Americans love the stock market because there’s nothing exotic about it.
You probably own some stocks, and they are pretty easy to understand. Say you own 100 shares of Apple (AAPL). That makes you an owner of the company. A small owner without much say, but an owner, nonetheless. The stock will go up sometimes and down sometimes—hopefully, more up than down. But that’s about it.
If you only know about stocks, though, you know next to nothing about finance.
The best way out of the dark is to learn a little something about bonds. So, let’s talk about bonds.
[ANNOUNCEMENT FROM OUR PARTNERS AT MAULDIN ECONOMICS]
A bond is a loan to a company or government from the investing public. We’ll use Apple as an example again. If you buy one of Apple’s bonds (or, more likely, part of a bond), you are making a loan to Apple. In return, Apple will pay you interest over time. And at the end of the loan term, it will give you the original amount of the loan back. Or it might not—it might default. But Apple is a pretty stable company, so you will probably get your money back.
The difference between bonds and other loans is that you can trade them like stocks. And yet, when you turn on CBNC, you don’t hear much about the bond market. The talking heads just jabber on about stocks. But the bond market is much bigger and much more important than the stock market.
When I first started investing back in 1997, I picked up a pamphlet, and it said two things…
The first thing: when interest rates go down, bond prices go up. That’s a tidbit you should commit to memory.
The second thing this pamphlet said is that I should have some bonds in my portfolio. Remember, I knew nothing about investing back then. So, I decided, hey, other people know more about this stuff than I do. And when I built my portfolio, I put some bonds in it.
I didn’t find out why I needed to own bonds until a few years later when I was in business school. There’s a fair amount of math involved, which some people take to. I majored in math at the Coast Guard Academy, so I’m fine with it. But for many people, the math part is hard.
I don’t expect anyone to learn a bunch of bond math in his spare time.
All you need to do is pretend you’re me in 1997. Someone is recommending you own some bonds, so you follow the guidance.
Why? The easy answer is that, generally speaking, if stocks go down, bonds go up, and vice versa. The name for this is “correlation”—stocks and bonds are negatively correlated. So, bonds smooth out the volatility in your portfolio. They make it much more stable.
That doesn’t sound terribly exciting, but it’s important. Because here’s what happens—if you have a portfolio of 100% stocks, and the stock market plummets 30%, maybe 40%, or more, you are going to freak out and sell at the worst possible time.
But if you have some bonds in your portfolio, they will help limit your potential drawdowns—or losses you might sustain from top to bottom. And they will keep you from freaking out and having a heart attack. So, buy some bonds—they should make up 20% of your portfolio.
And if you want to know more about bonds…
I taught bond math at the college level for about five years. Somewhere in the middle of all that, I decided to develop a course that would teach people outside of the finance world everything they need to know about bonds in a faster, simpler, much less expensive format. So, I sat down, and over the course of a few weeks, I wrote up The Bond Masterclass. And I have to say, taking this course is one of the best things you can do to improve your financial literacy. Get the details here.
Just enter your email address below. We’ll send you a free special report from Jared, along with his free weekly e-letter every Wednesday.