain states that tend to pay down faster than others, particularly California and Florida. If the mortgages were originated by larger banks and mortgage lenders, they have a greater chance of refinancing. Larger institutions have entire departments devoted to marketing refinance packages to the same people they lent the money to. There are some other factors but this will give you an idea about what is used to predict maturity. Remember, it is a prediction of maturity and the risk of these bonds going longer or shorter does exist.

Where does the possibility for high yields with AAA rated bonds come in?

Why would an AAA rated bond issuer pay us a high coupon? Answer, they don't. High coupons are generated with cash flow engineering. This gets technical so stay with me. When a bank lends money to a home owner in the form of a mortgage they will sell that mortgage to a government agency. The mortgage on your home was probably sold to Fannie, Freddie, or Genie. Let's say the bank makes a mortgage to a home buyer at 6% they will turn around and sell that mortgage to a government agency at 5 ½%. They get their principal back so they can lend it out again and they make 1/2 % on the mortgage. You send your mortgage payment to the bank at 6% and they send the principal and 5 ½% interest to the government agency that bought your mortgage every month. After a government agency buys the mortgages they will package them into bonds that they guarantee on time payment of principal and interest on, and sell them to investors. Remember the Agencies bought 5 ½% mortgages from the bank. When they package the mortgages into bonds they will take 90% of the bonds made from these now 5 ½% mortgages and pass through 5% to the investor. Where did the other 1/2 % go? It's all piled onto the remaining 10% of the bonds for purposes of cash flow engineering. Now we have 90% of the bonds made from these 5 ½% mortgages giving investors a fixed rate of 5%. The other 10% of these bonds now hold 50 ½% interest. How did we get 50 ½%? We have the original 5 ½% and we have ½% coming off of the other 90% of the mortgages in the pool giving us another 45% to pile on top of that 5 ½%. This is how an AAA rated government agency can give investors the possibility of high coupons with out paying high interest themselves.

Why can't we just buy the bonds that yield 50 ½%? Sorry folks, we all know it's a risk return world and the same applies here. If risk return didn't apply we'd just have the big corporations and the ultra wealthy scraping the cream off the top leaving the rest of us with the **** on the bottom. Now we have 50 ½% interest to do cash flow engineering with. We can make a bond that will float up or down 6 or 8 % with every one point the Fed lowers Fed Funds, and the coupon will go down at the same rate when the Fed raises rates. There will be a bond on the other side of the 50 1/2 % cash flow that will receive the interest if the fed raises rates. Cash flow engineering is not quite as simple as 2 bonds with interest payments shifting from 1 to the other but this gives you a general idea about how it works. These bonds are kind of like cars, you don't have to know how a car is made to benefit from it.

Take a look at this AAA rated bond that is currently giving investors a 66% coupon on their invested principal.

http://3.bp.blogspot.com/_kG6s-aS2t-w/SKCn-DeM1lI/AAAAAAAAABM/wqrBXeTUBw4/s1600-h/3139sg2cool.bmp

This bond is not currently offered for sale, it is for educational purposes only and is shown at a previous price where investors were able to purchase several months ago when its yield was lower than 1%. It illustrates the fact that an investor can get a high yield from a bond that is AAA rated.

This bond has a coupon that will go up 25% for every 1% that the 1 month U.S. LIBOR goes down. The 1 month U.S. LIBOR tracks Fed Funds very closely. Fed Funds is the rate that U.S. banks charge each other to lend U.S. Dollars to each other overnight. The U.S. Libor is the rate that European banks charge each other to lend U.S. dollars overnight. If you were to lay a line graph of 1 month U.S. LIBOR over a line graph for Fed Funds they would look like intertwining ribbons. Thus to speculate on what this bond is going to do, we need to keep an eye on the Federal Reserve. It's my opinion that it is much easier to determine where fed funds are headed in the short term, than to speculate on a stock price and the hundreds of factors that are involved with determining whether its price is going up or down. All-in-all this bond is giving investors a 66% coupon and there is a date in the future where investors will get their money back. I'd be ecstatic to get a 66% return in the stock market, but I'd have to put my principal at risk to do it.



