42: How We're Introducing Bonds to Our Portfolios in 2024

0:00This is a real good story about Bronx and his dad Ryan, Real United Airlines customers. We were returning home and one of the flight attendants asked Bronx if he wanted to see the flight deck and meet Captain Andrew. I got to sit in the driver's seat. I grew up in an aviation family and seeing Bronx kind of reminded me of myself when I was that age. That's Andrew, a real United pilot. These small interactions can shape a kid's future. It felt like I was the captain. Allowing my son to see the flight deck will stick with us forever. That's how good leads the way. Shopping is hard, right? But I found a better way.

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1:15We had 964 of you fill out this questionnaire survey. It was about a dozen questions that we had shared. I think it was during the Thanksgiving week, so a couple weeks ago, because we want to better understand our audience. We want to better understand our listeners. We want to understand where you all are from. We want to understand your interests, if you have debt or not, just your whole background so we can create the best possible content in 2024. So with that being said, Robert, are you ready to give away the first$500 worth of these Amazon gift cards? I am so ready and so excited. And we appreciate all of you for taking the time to fill out the questionnaires.

1:52It's only going to benefit you and us going into 2024 because the more we know about you, the more we can tailor our information to help you grow in your financial journey. So I'm super excited and Austin had a great idea today. We are gonna use a random number generator to do this right, do it legit and give away this money. Okay, so I'm on Google's random number generator here. We have a minimum number of one and a maximum number of 965 because that's how many of you actually filled this out, which is astonishing to us. So I'm going to generate the first number, 907. So our first winner is jmavado at gmail.com out of Pennsylvania.

2:35We're going to send you an email with the gift card right after this. Congratulations on winning. Let's check in on number two. Now our second winner is number 355, whose email address is lingchan5 at yahoo.com. We will send you an email right after this. Thank you so much for filling out the questionnaire. Time for number three. Email address number two is the winner for number three here. which actually is Ashley Northover at Live.co out of Jamaica. Thank you so much, Ashley, for tuning in from all the way over there to the Rich Habits podcast. You have now won$100. Now our fourth winner is number 705, which is WilliamSKristen at Mac.com, chiming in from Chicago.

3:15Thank you so much, William, for chiming in. Now our final winner that we're going to announce today and the next five are going to be announced next episode, so be sure to tune into that one. Our final winner for today is lucky number 421. Their email address is a little hard to say, but it's tinkaibna at Gmail. So we're gonna send you an email with all the instructions to claim your gift card. Thank you all so much for tuning in to the Rich Habits Podcast and sharing your perspectives on everything that interests you, what you are, what you're into, what you're not into more importantly. And we can't wait to announce the next five winners.

3:45We are so excited for this giveaway and we will get these out just in time for the holidays. So stay tuned and come back next week. With that being said, let's jump into this week's episode of the podcast. We have a super, super special guest that's going to be talking to us about why bonds could be a very good idea to have in your portfolio in 2024. For the last few years, bonds in general have been a bad investment. We saw TLT trade down from$150 to only$80, while the stock market traded up to all-time highs. However, we think this might be changing in 2024 and 2025. The three reasons why we believe this are, number one, slower economic growth, number two, cooling inflation, and number three, the central banks reversing rate hikes.

4:34So joining us on today's episode is Troy Cates. Troy is the co-founder and managing partner of Neos Funds. He has decades of experience and is going to help us break things down for you all today so everyone can make educated decisions for their portfolios. Troy, thanks so much for joining us. Thanks for having me today. Happy to be here. So just to kind of set the playing field, right? Robert, I think we do a pretty good job of making sure that all of our listeners have full information. We tell them what we're doing with our index funds and our money and how we're investing and how we're trying to build wealth.

5:09And we're sharing the ups and the downs, the lefts and the rights. And one of our business partners, Christian, came to us about, you know, call it mid to early October saying, hey, guys, you need to do an episode on bonds because there's a lot of stuff going on in the headlines as it relates to bonds in 2024 and 2025. And Robert, you know, you're one of these JP Morgan private bankers here. And they sent out a report, I think it was last week, essentially saying that despite the potential catalysts for bonds, the amount of people invested in bonds as a percentage of their portfolio has stayed the same from 2021 to 2022, now to 2023.

