Ep 52: Introduction to Bonds

Jessie (00:00)
Next week is the September Fed decision, where Papa Powell will bless us with an interest rate decision, finally. Since the broader consensus is rate cuts, and we have been talking about locking in higher interest rates for some time now, I want to know more about bonds.

Jess (00:16)
yes, and we're gonna get a dot plot, that series of economic projections. They're gonna tell us where they interest rates are gonna be through the end of the year, even the following year, growth, where they think inflation's gonna be.

Jessie (00:27)
and even more reason to understand the different ways to lock in higher interest rates.

Jess (00:31)
Yeah, so let's talk about bonds, does make me really want a martini, but shaken, not stirred.

Jessie (00:36)
coffee time for

Jess (00:37)
could have an espresso martini, but mix them together. Yeah, love that.

Jessie (00:40)
Ooh, espresso martini, our fave.

You're listening to Market MakeHer Podcast, the self -directed investing education podcast that breaks down how the stock market and the bond market works from her perspective.

Jess (00:57)
We talk about current events like the Fed cutting rates next week, or supposedly they will, yeah, they may not. We educate and explain like who the Fed is and what is a bond, which is today's topic, and what action you should consider at your brokerage firm, like locking in higher rates before they drop utilizing fixed income products, not financial advice, but educational, informational, all disclosures.

Jessie (01:19)
And

And we do it all teacher learner style. So I'm Jessie DeNuit on a mission to learn how this esoteric world of investing works and do that thing rich people do where they make their money make money. Cause I want to make my money make money, which means I am literally learning alongside you. I ask all the questions and I always have a lot of them.

Jess (01:38)
we love the question. So it's important. That means no financial jargon. And I'm Jessica Inskip what we call the resident finance expert. I've worked in the self -directed space for 15 years now held big girl jobs at Merrill and Fidelity Jessie convinced me to start this podcast with her to make it make sense. It being the stock market.

Jessie (01:56)
That's right. And general financial literacy and investing things.

Jess (01:59)
Yes.

Jessie (02:00)
today's episode is, what is a bond?

Jess (02:03)
A bond is a type of fixed income product. There are other fixed income products and they're issued by governments and corporations when they're looking to raise money.

It's a loan from the buyer or whoever's holding it, whoever owns that bond to the issuer of the bond.

Jessie (02:20)
So we're the issuer. No, they're the issuer. We're the buyer or holder. Okay. So who issues bonds and why do they issue bonds?

Jess (02:22)
No, we're, yep, that's right. Yes.

governments can issue bonds and we talked about treasuries and the sovereign quite a bit, just with what it has to do with the market and investing in them slightly. But corporations also issue bonds and governments can be municipalities too. Those are who the issuer is. So when we say issuer, remember everything is in the name. Finance terminology is not creative in the slightest. So the person giving the loan, they're called the issuer and

It basically is like a binding agreement between you and the person issuing the bond. By buying a bond, you're literally just giving whoever's issuing it, the issuer, a loan, and they agree to pay you back the face value of that loan on a specific date, and they pay you interest payments periodically throughout the duration of that loan.

Jessie (03:17)
So it's like an IOU, but you get like extra money on top of the IOU along the way.

Jess (03:22)
Yeah, but I guess a better analogy would be like an auto loan or a mortgage or something like that where you're literally lending money for some type of purpose. In this case, it'd be someone's lending me money so I can buy a car. in exchange for that, I'm going to pay them interest. We're just flipping the script this time. You're the issuer.

Jessie (03:25)
Hmm.

Yeah.

and we've talked about this in previous episodes, we have an episode on bond ETFs. just so we are clear when we say the sovereign, we're talking about like the US government, US treasury, right?

Jess (03:50)
That's right.

Jessie (03:51)
we've defined municipalities before, when we are talking about that, we're saying you can buy bonds at the local government level, right?

