Bonds often get a bad rap.
A treasury bond is a government debt security that you can buy and sell just like a stock. But it offers lower yields, making it a much less attractive investment.
What many people don’t know is that bonds are actually a vital source of revenue. They help to keep the lights on for governments, states, and corporations…
And they offer an ideal safe haven in bearish market conditions.
With all three major indices down more than 20% from their recent highs, markets have officially entered bearish territory – making now the perfect time to get into bonds.
You don’t have to worry about lower yields, either.
Now Is the Perfect Time to Buy Bonds – Here’s How
In 1693, the Bank of England issued bonds to raise money for the country’s war against France, creating today’s government bond.
Following the trend, the U.S. government issued bonds to support Revolutionary War efforts. In fact, one could even say that the ultimate outcome of the war was greatly influenced by the money raised through bonds.
You see, a bond is essentially a loan. Like a loan, bonds pay interest at a particular rate called the coupon rate, which produces the yield of the bond.
Yield = Coupon Rate X Bond Value
Bonds are considered safe instruments depending upon who’s issuing them.
There are three broad classifications of bonds:
- Government (U.S. Treasury Bonds)
Treasury bonds are considered high-quality for most governments. In the U.S., they are regarded as the highest-quality available.
This makes sense when you consider they are backed by the full faith and credit of the U.S. government, making the risk of default slim-to-none. In addition, the interest earned is exempt from state and local taxes.
Treasury bonds are liquid and trade on the secondary market. They have maturity dates which range from 30 days to 30 years.
- Municipal Bonds
Issued by state and local governments, “munis” are used to fund construction and maintenance of infrastructure like schools, highways, sewer systems, and housing. They are typically exempt from federal income tax and, in some cases, state and local taxes.
They are, however, considered riskier than treasury bonds, as state and local governments have more bankruptcy risk. Given the added risk, municipal bonds offer higher coupon rates than treasuries.
- Corporate Bonds
Corporations may also issue bonds to fund business expansion. Corporate bonds carry more risk than treasury and municipal bonds and, therefore, typically provide higher yields.
As you can see, there is a relationship between yield and risk to consider before investing in bonds.
Higher risk of default = Higher yield
Lower risk of default = Lower yield
Let’s take a look at the current yield of the lowest-risk bonds, the “treasuries.”
In comparison, here’s a look at typical municipal bond yields:
Obviously, “muni” yields are higher than treasuries – but so is the risk of default. The same goes for corporate bonds. The higher the risk, the higher the yield.
This inverse relationship between risk and reward governs trading and investing as we know it today.
Now, in this current market, it’s important to understand that bonds in general are considered safer than stocks. When the going gets tough for stock traders, money generally flows from stocks to bonds, driving their prices up. Those owning bonds in a bullish bond market profit from this flow.
Additionally, as interest rates drop, bond prices rise. Currently, interest rates are at record lows. The Federal Fund Rate is currently at 0.25% – making the bond market significantly bullish.
If these bearish market conditions continue, you can expect bond prices to rise – meaning buying bonds right now is smart. You should consider diversifying your current portfolio with bonds.
But what if I told you that you could dramatically increase your yield and secure the safety of bonds?
Well, with exchange-traded funds (ETFs), you can.
Bond ETFs invest in bonds and are traded as stock on the stock exchange. They don’t mature, meaning you can hold them indefinitely. Plus, they are liquid, even if the component bonds are not.
And the best part?
Bond ETFs pay monthly dividends. In fact, the yearly yield is much higher than typical bond yields.
Take the iShares 20+ Year Treasury Bond ETF (NYSE: TLT), for example. It’s currently offering an annual dividend of $3.016, or 1.89%.
By purchasing the liquid stock, you can make $3.016 per share each year in dividends indefinitely.
Pretty good – but with options, you can supercharge those returns.
Right now, you can sell 30-day, out-of-the-money (OTM) calls against TLT stock for around $4.00. That’s an extra $48 dollars a year in premium – 1,600% more than you would make purchasing the liquid stock.
Here are the most popular treasury bond ETFs:
Symbol ETF Name
SHY iShares 1-3 Year Treasury Bonds
IEF iShares 7-10 Year Treasury Bonds
TLT iShares 20+ Year Treasury Bonds
Now is the perfect time to invest in bonds, particularly treasury bonds. Whether you’re purchasing a bond, a bond ETF, or options on either, you and the country benefit!
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