Money Rehab with Nicole Lapin - What People Get Wrong About Bonds— and How To Get It Right

Episode Date: March 25, 2024

Short-term Treasury Bills are killing it right now. You can get a one-month Treasury for over 5%. However, there is a really common misconception about bonds that can seriously mess up the way that yo...u plan for your investment returns. Nicole explains this mistake, and how to fix it. $ If you're ready to find your dream team, use LinkedIn Jobs. Post a job for free at: linkedin.com/mnn $ Want to level up your money moves? Check out Facet. Facet is the next generation of personalized financial planning that is making professional financial advice accessible to the masses, not just the rich. Facet will help you understand and expand your financial opportunities by providing you with a team of financial planners (with the CFP® certification you want) and a team of professionals across all the major food groups of your financial wellness: retirement planning, tax strategy, estate planning and more. To claim Facet’s offer for Money Rehabbers, go to: https://facet.com/moneyrehab 

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Starting point is 00:00:00 Money rehabbers, you get it. When you're trying to have it all, you end up doing a lot of juggling. You have to balance your work, your friends, and everything in between. So when it comes to your finances, the last thing you need is more juggling. That's where Bank of America steps in. With Bank of America, you can manage your banking, borrowing, and even investing all in one place. Their digital tools bring everything together under one roof, giving you a clear view of your finances whenever you need it. Plus, with Bank of America's wealth of expert guidance available at any time, you can feel confident that your
Starting point is 00:00:29 money is working as hard as you do. So why overcomplicate your money? Keep it simple with Bank of America, your one-stop shop for everything you need today and the goals you're working toward tomorrow. To get started, visit bofa.com slash newprosmedia. That's b-o-f-a dot com slash n-e-w pros p-r-o-s media. bfa.com slash newprosmedia. I'm Nicole Lappin, the only financial expert you don't need a dictionary to understand. It's time for some money rehab. it's time for some money rehab. Short-term treasuries, or US government-backed bonds, are killing it right now. You can get a one-month treasury for more than 5%, 5.365% to be exact. And because of how awesome yields have been, I think bonds are finally cool again. You know, I have been trying to bring sexy back to bonds for a minute now.
Starting point is 00:01:26 In recent years, they have gotten such a bad rap. I know it's popular opinion, especially in the crypto bro circles, to say that bonds are boring, but the truth is that bonds are just less risky compared to other investments. And what is more exciting than knowing exactly how your money is going to grow? Literally nothing. However, there is a really common misconception about bonds that can seriously mess up the way you plan for your investment returns.
Starting point is 00:01:52 But first, let's do a little primer. A bond is essentially a really legit IOU. Let's say you buy a bond from me. I am giving you my word that I will give you your money back with a certain interest rate after a certain period. There are three major types of bonds. First, federal government bonds, typically called US Treasuries. Second, municipal bonds or muni bonds for cities and states. And third, corporate bonds for businesses. Today, I'm going to focus on Treasuries because the one month variety have
Starting point is 00:02:21 that awesome 5% plus interest rate I was just talking about. The history of US treasuries go back to day one, literally. Treasuries and the Department of Treasury at large was founded during the American Revolution. During the revolution, millions of dollars were raised through government bonds for the war effort. As you can probably imagine, war is extremely expensive. And there is a long history of nations all over the globe using bonds to finance war. Of course, bonds are not exclusively used to fund war. Tons of important national projects were made possible through the use of bonds. The Golden Gate Bridge, the Louisiana Purchase, the Transcontinental Railroad, Route 66, JFK Airport, the Panama Canal, and the Purchase of Alaska were all made possible with some
Starting point is 00:03:05 fundraising through bonds. Yes, bonds have been a very important way for the American government to finance infrastructure development. But bonds have also provided for the development of some intangible infrastructure as well. Funding projects through government bonds means that the government does not need to rely solely on funding from banks, other private institutions, or, hello, us and our tax dollars. When you purchase a U.S. Treasury, you're essentially lending money to the U.S. government. In return for this loan, the government pays you back plus interest. At its core, the yield of a treasury represents the annual return on investment expressed as a
Starting point is 00:03:40 percentage of the bond's face value. Nictionary note here, the face value, also known as par value, is the amount of money that you'll get back when the bond matures. Now, even though there's a lot of attention focused on longer term Treasury bonds, shorter term Treasuries play a crucial role in financial markets, particularly for investors who want to get their money back quickly and are looking for a low risk investment. I'm going to tell you that big misconception in just a sec, but first I want to note an important trend that's super helpful to keep your eye on when you're considering treasury investments. Right now, the one-month treasury is 5.365%, the one-year treasury is 5.002%, and the 10-year treasury is 4.273%. It's a clear trend.
Starting point is 00:04:24 At the current yields, the longer-term bonds are earning a lower rate of return than the shorter-term bonds. That is not always the case. It happens to be the case right now because when the Fed met last week, they kept interest rates steady at 5.3% and suggested that they would make quarter-point rate cuts three times before 2025. Treasury yields are one of those rates that move in the very same direction as the Fed rates. So when the Fed rate goes down, Treasury yields go down. So the expectation is that interest rates will be lower in a year than they are now, hence the lower yield for one year treasuries. But the Fed isn't cutting rates in the immediate
Starting point is 00:05:01 future, hence the higher yield for one-month treasuries. Alright, now that we understand what's happening and why, it is time to clear up how much you actually earn from a one-month bond. Let's say you decide to invest $5,000 in a one-month treasury with a yield of 5% for EasyMath. After one month, when the bond matures, you'll receive not only your initial investment of $5,000 back, but also the interest during that month. When newbie investors go to predict how much interest they'll earn, they expect that they're going to get 5% of that $5,000. That is wrong, because here's the thing. The interest rate on bonds are represented as an annualized number, meaning you would earn 5% if it were a
Starting point is 00:05:41 one-year treasury. So you actually have to divide the 5% interest payment by 12 because what you can earn in one month from an annualized rate is going to be that annualized rate divided by 12 for 12 months. So let's calculate the interest rate you earned. You multiply the face value of that bond, $5,000, by the yield, 5%, and then divide by 12. So what you'd actually get from interest from a one-month bond is around $20 for that one-month period. So your total return would be $5,000 and $20. Your initial investment plus your interest. While this might seem like a relatively small return, it's important to remember that short-term treasuries offer investors a safe haven for
Starting point is 00:06:22 their funds with minimal risk of default. For today's tip you can take straight to the bank. A bond's rate isn't locked in until you buy it. So if you buy a one-year treasury at that 5.002%, you'll have that rate for a whole year until the bond matures. But until you buy that bond, the interest rate can change. And even if you do buy a bond, once it matures, you're not guaranteed that same rate again. So if you go to buy a one month treasury, even though that rate is annualized, you are not guaranteed that rate of return for a year. If you decide to renew it after that month, you're only guaranteed the rate for that one month. So if you decide that a one month bond is perfect for you, you'll probably want to do it before the Fed meets again
Starting point is 00:07:05 at the end of April. Money Rehab is a production of Money News Network. I'm your host, Nicole Lappin. Money Rehab's executive producer is Morgan Lavoie. Our researcher is Emily Holmes. Do you need some money rehab? And let's be honest, we all do. So email us your money questions, moneyrehab at moneynewsnetwork.com to potentially have your questions answered on the show or even have a one-on-one intervention with me. And follow us on Instagram at Money News and TikTok at Money News Network for exclusive video content. And lastly, thank you.
Starting point is 00:07:39 No, seriously, thank you. Thank you for listening and for investing in yourself, which is the most important investment you can make.

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