What’s All the Talk About Bond Yields?

Bond yields are a hot topic in the financial news, with daily announcements that “bond yields moved higher” or “bond yields fell sharply.”

Nothing puts people to sleep faster than a good old-fashioned bond yield discussion. But what does that mean? Everyone should have a basic understanding of bonds because they affect all of us daily.

A bond is simply a loan.

When you buy a bond, you are lending money to a government, municipality, or company. Bonds are typically issued in $1,000 units. So, if you buy 10 bonds, you are essentially making a $10,000 loan.

In return, the borrower agrees to pay you interest and eventually return your money in full when the bond matures.

With a traditional fixed-rate bond, two important things never change:

1. The interest payment the bond promises to make.
2. The date the borrower is scheduled to repay the bond.

For example, suppose you buy a $1,000 bond paying 4% interest that matures in 10 years. The bond will pay $40 a year, and at maturity the borrower repays you the $1,000.

Bondholders can almost always sell their bond before the maturity date. What can change is what that bond is worth to someone else before those 10 years are up.

That brings us to yield. If you buy a new bond for $1,000 and hold it until maturity, the bond’s stated interest rate and yield are the same. But if you buy it secondhand or sell your bond before maturity, the yield can be different from the stated interest rate. If you want to sell a bond you own before maturity, you likely won’t get $1,000 for it. That’s because a buyer will compare the interest rate your bond pays with the interest rate a new bond pays. If newly issued bonds begin paying more interest, your older bond (paying less interest) becomes less attractive, and its market price may fall. If newly issued bonds begin paying less interest than your bond, then your bond becomes more attractive, and its market price may rise.

In addition, the buyer will try to determine what effects inflation, future interest rates, and the state of the economy will have on bonds. That’s because bonds are loans that can last for years and buyers are trying to avoid future problems. Predictions about the future (inflation, higher interest rates, etc.) can result in bond buyers wanting a higher return for lending money, and thus they will demand a higher yield. Those predictions could also result in buyers accepting a lower yield for the safety of a guaranteed payment.

Hence, this very basic rule: Bond prices and bond yields move in opposite directions.

What are people trying to learn from bond yields?

When investors pay attention to changes in bond yields, they are trying to read what the bond market is collectively saying about the future of:

• Interest rates
• Inflation
• The economy

But there is an important catch:

Bond yields tell you what investors are doing, but they don’t tell you exactly why they are doing it.

That is why I think of bond yields as a signal rather than a prediction. They give us a glimpse into what investors collectively believe about the future, and, of course, the future has a way of proving everyone wrong from time to time.

So… you will probably hear a lot more about bond yields in the coming months. For the most part, think of that as just another element of noise that really has little effect on long-term investing. However, changes in bond yields affect all sorts of loans, including car loans, credit card rates, and mortgages. You might feel the effects despite the fact that you can’t use bond yield changes to make an effective long-term investment strategy.

Fun Fact: August is named after Augustus Caesar, the first Roman emperor. The month was originally called Sextilis, but it was renamed in his honor in 8 B.C. because several of his most important victories occurred during that month.

Start Like Call -But End Like Gus

I just finished the epic series on the early American West by Larry McMurtry. His western novel Lonesome Dove won the Pulitzer Prize for Fiction in 1986, it’s that good. It follows the lives of Woodrow F. Call and Augustus “Gus” McCrae, two men who are inextricably tied together with a strong but sometimes volatile relationship. If you want a full picture of their careers together as Texas Rangers and then cattle drivers, start with the novel Dead Man’s Walk, and then proceed to Comanche Moon. Those are the Texas Ranger days when Comanches ruled the Southwest. Lonesome Dove picks up after the colonizers overpowered the Indians, but not without tremendous effort.

Life in the Wild West, in those days, was truly harsh. Death was always near and could come from many sources, including weather, horses, snakes, disease, Indians, or just plain bad luck. A central theme of McMurtry’s novels is how these two very different people worked together to successfully survive their harsh surroundings.

They both met with success, but in very different ways. Call is a stoic “work comes first” fellow. He is extremely disciplined, always thinking ahead. Gus is more intuitive, notices people, conversation, food, women, humor, and some of the simple pleasures along the way. One common trait is that they’re both tough as nails. Though very different, they formed a bond at a young age that grew stronger over time.