Jess (03:59)
Yeah, like counties. And we'll go into the details of that. It's actually kind of interesting. Nonetheless.

Jessie (04:03)
Yeah. Okay. now let me ask you this. Companies issue stocks to raise capital or get money, right? Then they give up part of their company in the process. So is it the same with bonds?

Jess (04:16)
That is such a lovely question. unlike stock, you don't have any ownership. you're on the creditor side of this now. you're literally lending them money, but the intent is the same from the company's perspective. They are trying to raise money. That's the goal. It's just another method that they can, instead of giving up ownership, they are seeking a line of credit from you. And that's why when you buy a bond, you're

Jessie (04:37)
Hmm.

Jess (04:40)
literally giving them a loan. They agree to pay you back on a specific date and they pay you interest until it's maturity and they agree to pay you back what's called the face value, or par value is another word for it.

Jessie (04:48)
the amount. value and par value are the same thing.

Jess (04:52)
That's right. And it's normally increments of a thousand dollars. So you might say, okay, I've got a corporate bond for a thousand dollars. You agree to pay me 5%. That's the annual yield and I'll get payments quarterly

5 % on that a thousand dollars. And then when it comes to maturity, which may be, two or three years from now, I'll get that full $1 ,000 back.

Jessie (05:09)
See, I actually didn't realize that you got the interest payments along the way with bonds. I just thought it was all at the end of the time period that you bought it for. And that's when you get it. Okay.

Jess (05:17)
Well, varies. There are different methods.

bonds, you are getting the interest payments periodically. It varies when we get to the government side.

Jessie (05:29)
Okay. Okay. So is that why you would hold on to a bond then like you talked about how this has to do with portfolio management?

It's not affected by the stock market roller coaster as much right?

Jess (05:42)
Yeah, that's an important part of it because when you don't own a piece of the company, you don't benefit from the growth of it. So I'm investing in Apple stock. If Apple does really well, they have a new AI iPhone and all of the sudden they're selling a lot of iPhones, that stock's gonna go up in value or should go up. If like they don't have a lot of iPhone sales, then it's gonna go down in value, like the volatility, like you're saying. I'm invested in that company. I'm invested in the growth of that company.

But if I am becoming a creditor of that company, I still wanna make sure that they can make their payments, but I'm not investing in the growth. I'm not affected by their growth. If they sell more iPhones and the stock price goes up more, it doesn't do anything to my bonds. But also conversely, it doesn't go down if they don't sell enough iPhones, for example, like there could be lots of other reasons. So you're not subject to that volatility. You gotta smooth out the volatility.

is what we'll call it. But we wanna make sure you know that the company's doing well enough to pay you. That's important.

Jessie (06:45)
their credit score, which we'll get into. We've talked about it a few times. But let's define some terms, you just mentioned volatility. Is that only stock market fluctuation, or is volatility also used in terms of the bond market?

Jess (06:48)
Yeah, exactly.

Well, that's a good question. Volatility could be anything, literally anything. I use it in my everyday life. say when my son is acting up, I say, he's volatile right now. It just means heavy fluctuations. So it can be used in any aspect. Yeah, it could be. But yeah, you could say tech has a lot of volatility. It's high volatility. And volatility.

Jessie (07:08)
Like my menstrual cycle. My PMDD.

Jess (07:25)
I think I've said this before, I think it's such a bad rep is important. You need those fluctuations in order to grow. But when you're investing in bonds, you're trying to offset that volatility. You are not growth oriented. Like you're literally focused on adding yield, adding income. You're preserving your capital, guarding your money, collecting those coupons. You're not looking for growth. So you're smoothing out the volatility.

Jessie (07:29)
Mm.

let's talk about the coupon then. So that is the fixed interest rate paid by the issuer to you. So that's the like interest rate you're getting periodically.

Jess (07:53)
Mm -hmm.

they have a face value. This is the amount that it's issued for. And then the interest rate or yields is the coupon, the initial one.

