Skip to main content

ELI5 - Why Buy Bonds?



Gold-colored Coins Near Calculator

We've talked a lot about stocks, today let's take a look at the safer side of portfolios and talk about the value of bonds.

First, How Do Bonds Work?

Bonds are loans. We're all familiar with borrowing money, whether it's mortgages, credit cards or student loans. 

Regardless of how you borrow, the process typically looks like this:

1) A lender gives you money.

2) You promise to pay it back (with interest) in the future.

This is how bonds work but the roles are reversed. You become the lender. Bond issuers are the borrower and they are obligated to pay YOU back. Oh how the tables have turned.

Bond issuers are typically governments and corporations. Governments issue bonds to fund initiatives such as roads and schools. Corporations issue bonds to fund their business.

So Why Buy Bonds?

Bonds typically generate a much lower return than stocks. Returns are even lower these days given the rock-bottom interest rates. Given the poor returns, why buy them?

It all comes down to risk management. Bonds are less volatile, providing a much more stable return. This means smaller upside potential but also less downside potential. Lower rewards but lower risk. This comes especially handy during times of turmoil.

Investors with a long time horizon (or higher risk tolerance) will typically have more stocks in their portfolio, they can handle the turbulence. Those who are retiring soon (or can't stomach the rollercoaster ride) will have more bonds. It would be risky for near-retirees to own mainly stocks. A common theme in portfolios is a gradual shift from stocks to bonds as one grows older.  

Bonds are a valuable investment, but their value comes not from creating wealth but from protecting it. 

Comments

Popular posts from this blog

The Art of Giving Feedback

Constructive feedback is an awkward affair. You don't want hurt feelings, but recognize the importance of honesty. You've tried the classic "hoping things will get better on its own" and unfortunately it hasn't played out. When giving feedback, here are a few things that I try to keep it mind. Start with empathy. Step into their shoes and understand their story. If you don't know, ask. Be genuinely curious. Feedback is a dynamic affair. Shared communication with a shared goal towards progress. Take the emotion out of it. Focus on the situation, not the person. Focusing on the person adds unnecessary weight to an already emotionally-bloated event.  Be specific. Give clear examples. Vague feedback equals dismissed feedback.  Doing above won't de-awkward things fully, but it will dampen it and increase the chance of better outcomes. 

ELI5: The Stock Market

Today we get back to basics and answer some of the most common questions about the stock market.

Step One is Knowing

In school, we listen to our teachers. At home, our parents. Throughout our childhood, following instructions is praised and rewarded. When we're young, there's value in this. We don't understand how the world works quite yet, so guidance can be lifesaving.  The bias to just accept obviously has drawbacks. Insert old jumping off a bridge adage .  This conditioning is especially strong for kids from lower income households. Their parents are more likely in working class jobs involving strict order-taking. Parents of middle-class households tend to be knowledge workers where influence is essential.  Studies have shown kids from middle-income households are more willing to negotiable with their teachers. They learn from their parents that things are not set in stone. This leads to better grades and learning outcomes when compared to their lower income counterparts who don't negotiable.  In business, if we simply accept things as they are, we would never innovate. In work, w