Bond Investing For Canadians For Dummies

Introduction

Perhaps you bought this book online, either in text or digital format. But if you’re still the kind of Canadian reader who prefers to browse through aisles and handle books before you buy them, you may be standing in the personal finance section of your favourite bookstore right now. If so, take a look to your left. Do you see that schmo in the baggy jeans perusing the book on day-trading stock options? Now look to your right. Do you see the ninny in the blue hoodie thumbing through that paperback on how to make millions overnight in sketchy real estate property flipping deals? We want you to walk over to them. Good. Now we want you to take this book firmly in your hand. Excellent. Finally, I want you to smack each of them over the head with it.

There. Didn’t that feel good?

Wiley, the publisher of this book, has lawyers who will want us to assure you that we’re only kidding about smacking someone with this book. So in deference to the attorneys, and because we want to get our royalty checks, we’re kidding. Really and truly, don’t hit anyone.

But the fact is that someone should knock some sense into these people. If not, they may wind up — as do most people who try to get rich quick — with nothing but big holes in their pockets.

Those who make the most money in the world of investments possess an extremely rare commodity in today’s world. It’s called patience. At the same time that they’re looking for handsome returns, they’re also looking to protect what they have. Why? Because a loss of 75 percent in an investment (think tech stocks 2000–2002) requires you to earn 400 percent to get back to where you started. Good luck getting there.

In fact, garnering handsome returns and protecting against loss go hand in hand, as any financial professional should tell you. But only the first half of the equation — the handsome returns part — gets the lion’s share of the ink. Heck, there must be 1,255 books on getting rich quick for every one book on limiting risk and growing wealth slowly but surely.

Welcome to that one book: Bond Investing For Canadians For Dummies.

YES, we know, we know. This book is being published in what may turn out to be possibly some of the worst few years in bond history. What lousy timing. Well, no, not really…. In fact, to make this year (2023) the worst year in history, bonds would have to lose more than the aggregate US bond market lost in 1969 — a tad more than 5 percent. Heck, the stock market can easily lose double that in a day. As we’re writing these words, the Canadian and US stock markets on Bay and Wall Street continue to be fickle and volatile, with no clear longer-term direction in sight.

So just what is this investment that even in the worst of times loses little value, this investment that is both the past and present’s best complement to stocks?

A bond. That’s what. A bond is basically an IOU. You lend your money to the federal or local government, to General Electric, to Microsoft, to Barrick Gold, or to the Canadian city where you live — to whatever entity issues the bonds — and that entity promises to pay you a certain rate of return in exchange for borrowing your money. Bond investing is very different from stock investing, where you purchase shares in a company, become an alleged partial owner of that company, and then start to pray that the company turns a profit and the CEO doesn’t blow it all.

Stocks (which we love as well by the way, thank you very much) and bonds totally complement each other! Like peanut butter and jelly. Bonds are the peanut butter that can keep your jelly from dripping to the floor. They’re the life rafts that can keep your portfolio afloat when the investment seas get choppy. And yes, bonds are handy as a source of steady income, but, contrary to popular myth, that shouldn’t be their major role in most portfolios.

Bonds are the sweethearts that may have saved your grandparents from selling apples on the street during the hungry 1930s. (Note that we’re not talking about high-yield junk bonds here.) They’re the babies that may have saved your RRSP from devastation during the three growly bear-market years on Bay and Wall Street that started this century. In 2008, high-quality bonds were just about the only investment you could have made that wound up in the black at a time when world markets frighteningly resembled the Biblical Red Sea. And in March of 2020, when the pandemic unleashed itself upon the world and the Dow and Toronto Stock Exchanges dropped precipitously over the course of several days? Yup, bonds were the place to be.

Bonds belong in nearly every portfolio. Whether or not they belong in your portfolio is a question that this book will help you answer.

About This Book

Allow the following pages to serve as your guide to understanding bonds, choosing the right bonds or bond funds, getting the best deals on your purchases, and achieving the best prices when you sell. You’ll also find out how to work bonds into a powerful, well-diversified portfolio that serves your financial goals much better (we promise) than day-trading stock options or attempting to make a profit flipping real estate in your spare time.