Jessie (08:10)
Okay, but our interest rate and yield the same thing.

Jess (08:13)
No, there are lots of different yields with bonds. So coupon is what it's issued with. Yield is when it starts going to the secondary market. Those prices are going to change, which means that the yield is going to change. That's why when you turn on CNBC or Fox Business or Yahoo Finance or the Schwab network, wherever you could see treasury yields on the TV and they're constantly changing. If they were showing corporate bonds,

you could see that too, because when something's on

secondary market, pricing mechanics come into play and that changes the yield aspect. We'll go into a little more detail that. And we talked about it on the yield curve episode.

Jessie (08:47)
Okay.

So we talked about coupon and interest and yield volatility. What about maturity? What is that?

Jess (08:59)
So that's the, your money locked up for how long of a time. So I have issued you this loan. This loan comes to maturity December of 2025. Let's win it.

Jessie (09:05)
Okay.

And that's when you get your par value or face value back in addition to the interest or yield. Okay.

Jess (09:15)
Right. Any odd interest based off of the initial coupon? We'll, we'll make it make sense. Or we can go through that now if you want.

Jessie (09:26)
Wait, when we talk about the secondary market though, we've talked about the secondary market as the stock market over and over again. So the bond market is also a secondary market where you can exchange bonds. So is that only where the bond like ETFs are, but not the actual bonds.

Jess (09:42)
Nope, ETFs trade on the exchange. So they're on the stock market ETFs exchange traded funds trade like a stock. And then the bonds are on the fixed income market or the bond market, the debt market.

Jessie (09:46)
Right.

Okay, so it's not, today we're not talking about ETFs we're talking about like actually buying bonds from either like treasury .gov or like your brokerage firm.

Jess (10:01)
We're going talk about what the bond.

Yeah, you can buy them in your brokerage firm. don't have to even participate in treasury auctions. You can do them on your brokerage firm. You don't have to go to treasury .gov. Yeah. Just like the brokerage CDs, it's all the centralized location. Most brokerage firms, not all of them offer it, but the bigger ones do. But the pricing it's a quick example. I am going to have to do math in my head. let's, let's all bear with Jessica here because it's been a day. But if you say.

Jessie (10:11)
Okay.

Okay.

Okay.

Jess (10:29)
Apple, for example, issued a billion dollars worth of bonds and they're issuing it to innovate on AI, And then you're going to purchase one at a face value of $1 ,000 on the primary market. So like, like a stock IPO bonds are going to IPO to going to have their initial public offering. So if it's $1 ,000 face value.

It's giving you 10 % that's extreme and super high, but I'm using that for easy math on myself. That's a hundred dollars a year, right? Because that's going to be an annual, that's the initial coupon amount. If something happens and the price of the bond goes down to $900, you're still going to get a hundred dollars annually.

Jessie (11:00)
Okay.

Jess (11:20)
but that's a lot more than 10%. So the yield will go up. Does that make sense?

Jessie (11:27)
but when you buy a bond, it's locked in, right? are you saying the price of the face value of the bond, it can be $1 ,000 today and you lock that in until the maturity date, but then the price of that same bond might go down for someone else next month or something?

Jess (11:32)
Y -yes.

Yeah, the second you own it, it's gonna start trading on the secondary market. It's available because there's a bunch of them, right? And so if it goes down to 900, the price of it, that's trading at a discount, you're gonna see yield of 11%. That's what I mean by difference of coupon and yields. Because the coupon,

Jessie (12:04)
So the yield goes up because the price of the bond went down, but you're still getting the same amount that you were like promised when you bought it. Okay, so that's why the percentage changes, the interest or yield goes up because the value of the bond went down, but you're still promised that higher amount. So it like goes up to reflect the difference. Okay.

Jess (12:07)
The

Absolutely. That's right. That's right.

