Bond laddering; 5 common extreme money scripts

Flashing back to 2009: I have images of articles from a February, 2009 BusinessWeek issue.  Last week I mentioned that, in early 2009, 10,000 people a day were losing their jobs.  What was also reported was the downsizing of industry.  A variety of industries were expected to feel the burn of the economic meltdown. Because inventories were high and consumerism slowed to a stop, industries that produced goods were likely to continue reducing their employee headcount.  Some of the sectors that were expected to continue dropping employees were apparel production, car, train and plane productions and construction.

The attached article  reports on the surge of foreclosures and the big banks’ response in helping homeowners.  The loan modifications offered didn’t help and the think tank of bank executives offered hollow promises.  Sadly, most borrowers went into foreclosure or were forced to declare bankruptcy.

Based on information that I read last month at the 10-year anniversary, some people reported suffering equity losses that they’ve never recovered from.

This article has so much information about what not to do and is a learning tool for not repeating others’ mistakes.  I’ve included it here.

Bond laddering

Two main asset investment classes are stocks and bonds.  Because of perceived volatility, stocks are the evil twin and bonds are the safe twin.  I’ve heard people say, “I don’t play stocks.”  Play stocks…?  If someone considers it a game, it’s probably not done with any intellect behind it.  But where stocks are considered volatile, bonds are the calm alternative.

I wrote a bond piece several months ago and it was met with some criticism.  I emphasized how stocks and bonds move in opposite directions, therefore, you would want to own bonds to offset stock downturns.  My analysis of polar correlation was shot down by those taking into account the latest bond yields that are not in direct opposition to stock market activity.  While that may be true, I still like bond instruments for their predictability.

When I worked as a tutor, I was helping someone do accounting journal entries for a bond purchaser.  The very first entry subsequent to the purchase would be the recording of interest income.  Very simply, a bond is a loan that pays interest.  Interest is the cost of money and it’s a stated amount on the issuance of the bond.

Therefore, when someone needs money, they will ask for a loan, i.e., offer a bond to another party.  Let’s say it’s a $10,000 loan; the loaner/investor gives the borrower the $10,000.  In exchange for borrowing the money, the bond/borrower will pay a stated interest rate at frequent interest dates throughout the life of the loan.

For accounting purposes interest income is reported at the interval it’s received.  So, if the $10,000 loan earns 2% on an annual basis, the interest income will be $200 at the end of the year.

This is the same as earning interest on a CD.  Unless the borrower defaults on the loan, the revenue stream is pretty predictable.  You know everything at the beginning of the loan arrangement, and the interest amount is earned when it’s scheduled.

Types of bond instruments

  • Money markets are mutual funds that invest in short-term debt instruments. They are not insured by the federal government.
  • CDs are bonds issued by banks or credit unions, insured by the FDIC.
  • Bonds are debt instruments issued by a governmental institution or a corporation.

 

Bond laddering is a certain type of investment strategy accomplished by purchasing bonds with staggered dates.  It’s way to plan interest income on a scheduled basis.  When a bond matures, the principal can be reinvested in another bond with a maturity date that ends after the last bond on the schedule.

 

Reasons for:

Wealth preservation – less emphasis on growth

No surprises – predictable, consistent income streams

Laddering helps to avoid being locked into an interest rate.  Bonds can be purchased with varying interest rates.

If bonds are held to maturity, no loss of principal (unless borrower goes into default)

Reasons against:

The opposition feels that bond laddering locks an investor into an interest rate.    Even though there are multiple bonds in the portfolio, some seem to think it creates an interest rate lockup.  If a competitive interest rate is higher than the investor is earning, the instrument already owned is not as valuable and provides less interest income.

Alternative products can be used, such as CDs, corporate bonds, municipal bonds, etc.  I’ve read opposing thoughts on bond laddering, where the recommendation is to use a bond fund instead.

Here are another five common extreme money scripts.

There Will Always Be Enough Money

Here’s the ultimate in being irresponsible.  The people that tell themselves this lie spend recklessly, bury their heads in the sand, and throw their money away on credit card interest and fees while flaunting their consumerism.

Entitlement also has a role in this movie.  Individuals that grew up with everything falling into their hands live by this thinking.

Money Is Unimportant

This inner dialogue is another version of irresponsibility.  By taking a dismissive attitude towards money, they justify their lack of planning and poor financial decision making.

Money Will Give Me Meaning

The people that live with this frame of mind develop a judgment of others based on how much money they think or perceive that another person has.  They also believe that by boasting about their own amount of money or possessions, they are impressing others and deserve respect.  While their behavior leans towards judging people by money, they will claim that they have deep non-monetary values.

It’s Not Nice (or Necessary) To Talk About Money

It was reported last year that people would rather talk about their sexually transmitted disease than discuss money issues.

There is so much secrecy and sensitivity surrounding money, that no one talks about it.  Debt levels and spending levels are an embarrassment for some, therefore, they won’t pursue information or ask questions.

If You Are Good, the Universe Will Supply All your Needs

The research indicates that those will religious beliefs buy into this assumption.  I’m not knocking anyone’s religious beliefs, but those that are waiting for the universe to drop money down on them will be waiting a very long time.

Do you hear yourself saying any of these statements to yourself?  If you are, they could be avoidance mechanisms that will deprive you of good decision-making.  Better to be realistic than pretend money isn’t important, when it is.

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