Bonds 101: What Every Investor Needs To Know
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If you are just thinking purely in terms of how much risk you can take between now and the next 20, 30 years, what have you, I think you can probably rely on the bond portion of your portfolio a little bit better than you could when rates were so much lower because that does give them a cushion, helps them be a little more resilient. The overall thinking is that the less risk you want to take or you can feel comfortable taking, the

The less money you want to have in stocks and the more you want to have in bonds. When it comes to the stock market, going it alone can be overwhelming. That's why we created Investing Fix, the investing club for women who want to grow their portfolios with confidence, clarity, and community. Together, we decode the jargon, simplify the strategy, and make investing approachable. No finance degree required.

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Hey, everyone. Thanks for joining us today on Her Money. I'm Jean Chatzky. And this is a show that I have been wanting to do for a while. We're going to talk about bonds. Don't press escape. Don't leave. Look, for forever, bonds have been a really important part of your portfolio. 40%.

has often been the amount that people said put in bonds. And what has happened in the past couple of years is that advice has started to get controversial. It started to get squishy.

We don't know what to do about our bonds, but by the end of this half hour, I promise you will know what to do. And that's because I've asked Eric Jacobson to join me for this episode on bonds.

Bonds 101. We're really going back to basics. Eric is the Director of Manager Research with a focus on U.S. fixed income strategies for Morningstar. He has been there almost 30 years. He and I have been talking about bonds that long because when I think about bonds, and I

I gotta tell you guys, I am confused right now too. That is part of why I wanted to do this show. But when I know that I need to take a step back and really understand what to do about bonds, I call Eric. And Eric is here today. So Eric, thank you so much for doing this. It's really good to see you. Always. You too. And it's my pleasure and I appreciate you having me. I

I am going to start at the very, very beginning. What's a bond? So I'd like to say that's a great question because I think a lot of people really don't know that. And the answer is it's a loan. It's a way for another party to borrow money from the person buying the bond. And it's as simple as the U.S. Treasury borrowing money from investors. There's reasons why sometimes they do and sometimes they don't. But it turns out to be a critical piece of infrastructure for the entire system.

And if you buy a bond, whether it's a treasury bond or a corporate bond or even a savings bond, right? Like each bond has a few of the same components. Can you explain what they are and how they work?

Sure. The most basic version of a bond we tend to think of as a U.S. Treasury bond, in part because it's sort of the base layer of the entire market. Everything else that's a bond sort of either prices off of it or is customized in a way that differs from it somehow. But a basic Treasury bond in a prototypical way is you buy a bond for $1,000. You hold it, ideally, if you're an individual, maybe until it matures, right?

And it pays you an income stream over the life of that maturity. So that's the starting point. And that income stream, that's the interest rate? Exactly. Whatever the stated interest rate of the bond is, is what you can expect to get. And that's based off of the original $1,000 that you put in. And you expect to get that in pieces every six months. And when we talk about bonds, we don't really call it an interest rate, right? We call it a yield. Right.

We tend to think about it in terms of yield because we calculate the yield on an ongoing basis as if the price of the bond moves up and down. When you look at the bond itself, just plain vanilla, that actually is an interest rate. But when you think about how much that is worth as time goes on, we look at it in terms of yield to adjust for the price going up and down.

But just to be clear, if you hold your bond to maturity, you're going to get your principal back. You don't have to worry about the price. That's right, especially with a treasury bond. We consider that to be the safest available because the treasury always pays its bills. Is that why bonds have earned their place in the typical market?

pension fund or typical investment portfolio. I mean, for as long as I can remember, we have been talking about a portfolio of 60% stocks and 40% bonds as being kind of the gold standard.

Yeah, I think that's absolutely true. I think when you talk about pension funds, that's really a cornerstone point just to mention is that they think of themselves as having very, very long-term liabilities. And especially with treasury bonds and highly safe bonds, they know they're going to get their money back. They're looking to lock in some kind of return to be able to do that. And so they trust it. They use stocks and other things now as well, but that's sort of the backbone.

And then in terms of that 60-40 combination, I think the general thinking is this. If you're investing for the long term,

You probably want to invest in stocks and depending on how young you are and what your mix of needs are, you probably want to hold as much as you can in some cases, but you're using those bonds as a ballast. They're not perfectly inverted, but oftentimes, especially if stocks go down, hopefully your bonds will smooth that out or even gain in value as a balance so that you don't feel that pain quite as much.

they tend to move in the other direction. I mean, you said most of the time, right? There have been these years where that didn't happen, right? At the beginning of this decade, that didn't happen for a little while. But historically, is that still something that you believe will continue to hold true? I do. And I think...

