Episode 23: More About Bonds

GRANT: Mak, now that we have a better handle on stocks, do you think we should dive into bonds?

MAK: Well, that makes sense. Dad says that stocks and bonds go together like peas and carrots.

GRANT: That’s funny. Isn’t that some old movie dad loves.

MAK: Yeah, but I remember it has something to do about “life being like a box of chocolate”, and you know…

GRANT: You love chocolate. I’ll never forget that!!

MAK: So, it sounds like we should probably ask a bit more about bonds then.

GRANT: Agree!!

MAK: Where is dad?

GRANT: Dad, it’s time to talk about bonds!!!

DAD: I’m down here in the basement doing a science experiment.

MAK: Doesn’t sound like it’s going very well.

GRANT: Are you sure you know what you’re doing?

DAD: Well, I thought I did. Obviously not. What do you guys need, how can I help?

GRANT: We have some questions about bonds? Can you come out to play?

DAD: Funny, ha ha. Do you mean a chemical bond, like when you’re doing an experiment (big bang)? Darn it. I need to get out of here.

MAK: We’re not talking about “chemical bonds”, whatever those are. We’re talking about stocks and bonds. You know, about money.

DAD: Oh, sorry. I was thinking about science. Sure thing, what do you need to know?

GRANT: Well, you said stocks and bonds go together. Like peas and carrots

DAD: They do. Most people like to talk about stocks a lot more than bonds, because they think they’re more interesting.

GRANT: Since I know nothing about bonds, stocks do sound more interesting.

DAD: What if I told you if you add up all the bonds and compare them to all the stocks in the US, bonds total $40 trillion and stocks are $20 trillion.

MAK: Did you say a TRILLION dollars? How much is that? Is that close to a gazillion?

DAD: Well a gazillion is just a word for a lot. It’s not an actual number. A million has 6 zeros after it, a billion has 9 zeros and a trillion has 12.

GRANT: That’s more zeros than we’ve been alive.

MAK: That’s a gazillion zeros. Did I get that right?

DAD: Absolutely! It is a lot. Did you know if you stacked up a trillion one dollar bills, that would be almost 70 miles long.

GRANT: I do now, and that’s a massive amount of paper. That’s a lot more paper than in your boring accounting books.

DAD: Ouch, that was harsh. I think we need to talk about your weekly video game playing.

GRANT: Sorry dad. I LOVE YOU!!

DAD: Ok, so what do you remember about some of the basics about bonds?

GRANT: Wasn’t there something about being a bank?

MAK: And, that there is usually less risk and less reward?

DAD: Sounds like you do remember some stuff. And, yes you do become the bank.

GRANT: So, how do we do that? I don’t own a building, ATM Machines or anything like a bank.

DAD: Well, let’s think about it. First off, who needs the money?

MAK: A company does. They can either sell ownership, by selling stock or borrow money, which can be selling bonds.

DAD: Yep, exactly. The company would sell a bond to people that want to act like the bank. Did you know that governments need money too?

GRANT: I thought they got their money through taxes.

DAD: Yes, that’s true, but sometimes they have to spend big money at one time for roads, electrical plants that make energy and even stadiums.

MAK: What, a government can issue a bond to pay for a stadium? Which one?

DAD: Well, I think you know mom loves the Chicago Bears, and each year they play the Vikings twice. The Vikings stadium cost over a $1billion and almost $400million was done through local government bonds.

GRANT: That sounds weird. The Vikings aren’t part of the government.

DAD: Agree, but with a new stadium, the government hopes people will spend a lot more money which increases taxes. We’ll have to talk about taxes one day for sure.

MAK: I know, dad. Your FAVORITE dream. Lower taxes.

DAD: I’ve got a huge smile on my face. So Grant, if a company or government borrows money, how does that happen?

GRANT: Well, if I was going to buy something, I would give money to a store. And in exchange for the money, I would get something. So, if I went to Dairy Queen, I would give them money for a vanilla cone.

MAK: Or a chocolate cone dipped in chocolate!

DAD: Exactly. So, if a company sells a bond. How do you think that works?