We present to you, in easy-to-understand English (unless you happen to be reading the Swedish or Korean translation), the sometimes complex, even mystical and magical world of bonds. We explain such concepts as bond maturity, duration, coupon rate, callability (yikes), and yield. And we show you the differences among the many kinds of bonds, such as Treasuries, agency bonds, provincial bonds, corporates, munis, zeroes, convertibles, and strips.

Because this book is all-new in Canada, we also fill you in on some important goings-on in the bond world over the past decade. Notably, we cover the deep pandemic-induced stock market dip of early 2020 and the rush to safety that made bonds, especially US Treasury and Government of Canada bonds, the belles of the ball. We also discuss less cheerful times for bonds, starting with the super-low interest rates of the past decade or so, culminating in early-to-mid 2022 with a sudden, steep rise in interest rates, bringing a serious sag in bond prices.

In recent years, the number and types of bond funds in which Canadian investors can now sink their money has virtually exploded, for better or worse. Many of these new funds (mostly exchange-traded funds) are offering investors slices of the bond market, often packaged in a way that makes bond investing trickier than ever.

In this book, you discover the mistakes that many bond investors make, the traps that some wily bond brokers lay for the uninitiated, and the heartbreak that can befall those who buy certain bonds without first doing their homework. (Don’t worry; we walk you through how to do your homework.) You find out how to mix and match your bonds with other kinds of assets — such as stocks and other financial resources — taking advantage of the latest in investment research to help you maximize your returns and minimize your risk.

Here are some of the things that you need to know before buying any bond or bond fund — things you’ll know cold after you read Bond Investing For Canadians For Dummies:

What’s your split gonna be? Put all of your eggs in one basket, and you’re going to wind up getting scrambled. A key to successful investing is diversification. Yes, you’ve heard that before — so has everyone — but you’d be amazed how many people ignore this advice.

Unless you’re working with really exotic investments, the majority of most portfolios is invested in stocks and bonds. The split between those stocks and bonds — whether you choose an 80/20 (aggressive) portfolio (composed of 80 percent stocks and 20 percent bonds), a 50/50 (balanced) portfolio, or a 20/80 (conservative) portfolio — is possibly the single most important investment decision you’ll ever make. Stocks and bonds are very different kinds of animals, and their respective percentages in a portfolio can have, will have, a profound impact on your financial future. Chapter 12 deals with this issue directly, but the importance of properly mixing and matching investments pops up in other chapters as well.

Exactly what kind of bonds do you want? Depending on your tax bracket, your age, your income, your financial needs and goals, your need for ready cash, and a bunch of other factors, you may want to invest in Treasury, corporate, agency, or municipal bonds. Within each of these categories, you have other choices to make: Do you want long-term or short-term bonds? Higher quality bonds or higher yielding bonds? Freshly issued bonds or bonds floating around on the secondary market? Bonds issued in Canada and the United States, or bonds from Mexico or Japan? We introduce many different types of bonds in Part 2, and we discuss which may be most appropriate for you — and which are likely to weigh your portfolio down.

Where do you shop for bonds? Although bonds have been around more or less in their present form for hundreds of years (see a brief history of bonds in Chapter 3), the way you buy and sell them has changed radically in recent years. Bond traders once had you at their tender mercy. You had no idea what kind of money they were clipping from you every time they traded a bond, allegedly on your behalf. That’s no longer so. Whether you decide to buy individual bonds or bond funds (Chapter 14 helps you make that thorny decision), you can now determine almost to the dime how much the hungry Bay Street brokers intend to nibble — or have nibbled from your trades in the past. Part 4 is your complete shopper’s guide.

What kind of returns can you expect from bonds, and what’s your risk of loss? Here’s the part of bond investing that most people find most confusing — and, oh, how misconceptions abound! (You can’t lose money in AAA-rated bonds? Um, how can we break this news to you gently?) In Chapter 4, we explain the tricky concepts of duration and yield. We tell you why the value of your bonds is so directly tied to prevailing interest rates — with other economic variables giving their own push and pull. We give you the tools to determine just what you can reasonably expect to earn from a bond, and under what circumstances you may lose money.

If you’ve ever read one of these black-and-yellow For Dummies books before, you know what to expect. This isn’t a book you need to read from front to back or (if you’re reading the Chinese or Hebrew edition) back to front. Feel free to jump back and forth to glean whatever information you think will help you the most. No proctor with bifocals will pop out of the air, Harry Potter–style, to test you at the end. You needn’t commit all the details to memory now — or ever. Keep this reference book for years to come as your little acorn of a bond portfolio grows into a mighty oak.