5:47So we thought it was appropriate to bring an expert onto this episode, break down what the bonds are, further explain where they might fit inside of someone's portfolio, better understand why they might or might not be a good investment for you in your specific situation. So that's this episode. We really want to make sure that everyone has full information and that they're learning and understanding why we're excited about bonds and kind of where we're coming from here. So Troy, can you explain to us what happened over the last couple of years with bonds and why are bonds now beginning to make sort of a comeback in their value?

6:19Sure. I think, you know, like you said, the sell-off in bonds started in the summer of 2020. And prior to that, we'd really never had we had back to back years where the where the bond market would decline, you know, with rising interest rates. But we never had this back to back to back decline. And so here we are, you know, three years later looking at what happened to this to this market. And people in that 60, 40 portfolio, you know, especially in 22, had their portfolios really damaged. They were looking at their 60 percent that was sitting in stocks. And we had a big drawdown in the stock market in 22.

6:53And at the same time, their bond portfolio, that 40%, that's how they were allocated, was coming in too. So it was a difficult year last year in 2022 for people in those portfolios. And we've started to see that sort of reverse in October. We had a little bit of a bottom in where the aggregate bond market was starting to turn around and hopefully come back. And I think a lot of that was as the Fed was starting to raise rates or indicating that they were going to raise rates. You have this sell-off in bonds. You have this rates go higher, bonds go lower. So you have this market where you might be invested in a bond and you have this fixed coupon for a number of years, but your underlying principle might go lower over that time.

7:34Yes, if you hold it to maturity, you'll get that money back. But I think a lot of people get nervous or worried when they look at their overall portfolio and see these prices coming in. So just to kind of break things down for the layman listening right now, what Troy was alluding to here is that when interest rates rise, the prices and the value of bonds fall. Because think about it like this. If there was a bond issued that was maybe issued in 2022, and you could buy that bond for$100, and that bond is going to pay you 3 % interest every single year for the next five years, right? That bond is worth 100 bucks.

8:11You bought it, you pay for it, all that fun stuff, you get the interest payment, all the goodies. But now as interest rates rise even higher and you can now issue bonds at 5 % or buy bonds at 5 % or 5.5%, why would someone want to own a bond paying 3 % when they can own a bond paying 5 %? And so that's what Troye's would have alluding to here is interest rates rise, the existing value of bonds and those 2%, 3%, 4 % bonds fall in value. And that's why a lot of people's portfolios got wrecked in 2022 because bonds normally aren't these volatile assets. But the reason they fell so quickly is because we essentially had the fastest hike of interest rates in modern history, right?

8:5340 years from essentially zero to 5 % in about 12 to 14 months. So just as fast as interest rates rose, that's how fast prices of bonds fell. So Robert, I've shared a lot now about my perspective on bonds. I know you have some opinions as well. So feel free to jump in here. Yeah, I want to actually go back a little bit further kind of to the basics because so many people I feel out there just don't really understand what bonds are and the benefits of bonds in these kind of up and coming certain economic times. So Troy, I'd like it if you could break down the difference between a treasury bond and a municipal bond, because there are some differences and touch on the tax benefits of the municipal bond versus the treasury bond?

9:37Sure. I think one thing to focus when you're talking about treasuries is there's a number of different treasuries. There's treasury bills, treasury bonds, treasury notes, and a lot of people can sometimes get it a little confused. And I think when you're looking at it, when you think of the short end of the curve, you hear this a lot, you know, watching news and different news cycles. And when they're talking about T-bills, the short end of the curve, they're talking about anywhere from four to 52 weeks. And when you're buying a T-bill, these are purchased at a discount. So as Austin was mentioning before, you're buying this bond at 100 at par.

