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 1About This Book 2Conventions Used in This Book 5What You’re Not to Read 5Foolish Assumptions 5How This Book Is Organized 6Part 1: A Quick Guide to the Fixed-Income Universe 6Part 2: Bonds of Many Distinct Flavors 6Part 3: Bonds as Portfolio Cement 7Part 4: A Manual for Smart Bond Shopping 7Part 5: Bonds as Good Friends of Retirees 7Part 6: The Part of Tens 7Icons Used in This Book 7Beyond the Book 8Where to Go from Here 8Part 1: A Quick Guide to the Fixed-Income Universe 9Chapter 1: Buying Bonds: In Your Best Interest 11Understanding What Makes a Bond a Bond 12Choosing your time frame 13Picking who you trust to hold your money 14Recognizing the difference among bonds, stocks, and cryptocurrencies 15Why Hold Bonds? (Spoiler Alert: It Isn’t to Make You Rich) 16Identifying the best reason to buy bonds: Diversification 16Going for the cash 17Investing in an Era of Low, Low Interest Rates 19All this fuss about the Fed 20Real (after-inflation) interest rates matter most 20Don’t get depressed over depressed rates 21Introducing the Major Players in the Bond Market 22Supporting (enabling?) your Uncle Sam with Treasury bonds 22Collecting corporate debt 23Demystifying those government and government-like agencies 23Going cosmopolitan with municipal bonds 24Buying Solo or Buying in Bulk 26Picking and choosing individual bonds 26Going with a bond fund or funds 26Chapter 2: Constructing Your Portfolio’s Foundation 29Focusing on Your Objectives 30Deciding what you want to be when you grow up 31Picturing your future nest egg 31Understanding the Rule of 20 (preferably 25) 32Choosing your investment style 33Making Your Savings and Investment Selections 34Saving your money in safety 34Investing your money with an eye toward growth 36Understanding Five Major Investment Principles 381 Risk and return are two sides of the same coin 382 Financial markets are largely efficient 393 Diversification is just about the only free lunch you’ll ever get 394 Reversion to the mean — it means something 405 Investment costs matter — a lot! 41Chapter 3: A (Mostly) Heroic History of Bonds 43Reviewing the Triumphs and Failures of Fixed-Income Investing 44Beating inflation, but not by very much 44Serving a savoir in times of distress 45Looking Back Over a Long and (Mostly) Distinguished Past 47Yielding returns to generations of your forebearers 48Gleaning some important lessons 49Realizing How Crucial Bonds Are Today 52Viewing Recent Developments, Largely for the Better 54Chapter 4: Interest, Sweet Interest 57Calculating Rates of Return — Tougher than Deciphering Babylonian 58Cutting deals 59Changing hands 59Embracing the complexity 60Conducting Three Levels of Research to Judge the Desirability of a Bond 60Level one: Getting the basic information 61Level two: Finding out intimate details 63Level three: Examining the neighborhood 66Understanding (and Misunderstanding) the Concept of Yield 69Coupon yield 70Current yield 70Yield-to-maturity 70Yield-to-call 72Worst-case basis yield 72The 30-day SEC yield 73Appreciating Total Return (This Is What Matters Most!) 73Figuring in capital gains and losses 73Factoring in reinvestment rates of return 74Allowing for inflation adjustments 74Weighing pretax versus posttax 75Measuring the Volatility of Your Bonds 76Time frame matters 76Quality counts 76The coupon rate matters, too 77Foreign bonds, added risk 78Revisiting the Bonds of Babylonia 78Interest short run, interest long run 79Interest past, interest future 79Part 2: Bonds of Many Distinct Flavors 81Chapter 5: US Treasury Bonds: As Safe as Safe Can Be 83Investing with Uncle Sam in Myriad Ways 84Savings bonds as gifts or small investments 85Treasury bills, notes, and bonds for more serious investing 90Treasury inflation-protected securities (TIPS) 91Easing Your Fears of Default 93Deciding Whether, When, and How to Invest in Treasuries 94Figuring out whether you want Treasuries 94Picking your own maturity 97Adding in some inflation protection 99Entering the Treasury Marketplace 99Buying direct or through a broker 100Choosing a new or used bond 101Tapping Treasuries through mutual funds and exchange-traded funds 102Chapter 6: Getting Down to Business: Corporate Bonds 103Why Invest in These Sometimes Pains-in-the-Butt? 104Comparing corporate bonds to Treasuries 104Considering historical returns 106Getting Moody: The Crucial Credit Ratings 107Revisiting your ABCs 108Gauging the risk of default 110Special Considerations for Investing in Corporate Debt 111Calculating callability 112Coveting convertibility 112Reversing convertibility —imagine that 113Appreciating High Yield for What It Is 114Anticipating good times ahead 114Preparing for the bad times 115Investing in high yields judiciously 115Chapter 7: Powerful and a Tad Mysterious: Agency Bonds 117Identifying the Bond Issuers 118Slurping up your alphabet soup 118Separating