Conventions Used in This Book

To help you navigate the text of this tome as easily as possible, we use the following conventions:

Whenever we introduce a new term, such as, say, callability or discount rate, it appears (as you can clearly see) in italics. You can rest assured that a definition or explanation is right around the corner.

If we want to share some interesting tidbit of information that isn’t essential to your successful investing in bonds, we place it in a sidebar, a grayish rectangle or square with its own heading, set apart from the rest of the text. (See how this whole italics/definition thing works?)

We’ve formatted all web addresses clearly so they’re easy to pick out if you need to go back and find them.

Keep in mind that when this book was printed, some web addresses may have needed to break across two lines of text. Wherever that’s the case, rest assured that this book uses no any extra characters (hyphens or other doohickeys) to indicate the break. So, when going to one of these web addresses, just type in exactly what you see in this book. Pretend that the line break doesn’t exist.

What You’re Not to Read

Unless you’re going to become a professional bond trader, you don’t need to know everything in this book. Every few pages, you’ll undoubtedly come across some technical stuff that’s not essential to becoming a successful bond investor. Read through the technical stuff if you want to, or, if ratios and percentages and such make you dizzy, feel free to skip over it.

Most of the heavy technical matter is tucked neatly into the grayish sidebars. But if any technicalities make it into the main text, we give you a heads up with a Technical Stuff icon. That’s where you can skip over or speed read — or choose to get dizzy. Your call!

Foolish Assumptions

If you feel you truly need to start from scratch in the world of investments, which is dominated by equity investments, perhaps the best place is the latest edition of Stock Investing For Canadians For Dummies (published by Wiley). But the book you’re holding in your hands is only a smidgen above that one in terms of assumptions about your investment savvy. We assume that you’re intelligent, that you have a few bucks to invest, and that you have a basic education in math (and maybe a rudimentary knowledge of economics) — that’s it.

In other words, even if your investing experience to date consists of opening a savings account, balancing a checkbook, and reading a few Report on Business or other business columns in Canadian dailies, you should still be able to follow along. Oh, and for those of you who are already buying and selling bonds and feel completely comfortable in the world of fixed income, we’re assuming that you, too, can learn something from this book. (Oh? You know it all, do you? Can you tell me what a sukuk is or where to buy one? See Chapter 9!)

How This Book Is Organized

Here’s a thumbnail sketch of what the following pages entail.

Part 1: A Quick Guide to the Fixed-Income Universe

In this first part, you find out what makes a bond a bond and discover the rationale for their very existence. We take you through a portal of time to see what bonds looked like decades, even centuries, earlier. You get to see how bonds evolved and what makes them so very different from other investment vehicles. We give you a primer on how bonds are bought and sold. We introduce you to the sometimes quite confusing ways in which bond returns are predicted and measured. And we discuss today’s low interest-rate environment and how that affects you as a bondholder (beyond the obvious).

Part 2: Bonds of Many Distinct Flavors

Practically anyone who wants to raise money can issue a bond. The majority of bonds, however, are issued by the US Treasury, Canadian federal government, government agencies and provinces, corporations, and municipalities. This section examines the advantages and potential drawbacks of each and looks at the many varieties of bonds that these entities may offer. We also introduce you to some rather unusual breeds of bonds — not the kind your grandfather knew!

Part 3: Bonds as Portfolio Cement

All investments — including bonds — carry their own promises of returns and measures of risk. Some bonds are almost as safe as bank GICs; others can be as wildly volatile as tech stocks. In this part of the book, we help you assess just how much investment risk you should be taking at this point in your life, and how — by using a mix of different bonds — you can minimize that risk for optimal return.

Part 4: A Manual for Smart Bond Shopping

Here, we address the role of bond brokers; discuss the pros and cons of owning individual bonds as opposed to bond funds; explain how to buy and sell bonds without getting clipped; and offer ways to protect yourself so that you don’t get stuck with any fixed-income dogs. (The kennel has lately become overpopulated.) We reveal ways for you to blow away the black smoke that has long shrouded the world of bond trading.