10:09You're buying a T-bill below par. And what happens is whether it's a four-week or a 52-week, you're buying it below par and it matures over that time. And when it matures at that final date, you're getting$100. So you might get this, as people are talking about in the news, the short end of the curve, you're getting these 5 plus percent yields and T-bills, really that's you're buying this at a discount and it's maturing. A treasury bond is further out. You're talking about the long end. So you're talking about 20 or 30 year bonds. And what that is, you're buying this bond to receive a coupon. And a coupon is just your interest payment.

10:45It's a fixed payment, hence the fixed income. And coupons are paid every six months. For treasury notes, those are kind of smack in the middle between T-bills and bonds. And those are anywhere from two, five or 10 years. And that's a similar type payout structure. You're getting this coupon every six months where you get this payout and you're basically lending money to the U.S. government to get an interest rate back to you. And in the end, this is whether it's a T-bill, T-bond or a note, it's all guaranteed and backed by the U.S. government. So, you know, at the end, you'll get that hundred dollar par price.

11:18When you're talking about municipals, you're lending money to a local municipality, whether it's your local state or your local town or government. And that's a little bit different. There's tax differences, taxes for municipals. You're exempt for certain taxes within your state. But then again, you do get some preferential tax treatment from buying treasury bonds and treasury bills. And it's definitely something you should talk to your tax advisor about to understand how it fits in your portfolio. Should you be investing in uni bonds? Should you be looking at more treasury bonds and looking to lock in a rate for 20 or 30 years, depending on what your portfolio looks like?

11:56We talk about T-bills and the advantages a lot. And right now, looking into 2024, we assume there's going to be some slower economic growth. We assume that the central banks are going to reverse rate hikes. Inflation is going to cool. So with those things in mind, do you think it's a good idea for our listeners to maybe cut back on their T-bills and put more money towards these bonds? Or do you think it's okay? Where would you look at the weighting being between the two? Because I still believe people should be holding these T-bills, but obviously bonds are looking more attractive going into 2024 and 2025.

12:32Sure. I think it varies per client, per customer, what their portfolio looks like, what their goals are for their portfolio. I always think there's room for T-bills, there's room for bonds in a portfolio, and there's room for equity exposure in a portfolio, depending on who you are, how old you are, what your goals are for investing over that timeframe. So it's something that I wouldn't go out and say that, yes, replace your T-bill portfolio with a bond portfolio. But it's something we started to see not too long ago. And, you know, as we looked at people were talking about on the news, how the 10 year had touched 5%.

13:06And that was a big number where we were looking at 5 % interest rates on holding a 10 year treasury note. And once it hit that 5%, we started to see that yield come in as because people were going out and buying that and saying, you know, at 5%, what's really attractive for a 10 year period at this point for my portfolio. And as you've seen that over the past few weeks, that 10-year is now down to 415, 420 or so. So that's people rushing out to buy that, to lock in that 5 % or that 4.9 % or so, and really see if they could hold on to that for a 10-year period. But there's always a place for a T-bill and a portfolio, in our opinion.

13:47There's always a place for bonds and equities. So let's talk a little bit about BNDI. Obviously, there are other ETFs out there that track the bond market. We have BND, which is the Vanguard Aggregate Bond ETF. We've got AGG, which is the iShares Bond Market Index ETF there. Can you talk about a little bit as to how BND, your bond ETF, not only has those ETFs as major holdings, but also how you're able to generate just a little bit more extra, recall, 2 % to 2.5 % yield on top of the existing 3.3 % yield, I believe that those ETFs are generating at the moment as well. So B &DI is our Enhanced Income Aggregate Bond ETF.

14:32And the goal with this product was how can we build an option portfolio on top of your core bond exposure and give you an enhanced yield on top of that and distribute that monthly. So as you were saying, the fund does hold B &D and HGG in an equal weighting. And we wanted to buy those two ETFs because they're both been around for a long time. They are massive in amount of AUM they have, but they also give you an exposure to treasuries, to corporates. And if you look at their holdings, you're talking about holding tens of thousands of bonds in these ETFs. So we wanted to get that core market, core aggregate exposure to the bond market.