federal agency bonds from GSEs 119Sizing up the government’s actual commitment 120Introducing the agency biggies 120Comparing and Contrasting Agency Bonds 125Eyeing default risks, yields, markups, and more 125Weighing taxation matters 126Discos, floaters, and step-ups 127Banking Your Money on Other People’s Mortgages 127Bathing in the mortgage pool 128Deciding whether to invest in the housing market 128Considering Agencies for Your Portfolio 129Chapter 8: (Practically) Tax-Free: Municipal Bonds 131Appreciating the Purpose and Power of Munis 132Sizing up the muni market 133Comparing and contrasting with other bonds 133Delighting in the diversification of municipals 134Knowing That All Cities (Bridges or Ports) Are Not Created Equal 136Dealing with the rare default 136Enjoying low risk 137Choosing from a vast array of possibilities 138Consulting the Taxman 139Bringing your bracket to bear 140Singling out your home state 141Matching munis to the appropriate accounts 142Recognizing Why This Chapter Is Titled “(Practically) Tax-Free: Municipal Bonds” 142Reckoning with the AMT tax 143Capping your capital gains 143Introducing the fully taxable muni 144Buying Munis Made Easier 144Chapter 9: International Bonds and Other Seemingly Exotic Offerings 147Traveling Abroad for Fixed Income 148Dipping into developed-world bonds 148Embracing the bonds of emerging-market nations 152Bond Investing with a Conscience 155Having faith in church bonds 155Adhering to Islamic law: Introducing sukuk 157Sustainability-linked bonds 158Playing with Bond Fire: Potentially Risky Bond Offerings 161Rocking with Bowie Bonds 161Cashing in on catastrophe bonds 162Dealing in death 162Dancing in the Flames: Derivatives and Default Bond Products 163Daring to delve into derivatives 163Banking on losses with defaulted bond issues 164Catching a fallen angel 166Evaluating Exchange-traded Notes 167What are they? 167Should you invest? 168Part 3: Bonds as Portfolio Cement 169Chapter 10: Return, Risk, and Realism 171Searching, Searching, Searching for the Elusive Free Lunch 172Making a killing in CDs yeah, right 172Defining risk and return 173Appreciating Bonds’ Risk Characteristics 173Interest rate risk 174Inflation risk 175Reinvestment risk 176Default risk 176Downgrade risk 177Tax risk 178Fear-of-missing-out (FOMO) risk 178Regarding all these risks 179Reckoning on the Return You’ll Most Likely See 181Calculating fixed-income returns: Easier said than done 181Looking back at history: An imperfect but useful guide 182Investing in bonds despite their lackluster returns 184Finding Your Risk-Return Sweet Spot 187Allocating your portfolio correctly 187Tailoring a portfolio just for you 187Chapter 11: The Art and Science of Portfolio-Building 189Mixing and Matching Your Various Investments 190Dreaming of limited correlation 190Seeking zig and zag with Modern Portfolio Theory 192Translating theory into reality 192Appreciating Bonds’ Dual Role: Diversifier and Ultimate Safety Net 194Protecting yourself from perfect storms 194Eyeing a centuries-old track record 195Recognizing Voodoo Science 197Comparing actively managed funds to index funds 197Forecasting the future — and getting it wrong 198Ignoring the hype 199Chapter 12: Slicing the Pie: How Much Should Be in Bonds? 201Why the Bond Percentage Question Isn’t As Simple As Pie 202Minimizing volatility 203Maximizing return 204Peering into the Future 205Estimating how much you’ll need 206Assessing your time frame 206Factoring in some good rules 206Recognizing yourself in a few case studies 207Noticing the Many Shades of Gray in Your Portfolio 212Bonds of many flavors 213Stocks of all sizes and sorts 213Other fixed income: Annuities 214Other equity: Commodities and real estate 215Making Sure That Your Portfolio Remains in Balance 216Tweaking your holdings to temper risk 217Savoring the rebalancing bonus 217Scheduling your portfolio rebalance 218Chapter 13: Making Your Preliminary Bond Choices 219Reviewing the Rationale behind Bonds 220Making your initial selection 220Following a few rules 221Sizing Up Your Need for Fixed-Income Diversification 222Diversifying by maturity 222Diversifying by type of issuer 222Diversifying by risk-and-return potential 223Diversifying away managerial risk 224Weighing Diversification versus Complication 225Keeping it simple with balanced funds (for people with less than $2,000) 225Moving beyond the basic (for people with $2,000 to $4,000) 225Branching out (with $4,000 or more) 226Finding the Perfect Bond Portfolio Fit 226Case studies in bond ownership 226Seeking out the more exotic offerings 232Part 4: A Manual for Smart Bond Shopping 233Chapter 14: Planning Your Bond Buys and Sells 235Discovering the Brave New World of Bonds 236Finding fabulously frugal funds 236Dealing in individual bonds without forking over a fortune 237Deciding Whether to Go with Bond Funds or Individual Bonds 239Calculating the advantages of funds 239Considering whether individual bonds or bond funds make more sense 241Is Now the Time to Buy Bonds? 