Part 5: Bonds as Good Friends of Retirees

Many people think of bonds as the ultimate retirement tool. In fact, they are — and they aren’t. In this section, we discuss bonds as replacements for your paycheck. As you’ll discover, many retirees rely too heavily on bonds — or on the wrong kinds of bonds. Reading this section, you may discover that your nest egg needs either a minor tune-up or a major overhaul and that your bond portfolio needs beefing up or paring down.

Part 6: The Part of Tens

This final section — a standard feature in all Dummies books — wraps up the book with some practical tips and a few fun items.

The web offers much in the way of additional education on bonds, as well as some excellent venues for trading bonds. Let the appendix, which appears after this part, serve as your web guide.

Icons Used in This Book

The margins of this book are filled with little cartoons. In the Dummies universe, these are known as icons, and they signal certain (we hope) exciting things going on in the accompanying text.

Tip Although this is a how-to book, it also has plenty of whys and wherefores. Any paragraph accompanied by this icon, however, is guaranteed to be at least 99.99 percent how-to.

Remember Read twice! This icon indicates that something important is being said and is really worth committing to memory.

Warning The world of bond investing — although generally not as risky as the world of stock investing — still offers pitfalls galore. Wherever you see this icon, you know that danger of losing money lies ahead.

Technical Stuff If you don’t really care how to calculate the after-tax present value of a bond selling at 98, yielding 4.76 percent, maturing in 9 months, but instead you’re just looking to gain a broad understanding of bond investing, feel free to skip or skim the denser paragraphs that are marked with this icon.

Beyond the Book

An effective way to focus on some of the key concepts of this book is to check out the online Cheat Sheet. Go online to dummies.com and search for Bond Investing For Canadians For Dummies Cheat Sheet.

Where to Go from Here

Where would you like to go from here? If you want, start at the beginning of this book. If you’re mostly interested in municipal bonds, hey, no one says you can’t jump right to Chapter 8. International bonds? Go ahead and flip to Chapter 9. It’s entirely your call. Maybe start by skimming the index at the back of the book.

Part 1

A Quick Guide to the Fixed-Income Universe

IN THIS PART …

Getting a bird’s-eye view of the bond market.

Appreciating the importance of bonds in a portfolio.

Exploring the history of bonds.

Understanding basic bond concepts such as interest and yield.

Chapter 1

Getting Interested in Bonds

IN THIS CHAPTER

Bullet Getting a handle on what exactly bonds are

Bullet Knowing why some bonds pay more than others

Bullet Meeting the major bond issuers in Canada and the US

Bullet Considering individual bonds versus bond funds

Long before we ever knew what a bond was, we both shared an experience early in life where we agreed to lend a small amount of money to friends. This was the first time we’d ever lent money to anyone. Neither of us could recall why our friends needed the money, but they both promised to repay us. After all, they were our friends.

Weeks went by, then months, and we couldn’t get our money back from our respective friends. One of us decided to escalate the matter to a higher authority, also known as the dad of one of our friends, Mr. Potts. The plan was for the dad to deliver a stern lecture to his son Tommy on the importance of maintaining his credit and good name. The conversation went something like this: Er, Mr. Potts… I lent Tommy five bucks, and —

"You lent him money? Mr. Potts interrupted, pointing his finger at his deadbeat 12-year-old son, who, at that point, had turned over one of his pet turtles and was spinning it like a top. Um, yes, Mr. Potts — $5. Mr. Potts neither lectured nor reached for his wallet. Rather, he erupted into boisterous laughter. You lent him money! he bellowed repeatedly, laughing, slapping his thighs, and pointing to his turtle-spinning son. You lent him money! HA…HA…HA…"

And that, dear reader, was a very memorable first experience as a creditor. We both experienced similar outcomes, under different scenarios, where neither of us ever saw a nickel from our friends, in either interest or returned principal.

Oh, yes, we’ve learned a lot since then.

Understanding What Makes a Bond a Bond

Now suppose that Tommy Potts, instead of being a goofy kid in the seventh grade, were the Canadian or US government. Or the cities of Vancouver, Toronto, or New York. Or Canadian Natural Resources Ltd. Tommy, in his powerful new incarnation, needs to raise not $5 but $50 million. So, Tommy decides to issue a bond. A bond is really not much more than an IOU with a serial number. People in spiffy business attire, to sound impressive, sometimes call bonds debt securities or fixed-income securities.