15:08And what we do with our option portfolios, we use SPX index options. We use index options wherever we can in our products to get that preferential IRS Rule 1256 treatment, which says that no matter the holding period, they're being taxed at a 60, 40, long-term, short-term capital gains rate. So they're a little bit more tax efficient than using ETF options or individual name options or any other type of option, whether it's a note or a swap. So we like to use the index options. And what we're doing with that portfolio is we employ a put spread strategy. So we're selling put spreads to bring in income.

15:43We roll this strategy on a weekly basis to move with the S &P 500. And like you said, the goal is how can we provide an extra two to two and a half percent over whatever core bond is doing, but keep the volatility of the portfolio the same as your core aggregate bond portfolio. So we didn't want to increase the volatility of the portfolio by adding options. We wanted to keep it the same and give you that incremental income on top of it. So while core aggregate bonds yielding just around 3.3%, as of now, BDIs yielding, five and a quarter or a little higher. So thinking now to the retail investor, who's got maybe their 60-40 retirement portfolio, or maybe they're a little bit more aggressive on the stock side, call it 70-30, maybe 80-20, right?

16:24But they might have 15, 20 % of their portfolio, especially now with the sort of catalyst that we've talked about with 2024 and 2025, from a price appreciation perspective and a yield perspective on these products. Thinking about now, should they have BND, AGG, T-bills, BNDI? Can you add a little bit more color as to why someone would want to choose BNDI over an AGG or over a BND, right? Why they would want this extra income? You mentioned the tax efficiencies. You mentioned that there's little to no risk given the extra income that you're producing for them. So just add a little bit more color there for us.

17:03Yeah, I think if you're looking to expand your core bond holdings and you're looking at ETFs like BND or AGG, BNDI should fit in there nicely. One, because we do hold those ETFs, but two, we're giving you that enhanced income through the option portfolio. And BNDIs really can slide into a couple of different portfolios for people. It could fit in that fixed income portfolio, but it could also fit in that alternative income generating side of your portfolio. A lot of people, yes, have traditionally been 60, 40, 70, 30, however you want to split it up, depending on your age or your goals. But we've seen a lot of portfolios kind of morph into more of like a call it a 50, 30, 20.

17:41And that 20 is alternatives. And alternatives could be a number of things. It could be products like BNDI or some of our other products here at Neos. It could be commodities. It could be a number of different areas. Crypto, exactly. So the alternatives part of the portfolio where we have our option-based ETFs really slides well into that part of the portfolio, but can slide well into your income generating portfolio or whatever portion of that, whether that's equities or bonds. Okay. So I'm really glad you said that because for a lot of people listening right now, we're always sharing, right? Have your sort of core holdings, be in the S &P 500, be invested, But don't ignore the, you know, cryptocurrency, the collectibles, the farmland, the, you know, real estate, all these other different sort of ways that we can diversify our portfolios.

18:29So it's cool to hear from you that you believe that BNDI is another one of these ways to diversify your portfolio out of just core equities. But even, you know, you have bonds, but now it's even a little bit different because you guys have this sort of option contract strategy on top of that, making it more attractive, call it two to two and a half percent here than just the aggregate bond market. So I really like that perspective. I do too. And something that I want to ask because of the recent past with the bond market, why would someone not want bonds in their portfolio? Obviously, we've seen a massive drawdown in 2023.

19:01Is that going to happen again? Or do you feel similarly to what Austin and I feel that the bonds are going to become more and more attractive in the next two, three years just because of where we believe the economic conditions are going? So when we talk to clients or we talk to advisors allocating money for their clients, a lot of people that we know that aren't really interested in bonds in general and why they don't want them in the portfolio is because they just have different investing goals. They might want to take more equity risk. They might want to put more into some of those alternatives that Austin had mentioned.

19:35So, you know, we have other funds that we offer that can kind of fit that profile, looking at the equity side with SPYI or T-bills with CSHI. but I think it really comes down to your investing goals and what you're looking for out of your portfolio. Most people that don't want bonds are usually younger in their investing career or life cycle and not thinking about so much of fixed income. And I want to lock in a 5 % rate over the next 10 years. They're looking to maximize their portfolios now while they can take the risk, because if something doesn't work out, they always have the time to rebuild.