When it didn't happen in some of those periods, it was because we were at extremes going into them. The bond market was very unusual in its composition and valuations in a historic way. But if you look back, for example, at the financial crisis in 2008,

they really did serve their purpose because when I say bonds, I'm talking about high quality regular bonds, not necessarily the mortgage securities that did poorly, but when stocks tanked, high quality bonds acted as a ballast for that.

So we are talking, you and I, in early 2025, the yield on 10-year treasury bonds recently reached its highest level in 14 months, the interest rate they're paying, highest level in 14 months. So

Is now a good time to invest in bonds? Is there a better time or a worse time? And how should the individual investors who listen to this show, and I think most of this audience, it's comprised of people, largely women, who would someday like to be able to retire. How do we think about this? So the very first thing I would say is,

everybody has a somewhat different, arguably unique financial situation. And so you really want to take that into account regardless, because depending on your age, as you mentioned, what your needs are, if you still are saving for college for your kids or not, when you plan to retire, all those things are relevant and important. So I wouldn't, I would want to give universal advice about it. But in terms of where we are right now,

Those yields, as you mentioned, are historically pretty high. That's good. There are parts of the bond market that are pretty expensive. And we talk about that a lot in my world because we're looking at all the bonds across the universe. But if you look at what some of the firms like Vanguard are talking about these days, they're very concerned about stock valuations. They think stocks are overvalued. And so on a sort of tactical basis, they're recommending that people own

more bonds. And part of the reason is, as you just said, those yields are relatively high right now. We've had a big sell-off in 2022. Inflation had scared the markets a little bit. So yields are higher than they've been in a long time. I think it's real important to mention that when you look at what Vanguard's saying, the probabilities they calculate in terms of how it might underperform a 60-40 portfolio are pretty even. So they're not even going out there making a grand proclamation that everybody should flip

to 60% bonds. But the point is, is that in the grand scheme of things, if you're tilting things a little bit, it wouldn't be such a great time to dump a lot of money in the stocks if the valuations are tight or overvalued. And bonds are probably reasonably valued on average because of that sell-off I mentioned before in 2022, the fact that we had a little bit of an inflation shock, it drove up those bond yields. And overall, they're much more attractive than they were before that.

Can you explain the relationship between inflation and bond yields? Like, why would an inflation stock drive up bond yields? And if you are so tempted to talk about interest rates in the same conversation, we're at a bit of a pause in how the Federal Reserve is looking at interest rates, although they reduced rates a couple of times last year. Maybe they'll lower them again this year. We're unsure. How do these...

levers all work together? Sure. So if you purchase a bond, as we mentioned before, especially if you buy it right from the treasury at $1,000, you know that you're going to get those cash flows, those interest payments over the next 10 years, if we're using a 10-year bond, and you're going to get your $1,000 back at the end. That's a fixed number of dollars. You feel comfortable. You're going to get those. You know exactly what you're going to get at the end.

The risk is that if there is a lot of inflation between now and then, the utility of those dollars over the time period and certainly at the end of that period when you get your $1,000 back could be lower. Just like we all know if we look back 10 years before, what we'll be able to buy with it 10 years from now likely will be less. So the idea is in terms of the way that those interest rates are set, and they're set by the marketplace in this case for a 10-year bond,

you should be able, hopefully, to earn more in those interest payments than the level of inflation so that they should still buy you just as much, ideally, at the end of that period as they do in the beginning. It's meant to compensate you for that risk. The problem is that if inflation goes up too high or more,

it can erode the purchasing power of that income stream, even if you bought that at the beginning and it seemed like it should. So if you were forced, if you weren't holding your bond till the end, till it matured, and you were forced to sell it on the secondary market, you would get less than you paid if inflation spikes.

That's right. Now, it gets really complicated in there if you do start talking too deep down the rabbit hole, but it's also possible, and this is one of the reasons why mutual funds are sometimes useful, is that you can sell the bond and then use that money to buy one with a higher rate. That's how the market works. When bond prices go down, expected or required yields, if you will, go up, and so there may be other bonds out there that are worth buying.

That gets us into the world of bond funds versus individual bonds. The nice thing about individual bonds is if you do hold it to maturity, you know exactly what you're going to get. It's really predictable. But for individual investors, it can be hard to build a portfolio of individual bonds. It's a little labor intensive. Right.

How do bond funds work and who should be in bond funds rather than in bonds?

Well, let me say at the beginning, there are a lot of people who prefer, as you suggested, just to buy the bonds. If you do that, there are strategies in place to try and smooth things out and make it so you're not taking risks and you're keeping it cheap and so forth. And I'm certainly not against those, especially if you're talking about using treasury bonds. As soon as you break out of that sphere...

Any kind of bond other than a treasury bond always has some sort of feature that complicates things. The treasury leaves its bonds outstanding until they mature, and then they pay you back.

