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Hopefully you have started your financial path to, and possibly have already achieved, becoming a Capitalist.

Regardless of where you are in this journey at some point you will have a certain amount of money “sitting on the sidelines” and ready to be deployed as your untiring worker.

One of the scariest decisions is to take that hard-earned, and even harder to save, money and send it out in the world in hopes that not only will it return back to you but also bring more of its friends along in the process.

With so many investing opportunities out there an investor can be overwhelmed and easily suffer what is called analysis paralysis.

In essence a potential investor is paralyzed by indecision due to the fact that there are so many opportunities out there.

“Twenty years from now you will be more disappointed by the things that you didn’t do than by the ones you did do.” –Mark Twain

In order to make the investing world more manageable it is crucial to break it down into more manageable components, called asset classes.

The big three asset classes are Stocks, Bonds, and Real Estate, each with it’s own pros and cons for a potential investor.

Before you invest in anything, you truly have to understand it in order to avoid my foolish mistake 4a.

I feel a primer is therefore necessary to give you a very basic overall lay of the land.

Bonds:

Whereas stocks are buying an equity stake in the company, think of bonds more as a loan to the company.

Pros:

• Less volatile than stocks.   Bond holders typically get priority payment over stock holders (If a company goes bankrupt, funds from liquidating assets go to paying bond holders first)
• More reliable source of fixed-income

Cons:

• Over the long run stocks outperform bonds with rate of return.

Terminology

• Maturity: Length of time until the bond amount is due
  • Short-term is typically < 1 yr
  • Medium-term is typically 1-10 yrs
  • Long-term is typically >10 yrs
• Par value: This is the face value of the bond and the amount you receive at the bond’s maturity date
• Discount: Some instances you can buy a bond below it’s par/face value
• Premium: Some instances bonds can trade higher than it’s par/face value
• Coupon interest rate: The % interest the bond holder will pay based on par value
• Yield: True rate of return
  • Example of where yield and coupon interest rate can differ:
    • If buy a bond at par value ($1000k) at 5% interest rate, the yield and coupon interest rate will be the same and generate $50/yr
      • If buy the same bond but at a discount ($750 for example), the coupon interest rate remains 5% but the yield increases to 6.7% ($50/$750)

Classes of Bonds

1. Treasury bonds
   • Pros: Considered credit-risk free
   • Cons: Lower yield
2. Other US government backed bonds
3. Investment-grade corporate bonds (high quality)
4. High-yield/junk bonds (low quality)
   • Pros: Typically give highest yields of any bond
   • Cons: Backed by less reliable entities that can default on bond, thereby losing initial investment
5. Foreign bonds
   • Have to also consider currency exchange rate risk (if paying country currency subsequently drops relative to the US dollar)
6. Mortgage backed bonds
   • Typically require larger amounts ($25,000).
   • Pre-payment risk (value drops when rate of mortgage pre-payment rises)
7. Municipal bonds
   • Pros: Interest from these bonds are typically free of tax implications
   • Typically lower yields offered
     • Tax bracket of investor major consideration if these lower yields are adequately compensated by the lack of tax implications.

External forces that can affect bond values:

1. Market interest rates can influence prices which bonds trade at.
   • Example: a bond has a coupon interest rate of 5%
     • if interest rates drop (ex. 3%), investors will be looking to get gain 2% advantage by buying these bonds instead.  With increased demand the bond value increases
     • if interest rates rise (ex. 7%), investors in this bond are essentially missing out on 2% extra interest and hoping to sell this bond and get another one at this new higher rate.   With increased supply the bond value diminishes

Again with so many options, an investor looking to dip his or her toes in the bond market can face a daunting task.

Luckily there are similar solutions to what is offered in stocks, the ability to buy the entire bond universe with a simple total index fund (such as Vanguard Total Bond Index Fund (VBFMX).