Exactly. You are getting 10 % of a thousand dollars, but because that bond is trading at $900, then it's going to show it has a yield of about 11 % it has a higher yield because it's a lower price now, but it's calculating interest based off of the original face value. That's going into the details that I didn't intend to today, but that's okay. Yeah.

Jessie (12:48)
But no, it's good to know because if, mean, like, you know, you're gonna hold, like, you shouldn't, you should buy, if you're buying a fixed income security for a set amount of time, you get penalized for withdrawing that money earlier than the set amount of time, right?

Jess (13:01)
Yeah, you could. And that's why, due to the fluctuations on the market. But it fluctuates on the market due to outside mechanics as well, like interest rates. Bonds have interest rate risk.

Jessie (13:12)
So bond rates, like fixed income security rates, just like interest rates for credit cards, loans, or like whenever they get cut by the Fed, the bond and treasury and fixed income security rates might also start dropping.

Jess (13:26)
Yeah, so like say that same Apple corporate bond was like at 1 % when it was issued and then all of a sudden the Fed is raising interest rates. Okay, well I can get a better rate on a high yield savings account or on a short term treasury. That's the inversion, right? So if the risk free rate, which is the treasuries is a lot higher than what I'm getting on this corporate bond, there might be a lot of selling of that bond.

Jessie (13:26)
or we'll start dropping, so.

Jess (13:55)
Selling is a lot of supply, which makes prices go down. And that's how it adjusts. Everything adjusts.

Jessie (14:01)
But since if it's a corporation or whatever, still has to pay you what they owe you, that IOU or whatever, like the loan, they still have to pay you that plus the interest that you locked in, right? Yeah, no matter what the value of it is now. Okay.

Jess (14:08)
That's.

That's right. That's exactly right.

That's right. And if they

then they could end up in default. Like literally if they miss one payment, they're at default risk. And that means you should look at credit ratings. Yeah.

Jessie (14:24)
And the credit ratings, yes. Okay, so we've talked about this before too, but that's where a credit score comes into play. just like you and I, how we all have our credit score, so does the government, so do corporations, and you can actually look at it, right? what does that look like? How do I know that, they can pay me back basically?

Jess (14:44)
So default risk is the name of it. Two main risks with bonds, it's interest rate risk, which talked about a little bit, and default risk. Just like you're going to get your auto loan, like you said, they're going to look at your credit score. They're going to look at your credit worthiness. Have you made payments on time? Do you have that income in order to even get that loan? All the things, right? They do the same thing. It's great. So it's the issuer's credit rating. It's done by Fitch, Moody's, and S &P.

Usually on your brokerage firm's you can even look at this from an analysis perspective if you're looking at a company's health, do they have a good credit rating?

it's just like trans union experience. And then the third one, I always forget.

Equifax, that one, yeah. So they look at the financial statements because there's balance sheets, cashflow statements, income statements from a public company. It's just like we learned in episode two, a company goes public. Now we get to see all their financial documents and their credit history, which is their credit worthiness, essentially. it works exactly the same as it would for you and I, the lower that their...

credit worthiness or score, the higher interest you'll pay, the higher interest they will pay.

but that should give you a pause for a moment. like, okay, wait, if you're a higher interest paying bond compared to someone else, what's your rating?

Jessie (16:03)
Yeah, how do I know you're gonna actually pay me back? If it seems too good to be true, you might wanna do a little research and make sure this company actually has some credit worthiness to get your money back.

Jess (16:06)
Exactly.

Yeah. And so what goes into the due diligence of the credit rating, and actually they're filed with the SEC and the Edgar system. We could put a link to that. You could literally search it, everything comes with a prospectus, just like mutual funds. So you could literally read through it on the prospectus, will be on your brokerage firm's website and that Edgar platform on the SEC. Or you just look at the credit rating and that's normally going to be right next to the bond if you're looking at it on your brokerage firm's website.

Jessie (16:40)
OK, their actual credit score or credit rating will be there. And it's a letter system, right?

