How To Manage Personal Finances Book: Chapter 12- Crushing Life Goals and Bond Investing
Author’s Note:
I am posting a text version of this entire book on Substack, and video versions on YouTube. Email ken@stltest.net for details on my 5th book’s publishing date in late ’24 or early ’25.
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Based on what I see on social media, hundreds of people are “crushing life goals”.
The typical comments look like this: “I sold my startup business for an 8-figure exit price, lost 50 pounds, went to Burning Man, and live with my soulmate.”
You’re asked to read a thread, attend a course, or join the online community to find out how you too can crush life.
‘Trouble is that most people aren’t crushing life. We all struggle, make mistakes, and learn from the experience. This is true for most investors.
You read earlier that there are two ways companies raise money to operate the business: issue stock or issue bonds. I’ll assume that Sally (our investor) can invest using stocks or bonds- or both.
In Chapters 9, 10, and 11, I introduced the basics of common stock investing. Now let’s move to bond investing.
Bond basics
Corporations, municipalities (states, cities), and the federal government can issue bonds. Here are some bond investing terms:
Issuer: Assume that IBM issues a corporate bond.
Face amount (par amount): The amount that IBM must repay the bondholder when the bond matures. This dollar amount is also referred to as the principal amount.
Maturity date: The date that IBM must repay the bondholder.
Coupon rate: The interest rate used to calculate interest payments.
Bond rating: A letter rating that ranks the creditworthiness of the issuer. In other words, how likely is it that IBM will pay all interest and principal payments on time?
Standard and Poor’s (S&P) rates bonds from AAA (highest) to D (lowest). Investment-grade bonds are rated from AAA down to BBB, and most investment advisors only recommend investment-grade bonds.
Understanding Bond Prices and Bond Yields
Bonds trade in the marketplace, just like stocks, and the price of a bond can change.
Assume that IBM issues a AA-rated $5,000 6% 10-year corporate bond at par, or $5,000. Each year the investor earns 6% on $5,000, or $300, and that $300 payment never changes for the 10 years the bond is outstanding.
Now, assume that interest rates increase. If comparable corporate bonds (same AA credit rating) can be issued at 8%, the 6% IBM bond will decline in value.
Why?
Because investors can buy a new bond issue at 8%. As a result, the $5,000 IBM 6% bond might be worth only $4,800.
The Bond’s Total Return
So, why would someone buy the 6% bond if new bonds of similar quality are being issued at 8%?
If the buyer can pay a discount, the 6% purchase might make sense.
A bond’s total return (also called yield to maturity) is the interest income plus any gain or loss on the bond when it matures. If an investor buys the $5,000 IBM 6% bond for $4,800 the total return is:
Annual interest: $300 in annual interest payments, plus
Gain on bond: The difference between the $4,800 cost and the $5,000 received at maturity is a $200 gain.
When you speak with an investment advisor about bonds, ask about the bond’s total return.
Bonds may offer more predictability than stocks. The IBM bondholder can hold the corporate bond until maturity and know both the interest and principal amounts that will be paid (assuming that IBM maintains a good credit rating).