A bond is always issued with a specific face amount, also called the principal, or par value. Most often, simply because it’s the convention, bonds are issued with face amounts of $1,000. So, to raise $50 million Tommy would have to issue 50,000 bonds, each selling at $1,000 par. Of course, he would then have to go out and find investors to buy his bonds.

A bond pays a certain rate of interest, and typically that rate is fixed over the life of the bond (hence fixed-income securities). The life of the bond is the period of time until maturity. Maturity, in the lingo of financial people, is the date that the principal is due to be paid back. (Oh yeah, the bond world is full of jargon.) The rate of interest is a percentage of the face amount and is typically (again, simply because of convention) paid out twice a year, with some exceptions.

So, if a corporation or government issues a $1,000 bond, paying 5.5 percent interest, that corporation or government promises to fork over to the bondholder $55 a year — or, in most cases, $27.50 twice a year. Then, when the bond matures, be it one year, or 10 or 20 years down the road, the corporation or government repays the $1,000 to the bondholder.

In some cases, you can buy a bond directly from the issuer and sell it back directly to the issuer. But you’re more likely to buy a bond through a brokerage house or a bank. You can also buy a basket of bonds through a company that packages bonds into bond funds, mutual funds, or exchange-traded funds. These brokerage houses and fund companies will most certainly take a piece of the pie — and sometimes a quite sizeable piece. More on that and how to control the size of that piece of pie in Part 4.

So far, so good?

In short, dealing in bonds isn’t really all that different from the deal I worked out with Tommy Potts. It’s just a bit more formal. And the entire business is regulated by the Securities and Exchange Commission (SEC) in the US, the Canadian Securities Administrators (CSA) in Canada (among other national and provincial regulatory authorities), and most bondholders — unlike me in the seventh grade — wind up getting paid back!

Choosing your time frame

Almost all bonds these days are issued with life spans, or maturities, of up to 30 years. Few people are interested in lending their money for longer than that, and people young enough to think more than 30 years ahead rarely have enough money to lend. In US and Canadian bond lingo, bonds with a maturity of less than five years are typically referred to as short-term bonds. Bonds with maturities of 5 to 12 years are called intermediate-term bonds. And bonds with maturities of 12 years or longer are called long-term bonds. With specific reference to Treasury securities in both the US and Canada, one month to one-year maturities are bills, over one year to less than ten-year maturities are notes, and 10 years and longer are bonds.

When you look at the Globe and Mail’s financial pages, you typically see the current rates of return for 2-, 5-, 10-, and 30-year bond terms next to their return figure. These are also common terms posted for US Treasuries, be they bills, notes, or bonds. In reality, most Canadian government bonds have terms of 1, 2, 3, and 6 months; as well as terms for 1, 2, 3, 4, 5, 7, 10, 20, and 30 years. (We explain how returns are measured later on in Chapter 4.) In the US, bonds across all of these maturities are referred to as Treasuries or Treasurys. You may hear the terms Treasury Bill, Treasury Note, or Treasury Bond when US bonds are being discussed. In Canada, and when referring to Canadian equivalent financial instruments, a government bond can be called, for example, a Canada 1 Month Bill, Canada 2 Year Note, or Canada 10 Year Bond. Or, it can just be called a Canada Bond (or even Canadian Treasury) with the term indicated next to it. Sometimes they are just called Government of Canada Bonds, also with terms attached. There is no hard and fast rule for bond names and terms. In this book, we use terms interchangeably.

Government bonds can be bought in denominations ranging from $1,000 to $1,000,000. In Canada, you can find government bonds issued by both the federal and provincial governments, as well as municipalities and government agencies. Treasury bills in the US and Canada do not pay a coupon (something we explain in Chapter 4). Rather they are offered at a discount to face value. Notes and bonds, on the other hand, pay you interest in the form of coupons, and this is done semi-annually. T-bills are typically short-term investments, with maturities ranging from a month to a year.

In general, the longer the maturity, the greater the interest rate paid. That’s because most bond buyers expect higher compensation in relation to the amount of time their money is tied up. The longer the time frame, the degree of risk increases that could affect the return. At the same time, bond issuers are willing to fork over more interest in return for the privilege of holding onto investors’ money longer. We delve deeper into interest and yield on bonds in Chapter 4.

It’s the same theory and practice with bank certificates of deposit (CDs) or term deposits (TDs). Typically, a two-year CD or TD pays more interest than a one-year CD or TD, which in turn pays more than a six-month CD or TD.