Jess (16:41)
and they look at a.

Yes. you're looking for, for triple B or higher. So B, B, B, there's pluses and minuses. So minus is still considered investment grade and then higher is better. So triple B minus is like passing and it's like school and it, it goes all the way down to a D and a D means default.

Jessie (16:49)
Right.

bonds are supposed to be considered less risky though, right? a government bond is no risk, right? Because the US government always pays its debts. So far, yeah. And they haven't defaulted or anything, but corporations, like if you're looking at corporate bonds, that might be a little bit more risky depending on their credit worthiness, right?

Jess (17:14)
the Lannisters,

Yep, they're considered on the risk scale investment grade. So again, triple B or higher are considered higher risk than treasury bonds because it's backed by an individual company, not the whole United States of America, full faith and credit of the government they call it. But there's due diligence that goes into it. So these are questions I would ask myself if I'm getting into a bond, if it wasn't through an ETF or something, but also that the rating agencies are going to look at.

Jessie (17:43)
Right.

Jess (17:53)
What are they using the funds for? They're literally issuing debt. Why? Why are they issuing debt? Is it to keep the company alive, like operating expenses, to pay their staff? Is it expanding? Are they innovating? Why are they issuing all these bonds? And Apple does issue them. it's very

Apple has a higher credit rating because they also have a lot of cash. is that company profitable? Just like we would look at on stocks, is earnings going up?

Do they have a healthy profit margin? Same thing applies. What is free cashflow like? Is that positive or negative? you can see that on your brokerage firm as well. Right on your brokerage firm's website, put in the security, hit financials, and then you'll see cashflow there. But again, this is the hard way. Easy way is the credit rating by the rating agencies.

Jessie (18:23)
How do you see their free cash flow?

Yeah.

Jess (18:36)
the big one though, will interest rates have a big impact on future financing needs? but right now we think interest rates are gonna drop. So companies who have a lot of debt should stand to benefit because they can refinance that debt at a lower rate, less expenses, right?

Jessie (18:44)
Mm

Right.

All

which also means interest rates on bonds and treasuries are going to drop too. that's how the stock market and bond market can kind of fluctuate. if the stock market is not doing so well, sometimes the bond market is, Because it's

better time to buy bonds or lock your cash into something while the interest rates are higher. Once interest rates get cut, then these higher yields, even on your higher yield savings accounts are gonna start going down too.

Jess (19:18)
interest rate risk right there that's a whole episode we could do on duration and convexity and understanding the impact of that. Yes, a fun word. Yes.

Jessie (19:25)
convexity. Hmm. New word. And yeah, duration for sure, because I thought I understood duration and I looked it up and I don't. So we should probably do a whole episode on that. Yeah.

Jess (19:37)
It's a lot of fun, fun math, fun math equation. But this is introduction to bonds today. Introduction.

Jessie (19:42)
Okay,

so are there any other terms we should know today for this introduction to Bonds episode?

Jess (19:47)
Yeah, well, maybe we could do a review of the ones we've done so far. So we did issuer, which is the company or government issuing the bond. So we'll say issuer a lot, face value, AKA par value, the amount that is issued, usually increments of $1 ,000.

Jessie (19:50)
Okay, let's review.

Mm

Jess (20:05)
that's a fun one because of the history. So it's the fixed interest rate that's paid by the issuer to you. based on the face value. And they were literally like paper coupons back in the day. So people would literally get like their coupon payments, but I might age myself,

Jessie (20:19)
course.

Jess (20:24)
Remember when you'd get auto loans back in the day and they'd give you this paper book and you'd have to write in to make your payments and include interest? that's that. Yeah.

Jessie (20:31)
Yeah, they did it for my mortgage too. Like my first, yeah, like a house I bought the mortgage, had this coupon book and my dad told me like, you'll get a coupon book. like, what the heck is that? Like, why can't I just pay it online? And I did.

