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The Bond Hoax | Entreprelife

The Bond Hoax

Bond St.

Think bonds are safe?

Most people would agree that bonds are one of the safer invest­ments and a great alter­na­tive to the stock market for the risk-adverse. If you’re older or more conser­v­a­tive or can’t handle the ups and downs of a good mutual fund, bonds are where your money should go.

Or are they?

The idea that bonds are safer than stocks is true in one sense and untrue in another.

What Are Bonds?

Bonds are loans. Unlike stock where you’re paying for part ownership, bonds are low-interest loans given to a company, orga­ni­za­tion, or country.

Like car or home loans they are broken up into years and can be paid out yearly, quarterly, or once at the end of the loan term.

So when someone says, “China owns America” what they mean is China owns a massive amount of U.S. bonds. To put it another way, China has loaned America a huge amount of money and now we owe insanely more than we make in taxes and fees.

The Risk of Bonds

So what’s the risk of bonds? Most people would say “none”. But there is one huge risk: bankruptcy.

Bonds are consid­ered safer than stocks because a company has to pay bond holders before stock holders if they file bankruptcy.

But what if the company doesn’t have the assets to pay bond holders? It’s like you or I filing bank­ruptcy on a credit card. Sure, we might pay part of the loan, but most of it disappears.

Two Examples

It’s hard to explain without examples, so I’ll give you two: Enron and Greece.

Enron

Remember Enron? Before the scandal, Enron was the sure thing. If you had a mutual fund, they were in it. If you were looking to trade bonds, they were the ones you wanted. They were prof­itable and growing bigger every day

Or were they? Under­neath the hype, Enron was a lie.

They were using shelter corpo­ra­tion and shady (but legal) accounting practices to turn billions of dollars in losses into profits.

The insane profits are what made everyone want to give them money — until 2001.

In 2001 they filed for bank­ruptcy protec­tion and after years of proceed­ings (and lots of jail time for exec­u­tives) they liqui­dated. Stock holders lost every­thing; millions of lives were ruined; and even the bond holders were left with nothing but a piece of paper.

Greece

Greece is a bit more recent.

Most Americans don’t really know what’s going on in Europe outside of a “debt crisis” (whatever that means). A few know that Greece is somehow involved.

The Greek Debt Crisis started with a lie.

The country was able to adopt the Euro as its currency because it lied about its high deficit levels. Because of the lies, investors put money into Greek bonds. When the truth came out and Greece had to announced their true deficit levels, bond holders cut their losses and ran.

In an instant, Greece ran out of money and their already shaky economy crumbled.

Currently, Greece hovers on the edge of bank­ruptcy with only a German bailout to possibly save the day. Unfor­tu­nately for bond holders, bailouts are never free. As part of the bailout terms, Germany and other European nations are requiring Greece to nullify several of its debts.

To put it another way, Greece isn’t going to pay the people, orga­ni­za­tions, and countries who loaned the money; and there is nothing we can do about it.

The Greek bond holders will are left with little to nothing, even though Greek bonds were a “sure thing” only a few years ago.

Should I Get Rid of My Bonds?

Bonds aren’t bad, and in a lot of instances they can be really good – but they are never safe.

Any orga­ni­za­tion, corpo­ra­tion, or country can crumble. Anyone you accepts a loan can run out of money to pay it back.

But that’s part of investing. There is no such thing as a safe invest­ment; else there would be no profits.

Having bonds as part of a solid mutual fund and talking them through with an invest­ment profes­sional is necessary for any investor. They’re a great buffer against a falling stock market.

Just don’t think of them as safe.

Do you invest in bonds?

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6 Responses to “The Bond Hoax”

  1. Pastor Matt February 9, 2012 at 5:16 PM #

    Great post, bro.

    • Alex February 11, 2012 at 2:38 PM #

      Thanks!

  2. ixnayonthetimmay February 10, 2012 at 2:50 AM #

    Bonds aren’t safe? If bonds aren’t, nothing short of cash is safe!

    Bonds are like any other invest­ment. The reward for putting your money there is supposed to reflect the risk of losing your money alto­gether. Bonds are therefore consid­ered “rela­tively safe” by most analysts and investors and their low yields reflect that.

    The problem as I see it is that they are sometimes pushed as being as safe as cash (partic­u­larly in the case of U.S. Govern­ment bonds) when they are clearly not as evidenced by the examples you showed.

    I also worry about distor­tions in the market; how much are the low bond yields being sustained by the Federal Reserve buying up trea­suries for example? Or what about Europe bailing out Greece in an effort to keep rates down on other govern­ments’ bonds, effec­tively canceling out the reward incentive for rising perceived risk in those bonds?

    Those are all symptoms of other issues that can’t be addressed here, but I look at bonds like any other invest­ment — they have a certain measure of volatility and risk and the payoff reflects that. I don’t invest in bonds just because the yield is too low for my taste. At my age, I can afford to take on a bit more risk in my investments.

    • Alex February 11, 2012 at 2:39 PM #

      Some fantastic comments and obser­va­tions as always, Tim. Something we all need to take into consid­er­a­tion when investing into bonds

  3. Loren Pinilis February 10, 2012 at 8:32 AM #

    I person­ally don’t invest in any bonds at the moment. I’m 31 (makes me feel old to type that), so I’m purely in stocks right now for retire­ment. Come to think of it, we have college savings for the kids — and they’re invested in some mutual funds that probably contain bonds. So I guess in a very convo­luted way I’m invested in bonds.
    Bonds carry with them a little risk, but they also have their own benefits. Appar­ently, the tax benefits from govern­ment bonds are night. And local munic­i­pality bonds are the best for tax benefits.

    • Alex February 11, 2012 at 2:40 PM #

      I’m the same way, all my bond invest­ments are part of mutual funds I like.

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