WHY BONDS ARE STILL MISUNDERSTOOD

For those of you who know me, you will know that I am a huge advocate of people taking control of their lives through sensible investing. It’s one of those things that is sorely missed in our education system. Even with my own education with an ‘A’ in Economics A-level, a 2.1 degree in Economics and Accounting, a Masters in Business and Finance and various post-graduate professional qualifications to my name, I can honestly say that none of these courses actually taught me anything about investing. It was all theory with lovely concepts, ideas and historical reasoning. It was all about yesterday and nothing about tomorrow. More importantly the way in which it was taught was over-bearing, unnecessary and exhaustingly comprehensive to the point that it either bored or suffocated you into submission. Think about it. What does a lawyer, an accountant, a shop keeper, a pilot, a bus driver, a teacher, a dinner-lady, a postman, a plumber and anybody else with any other profession for that matter have in common? Correct. They all need to know what to do with their money after they earn it from their salary. So, if I’m an accountant and I earn gross £4,000 per month and after tax and my household bills are paid let’s say that I am left over with £1,000 to save, the question is what do I do with that thousand pounds? Well the chances are that I will put it into the bank which is most people do, not because I am happy with 0.1% on my savings but simply because I don’t know any better. And note that an accountant work in finance and therefore should be good with numbers and yet they will also make the same cardinal mistake. That’s because even as an expert in accountancy that doesn’t mean that the person knows anything about investing. In fact, my existing clients who are accountants are some of the most well-intentioned and misinformed group of clients that I know. I’m not entirely sure why but I guess it’s the common story that because they spend their entire working lives helping others to sort out their finances, they usually end up neglecting their own. The simple truth is that investing is not only easy but it’s fun. In fact, anything is fun once you become good at it. It’s enjoyable. I mean, think about it. You slog your guts off and kill yourself for 8-10 hours a day for bits of green paper that when all said and done you realise doesn’t actually buy you all that much anyway. Wouldn’t it be nice then that instead of being a slave to your money that your money returns the favour and becomes a slave to you? That’s right folks. It’s time to turn the tables. So, a quick lesson for today that might just change the way you see things and will certainly prepare you better than your Economics teacher ever did. Put simply there are only 4 ways in which you can invest your money – Cash, Bonds, Equities or Property. That’s it. Forget about anything else outside of these four boxes unless you happen to be a specialist arts dealer, antique car expert or professional stamp collector. Cash – ‘Cash is not king’ and hasn’t been for many years; in fact, it’s not even a prince. As nice as that saying sounds that was back in the day when interest rates were 7%. Since the 2008 collapse and interest rates at close to zero, cash has been the worst asset class of all and with inflation it’s just going to kill you in the end. It may make you feel all nice and snug at night but really, it’s just starving your portfolio of oxygen and one day you will wake up and find that you are actually broke. Inflation is not 3% by the way as the headline figures might suggest but probably closer to 10% in terms of the real cost of living to you as a consumer. Bonds – otherwise known as ‘fixed income’ is the most misunderstood asset class which is a shame because this is the area which is probably one of the best investment vehicles right now given the market volatility and uncertainty. The main issue is a lack of knowledge in how interest rates will affect bonds. So, let me dispel a myth if I may about interest rates and why you shouldn’t be worried. Yes, it’s true that if interest rates goes up then that will bring the price of bonds down. But here’s the kicker. None of that matters as long as you hold the bond to maturity. That’s because at maturity all bonds redeem at par (which is 100). So, if you buy a 5-year bond that pays 5% per annum as a coupon and it is trading at 105p then this means that in 5 years’ time you will lose 5% on the principal investment or put it another way you will make 5% for every year for 4 years and in the 5th year you will earn nothing. That means that you will make 20% over 5 years or an average of 4% per annum. That’s not great but still a damn sight better than getting 0.1% on your bank deposits. The point is that interest rates will only impact you if you don’t hold the bond to maturity which is something that I wouldn’t advise that you do in any case. Equities – are generally higher risk but also offer higher return. This is hugely popular but again in my experience most retail investors don’t know what they are doing. I don’t want to appear condescending when I say that but that’s no nice way to put it, and besides if I sugar coat the truth, it doesn’t change the truth and I will probably do you an injustice because people won’t take my comments so seriously. Investors either put money into the market for the long term and make money if the market goes up (and give most of it away when the market inevitably crashes). If that’s not happening then they usually pay over the odds to greedy financial advisor and fund managers who take no risk but still keep the lion share of any return. Call me angry if you will but somebody has to get angry if you won’t. This is your hard-earned money just fluttering away in the wind. It’s time to take action. Educate yourselves now and make that money work for you. I hope that is of some food for thought, even if you are just going to read this and then forget all about it. Obviously, I could write an entire book on this, as have many others have done before me, but that would defeat the entire purpose of KISS (Keep It Simple Stupid). Investing is easy and always has been – let’s try and keep it that way.