Jess (20:42)
Yeah. I wonder if that's where coupons came from, because they call it like clip and coupons. literally fun, fun little history there. And we talked about yield. So when they trade on the secondary market price fluctuates, which means the interest rate does too. if the price is fluctuating. that's the yield. That's the fluid one.

Jessie (20:50)
Well,

Wait, so the yield is fluid, the interest rate is too,

Jess (21:04)
The yield is the interest rate, synonymous. Well, there's the initial interest rate, which is the coupon. And then there is the current interest rate, which is fluid, and that's the yield.

Jessie (21:16)
Okay, that just finally clicked into my head. Thank you. Okay, got it. And what's the penalty for getting your money back ahead of the maturity date then?

Jess (21:17)
Mm -hmm.

Good, you're welcome.

really depends on the market. If interest rates have gone up or moved, there may not be much of a penalty. There might be more of a penalty. It really depends on what the price of that bond is. it also depends on where you bought that bond. So capital gains come in as well. So if you bought the bond at $900 face value but then it rises back up to a thousand. now

You don't have a penalty, you have a gain. And you might say, you know what, I'm going to get rid of this early. That's an extreme example. They don't fluctuate that much, so you know.

Jessie (21:53)
Hmm. No, but I also like totally forgot that you still have to pay taxes on your bonds because you're making money.

Jess (22:03)
right.

Right, yes, but if you bought it at a discount, you'd pay taxes on that. The IRS always has its hand out, but when you make money, not when you.

Jessie (22:10)
Wait, but aren't you always gonna make money unless like the company defaults or something, but aren't you always gonna make money on the bond?

Jess (22:17)
Well, yeah, it's a point of investing in it. You're to get some income. is it taxed as income? Right. So there's taxed as income or taxed as a capital gain, and those all have different rates.

Jessie (22:18)
Yeah, because it's lower risk. OK.

I see. Okay.

Jess (22:30)
and there's more terms.

Jessie (22:32)
What's the, there's more terms, okay. I see there's a fallen angel term, what is that?

Jess (22:41)
Yes, so there is something called a fallen angel and a rising star. you don't hear these ones too much. But back to the credit ratings, you could see someone's put on watch, where moody's would be like, I'm watching you, Apple. And it means something's in the mix. And if they suddenly go to below investment grade into high yield, high yield bonds and junk bonds are actually synonymous terms.

Jessie (22:47)
Never heard those.

Jess (23:06)
They're called a fallen angel because they were high up there in the good credit worthiness heavens, but they have fallen. And then inversely, you're a rising star if you moved from junk bond into the ranks of the high grade credit worthiness. No, no. But I think it's...

Jessie (23:22)
Does it say that like next to their rating or something somewhere? that's just what they get referred to.

Jess (23:28)
Yeah, but I mean, again, it's not creative. It's in the name. It makes sense. But it's good to know because like when there is potential economic downturns, the Fed would implement a policy to protect fallen angels or something like that. And so if you know that, that has to do with the bond market.

Jessie (23:32)
Yeah.

Hmm.

Good to know. Okay, so any other risks or important info to know about corporate bonds?

Jess (23:47)
Yeah.

Well, I think we covered it because we talked about default risk and we talked about interest rate risk. we talked about taxation and the intent of it is capital preservation and adding yield to your portfolio, smoothing out volatility.

Jessie (24:05)
And when yields rise, bond prices drop, making the bond less valuable to the original holder. Higher yield equals lower price and vice versa. Got it.

Jess (24:14)
That's right, relationships, little seesaw.

Jessie (24:16)
Yeah, seesaw, cute, teeter -totter. Okay, so are there other types of bonds issued? Yeah.

Jess (24:18)
You

Yep, so we can go through the different government bonds. We've talked about that.

Jessie (24:27)
So we just deep dived into corporate bonds. Now we're gonna go into government bonds. Okay. Yes, municipalities.