Remember CDs, a term used more in the US, and TDs, a term used in Canada, are time deposits and are essentially savings accounts where you promise not to touch the money for a period of time. The same is true with a GIC, another financial instrument that most Canadians are familiar with. We keep our discussion limited in this book to GICs and TDs.

Remember Government of Canada Bonds are sometimes just referred to as a Canada Bond (with the terms being one of 1, 2, 3, and 6 months; and 1, 2, 3, 4, 5, 7, 10, 20, and 30 years).

The key difference between a guaranteed investment certificate and a term deposit is that term deposits usually have shorter terms (ranging between 30 and 364) days than GICs (usually locked in for at least one year and up to five years).

The different rates that are paid on short-, intermediate-, and long-term bonds make up what’s known as the yield curve. Yield refers to the annual payout on your investment. Because longer-term bonds tend to pay more, the yield curve, when seen on a page, typically slopes up to the right. But sometimes the curve can be flat, or, in rare instances, even slope downward (that’s called yield-curve inversion). In Chapter 4, we provide an in-depth discussion of interest rates, bond maturity, and the all-important yield curve.

Picking an issuer you can trust to hold your money

Consider again the analogy between bonds and bank GICs. Both tend to pay higher rates of interest if you’re willing to tie up your money for a longer period of time. But that’s where the similarity ends.

When you give your money to a savings bank to plunk into a GIC (or TD, savings or chequing account, or foreign currency) that money — your principal — is almost certainly guaranteed (up to $100,000 per account, per person, per ownership registration in a registered account such as an RRSP, TFSA, RDSP, or RRIF) by the Canada Deposit Insurance Corporation (CDIC). You can choose your bank because it’s close to your house or because it gives lollipops to your kids, but if solid economics are your guide, your best bet is to open your GIC where you’re going to get CDIC insurance (almost all banks carry it) and the highest rate of interest. End of story. Per person, per ownership registration, in case you’re wondering, means that a joint account would be insured up to $200,000. Check out the CDIC website at www.cdic.ca for the latest updates and to see whether your financial institution is covered.

Remember Things aren’t so simple in the world of bonds, where the CDIC does not insure your investment. In this world — and I can’t emphasize this enough — a higher rate of interest isn’t always the best deal. When you fork over your money to buy a bond, your principal, in most cases, is guaranteed only by the issuer of the bond. That guarantee is only as solid as the issuer itself. (Remember our inaugural — and only — lender experience?) That’s why US Treasury bonds (guaranteed by the US government) and Government of Canada Bonds (fully guaranteed by the Canadian government) pay one rate of interest, Microsoft bonds pay another rate, and Cadillac Fairview Properties Trust bonds pay yet another rate. Can you guess where you’ll get the highest rate of interest?

You’d expect the highest rate of interest to be paid by Cadillac Fairview. (Currently true, in large part thanks to a sluggish post-pandemic commercial real estate recovery.) Why? Because lending your money to the real estate developer involves the risk that your money may sink into a deep dark hole. In other words, if real estate values plunge and the developer cannot finance its projects, you may lose a good chunk of your principal. In order for investors to accept that amount of risk, the company has to pay a relatively high rate of interest. Without being paid some kind of risk premium, you’d be unlikely to lend your money to a company that may not be able to pay you back.

Conversely, the US and Canadian governments, which have the power to levy taxes and print money, aren’t going bankrupt anytime soon. Therefore, US Treasury bonds and Canada Bonds, which are said to carry only a very small risk of default, tend to pay the most modest interest rates. Often, the interest rate paid on Treasury bonds is referred to as the risk-free rate.

Remember Bonds that carry a relatively high risk of default — are commonly called high-yield or junk bonds. Bonds issued by established and financially sound companies and governments (federal or provincial) that carry little risk of default are commonly referred to as investment-grade bonds.

There are many, many shades of gray in determining the quality and nature of a bond. It’s not unlike wine tasting in that regard. In Chapter 4, and again in Chapter 14, we give specific tips for tasting bonds and choosing the finest vintages for your portfolio.

Recognizing the difference among bonds, stocks, and cryptocurrencies

Aside from the maturity and the quality of a bond, other factors can weigh heavily in how well a bond performs. In the following chapters, we introduce you to terms that affect bond performance, such as callability, duration, and correlation, and explain how the winds of the Canadian and US economies — and even the whims of the bond-buying public — can affect the returns on your bond portfolio.

