Everybody needs to learn about investing in bonds since they are important in every portfolio. Should you choose a money market fund or a bond fund? Or perhaps dividend-paying stocks? Learn how each of these differ in this episode.
Video Transcript: What is a money market fund?
Life is complicated. Bonds are not. Let’s learn the essentials!
At first glance, some investing options look similar. Consider this: Which types of investment will give you both a stable income stream and keep the principal at a stable value? In other words, if you have $40,000, is there a way to invest it such that every month they’d pay you a fixed amount, say $100, but at any time you desire you could stop and get your $40,000 back?
Would you look for: a Money Market Fund, a Bond, a dividend-paying stock, or none of these? Make your best guess. Click on one, and then I’ll tell you the answer.
Stocks pay dividends. Buying a stock is buying ownership in a company. You can own it forever. You might wonder about whether these dividends are like bond dividends—after all, they are both called dividends, and both are payments on specific dates. But stock dividends are not contractual obligations with stockholders—they can be changed at any time, even eliminated. And the value of the stock moves with the stock market. No guarantees; but probably not the best answer to our thought problem.
A Money Market Fund does guarantee to protect your investment. It’s a perfect place to stash your cash for the short-term. You can always get back your investment, plus they pay you some interest for that money every month. But, the interest rate varies so it cannot be relied upon to provide a stable income stream.
Bonds do that. They are a simple loan for a fixed length of time, and in return you get a fixed dividend every period and your money returned at the end of the term. So, bonds can assure you a stable income stream, but the market value of the bond can fluctuate over the term. In fact, it varies every time interest rates change. The price wanders in a totally unpredictable direction (since you can’t predict interest rate changes) but gradually drifts towards that one date when you’re guaranteed to get your investment back, the end of the term when the bond matures.
Correct. It’s “none of these.” So, to summarize: You can have stable income stream or stable principal value, but you cannot have them both.(1)
Bonds can be a general term, but now we’ve seen the reason why fixed income securities is a better term that describes what is common about this whole category of investments.
Learn some surprisingly interesting things about CD’s in the next video.
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Footnotes and Video Production Credits for Bond Basics #1: Money Market Funds
(1) “The Twelve Pillars of Wisdom: Lessons We Should have Learned before the Bear Market Arrived, but are Only Learning Now”, John C. Bogle, April 27, 2001, Pillar 9, http://www.vanguard.com/bogle_site/april272001.html
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Video copyright 2009-2014 Rick Van Ness.