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Duped By Bonds

As a former bond salesman, the smartest advice I can give, is  -  DON’T BUY BONDS when Interest Rates are LOW !!!

That is sooooo important that it needs to be said again and again.

DON’T BUY BONDS when Interest Rates are LOW !!!                      DON’T BUY BONDS when Interest Rates are LOW !!!

When it comes to investing, you need to know the consequences of your actions when you buy a bond.

The first thing a stock broker or bank will tell you is that Municipal Bonds and U.S. Government Bonds are safe – generally with AAA ratings. 

Of course, but so are FDIC insured CD’s.

Safety IS NOT the issue when it comes to bonds. If you invest $10,000 into a 30-year CD, you’ll get your money back in 30 years.

If you invest $10,000 into 30-year Municipal or U.S. Bonds (2 bonds @ $5,000 each), you’ll get your money back in 30 years.

Who is going to hold a 30-year CD or Bonds (with low interest) for 30 years? Nobody, that’s who. You’ll want to sell or redeem in 3 or 5 years – and THAT’s when you’ll realize that you’ve become DUPED ! 

A low interest bond is much like a new automobile. It sells for one price on the dealer’s lot, and becomes heavily devalued the moment you drive it off the lot.

You buy 2 bonds for $5,000 each ($10,000) at the broker’s office, and if you try to sell them back the following day, you’ll find that you’ve already lost 2 to 4% of your investment – due to his commissions for selling the bond TO you.

(And, he’ll add another 2 to 4% for reselling the bond FOR you. Already, in just one day, you’ve lost $400 to $800 in just commissions. That’s pretty heafty for a $10,000 investment.)

That’s reason #1.

Reason #2 is far, far more important – for low interest bonds.

Bond interest rates are all RELATIVE. That is, every bond is related to every other bond, given credit rating, interest rate, and maturity date. But, it all starts with the Federal Reserve in Washington.

The Federal Reserve determines the “starting” rate, from which every other bond is related. For example:

Fed Rate    Muni Rate    U.S. Bond    Corporate Bond       Junk

…..1% …………. 2% ………….. 3% ………………. 4% ………………….??

“starting rate”

If and WHEN the Fed raises its rate, every other NEW bond will increase its respective rate.

Your OLD bonds at 2% will remain the same though. It can’t change its rate.

If the Fed raises its rate to 3%, your OLD rate will STILL BE 2%.

If the Fed raises its rate to 6%, your OLD rate will STILL BE 2%.

Get the idea?  Who will want to buy your bonds for $10,000 (par) paying ONLY 2%, when NEW fresh bonds are paying 6%?  They will – if you REDUCE the “selling” price of your bonds below $10,000.

The question then is, how much BELOW $10,000 would your bonds have to be selling at – to make them attractive against the 6% bonds?

Now, here is the crucial point in the entire argument. What if you want to SELL your $10,000 worth of bonds while other NEW bonds are offering 6%?

Your bonds are paying only $200/yr. New bonds are paying $600/yr. Why would anybody want your bonds?

For the two bonds to be somewhat equal in the secondary marketplace, and make it easier to sell your bonds, and for the YTM (Yield To Maturity) to be somewhat equal, the “market value” of YOUR bonds drops to about $3,000, in total.

WHAT? Can this be TRUE?     Yes !!!  You would have lost about $7,000 of your investment IF you decided to sell those bonds early. (Don’t worry.  IF you decide to hold them till maturity, you’ll get ALL of your money back – 30 years down the line because they are “safe” investments.  Oh yeah !!!  And, many people fall for that “safety” spiel.)

They didn’t tell you that back at the broker’s office, did they?

You will be paid back – SAFELY – for your $10,000 “in 30 years”.   BUT, in the meantime, just like a used car, the MARKET VALUE of your bonds will fluctuate, according to the Federal Reserve interest rate.

The Federal Reserve interest rate right now is about 1/2%. It can’t go down any lower, without giving money away to banks for free.

BUT, the Federal Reserve interest rate CAN and WILL go up – as they see fit, to control INFLATION. In 1980, the rate went as high as 12%.

In today’s world, the rate can easily move upwards to 4% to 6% – while the ”market value” of your newly acquired Municipal or Government Bonds decline DRASTICALLY in value. 

If you need the money in 3 to 5 years, you may not get all of your $10,000 back. And, the broker you dealt with, will probably be working someplace else, or out of the business.

This morning, I heard an announcment on the radio that – in Virginia – they were going to “allow” small investors first crack at some newly issued municipal bonds – before they allow the larger banks to invest.

REALLY?  Is this such a great advantage for the small investor? Buying at low interest?  So, their investment can collapse WHEN the Fed increases rates later next year, because of Inflation, or any other reason they can think of?

In my opinion, this is BOND DUPERY!  The small guy is being set up and SCREWED AGAIN.

Read up about BONDS – all kinds – before you decide to invest. Especially the sections on “Yield-To-Maturity” and “Market Value”. 

Don’t be DUPED by the “safety” of investment - unless you intend to hold the bonds for 30 years.  If you wouldn’t sign up for a 30-year, 2% CD, WHY would you buy any bond with a low interest rate when the risk to your investment in the next few years is sooooo great.

Many people only lost about 40% in their 401(k)’s with the stock market. With SAFE Municipal or Government Bonds, you could stand to lose 60% (or more) if rates increase substantially over the next few years – if you decide to sell early.

Rates are NEVER static – and eventually they WILL GO UP.

Safety is NOT the issue here. PRESERVATION of CAPITAL is !!!

Don’t be DUPED by bond salespeople or your local state or county!

This has been another “Stock Market Exposed!”

STAY TUNED !

Jack

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