GRANT: I guess I would give the company money. But, I don’t know what they give me?

DAD: A promise.

MAK: Seriously, just a promise?

DAD: Yep, the company promises to give you your money back, with interest. There are laws that make it more than a simple promise, but that’s it.

GRANT: That seems really strange. Is that what happens with a bank?

DAD: Yep, you sign a contract that says you promise to pay them back with interest. And, if you don’t, the contract may allow them to take some of your stuff and sell it if you don’t. It’s exactly the same.

MAK: So, if you don’t pay, they could possibly take your car, house, motorcycle or something valuable?

DAD: yep.

GRANT: So, let me get this straight. You could give them thousands of dollars, and they only give you a promise?

DAD: That’s correct. And, why would people want that?

GRANT: Don’t ask me. That sounds insane.

MAK: Didn’t you say some people like interest payments, since those are required? Kind of like

DIVIDENDS!!!

DAD: Exactly. Dividends aren’t required, but interest is. And if you buy a bond, then you earn interest that normally pays you money every 6 months, but it can be more or less often.

MAK: So, how does someone lend them money?

DAD: It’s really simple. We spoke about how when you buy a bond, you give the company money. Since they have your money, and promise to pay it back, that’s a loan.

GRANT: Well, that was super simple.

MAK: And, how much interest do you get?

DAD: Well, interest is done as a percentage. Do you know what that means?

MAK: I think… Doesn’t “Per Cent” actually mean “every 100”.

DAD: It does. So, 10 per hundred or 10% means you get $10 for every $100 borrowed.

GRANT: Love it dad, and I love math. So, 7% is $7 for every hundred.

DAD: Yep.

MAK: Maybe we need to know how much a bond costs?

DAD: That’s a great question. Stocks can start at any price and move all over the place. Did you know the most expensive stock is over $300,000.

GRANT: And, is that for one share?

DAD: Yep. It’s the stock that Warren Buffet started. You know he is one of the best investors ever.

MAK: It’s hard to believe that a stock could cost that much. Are bonds the same?

DAD: Actually, no. Bonds are initially sold for $1,000. But, they do change prices.

GRANT: So, if you get 7%, and a bond is 10 times a hundred that means you would get $70 in interest and not $7.

DAD: Love it G!! You got the Jones math gene. I think we were born with calculators in our hands.

GRANT: So dad, what makes the price change?

DAD: Well, remember when we spoke about supply and demand? Supply is how much you have, and demand is how much people want what you have.

MAK: Oh yeah, I remember when people want something really bad, like that one video game example, the demand goes up, and so does the price.

DAD: Excellent Mak. Let’s speak about the economy for a second and make it super simple.

GRANT: Ok, isn’t that all the money in the US. If most people have jobs, everyone’s making money, spending it, and things are going well.

MAK: And, if companies aren’t hiring people, a lot of people don’t have jobs, they aren’t spending, so things aren’t going well.

DAD: Exactly, the amount of money being earned and spent is a big part of the economy. So, do you think the government wants things to go good or bad?

GRANT: I think they want it to go really well. They collect more taxes when people have jobs and when people spend money. So what can I do to make it better?

DAD: There are a couple things, but one thing is they can make it easy to get money, so they can spend it and make the economy better.

MAK: Ok, dad, slow down. It sounded like you said money can be easy to get. Does that mean a lot of supply?

GRANT: And, doesn’t more supply mean a lower price? While more demand raises the price?

DAD: Exactly. Do you remember that crazy game where you stand in a see through box with dollar bills, and they turn on that crazy fan?

MAK: Oh yeah, Grant got smacked in the face with all that money and only got $2.

GRANT: I didn’t see you do it with sticky hands!!!

DAD: Think about that game. You pay $5 to play.  What if there were 20, one dollar bills in the booth. You catch a couple, and it’s tough. But, if you put in a thousand one dollar bills, it’s easier, and you’d get more.

GRANT: So you pay $5 and get less in the first example, and in the second, you pay $5 and get a lot more. Plus, it would’ve been a lot more fun!!

