Hi, my name is Bob Brooks and today I want to talk to you about bonds and investing in bonds. Because my concern today is that people think that bond funds are safe. And in reality, there's a whole set of risks that go along with bond funds that may not have been there in the past, but they're definitely present today. And we'll talk about this in the sense of the financial crisis, pre financial crisis, investing in bonds, and post financial crisis investing in bonds. And today, I want to make sure that you really understand what you're getting yourself into, by relying on bond funds and that you're comfortable with that risk. Now, pop culture finance will tell you that bond funds are a safe alternative than stock for their sacred alternative and stock bonds.

And their proper diversification is investing in stocks and bonds. Now, you know, we talked we talked about pop culture finance, this is the beliefs that the mutual fund industry in the financial services industry wants you to believe they don't want want you to think they just want you to follow the rules that they say work. But really, we're we're talking about two different time periods of bonds, things that you got to be careful about that they're not telling you about when it comes to bonds and the safety of bonds. So let's talk a little bit about what a bond is and kind of get on the same page. First of all, a bond represents debt. And this is it very important to understand when we're in a world full of debt, make it shines a different light on bonds, when you're giving money to an entity, they give you a bond, and they use your money, they pay you interest, and then in a maturity date, they give you your money back.

I mean, it's loaning them money, it's a way of doing it. So you want to make sure that you're loaning that money to somebody who's going to pay it back. aleena that because there's always the default risk that goes along, then bond funds bond investing without a safety net. Now you don't have that safety net of that maturity date with bond funds mean a bond fund can start to lose value, continue to lose value and you may not get back The amount of money that you put into it. And that's something that's that I don't think a lot of people really realize they associate more with individual bond investing versus bond fund investing. And then this is extremely important to look at interest rates when interest rates go up, bond prices go down.

And when bond price when interest rates go down, bond prices go up. And let me show you a chart. This is a chart of the 10 year interest rate, as you can see it, it went to the very top in the early 80s. And is dropped Ever since then, down to the very bottom, which was 2012. So as you can imagine, when you think about the inverse relationship, this entire time, all these many number of years, bond prices have been pretty steady and going up. And I think that's why people associate the past with what's going to translate that into the future when I think it's a dangerous thing to do, because interest rates are starting to go up and that it could be the problem.

Now this is I took Don't use dated material. When we're talking, we're doing these teaching videos, I think this is important to see. Now obviously, if you're watching this, maybe a year or two from now, you're going to know what interest rates did. But it looks like though interest rates are on their way up as versus down, which could mean trouble for the bond market. Now dangers of investing in bond funds. I divide the world up when it comes to money into three different periods.

There was pre financial crisis, then there is financial crisis, and there's post financial crisis, or I refer to it as on the road to the new normal, whatever that looks like. We're in unprecedented times. Because the financial crisis did so much damage, created so much more debt, so much. The government interfering with companies in implementing new regulations, it changed the financial landscape. In my opinion, it created a whole set of risks for bond funds that people don't really realize. So let's take a look at what those are.

Firstly, liquidity risk. And what I mean by that is simply this. If you put money into a bond fund, and you need that money out, you expect to be able to go and call your financial advisor call the mutual fund company and liquid in and ask them to liquidate however many shares to get you the money that you need. And you expect that to be a pretty easy process. Well, there could be a day where the bond markets turned from being liquid to illiquid. And I'm going to show you I'm going to tie all this together and show this to you in a chart here in a minute.

But the problem is, is that it could be that you go try to get your money and you can't get your money. So the liquidity issue is a real thing. In fact, regulators are really looking at this right now. They're concerned about we could have no liquidity process problem when it comes to the bond market. Second is redemptions. Now, this is what I showed you that chart of interest rates and how it fell all the way down to 2012.

And they went like this, at the period of time that it went like that bond investors back in 2000. 12 never forget this did something they typically don't do. They started selling bonds, they started asking to get their money out of bond funds, and the redemption rate went way up. But basically what they were doing, they had been in bonds this entire time, they started to see bonds get into trouble, and the interest rates rise. So they rushed to get their money out and they switched it to stocks. If you get a lot of redemptions, it causes a problem for the bond fund manager and the bond fund manager, he or she, they have a certain amount of cash that they keep on hand.