246Predicting the future of interest rates yeah, right 247Paying too much attention to the yield curve 248Adhering — or not — to dollar-cost averaging 249Choosing between Taxable and Tax-Advantaged Retirement Accounts 250Positioning your investments for minimal taxation 250Factoring in the early-withdrawal penalties and such 252Chapter 15: Diving (Carefully!) into the Individual Bond Marketplace 253Navigating Today’s Bond Market 254Getting some welcome transparency 255Ushering in a new beginning 255Dealing with Brokers and Other Financial Professionals 256Identifying the role of the dealer 257Do you need a broker or agent at all? 258Selecting the right broker or agent 259Checking the dealer’s numbers 259Hiring a financial planner 261Doing It Yourself Online 262If you’re looking to buy 263If you’re looking to sell 264Perfecting the Art of Laddering 265Protecting you from interest rate flux 265Tinkering with your time frame 266Discount bonds or premium bonds? 268Buying and Selling an Individual Bond: My Own Journey 269Chapter 16: Choosing Bond Funds Wisely 273Defining the Basic Kinds of Funds 274Mining a multitude of mutual funds 275Establishing a position in exchange-traded funds 276Considering an alternative: Closed-end funds 278Understanding unit investment trusts 279Knowing What Matters Most in Choosing a Bond Fund of Any Sort 280Selecting your fund based on its components and their characteristics 280Pruning out the underperformers 280Laying down the law on loads 281Sniffing out false promises 281My Picks for Some of the Best Bond Funds 282Short-term, high-quality bond funds 283Intermediate-term Treasury bond funds 286(Mostly) high-quality corporate bond funds 287Junk city: Corporate high-yield funds 288Agency bond funds 290Municipal bond funds: Taxes be damned 291Taxable Muni Bonds 292Global and International bond funds 293Emerging market bond funds 294All-in-one bond funds 295Instant-Ladder, Defined-Maturity Bond Funds (Government, Corporate, Municipal) 298All-in-one bond and stock funds 298Target-retirement date funds (otherwise known as life-cycle funds) 300Part 5: Bonds as Good Friends of Retirees 303Chapter 17: Satisfying Your Need for Steady Cash 305Reaping the Rewards of Your Investments 306Aiming for freedom 306Estimating your target portfolio 307Lining up your bucks 308Finding Interesting Sources of Interest 308Certificates of deposit (CDs) 309Mining the many money market funds 309Banking on online savings accounts 311Considering the predictability of an annuity 311Hocking your home with a reverse mortgage 313Recognizing that Stocks Can Be Cash Cows, Too 313Focusing on stocks with sock-o dividends 314Realizing gain with real estate investment trusts (REITs) 315Taking a middle ground with preferred stock 316Introducing a Vastly Better Way to Create Cash Flow: Portfolio Rebalancing 316Buying low and selling high 318Rolling bond interest back in 320Dealing with realities 320Chapter 18: Ensuring Financial Security in Old Age 321Looking Ahead to Many Years of Possible Portfolio Withdrawals 322Knowing Where the Real Danger Lies: The Risk of Being Too Conservative 323Considering an aggressive approach 323Easing back toward your comfort zone 324Setting your default at 60/40 324Allowing for adjustments to suit the times 325Choosing my own and your ultimate ratio 326Calculating How Much You Can Safely Tap 328Revisiting risk, return, and realistic expectations 328Basing your retirement on clear thinking 329Making the Most Use of Uncle Sam’s Gifts 330Minimizing income is the name of the game 330Lowering your tax bracket through smart withdrawals 331Part 6: The Part of Tens 333Chapter 19: Ten Most Common Misconceptions about Bonds 335A Bond “Selling for 100” Costs $100 335Buying a Bond at a Discount Is Better Than Paying a Premium, Duh 336A Bond Paying X% Today Will Pocket You X% Over the Life of the Bond 336Rising Interest Rates Are Good (or Bad) for Bondholders 337Certain Bonds, Such as Treasuries, Are Completely Safe 338Bonds Are a Retiree’s Best Friend 338Individual Bonds Are Usually a Better Deal than Bond Funds 338Municipal Bonds Are Free of Taxation 339A Discount Broker Sells Bonds Cheaper 339The Big Risk in Bonds Is the Risk of the Issuer Defaulting 340Chapter 20: Ten Mistakes Bond Investors Need to Avoid 341Allowing the Broker to Churn You 341Not Taking Advantage of TRACE 342Choosing a Bond Fund Based on Short-Term Performance 342Not Looking Closely Enough at a Bond Fund’s Expenses 343Going Through a Broker to Buy Treasuries 343Counting Too Much on High-Yield Bonds 343Paying Too Much Attention to the Yield Curve 344Buying Bonds That Are Too Complicated 345Ignoring Inflation and Taxation 345Relying Too Heavily on Bonds in Retirement 345Appendix: Helpful Web Resources For Successful Bond Investing 347Index 353