DAD: Exactly, usually when money is easy to get, you may get more for the same price.  That’s like paying $5 and getting more money, like the second example. So, what is the price or cost of borrowing money?

MAK: Isn’t that the interest rate? So, that would be lower?

GRANT: And if there is a lot more demand for money, like everyone having a job, earning more, wanting to spend more, that would mean interest rates will probably go up?

DAD: Absolutely amazing. You nailed it. So, do you think companies sell bonds at the same interest rate every year?

GRANT: No. Because it sounds like things change a lot in the economy.

DAD: You’re right. But, there’s also another thing to think about. Let me ask you a question. Do all your friends keep a promise the same way?

MAK: No way dad. Amy ALWAYS keeps her promise. But, Jennifer NEVER does.

DAD: It happens the same way in business. Some companies don’t keep their promise to pay you back. Others always do.

GRANT: So, why would you buy a bond from a company that may not keep their promise?

DAD: Well, those companies will pay you more interest because there is more risk. If you make 7% with them, and another company that always pays on time is 2%, it might make you think a little harder.

MAK: Three times as much interest. That is making me think. Is there a company that always pays you back?

DAD: Well, the US government supposedly has no risk and has always paid you back.

GRANT: So, do they pay the lowest interest rate?

DAD: Yep. Local governments are thought to be the same, but be careful. There have been some local governments who didn’t keep their promise.

MAK: Like which one?

DAD: Well, in Alabama the government was caught dumping their poop and pee in local rivers. They got in trouble and had to stop. They had to build something to clean the poop and pee to make it safe.

GRANT: That sounds terrible. So what happened.

DAD: It cost a lot more than they thought and the government went bankrupt.

MAK: Ouch, so is there a way to figure out how well a company keeps their promise?

DAD: Well, get this. There are businesses that give out ratings for companies on how well they keep their promise to repay you. They give ratings from A through D.

GRANT: So, the A’s would be good, just like on my report card?

DAD: See how easy that was?

MAK: Do they use pluses and minuses too?

DAD: Yep, and which one do you think is better?

GRANT: An “A” is always better with a plus on it dad!!!

DAD: You’re absolutely right G!

MAK: Dad, you know if a company could do a rating system for friends, that would be worth millions. I think you always find out the hard way whether you can trust someone.

GRANT: Agree. I would have never given Terry $5. It’s been a year and he never paid me back. I would rate him a solid “D”!!

DAD: So, we went through stocks and bonds, and as Forrest Gump said “They go together like Peas and Carrots”.

DAD: Hey, what are you laughing about???

GRANT: Nothing dad, it was a joke we read the other day.

MAK: Yeah, it was in the box of chocolates I opened up!!

DAD: Ha ha. I think it’s probably time for me to sign off.

MAK: Thanks for being here through season #4.

GRANT: We really appreciate you being here…

Ben’s Two Cents

Bonds are seen as the more boring part of investing. Stocks seem to be much more exciting, as they can have bigger, faster changes in prices. But, bonds are an important part of a good investment plan and are twice as large as stocks in the US. We’ll get to how these all work together in the future, how they fit in a portfolio and how they offset some of the risk that stocks have.

But, for now, bonds are originally sold for $1,000. When you buy the bond, you exchange your money for the company’s promise to repay the $1,000 with a specific interest rate. This essentially makes you the bank!! Interest payments are required, unlike dividends. Some bonds pay more interest because they have more risk, and other bonds pay less because they have less risk.

We can tell the companies with more or less risk, because the rating agencies give a grade or rating from A to D, on how well these companies honor their promises. Those with the least amount of risk are believed to be US government bonds, because they have never defaulted, and they are backed by the full faith and credit of the US government. That’s big!! But, some smaller governments, known as municipalities have had problems.

Overall, there is a big desire to sell and buy bonds. It’s a very big market that offers benefits not available through a stock. So, it’s an important investment to think about as you invest.

Thanks for being here, we’ve had a great time in Season 4 and look forward to some fun bonus interviews before starting back up for Season 5 in the New Year!!! From all of us at Money with Mak & G, thanks for all your support! Goodbye and Thank you.