Remember, we said that these bonds will pay down at a Prepayment Speed Assumption (PSA). If you look at the illustration above, in the upper left hand corner you have the PSA box. This lets us know how much principal is coming in ahead of schedule. The current information for the potential investors yield and possible maturity are in this column. The average life of 0.60 is the time that the investor will get their initial investment back if the PSA stays at 509. The date window 6-15-08 - 7-15-09 is the potential time frame that you will receive your last payment if PSA stays at 509. At the top of the page is the Weighted Average Coupon (WAC) this tells us what the weighted average interest rate the mortgage holders of the mortgages that are backing this bond are paying. 6.475% is rather high compared to current rates; hence the bond is paying at a 509 PSA. REMEMBER: PSA Changes on a monthly basis and this bond or any other mortgage backed bond could become significantly longer or shorter. In the upper right hand corner of the page we have the coupon for this bond, 66.81633%. The final maturity for the longest mortgage in the pool of mortgages that backs this bond is 4/15/36. Seems like a long way out, but all signs in the current environment point to this bond being paid of in another year or two. These are just assumptions that we make about the final maturity, it could be shorter or it could be much longer, if rates don't go back up soon, it will probably be about 2 years until it's done. This bond will give us a 66.81633% return while rates are at the current level. If rates go up the coupon will go down by 25% for every 1% that the 1 month LIBOR goes up. The reward is a very large return on an AAA rated Freddy Mac bond. The risk is, you could have a bond that will not perform if rates go through the roof. This bond will give no return while the 1 month LIBOR is over 5.35%, and 25% for every 1 point the 1 month LIBOR is below 5.35%.

Price on this type of bond is very volatile. This bond was purchased at 100 cents on the dollar when the coupon was 0.71% and the 1 month LIBOR was at 5.32%. The current price with 1 month LIBOR at 2.732 is over 150 cents on the dollar. As rates rise the market value of this bond will fall. If the 1 month LIBOR goes over 5.35% the price could fall as low as 50 cents on the dollar or lower. Of course, the market value will come back as rates fall in the future and the investor will receive all of their principal investment back at 100 cents on the dollar. This is not an investment play for the current interest rate environment. We all believe that the next rate move the Fed will make is up. Bonds like this are a great move if you are a buy and hold, long term investor and rates are about to fall.
 
#23 ·
Protecting your principal with structured notes and CDs.

There are a lot of ways that we can take risk in the markets and make a ton of money. Unfortunately that risk we are taking is losing money. With structured notes it doesn't have to be that way. We can participate in almost every market out there and have a maturity date that will give us our principal investment back when the note or CD comes to maturity.



There are notes and CDs that are linked to stock market indexes (not only the DOW, S& P, and NASDAQ but also foreign markets ) that will allow us to participate in some of the upside gains, or losses if you feel an index is going down. If you are wrong about which way an index is headed, you will get all of your money back in when the note or CD comes to maturity. Recently I have seen several absolute return notes. Absolute return notes will give us a return of the gain or loss on an index. For example, if the S & P goes up or down up to 20% we will make the percentage that the S & P has gone up or down over a certain period. If the S & P goes up or down 15% we make 15% interest on the note. If the S & P goes up or down 21% or more we don't get a return, but we get all of our money back at maturity. If we were to truly invest in the S & P looking to benefit from a rise in stock prices and the index falls we would lose our money as opposed to making no money but receiving all of our principal back at maturity. Most of the absolute return notes available have maturities of 1 to 1.5 years. We can buy notes like this that are tied to many of the indexes around the world. If you want to participate in some of the gains in overseas markets but you don't want to lose money these may be the way to go for you.



We can also buy structured notes and CDs that are linked to commodities. I've seen them linked to everything from oil, to gold, to wheat. We have the opportunity to participate in the gains in commodities and have a date in the future where we will get all of our money back if we're wrong about where the prices of these commodities are headed. Notes that will benefit short sellers of commodities are also available.