Like any great novel, these characters represent something universal. In the world of retirement planning, it seems these two personalities have an important place. Many successful investors spend their early years like Woodrow F. Call: pragmatic, disciplined, sticking to the plan with their heads down and marching forward. For many (including me), the hard part comes later in life when the rewards of Call’s lifestyle start to pay off. Then I would suggest it’s time to think a little bit more like Augustus “Gus” McCrae. Slow down, enjoy life, smell the roses, laugh a little bit more and take things a little less seriously.

As I’ve stated more than once, research shows that many people die with much more money than they started with at the beginning of retirement. There’s nothing wrong with that inherently, but it should not be a manifestation of a life not well enough lived.

For most of our lives, we are taught to prepare for the future. Save more. Work harder. Be responsible. Keep going. But eventually, there comes a point when preparing for life should give way to living it. That’s not to say that we throw caution to the wind. For Call, life was primarily to be endured. But for Gus, life was primarily to be experienced.

Put it in simpler terms, at age 40 a good question is “how much will I have?” At age 70 and beyond the better question is “what am I still saving for?” Relax, you’ve earned it. In the illustrious words of Gus McCrae: “The older the violin, the sweeter the music.”

Fun Fact: Author Larry McMurtry wasn’t just a great author; he was an obsessed book collector. He had several buildings in his tiny hometown of Archer City, Texas, filled with used books. At its peak, his used-book operation, Booked Up, held nearly half a million books in four buildings. In 2012, he auctioned off more than 300,000 of them.

Can a Cup of Coffee Make You Rich?

Well, we all know the answer is no, but I’m about to tell you a true story about how a cup of coffee opened the door to riches.

First, I have to take you back about 30 years to a coffee shop in Portland, Oregon. I have a client who was in that coffee shop visiting her daughter, who moved from Michigan to Portland to find herself. My client, let’s call her Lina, met her daughter for a cup of coffee at what was then an up-and-coming regional coffee shop called Starbucks.

It turns out Lina thought the coffee was good and the shop itself had a nice vibe (that’s before anyone knew what a “vibe” meant). In fact, she liked it so much she invested $8,000 of her IRA in Starbucks stock—30 years ago. It should be noted that from my interactions with her, when Lina makes up her mind, that’s the end of it.

Flash forward to last week, when I met Lina and her husband at an assisted living facility where they now live in Metro Detroit. It’s a very nice facility, which they can easily afford. Lina and her husband are now both in their mid-90s but still mentally sharp. Lina never sold her Starbucks stock but just let it grow, and in 2010, when Starbucks began to pay a dividend, she had them reinvested. That initial $8,000 investment in Starbucks created $1.5 million in value for Lina as of last week.

That’s not Lina’s only investment, but it certainly was a game changer for her and her family. In fact, our recent meeting included updating her plan to make substantial gifts to grandchildren and great-grandchildren. A coffee she had 30 years ago made that possible.

I bring the story up for several reasons. First, it does reinforce the power of owning businesses through the stock market. There is no better tool to create wealth than equities. Second, it shows the power of time in investing. Lina found a gem of a company to invest in, but she also allowed time and dividend reinvestments to turbocharge the investment.

There is a third important point to remember here. If you’re like me, you find this whole story fascinating, and the real reason that you do is because of the unbelievable luck involved. To commit most of your retirement plan savings to a single company is very risky. I would never recommend it to a client. Lina hit a home run, but lots of people grow wealthy hitting singles and doubles.

In hindsight, it turned out to be a wonderful investment, but for every Starbucks story, there’s also the story of someone who went all in on Enron, America’s great growth company of the ’90s, whose story ended in tragedy. (I highly recommend the book The Smartest Guys in the Room for true insight into what happened there.) Or how about Eastman Kodak? Back in the mid-’90s, it was the blue chip of blue chip companies that made cameras and copy machines. What could possibly go wrong there? That’s what they were asking during their bankruptcy in 2012.

As Lina knows, I fondly refer to her as “the Starbucks lady,” and I’ll never forget her hunch and her patience, even though I know how much luck had to do with it.

I’m going back to see Lina and her husband to sign updates to their plan in a few weeks. I’ll have to remember to ask her how the coffee is at her assisted living facility. My guess is she’s going to tell me she’s had better.

Fun Fact: When Starbucks went public in 1992, it had approximately 140 stores. By the end of that fiscal year, it had 165 stores. Today, it has more than 40,000 stores worldwide. Quite a success story.