Jess (24:28)
review of

Yes. And municipal bonds. There's even something called government agency bonds, but I don't think we're going to cover those today because that'd be too, too much. treasury is real quick. So they are subject to federal tax, but normally exempt from state tax. That is good to know. It depends on your state. Yeah.

Jessie (24:39)
Okay.

exempt from state time. right. That makes sense. Okay.

Jess (24:52)
So there's tax benefits now that we're getting into government entities.

Jessie (24:54)
Wait a minute. So it depends on the state you live in, whether you're going to get hold on.

Jess (25:00)
It depends.

Jessie (25:01)
So you're talking about like income tax, income or okay.

Jess (25:03)
Yeah.

Always taxes. I'm going to add on another layer because I know we've talked about treasury bills. bills with the shorter term because the dollar dollar bills fluctuate. Maturities of one year or less. Yep. Love it. But these ones do not pay you interest actually.

Jessie (25:11)
Mm -hmm, one year or less.

Jess (25:20)
They're called zero coupon bonds. they're, they're issued at a discount.

Jessie (25:20)
What?

Jess (25:24)
you basically are paying less than the face value when you buy it and you get the full face value back when the bond reaches its maturity date. So you're not getting periodic interest payments, but you get the difference of it.

Jessie (25:35)
okay. Did not know that. This whole time did not understand that that's how you're getting money out of those. Yeah. So that's just for treasury bills though.

Jess (25:38)
That's how they work.

That's okay. We never, talked about it. We talked about the concept of them, but not the intricacies. And that's treasury notes notes are like the little IOU that you write down. two to 10 years and then treasury bonds, you're bonded to the issuer.

Jessie (26:03)
right.

Jess (26:04)
just the US government in this case have a maturity of more than 10 years, most commonly 30 then there's also the treasury inflated protected securities tips. There's also I bonds, things like that.

Jessie (26:16)
Yeah, because I actually have an eye bond. Totally forgot about it. to check in on that one.

Jess (26:19)
Yeah, different, yes you do. There's lots of different government type of securities, but the government issues these to fund its inner workings. And right now our biggest expense actually is the number one is social security. And then the second is the interest on our deficit.

Jessie (26:37)
Hmm.

Jess (26:37)
Higher than defense even. I know crazy. Yeah. But that means that the government also needs a fed interest rate lowering because it will help with the expenses because they're subject to pay that debt. it's not just free money.

Jessie (26:39)
wow, that's a lot.

Yeah.

What about the munis, the municipalities? We haven't really gotten into much.

Jess (26:58)
so tax wise, I think it's important to start with that. you're normally exempt from federal and from state taxes on the municipal bonds, on the state of issuance. So it might make sense for you if you're in a state that has state tax, a municipal bond in that state. You'd get some benefits.

Jessie (27:14)
Can you only buy them in your own state? Okay.

Jess (27:16)
No, you can buy them anywhere. But if you need some state tax help, that might be a good reason. Yep. But you're still subject to the capital gain taxes, but it all varies depending on the bond. This is not a set stone thing. Very, very important there. There are two type of bonds So there's something called the go bond or the general obligation bond.

Jessie (27:28)
Okay. Yeah.

Jess (27:36)
basically where you're getting the principal and interest secured by the full faith and credit of the issuer, the issuer being the municipality. And that's usually supported by the tax power, like the taxing power, as in like, is backing this bond? It's taxes, people's taxes might be paying that. And then what is that general obligation bond being used for? Could be the inner workings of the government. It's to fund something happening within that municipality. that's your go bond.

The other one is a revenue bond. Again, it's in its name. That's where it's secured by streams of revenue, like tolls. Florida has a lot of these. And so in order to get the funds for that outside of whatever like the federal government gives them, they might issue.

some revenue bonds and then those revenue bonds are going to pay you interest based on tolls. That's what's backed by the toll money will go into that revenue bond and then that's what's giving you those interest payments. That's the stream of income that goes through it.