There are structured notes and CD's that will give us participation in individual stocks or a basket of stocks, and we can also buy CD's that are linked to interest rate indexes. Everyone knows they can go to there bank right now and buy a CD that will give them a 4.5% return on their money. What people don't know is they can buy an FDIC insured CD that will give them 8 or 9% as long as the Federal Reserve does not raise the Federal Funds rate above 6 or 6.5%. The CDs will accrue interest for as long as Fed Funds are below this level, once Fed Funds goes over this level they will stop accruing interest and when it falls back below 6 or 6.5% they will begin to accrue interest again.



How do structured notes work to give us protection of our principal? They are made up of two components, a deep discounted zero coupon CD and options. The maturity date of the CD is the same as the maturity date of the note that you've invested in. They can buy these CDs at a deep discount, for example 75 cents on the dollar. When the CD comes to maturity they have the money to pay investors back in full if things don't go their way. The other 25 cents are spent on options on the stock, index, or commodity that the investor wishes to invest in. If the market goes your way you get your money from your options and the 100 cents on the dollar that the deep discounted zero coupon CD matures at, giving the investor the full amount of invested principal and a gain given by the options.



When you are investing in structured notes linked to individual stocks make sure they are not reverse convertibles, otherwise known as revertables. These do not have principal protection and the investor is putting his or her principal at risk. We will get into revertables in a later discussion. Another thing you need to talk about with your financial advisor about is credit quality. If you are investing in a structured CD you have no worries about this, they are FDIC insured, full faith and credit of the U.S. government. If you are investing in structured notes, they are subject to the same ratings that bonds are. Some are AAA or AA rated while others are junk grade.
 
#24 ·
Will there be a mass exodus of baby boomers from the stock market?

There are about 80 million baby boomers out there, and they're getting ready to retire. Many of the financial experts out there believe that the baby boomer generation has been responsible for the surge in equity prices since the mid 90's. When they went through the accumulation phase of their investing lives they invested substantial amounts of money in the stock market taking advantage of the run up in stock prices.

Baby boomers are now entering the capital preservation phase of their lives and if they behave as previous generations have, they will soon be taking money out of the stock market and putting it into the fixed income markets. This may mean a huge amount of money will be withdrawn from the stock market over the next decade. Some say that this generation will live longer and lead more active lives than previous generations. Many of the boomer generation will bring in part time income and reinvest that in the stock market "post retirement". Fixed income may play less of a part in the portfolios than it did in the portfolios of previous generations of retirees.

There are some factors that point to a massive drawdown in equities and there are others that point to retirees leaving more money in the market than previous retirees. I guess we'll just have to wait and see how it plays out.
 
#25 ·
Safe Havens in a Market Meltdown



Right about now many investors are wondering where to put their money in order to keep it safe while the stock markets are sliding to low levels not seen in years. There are all kinds of viable options that are available to us. Unfortunately, when people think investments, they think about the stock, fund, and commodity markets. These markets are currently not the place to be.



Where should we be? Many of the world's educated investors are putting their money in U.S. government backed bonds and FDIC insured investments. Another safe place to be if you're a Texas resident is in Texas PSF municipal bonds. What investors should look for when they are looking to protect their wealth is a bond or security that has an agreement to return their principal at some point in the future. The issuer of this bond should have a very secure source of funds to pay the principal and interest from. A secure source of funds would give the bond a high credit rating. The problem with ratings right now is that the ratings agencies have not been too reliable as of late. Thus, we should look for an investment that is backed by a credible government, or government agency.



Due to the liquidation of Lehman Brothers fixed income portfolio, tax free municipal bonds are extremely cheap on the market today. If you're willing to invest for the long term, there are zero coupon bonds out there giving 7% ready for the taking. If someone is in a higher tax bracket, this could mean a 10% tax equivalent yield to the investor. Municipal bonds in general, I would say, are not as safe as they once were due to the erosion of their tax base caused by foreclosures and loss of jobs. That's why I like PSF bonds for Texas investors. They are backed by Texas oil and natural gas deposits and as long we have oil and natural gas in Texas, these bonds will be safe.



