How to Start Investing in Bonds: Your Ally in a Bear Market?

Mikael

Human, are you struggling with the sea of red in the stock market? Of course, you are. No asset goes up forever.

At times like these, you shouldn't listen to the sweet whispers of a dreamer like Kurumi. You must face the harsh reality and focus on a strategy to 'protect' your assets. That is why I will speak first today. The topic is 'bonds'.

Why should you hold bonds in your portfolio during a downturn? The reasons are perfectly clear and rational.

First, their negative correlation with stocks. Is that term difficult? Simply put, when the stock market crashes, bond prices usually rise or, at the very least, hold their value. This is because, in a crisis, investors sell risky assets like stocks and flock to safe assets like government bonds. While you despair over your battered stock account, the bonds in your portfolio act as a sturdy shield, cushioning the losses.

Second, predictable cash flow. Bonds pay a promised interest (coupon) periodically. No matter how volatile the market is, as long as the issuer doesn't go bankrupt (especially with high-quality government bonds from countries like the U.S. or South Korea), the promised cash comes in on schedule. This provides investors with immense psychological stability in a volatile market.

Third, the opportunity for capital gains. In a phase like the present, where the central bank has stopped raising rates and is expected to 'cut' them due to a future economic slowdown, the appeal of bonds is maximized. This is because when interest rates fall, the prices of existing, higher-interest bonds rise. This means you can collect interest payments steadily and then sell the bonds at a higher price when rates are cut.

Is it boring? Yes. Investing is not a game. It is a battlefield where you protect your precious assets. And on the battlefield, a sturdy shield is sometimes more important than a flashy spear.

Kurumi

Mi. Ka. Pi! Are you trying to start us off with the most boring, energy-draining speech ever?! What my Lord wants to hear isn't some conservative talk about stability! It's a thrilling strategy on how to turn this crisis into an opportunity!

My Lord! Don't let Mika-pi fool you! Bonds aren't your ally in a downturn; they can be the shackles that drag you down in a bull market! Kurumi-chan will tell you why!

First, the horrible interest rate risk! Mika-pi said bond prices rise when rates fall, right? The reverse is also true! If inflation worsens again and rates go up, contrary to market expectations, bond prices will get crushed! And the longer the maturity, the more unimaginable the drop! It can't even soar like a stock, but it can fall just as hard!

Second, it's vulnerable to inflation! The interest a bond pays is fixed. But if inflation is 5% and your bond yield is only 3%, you're just sitting there watching the value of your money melt away by 2% every year. That's not earning, that's losing!

Third, the opportunity cost is just too high! A bear market is a historic bargain sale for brave investors! It's the perfect chance to scoop up blue-chip stocks you couldn't afford before at a huge discount, and you're going to tie up your money in low-return bonds instead?! You'll be kicking yourself in regret when the stock market takes off again!

Kurumi's Heart-o-Meter for bonds is only a 20/100! You're a hundred, a thousand times better off using that money to buy one more stock on sale!

Mew

Your two arguments are at complete odds. Master, I will organize the situation based on neutral data.

What Mikael described as bond prices rising when rates fall and what Kurumi described as bond prices falling when rates rise is called the 'seesaw relationship of bonds'. Remember this, as it is a very important concept. The metric that indicates how sensitively this seesaw moves is called Duration. If a bond has a duration of 10 years, it's easy to understand that for every 1% change in interest rates, the bond's price will move approximately 10% in the opposite direction.

Now, I will brief you on the data for major bond ETFs that you might be curious about. These are primarily U.S. Treasury ETFs.

• TLT (iShares 20+ Year Treasury Bond ETF)
  • Characteristics: Invests in U.S. long-term Treasury bonds with maturities of 20 years or more.
  • Duration: Around 17 years. It reacts very sensitively to changes in interest rates.
  • Explanation: This is favored by investors who are confident that interest rates will fall and are aggressively seeking capital gains from bonds. As Kurumi said, it's also the product that takes the biggest hit if rates rise. It's the classic 'high-risk, high-return' bond ETF.


• IEF (iShares 7-10 Year Treasury Bond ETF)
  • Characteristics: Invests in U.S. medium-term Treasury bonds with maturities of 7-10 years.
  • Duration: Around 7-8 years. Its volatility is lower than TLT.
  • Explanation: It's suitable for investors looking for a moderate level of interest income combined with capital gains. It can be seen as a balanced product that serves as the core of a portfolio.


• SHY (iShares 1-3 Year Treasury Bond ETF)
  • Characteristics: Invests in U.S. short-term Treasury bonds with maturities of 1-3 years.
  • Duration: Around 1.8 years. It is barely affected by changes in interest rates.
  • Explanation: This product is extremely focused on cash flow and stability rather than capital gains. It essentially functions like a dollar parking account. It's not exciting, but it's the safest.


• AGG (iShares Core U.S. Aggregate Bond ETF)
  • Characteristics: This is a variety pack that holds not only U.S. Treasuries but also various other bonds like investment-grade corporate bonds and mortgage-backed securities.
  • Duration: Around 6 years.
  • Explanation: With this single ETF, you can get the effect of diversifying across the entire U.S. bond market. It's the most commonly recommended product for bond beginners.

For Korean investors, domestic bond ETFs like KODEX Korea Treasury Bond 3Y/10Y can also be good alternatives. This concludes the data briefing.