So if a redemption comes in, they have cash they can give in and satisfy that redemption. If an investor wants their money back, if you get a lot of redemptions kind of a run worst case scenario or run on the bank so to speak, then they have to start selling bonds to get money so that they can fulfill the redemption. And this could be problematic because they could be selling bonds, when they don't want to be selling bonds and selling at lower prices. Remember, they're holding these bonds out to maturity in most cases. So if the bond price is down, then they could be losing money. So a high rate of redemptions is a real problem.

Now, I want you to take a look at this chart. This chart and by the way, I have no money invested in this bond fund, don't recommend this bond fund, nor am I telling you to sell this bond fund vegetable regulate regulator purposes, etc. The bond fund this was actually last year in July. Look how it's cratered and basically crashed it's lost over 50% of its value. Now, this is an extreme case when it comes to a bond fund because this is a junk bond fund. junk bond fund just as the name implies, it is high it's a high risk debt.

These are companies or entities that can't get loans or financing from any other place so they have to give, they get rated as junk, not even any type of a good credit rating. It's so rare, it is junk and they go to the junk bond market to get money. They have to pay higher interest rates because Investors excuse me, investors don't want. They want to be compensated for taking the risk. And this is a high default rate. Well, if you can see up at the top here that that fund was doing well, and then all sudden, some of those investments started to go bad.

Then all of a sudden you had investors rushing to get out. And he had so many this year, so many people trying to get out of this fun. This fun was $3 billion. At its top, it's now worth 780 $9 million. Now think of the unsuspecting people who might have put money in here thinking bond funds were safe, even though it makes no sense to me why you put money in a junk bond fund in this environment, but they put money in thinking I'm going to get that higher yield that higher interest rate and look at what has happened. And now.

This company is pooled somewhat of an unprecedented precedent and move. They said no more. We're going to block redemptions. We are going to do an orderly liquidation of this fun. Now, let's Listen, let me let me tell you what's happening here, then we're going to translate this into the broader market in the junk bond market is a rough place to be right now, obviously, with with a lot of bonds going into default, risky debt has a real tough time right now. And so these fund managers are getting all these redemptions in, and they're going in to sell bonds that they don't want to sell because they want this amount of money for it because they think this is the value.

But buyers are saying, I'm only going to give you this, this amount of money for it. And so at some point, they're forced to buy down and they lose all this money. Because buyers are smart, they know they're not gonna buy something that's distressed. If full value, they'll say, Look, I'll be a buyer, but I'm not a buyer up here. I'm a buyer down here. Now I was saying I was talking about this in the radio and I said Yo, you may think that I'm over sensationalizing one fund, that I'm saying that because this is happening, that this is going to happen all across the bond, the bond the world of bonds, I'm just saying it's a possibility.

That could happen, because the dynamics are still there, the dynamics are such that about any kind of a bond fund, we could have a high rate of redemptions. And it could put in the bond market, the environment of the bond market could be such that bonds are struggling and not doing well because interest rates are going up. And then the buyers are saying, you know, what, I won't buy up here, but I'll buy down here. And then it's a domino effect. So I think it could affect the rest of the market. It's a probability and I think here's the thing.

I'm not trying to take you know, what's happening to this may be an isolated incident, but it also may be a sign of what's to come. I remember a company back during 2007 chart look just like this or the stock it's called new century it was a subprime mortgage originator, okay. Now, subprime mortgages is what caused the financial big caused the financial crisis and in crash of 2008. This company went under just like this because of bad subprime mortgages and At the time, everybody was saying, Oh, that's an isolated incident. And yet it was a sign of things to come. So this is just once again, this paints the picture of what risk is in the bond market, and why you need to be careful, then there's this bad debt, you know, there's a lot of debt.

That is, that's in the markets, especially in the junk bond market. That is, can go for a long time being a bad debt and being close to default. It's interesting, if you look at the bonds of Puerto Rico, every quarter where they have to make the excuse me every quarter where they have to make the interest rate payment. Every quarter, they take a big deep breath, because they just barely make it they just barely escaped going into default. And so that can can limp along like this. And then but it has a day of reckoning, where it goes into default, and there's a lot of bad debt that is circulating in the system right now.