The rest of the bond market often does things differently. So a corporate borrower, for example, will put a call option into that bond, which means that if at some point they want to pay you back early, they can do that because they have this option to do that. Almost in every case, they're going to do that at the least advantageous time for you and the most advantageous time for them. It's just like refinancing your house. They will pay you back early so that they can refinance the bond.

The reason that's such a big deal is that at the front end, when you buy the bond, you really need to know what the value of that option is. And you need to know how much you should be demanding from the borrower to compensate you for the risk.

And the problem there is that's something that's very, very hard to know. You need to be extremely knowledgeable about finance and there's a lot of analytical work. And I will say this, companies and any kind of bond issuer would love to sell individuals bonds at the prices they tell you they're worth.

And have you not get compensated enough for that risk? And that's the reason that I often tell people, these are the cases in which you'd want to go with bond funds. Plain vanilla treasury bonds, very basic. You're not going to get fleeced bonds.

buying those. But if you buy individual bonds from corporations, especially, or really any other issuer that has complexities like that built in, you want to make sure that you're getting fair prices. And the easiest way to do that is to buy a mutual fund where you've got a professional manager doing that analysis and making sure that they're getting good pricing. It also has to do with the amount of bonds that you're

buying. You get much better prices if they're buying a million dollar blocks, which you're probably not going to do as an individual. The key thing is, as most people probably know, is you don't want to overpay for that mutual fund either. You want to get a fair price for it. But it's a pretty reasonable trade-off in terms of making sure that your bond portfolio is getting professionally analyzed and managed. The bond market lately...

has been very volatile. It's been very turbulent. Yields have been jumping around. They're reacting from everything from inflation fears to concern about the deficit, the debt of the United States to Federal Reserve policy to political uncertainty.

What do you make of the bond market right now? Have you ever seen this before? And what do you learn from that history?

So we've definitely seen periods of volatility generated by uncertainty. So that in and of itself isn't that unusual. I do think it's fair to say we're in a pretty unusual time in terms of the combination of things that we're seeing and the number of things that we're dealing with all at one time. Regardless of your politics,

The ideas that the new president has been signaling have sort of a mixed bag of implications. And there are things that he could choose to do that would be very good for the bond market, and there are things that would be very difficult and problematic. You know, a lot of the ideas that his folks have floated could generate a strong economic growth, not necessarily a lot of inflation, et cetera. But some of them,

For example, the tariffs that people have been talking about run the risk of jacking up inflation, if you will. So the bond market is consumed to some degree in trying to figure out that balance because that's really hard to analyze. It's very difficult to know what those policy outcomes might look like.

like. Next to that, you've also got the Federal Reserve issues that you mentioned. What the Fed has been trying to do all along is manage short term interest rates, which tend to affect

things that have a floating rate nature, like very credit sensitive corporations borrowing money, credit card rates, which generally stay high anyway. But anything that's linked to a short term rate at all is going to be very sensitive to what the Fed decides to do with what they call their Fed funds rate. So they've been trying to get that back down as inflation seemed to be cooling over the last couple of years.

But the data keeps coming back strong that the economy is doing well. And they're very nervous about lowering that rate too much, not because they don't want to see good economic growth, because if they do, they're happy about that. But what they don't want to see is that economic growth get to the point where there's so much money floating around as people do well that they start spending so much that they drive up inflation more.

So unfortunately, there's a few different things that can cause and affect inflation, and that makes the picture very complicated. And the more of those factors there are running all at the same time, the more you get that kind of volatility, especially when news comes out every other day about something. Or every other hour about something. I want to talk about how...

the movements in the bond market affect the finances of the average person. But before we do that, we're going to take a quick break.

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We are back with Morningstar's Eric Jacobson. We're talking about bonds. We're breaking it down. So when we look at the bond market, at volatility in the bond market, at yields, how does it affect the average person when we're talking about things like buying a home, buying a car, and our stocks? So it's interesting because

For the average homeowner, certainly in the United States, the mortgage market is the most important question in terms of what rate would you pay on a mortgage. And that tends to be relatively tied to what we would call a 10-year treasury bond.

Lately if you're going out to buy a new house or to refinance mortgage rates are much higher than they've been in a very long time And so the interesting thing about that is it's making it extremely difficult certainly for first-time buyers It's making it difficult for people to make decisions about moving Because if you sell your house and you have a low interest rate on your mortgage now your next one is going to be twice as much perhaps that changes everything about the calculus of what it's going to cost and

So what's happening right now, and you probably know this, is that a lot of people are not moving, they're not refinancing, and it's keeping things from flowing in the housing market, if you will. On the other hand, it's something that differentiates us in the United States quite a bit, which is that if you do have a low mortgage rate and you're able to stick it out and stay where you live and what have you, it makes you a little bit less sensitive to

to what's going on in the rest of the economy. Yeah, it's such a good point. I think a lot of people don't understand that in many countries, they don't have 30-year mortgages, right? They have these much, much shorter mortgages. And so you are going to have to pay the going rate sooner rather than later.

