Sixty-three years ago, the title of a classic Jane Russell-Marilyn Monroe movie, Gentlemen Prefer Blondes, entered the collective consciousness of the English-speaking world. It never left!
But a few decades before the 1953 movie, Andrew Mellon (1855-1937), the financier who served as United States Secretary of the Treasury from March 1921 to February 1932, had observed that “gentlemen prefer bonds”.
When I asked my audience at public workshops on financial planning and retirement funding if they had heard of stocks and bonds, many nodded.
Yet, when I drilled down: “Who can tell me the difference between a stock and a bond?”, people looked away.
Note: One stock (or share) of any company grants the person who possesses it a sliver of ownership. In contrast, a bond issued by a company or a government represents partial “loanership” because those who initially buy the bonds are lending money to the issuer.
So, a bond is a debt instrument.
If we own a bond or a bond fund, we are investors in what is called the fixed income asset class. It is important to also know that bonds move inversely with interest rates.
Therefore, the surprise Bank Negara Malaysia decision on Wednesday to cut our overnight policy rate (OPR) from 3.25 per cent to three per cent boosted bond prices.
Conversely, during periods of interest rate hikes, bond prices fall.
During more normal periods of interest rate stability, fixed income instruments provide steady returns that stabilise portfolios.
In their book, DIY Financial Advisor, authors Wesley R. Gray, Jack R. Vogel and David P. Foulke said: “Fixed income relates to investments that generate a return based on stable periodic payments at regular intervals with a return of principal at maturity. Fixed income investments, or bonds, typically provide income and have low historical volatility.”
Their explanation sheds light on Mellon’s observation on gentlemen and their love affair with bonds.
But why might we use fixed income instruments like bonds and bond funds in our wealth accumulation endeavours?
In fund manager Mark Mobius’s book, Bonds — An Introduction to the Core Concepts, he gives three reasons:
PREDICTABLE income streams;
CAPITAL preservation; and,
PORTFOLIO diversification.
Those first two pluses are not absolute guarantees of steady passive income inflows and total, perpetual certainty of getting your money back.
But since bonds generally carry less risk than stocks, their price volatility is also usually lower.
Direct investors in individual bonds tend to be wealthy and supremely focused on the rating grades that credit agencies grant bond issuers.
Frankly, it is simpler and less stressful for regular retail investors like us to gain fixed income exposure through bond funds instead of individual bond issues. When we use bond funds, we enjoy two advantages:
WIDESPREAD bond issuer diversification; and,
AFFORDABLE access to the expertise of a professional bond fund manager who is (hopefully) smart enough to avoid toxic issuers.
Bonds began about 800 years ago in the 13th century when the Venetian government issued the prestiti, which paid interest twice a year but was structured to never mature.
Later on, England and France followed suit with their own perpetual bonds called, respectively, consols and rentes.
Mobius writes: “Bonds reached their heyday during World War 2 when the US government raised almost US$200 billion (RM792 billion) in war bonds to propel the Allies to victory.” Thankfully!
Bonds have defined the world we live in so you might consider using them yourself! But first, it would make sense to know what the smart money is doing.
According to the 2016 World Wealth Report published last month by Capgemini, globally on average high net worth individuals have been raising fixed income’s share of their total investable assets from 16.4 per cent in early 2014 to 16.9 per cent a year later to 18.0 per cent in the first quarter of this year. Bonds’ allure is rising!
Second, take a closer look at bonds to see if you are using them appropriately within your own wealth accumulation portfolio.
Rajen Devadason is a Securities Commission-licensed financial planner, professional speaker and author. Read his free articles at www.FreeCoolArticles.com. He may be
connected with on LinkedIn at https: //www.linkedin.com/in/rajendevadason, rajen@RajenDevadason.com and Twitter@RajenDevadason.