For the moment, we simply want to point out that, by and large, bonds’ most attractive features for investors — and the traits that most bonds share — are stability and predictability, well above and beyond that of most other investments. Because you are, in most cases, receiving a steady stream of income, and because you expect to get your principal back in one piece, bonds tend to be more conservative investments than, say, stocks, commodities, cryptocurrencies, and collectibles. In a typical year, the value of investment-grade bonds might rise or fall no more than the stock market will on an average day, or some cryptocurrencies will in an average hour!

THE BOND MARKET IS HUGE

How much is invested in bonds worldwide? Are you holding onto your seat? According to the latest figures compiled by the Securities Industry and Financial Markets Association, the total value of all bonds outstanding worldwide is now over $127 trillion. That’s more than five times the current gross domestic product of the United States — the dollar value of all goods and services produced in that country in an entire year. The US fixed income market comprised 38.7percent or $49 trillion of the worldwide amount. In contrast, the Canadian market was 3.2 percent, or $4 trillion of the worldwide total, and continues to grow. In 2007, the Canadian market was $1.55 trillion; in 2021, it was $4 trillion. Given that the stock market gets so much more attention than the bond market, you may be surprised to know that the total value of all stocks outstanding worldwide is about a mere $100 trillion.

Another interesting fact is that in 2021, for US household liquid financial assets (bonds and equities) the size of the equity market holdings was actually slightly less than the bond market holdings. The same proportions apply to Canadian households.

Is conservative a good thing? Sometimes. Sometimes not. It’s true that many people (men, more often than women) invest their money too aggressively, just as many people (regardless of gender) invest their money too conservatively. The appropriate portfolio formula depends on what your individual investment goals are and your personal taste for risk. We help you to figure these out in Chapters 12 and 13.

By the way, our comment about men investing more aggressively isn’t a personal take on the subject. Some solid research shows that men do tend to invest (and drive) much more aggressively than do women.

Why Hold Bonds? (Spoiler Alert: It Isn’t Necessarily to Make You Rich)

In the real world, while lots people own bonds, they are often the wrong bonds in the wrong amounts, and purchased for the wrong reasons. Some people have too many bonds, making their portfolios too conservative; others have too few bonds, making their stock-heavy portfolios too volatile. Some have taxable bonds where they’d be better off with tax-sheltered bonds held in a registered plan such as an RRSP, RRIF, or TFSA, and vice versa. The first step in building a bond portfolio — or any portfolio, for that matter — is to have clear investment objectives. (I want to make money — something we hear from clients all the time — is not a clear investment objective!) We’ll help you develop clear objectives in Chapter 2. In the meantime, we want you to consider some of the typical reasons — both good and bad — as to why people buy and hold bonds. The main reasons we cover are for cash flow, diversification, and return (also called yield).

[heading] Going for Cash Flow

A typical reason is that people buy bonds because they perceive a need for steady income, and they think of bonds as the best way to get income without putting their principal at risk. It is generally accepted that bonds are a relatively safer investment than equities in general. That’s because equities are exposed to more types of risk. Nevertheless, risks still exist with bonds, and we discuss those risks in Chapter 10.) But thinking of bonds, or bond funds, as the best — or only — source of cash flow or income can be a mistake.

Bonds are a better source of steady income than stocks because bonds, in theory (and usually in practice), always pay interest; stocks may or may not pay dividends and may or may not appreciate in price. Bonds also may be a logical choice for people who need a certain sum of money at a certain point in the future — such as college tuition or a down payment for a home — and can’t risk a loss.

But unless you absolutely need a steady source of income, or a certain sum on a certain date, bonds may not be such a hot investment. Over the long haul, they have tended to return much less than stocks. We revisit this issue and talk much more about the differences between stocks and bonds, in Chapter 12.

Going for Diversification

One of the essential reasons people buy bonds has to do with diversification. What is diversification, you ask. It is a strategy of investing that spreads risk across a portfolio of investments. Bonds and stocks move in opposite directions when markets change. Bonds increase in value when stocks decrease in value, and vice versa. So you can see how holding both bonds and stocks in a portfolio has a balancing effect."

The key to truly successful investing, as we outline