Perception of safety. This could be my biggest concern because I think that people look at bond funds, as I said earlier, as they believe pop culture finance, it's a safe place to be bond. are steady, they don't lose money, but they do lose money, they can lose money, and bond funds can lose a lot of money. So you and the concern of this linking back to redemptions is that someone that is very conservative, as their money in a bond fund, all sudden starts seeing losses accumulate, what do you think they're going to do? Maybe panic, maybe go and sell that bond fund. You get this on our massive, massive basis and you have problems.

So the perception of safety is a tough one yield chasing what the investors are demanding and wanting higher interest rates. You know, today, in 2015, interest rates are a rock bottom, you can't get anything on savings kept barely thing in a CD. And so they're chasing yield. And when they do that, they don't really realize they're taking on more risk. And they're going to these bond funds and give me four or five 6% and they don't realize that the risk that they're taking, and then there's the environment. As I said, this is a big risk we pointed out earlier, we're in this post financial crisis.

This environment on that road to the new normal interest rates have not budged for a long time. They're about to start going up. And what's that look like? What kind of unintended consequences do we have in a world full of debt with a lot of that debt being bad? it you know, the thing is, is that you can push a debt debt situation, a debt crisis, a debt problem, often to the future for longer than you can imagine. But it someday it has a day of reckoning because that debt has to get resolved.

It either goes bad goes into default, someone loses, or someone pays it back with the enormous amount of debt that we have in the system right now. It's highly unlikely that it's going to get resolved by people paying it back. I think it will get resolved through the default. And then there's guilt by association. With this, this risk is simply this that any bond fund kind of gets thrown out gets sold. It could be a quality bond fund, it could be a gone bond fund you want to hold on to but yet all these problems in the bond fund market and And he said, Well, the that bond fund must be bad too.

And it gets guilt by association and it gets sold. I had someone call me the other day when they were listening to a story about this junk bond, that bond fund that was going under and the problems in the junk bond market. And the question was not, do we own any junk bonds, or junk bond funds? The question was, do we own any bond funds? You see, the perception is that guilt by association, that any kind of a bond fund is a bad place to be. So it's going to be interesting to see.

And of course, if you're watching this way down the road, you'll know what of what has happened. But it will be interesting seeing it does spell risk for anybody who's holding it. So what should you look for? I'm not saying don't go invest in bond funds. I'm just saying, know your risks before you go into it. Just like with any investment, you need to be smart and be prudent with that with the understanding of what is the risk that you face with these funds.

So that there's basically three things obviously credit quality, I would not Invest in anything that had a low credit quality. Every bond has a credit rating or it's a junk bond. And so I would only go with high highly rated credit quality bonds in any type of bond fund. Number two, the type kind of goes along with credit, I would say personally, I'm not giving this is a recommendation, there's no advice being given here. I would stay away from junk bond funds, I would stay away from high yield bonds, I would stay away from municipal municipal bond funds. I can't think of a bigger train wreck in some of these states that are they're barely limping along and so close to default.

And it's actually surprised we haven't seen it yet. So be real careful about the type I would only go with very high quality high, you know, corporate type bond bond funds that have that you have a good chance of them paying back their money and then paying their interest in no default risk or little default risk in duration. bond funds have a maturity they start here than a bond Excuse me have a maturity. So they start here. And they go out to here, where they mature, the, the longer the maturity, the bigger the risk when interest rates are rising, so you want to shorter maturity, so you can look for that in a bond fund as well. So here's the bottom line when it comes to bonds, you've got to look at bonds from two different time periods and not confused them.

There's pre financial crisis bond fund investing, and there's post financial crisis bond fund investing. They're two totally different environments. And there's a whole set of risks associated with post financial crisis investing that you need to be aware of. Once again, I'm not saying don't invest in bonds. I'm just saying be aware of the risks. Be aware of what could happen so that you're comfortable with it and you're not perceiving these to be a safe investment.

You're perceiving these to be a sound investment because you understand the pros and the cons.