20:09So that's where we see it. And one more question I want to add on and discuss. We're always talking about price and yield. And what I would like to hear from either of you is what is the difference between price and yield? Because I feel so many people are confused by those terms. And I want everyone listening to really understand that because it goes the same with mortgage rates with the APR versus the actual interest rate. So one of you, please break down the difference between price and yield when investing. So I'll kick that off. Let's talk about bonds for a second. Let's say that there is a big project that the government wants to fund.

20:45So they're going to take on debt through bonds. And what that means is they're looking for investors to buy sort of these bond certificates. And you can buy a bond certificate for a minimum of$100 and they're in$100 allotments. So like each share of the bond, quote unquote, is 100 bucks. And so you go out and you're buying all these bonds for$100, $100,$100. That's the sort of par value is what that's called. Knowing that you're going to get a coupon payment, an interest passive dividend, you can kind of think of it as paid to you as an investor. And that can be paid every year, twice a year, but it normally has a begin date and an end date.

21:19And so you're going to give them the$100, they're going to pay you these coupon dividend payments. And then at the end of it, once you received all your payments, they're going to give you back your$100. So why the prices are changing and why things are different now is because the investors realized, wait a second, if the interest rates at the Federal Reserve are being raised so high and so quickly, I could buy a bond right now for$100 and I could earn 2 % on that bond as a 2 % coupon rate, that's sort of dividend to think about. Or I can wait six months or three months, depending on how quickly they raise rates, and I can buy that same bond paying 5%.

21:54Who wants to own a bond that pays 2 % if you can own the exact same thing that pays 5%, right? So when those bonds that are issued paying the 3%, 4%, 5%, like what Troy was talking about, the 10 year, right? Paying 5 % there. There are bonds that are issued before that. And those bonds, the par value, the price of them have to drop well below$100 because no one wants to buy them. So to make them more like kind of attractive for investors, it's like, why would investor want a 2 % bond when they can get the same bond for 5 %? So they have to drop the value in relation to that interest rate yield of the other bonds.

22:26So investors kind of feel whole like, okay, wait, this works. I can get my 2%, but I only paid 60 bucks for it, right? Versus paying$100 for that 5%. Troy, do you have any color to add to that? No, listen, I think Austin explained it really well. I think what interests people to buy that 2 % bond right now when yields are 4.5%, 5 % is yes, they're fine taking that 2 % coupon, that fixed payment every six months or so, but they know when the bond finally matures, it's going to go back to par. They're going to get that$100 price. So they're okay buying it at a discount, knowing that it'll finally get there, but but they'll still earn that 2 % in this example as a coupon payment during the time that they hold it.

23:06And this is very important for everyone following along and listening because you hear Austin and I every single day talking about maximizing your gains and having velocity on your money. And so it's always about looking for those edges where we have the positive arbitrage of our money going in our favor. And that's why I want everyone listening to understand the difference between price and yield and really learn all the subtleties so you can understand what are the best investment strategies for your own personal gains. I couldn't have said it better myself, Robert. Troy, thank you so very much for coming in here as the expert, the financial markets guru, right?

23:42You've got 30 years now of experience doing this stuff. So we really appreciate it. Thank you for all the added color, all your information, and we can't wait to have you back. Thank you for having me today. I appreciate it. Man, what an incredible conversation with Troy Robert. I get so jazzed when I hear this man speak because he is an expert, right? He's been in this industry for decades and he grew up doing this Wall Street stuff and now he's in his maybe 40s or 50s, but he is an absolute titan in the space. So every time he speaks, I learn something new and I'm really excited to be adding BNDI to my personal portfolio in 2024.

24:15What about you? Yeah, I love it and definitely learn some things. And that's what the Rich Habits podcast really for me is all about, is for us to be able to provide the best information to all of our listeners and followers throughout the podcast, through our Discord, our private lives, our public lives, just all of the information that we provide. I am really proud of because we do so much work to really dig in and not just follow the herd and come up with stuff that we've already seen or heard on TikTok or Instagram, but really dig in deep and find the information that will truly help people benefit for years to come.