Take one look at this chart and tell me it doesn’t get you excited…
“The name’s bonds… bond excuses”
For the better part of 5, 10 and 30 years, a lot of people have found a reason to not invest in bonds:
“I don’t know enough.”
“They’re confusing.”
“The NASDAQ has gone up 15% per year, why would I own bonds?”
“I have a term deposit.”
“My offset account is good.”
“I can get 5% on a savings account.”
“Bitcoin is our lord and saviour (P.S. I still live with my mum).”
Those are all fair criticisms, at first. But they’re also a sign of an investor who really doesn’t understand:
a) Portfolio construction.
b) When bonds work.
c) When bonds don’t work.
Opposites attracting
Most people know a bond is just an ‘I-O-U’.
You lend money (e.g. $100), the borrower promises you interest payments (“coupons”) and then returns your money ($100, in 10 years).
It’s like a mortgage. Except you’re the bank: you lend money, for some interest and get it back in 3, 5, 10 or… 30 years.
Bonds get confusing because of the jargon.
The most important term to remember is this:”yield to maturity.”
Understand this one term and it could change your financial life…
Often shortened to “yield”, this is a formula which tells you: “If I hold the bond ETF from today until all the bonds mature, what’s my annual return?”
It uses the price of the bonds today, the coupons you receive, and the repayment of the original bonds/loans.
The Reserve Bank of Australia (RBA) has a great bond tutorial you can read for a slightly deeper understanding.
The RBA tutorial also explains the second most important concept:
Bond ETF prices move in the opposite direction to bond yields.
The RBA’s chart, below, shows it:
If the yield goes up, the bond price go down.
Bond FAQs
You: “Is that a good or bad thing?”
Typically, rising yields are not good for people who already own a bond ETF.
For example, over the past 5 years, since Covid, basically; interest rates and bond yields have gone up.
Meaning, bond ETFs like iShares Australian Core Composite Bond ETF (ASX: IAF) and Vanguard Global Aggregate Bond Index ETF (ASX: VBND) – two of Australia’s biggest bond ETFs – have fallen.
VBND is down 20% in 5 years (not including coupons/distributions).
IAF is down 11% in 5 years (not including coupons/distributions).
Inside Rask Invest, we own both (FYI: they’re only 15% combined, for Terra).
This is why people say things like ‘bonds are bad, just look at the recent returns.’
You: “So if the share prices have fallen, why do you own them?”
For the exact reasons we just mentioned.
Bonds go down… and up.
Secondly, bond yields are way up.
(Remember: the yield tells you ‘the expected rate of return, per year, if you held the bond ETF until all the bonds matured.’)
So, while most people – especially those who don’t understand bonds – say things like “but look at the share price,” and “stocks have done lots better”. The rest of us remember we invest for the future, not the past.
Depending on the type and quality of bond ETF you own (active, passive, Government, corporate, AAA-rated, junk/high yield, etc.) the yields today can range from 5% to 10%.
If you ask me, that’s seriously compelling.
Especially for retirees, risk-averse investors and those (like us) who prefer truly diversified portfolios – no just ‘YOLO-ing into AI stocks’ or the Firmus not-quite-IPO.
You: “Are there risks?”
Absolutely. Investing in bond ETFs is NOT like a savings account.
Firstly, even if you buy Government bonds via an ETF, the irony is they are not Government guaranteed, like a savings account up to $250,000 might be via the financial claims scheme.
Second, and perhaps more obvious: bond prices can go up and down. For example, if inflation keeps rising, that could push up the yields (meaning the bond ETFs prices should fall).
It’s not hard to imagine higher inflation: middle east conflict + higher petrol prices + our Government’s spending + very bad tax policies + high immigration…
If inflation goes up, the RBA will be forced to increase interest rates to combat it (i.e. yields will go up / bond prices will go down). Interest rates are still expected to go up.
Key educational point: investing is NEVER risk free. An investor’s job is to balance the returns and the known risks – and do it anyway.
These are just some of the risks. Always read a bond ETF’s PDS before doing anything. And if you don’t understand something, don’t invest – and always consider getting licensed financial advice.
You: “So… are you telling me to invest in VBND and IAF?”
No.
While we own them, in a small way, in a very diversified portfolio; they are not perfect. And bonds are not appropriate for everyone.
However, while everyone on Reddit, social media and so on has spent 30 years convincing you, “index ETFs are better than active investing” – it’s often completely wrong for bond investing.
I’d need another 500 words to explain why. But in short, index bond ETFs (like IAF and VBND) put more money into the companies and countries with the most debt. Think about that: they buy more of the thing that has the most debt.
The analogy would be CommBank choosing who it gives loans to based on how much debt they already have: whoever has the most debt, gets more debt.
If it sounds crazy, it probably is.
Active fund managers often – but not always – outperform the index bond ETFs simply because the bond index is really dumb.
Key point: consider researching beyond the index funds when it comes to bonds.
Buy, Hold or Sell
I don’t want 65,000 readers of my Sunday email to rush out and buy bond ETFs “because Owen said so.”
Just… don’t.
If you don’t understand an investment, don’t do it.
Why?
Because even if it goes up, you won’t know why it went up and you’ll be panicking and constantly worried if it’s time to sell.
And if it goes down, you’ll feel the same.
You’re a loser no matter how it turns out.
HOWEVER… if you do know what you’re doing (or your financial adviser does) the next 6 months could turn out to be the best time in the past 10 years to start researching and consider adding to your bond allocation.
Retirees, super funds, and all of the cashed-up bogans who read my weekly column should not ignore what’s happening in bonds right now.
Some of the best active bond ETFs I know (and we review) are offering yields of 7-8%. And remember: this is the defence side of a portfolio. Pretty good, right?
And here’s the other side: according to data compiled by Market Index, the Australian share market is yielding dividends of just ~3.3%…
Now *that* is interesting.
***
Rask Platform upgrade
By now, many of you know the Rask Platform has come a long way.
In just a few months we now have over 3,400 users and it’s growing. The most popular features are creating watchlists, monitoring portfolios, taking courses and tracking your net worth.
My personal favourite: sharing my vision board with my wife. The financial world is built for couples (and increasingly, families). So communicating and collaborating about your financial and lifestyle goals, milestones, and dreams is how most of us will power ahead over the next decade.
This fortnight marks the final week of our Beta period (the time when platforms emerge from the foundational build) as we undertake a massive project behind the scenes. What would usually take 120 “human weeks” of engineering, we’re going to do in less than 2 weeks with humans^AI. After that… magic will appear on our platform.
Soon, we’ll be launching an AI tutor to help you or a family member take a human-approved Rask course and learn faster, you’ll be able to integrate and track your cashflow and spending, monitor your portfolio more accurately across currencies, forecast across tax structures, and much more.
Thanks to everyone who has been part of this ultra-ambitious project. We’re about to complete step 1 of 3 of our master plan to disrupt the Australian financial education and financial advice space.
My personal goal over the next 2 years is simple: lower the cost of human-based financial advice by 50% while increasing the volume of great financial plans by at least 200%+.
Thanks again to everyone who has supported us thus far (readers, clients, listeners, other advisers, insurers, platforms, our shareholders, students, members, and followers).
Every conversation helps to transform a generation of Australians investing more confidently.
Onward & upward