So that's not backed by taxpayers' money or the full faith and credit of the issuer, which is municipality. It's backed by the revenue generating entity behind it.

Jessie (28:41)
And you can still for municipal bonds, muni bonds, you can still look at the credit rating, right? Yeah.

Jess (28:47)
Yeah, absolutely. Everything has a credit rating because it's a security. When it's a security, has to be registered with the SEC. When you register with the SEC as a financial owner or consumer base, we have the right to know what we're investing in and they make sure that we do.

Jessie (29:04)
Okay, good. And would you say that like on the risk scale are treasuries and like Treasury government bonds and muni bonds the same, same

Jess (29:12)
Treasuries still gonna be lower. Municipalities can vary, based on the more of the credit worthiness. I don't have the list. That's right, that's right.

Jessie (29:14)
Okay.

that BBB or higher. Okay. How can we invest in these?

Jess (29:24)
So you can buy them directly, but there's an ETF for that. It's going to be a series. Mutual funds too, though. Or you can purchase them directly. That interest rate risk management and understanding duration risk, the fund manager of the ETF or mutual fund is going to take care of that for you.

Jessie (29:29)
Haha

a

date fund, you know, in your retirement account, as you get closer to retirement, when that manager is switching things out from stocks into more bonds, are they switching it into like bond mutual funds and ETFs or just the bonds directly themselves?

Jess (29:55)
the target date mutual funds are a fund of funds. So they're mutual funds.

Jessie (29:58)
so the bonds in those are bond funds. Interesting. Okay.

Jess (30:01)
Right, exactly. there's bond funds on so many different things. You can get them just on treasuries with shorter durations, you get them on treasuries on longer durations, you can get them on corporate bonds, can get them on munis, there's so, so, so, so, so, so many.

Jessie (30:14)
And those are bought and sold on the stock exchange. Right. Okay. Got it. Yep. Because there isn't a bond exchange then, right?

Jess (30:18)
That's right. It's in the name, exchange. Mm -hmm, mm -hmm.

technically, yeah.

Jessie (30:26)
Like is treasury .gov the bond exchange? No? Okay. All right. Yeah. Yeah.

Jess (30:29)
No, that's the issuer. They're just giving you a means. Like they're acting like a brokerage firm because they need to fund their debt, you know.

there's more to it. There's auctions, there's a lot we're gonna...

Jessie (30:40)
Yeah, we've talked about doing an episode on the bond auction process. If you all want that, let us know because we have so many other episodes planned. But yeah, since you said there's an ETF for everything, I think maybe we should talk about sectors and more specifically when they make sense to invest in each one now that we've talked about bonds.

Jess (30:59)
I think that is a great idea. Let's do that next week. Because I think it makes sense right now because we've been thinking about where we are in the business cycle. Sectors go along with that business cycle. So if we are in fact contracting or leading to a further expansion, we need to look at all of the sectors. Let's do that. I like it.

Jessie (31:00)
Yeah. Okay.

No Darla, bad Darla. Darla is Jess's dog if you all haven't been watching. She likes to join the podcast recordings. no.

Jess (31:22)
She grabbed an expo marker. here she is because we said her name. Hello.

Jessie (31:27)
our mission is accomplished by introducing... I see what you did there. Sounds like our mission is accomplished by introducing a briefing on bonds. The market. The bond market.

Jess (31:36)
That's right. Keep your eyes peeled agents for interest rates and default risks.

Jessie (31:42)
your knowledge was stirred today, or perhaps shaken, feel free to share the refreshing insights with your friends and family.

Jess (31:49)
Yes, leave us a paper trail with a review or comment and do not forget we have that free ebook that we made and it's super awesome so you should check it out.

Jessie (31:56)
check out all the links because we have them in all the places. Follow us, follow along, review, share and remember when you build knowledge, you break barriers.

Jess (31:59)
We do, yeah.

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