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Welcome to Investing in Bonds For Dummies! Perhaps you bought this book online, either in text or digital format. But if you are still the kind of 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 favorite bookstore right now. If so, take a look to your left. Do you see that pudgy, balding guy in the baggy jeans perusing the book on getting rich by day-trading stock options? Now look to your right. Do you see that trendy young woman with the purple lipstick and hoop earrings thumbing through that paperback on how to make millions in foreclosed property deals? I want you to walk over to them. Good. I want you to take this book firmly in your hand. Excellent. Now smack each of them over the head with it. Nice job!

Wiley (the publisher of this book) has lawyers who will want me to assure you that I’m only kidding about smacking anyone. So in deference to the attorneys, and because I want to get my royalty checks … I’m kidding! I’m only kidding! 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 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 – something called patience. At the same time that they’re looking for handsome returns, they are 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: Investing in Bonds For Dummies.

So just what are bonds? A bond is basically an IOU. You lend your money to Uncle Sam, to General Electric, to Procter & Gamble, to the city in which you live – to whatever entity issues the bonds – and that entity promises to pay you a certain rate of interest in exchange for borrowing your money.

This 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 pocket it all.

Stocks (which really aren’t as bad as I just made them sound) and bonds complement each other like peanut butter and jelly. Bonds are the peanut butter that can keep your jelly from dripping to the floor. They are the life rafts that can keep your portfolio afloat when the investment seas get choppy. Yes, bonds are also very handy as a source of steady income, but, contrary to popular myth, that should not 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 I’m not talking about high-yield “junk” bonds here.) They are the babies that may have saved your 401(k) from devastation during the three growly bear-market years on 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 Red Sea. And in 2011, when stocks went just about nowhere during the course of the year, bondholders of nearly all kinds were richly rewarded.

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

About This Book

Allow the next 270 or so pages to serve as your guide to understanding bonds, choosing the right bonds or bond funds, getting the best bargains 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 (I promise) than day-trading stock options or attempting to make a profit flipping real estate in your spare time.

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

Since I wrote the first edition of this book, the number and types of bond funds in which 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.

And perhaps the biggest change since the first edition of this book was published is this: Interest payments – the main reason that bonds exist – have plummeted to historic lows. Never in our lifetimes – or our parents’ lifetimes – have we seen the negative “real returns” (after-inflation returns) that some bonds have been offering.

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 – I 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 real estate – 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 after you read this book:

✔ What’s your split gonna be? Put all 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 very possibly the single most important investment decision you’ll ever make.

✔ 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 the United States or bonds from Mexico or Brazil?

✔ Where do you shop for bonds? Although bonds have been around more or less in their present form for hundreds of years, the way they are bought and sold 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 is no longer so. Whether you decide to buy individual bonds or bond funds, you can now determine almost to the dime how much the hungry middlemen intend to nibble – or have nibbled from your trades in the past.

✔ What kind of returns can you expect from bonds, and what is your risk of loss? Here is 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 I break this news to you gently?) I explain the tricky concepts of duration and yield. I 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. I 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.

Foolish Assumptions

I assume that you are intelligent, that you have a few bucks to invest, and that you have a basic education in math (and maybe a very 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 Suze Orman columns, you should still be able to follow along. Oh, and for those who are already buying and selling bonds and feel completely comfortable in the world of fixed income, I’m 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, huh? See Chapter 3!)

Icons Used in This Book

Throughout the book, you’ll find little cartoons in the margins. In the Dummies universe, these are known as icons, and they signal certain (we hope) exciting things going on in the accompanying text.

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

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

The world of bond investing – although generally not as risky as the world of stock investing – still offers pitfalls galore. Wherever you see the bomb, you’ll know that danger – of losing money – lies ahead.

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, and subject to AMT, 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

In addition to all the material you can find in the book you’re reading right now, this product also comes with some access-anywhere goodies on the web. Check out the eCheat Sheet at www.dummies.com/cheatsheet/investinginbonds for helpful insights and details about the history of war bonds, collecting unusual bonds, using CUSIP to identify bonds, and how to calculate your minimum required distribution (MRD) in retirement.

And check out www.dummies.com/extras/investinginbonds for some more free extra content. There you’ll find articles on such topics as how the Fed moves interest rates, buying a primary or secondary bond issue, choosing between index funds and active mutual funds, and matching your portfolio to your longevity.

Where to Go from Here

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

If you’ve ever read one of these black and yellow For Dummies books before, you know this is not 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 in order 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 it all 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.