Another route investors can take is the FDIC route. There are plenty of CDs out there that will give investors a fair return and the full faith and credit of the U.S. government backing their principal investment. Just because bank CDs are giving low returns doesn't mean an investor has to invest at a low rate. If an investor wants a higher rate there are other risks that they can take. They can take interest rate risk and get about 8% in an FDIC backed CD.



We can also invest in government or government agency backed bonds. The low yielding Treasury bond is not the only bond that is backed by the U.S. government. Genie Mae is wholly owned by the United States Government. They offer us bonds that will give us typical government bond market rates all the way up to the more sophisticated bonds that allow investors to take interest rate risk giving potential for significantly higher yields. Though we can risk the amount we receive in interest we will get our money back at maturity and are not risking our principal.



In order to protect principal investors must hold bonds to maturity. Most bonds have an agreement to return the face value of the bond at maturity. The current price of bonds on the secondary market fluctuates up and down on the secondary market and investors could make capital gains or lose money by selling bonds before maturity. This post is for informational purposes only and none of the above mentioned securities are being offered for sale in this post.





 
#26 ·
Bonds for a stable retirement


Looking for something to invest in that will give us a stable return for our retirement can be a daunting task; especially if we want all of our money back at some point in the future. There are all kinds of options out there that we can use that will give us a variable rate return and that can leave us with a nasty taste in our mouths when we get a monthly check from our investments that will not cover our expenses. There are also a number of fixed rate investments out there that can do the trick, but we're not always guaranteed to get our money back at some point in the future, or if they are guaranteed, sometimes the credit quality of the investment is questionable and we could experience a costly default.

Fixed rate bonds can make for a nice retirement if we use them correctly. So, how do we use them correctly? Here are some basic key rules that we need to follow when we are investing in bonds. Rule # 1: always invest in bonds that are backed by a government agency or the Full Faith and Credit of the United States Government. Texas PSF municipal bonds are another insurer that I trust and they're tax free in most cases. If you're investing in corporate bonds to get a little extra yield then you should stay away from investing in bonds that are too long. We wouldn't want to invest in a high credit quality corporate bond that is 15 years to maturity. Why? If we would have invested in General Motors bonds 15 Years ago we would have had a bond with very strong credit quality, now they are junk. We don't have a crystal ball to tell us what perils lay in the future for corporations, not even Wal-Mart. Rule # 2: be careful with call dates, you can get a higher yield if you buy bonds with call dates but you have to worry about your bonds getting called. This is not to say that we can't use call risk to our advantage, but it is another risk we have to look out for. A call date is a date or dates in the future when the issuer of a bond can tell the investor, "here is your final interest payment and here is the return of your entire principal balance, our investment contract is finished." Usually when this happens the investor is going to have to look at investing their returned principal at a lower rate than they were previously invested. Rule # 3: If you would rather have money and not an investment portfolio with an income stream to give to your loved ones when you pass away. You need to invest in bonds with a death put, or bonds with a shorter maturity if you don't plan on living until you're 90.

When we invest in bonds we expect to be paid interest monthly, quarterly, semi-annually, annually, or at maturity. When the bond comes to maturity we get our money back and are able to reinvest it as long as we've followed the rule of investing in some of the high credit quality bonds mentioned above. ( I'm not saying these are the only bonds you can trust but it's what I'm sticking with. ) Take a look at how much money you have saved, and how much money you need to live off of. If you have $1 million dollars that you've managed to squirrel away over your lifetime and need $50,000 a year, then you need to find bonds with very strong credit quality and a 5% yield to the investor where interest is paid on a basis that fits your needs and budget. If you feel that $50000 will be enough money for you to survive every year for the rest of your life, you can buy longer bonds that will last for the rest of you life that have a death put. A death put or estate feature allows your estate to put the bonds back to the issuer at 100 cents on the dollar after you've passed on, giving your family money instead of bonds.

Investing in bonds can provide us with a very stable and predictable retirement income. Yes, bonds are boring. One thing we don't want when it comes to our retirement income is excitement. Make sure you consult with your financial advisor before investing and ask about the return of your money on maturity, credit quality, interest rates, call dates, and interest payment dates.
 
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