August 31, 2023
The first bond is dated 2400 B.C. It was written in stone and discovered in Mesopotamia. The bond was a guarantee to pay for grain. It is what today we call a surety bond. The currency-corn. 😊 The tablet is currently in the Pennsylvania Museum of Archaeology.
To say that the bond market – also referred to as the debt market or fixed income market – is old is an understatement. Debt has historically been a financial instrument to raise funds be it governments or corporations.
With a bond, the investor loans the money in return for interest paid and at the end of the term, the principal is returned. The interest rate has been declining over the last 40 years – until 2022 when the Fed ramped up interest rates quickly because of rising inflation.
According to the Wall Street Journal, “What Investors Need to Worry About Is the Bond Market’s Return to Normality,” a rule of thumb for the bond market: a 10-year Treasury interest rate was roughly half the represented the inflation target and roughly half the “real” yield (return after inflation). For example: a 4% 10-year Treasury would represent 2% inflation and 2% real yield.
It is probably a little too soon to say the bond market has returned to “normal.” We’ve had over a decade of low interest rates that prompted many companies to take on debt because it was so “cheap.”
It is still unclear where inflation will settle though the Fed’s target is 2%. We don’t know how well the economy will perform in a higher interest rate environment. In the meantime, many money market funds are paying over 5%. The phrase used to be “cash was trash” but lately the phrase is “cash is king.” According to Forbes, money market deposit totals are breaking records at $5.4 trillion.
However, Capital Group says investors are forecasting a decline of interest rates in 2024. If it comes to fruition, money market interest rates will also decline. Enter bonds. Buying bonds that don’t mature for a few years allows the higher interest rate to continue until maturity.
A combination of money market funds for your short-term needs and bonds for longer term withdrawal needs is a good combination. Although 2022 was an anomaly for the bond market because of the Fed’s rapid increase of interest rates, bonds still should offer a portfolio diversification as they have historically. As with most things, a balance in your financial assets is a good idea.
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