And that's true. And a number of them that even do have longer periods still have a component that is required to be floating like that, if you will. Some of them have currency issues, too. They may have to pay in dollars. It's really, really hard in most other places. We have a tremendous benefit from that in the United States. And that's part of government policy. And so what's interesting about that is that

If you look back before the financial crisis in 2008, I know we're going back already a little bit here, but lots and lots of people had adjustable rate mortgages. And it made a lot of sense at that time when rates were just slowly ticking down and down because people didn't really have to worry too much about rising rates, making their interest payments go up. But since the financial crisis, we've transitioned to a period where almost everybody's mortgages are fixed.

And so many people locked in low mortgage rates over the last few years until they started going up that as households, they're somewhat protected from a lot of things going on in the bond market and the economy. And interestingly enough, that makes it historically makes it a little bit harder for policymakers like the Fed to affect bonds.

household spending. For better or worse, part of what they're trying to do when they move interest rates around is affect whether there's a lot of activity in the economy. And at one point, they could rely more on that to be able to affect homeowner behavior and

And it's much less so now because of that. It's good for you as an individual if you have a low rate mortgage, but it's a little rougher for government policymakers. Let's come back to where we started this conversation and finish it up with the perspective of an investor. I'm a retirement investor. I'm a long-term investor building my portfolio. How do I decide these days with all of the implications, what

what percentage I want in bonds. So I will be 100% honest with you, which is that for myself, I would use a financial advisor of one kind or another, whether it's fee-based or what have you, because they're going to be the best equipped to help you think through, well, what needs might I have? What is this thing I might have to lay out money for later that I hadn't thought of?

I'm going through this a lot right now with family members who are elderly and thinking about how to pay for nursing care and all those things. And there's elements of that that are hard to know if you're not thinking about it all the time.

That said, if you are just thinking purely in terms of how much risk you can take between now and the next 20, 30 years, what have you, I think you can probably rely on the bond portion of your portfolio a little bit better than you could when rates were so much lower because that does give them a cushion, helps them be a little more resilient. And generally, I think the overall outcome

thinking is that the less risk you want to take or you can feel comfortable taking, the less money you want to have in stocks and the more you want to have in bonds. Now, there are going to be periods. Bonds aren't always going to stay super stable. They will go up and down. But you're almost always going to have less overall volatility risk with your bond portfolio than we will with your stocks. Last question, Eric. And this has just been such a good education. So thank you for that

Take us overseas. I mean, one of the things that has happened is that foreign buyers have put an awful lot of money over the years into U.S. bonds. The United States was the safe haven and U.S. bonds were the haven in that safety, right? With trade tensions rising and

and the global landscape looking a little bit more like the Wild West.

What do you think is going to happen in the bond market and what do you think that means for the overall economy? So without making any specific predictions, I can tell you what the sort of conventional wisdom is about how things would go in these situations. One thing I would mention is a lot of people tend to worry, for example, about China. China is a very large holder of U.S. debt, U.S. Treasuries.

The thing to keep in mind is part of the reason for that has to do with how they manage their own currency. So when the United States is buying a lot of Chinese goods, which is what their economy is sort of based on, is being able to sell to us and other countries, we're sending them dollars.

And in order to keep the Chinese currency from appreciating too much, they buy U.S. Treasury bonds to help balance that out. So they're really doing it for their own benefit as much as anything else. It's worth keeping in mind that people are sometimes worried that if we have some sort of political problem with China that they might just sell our bonds to hurt us. But the fact is it will hurt them.

too so they don't really have an incentive so much to do that so one of the other issues is that money in the international market tends to flow where yields are higher

And so where we are these days right now is a situation where yields in the US bond market are higher than they are in other Western countries for the most part, partly because our economy is doing so well. But there's also talk, for example, that Europe may lower their short-term rates sooner than we will. So when that's occurring, regardless of a lot of other things going on, that also tends to pull capital into our system and attract people to our bonds.

So, there are certain long-term concerns people have. They're understandable. They're worried about the U.S. deficit being high and how much money we need to borrow. And those are certainly things that are important to keep an eye on, I guess. But on a day-to-day basis, we probably shouldn't be quite as fearful from things like China dumping our treasury bonds.

Eric Jacobson from Morningstar, thank you so much for doing this. One of my money rules, and I think you know this, is that you shouldn't buy something that you don't understand. I can't guarantee that we understand everything about bonds following this conversation. I don't understand everything about bonds following this conversation, but I do understand more than I did going in, and that's the reason that we had it. So I really appreciate you and your time.

It was a pleasure. Wonderful to see you. Thank you for having me. Thanks so much. If you love this episode, please give us a five-star review on Apple Podcasts. We always value your feedback. And if you want to keep the financial conversations going, join me for a deeper dive.

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