If You Don't Understand Bonds, You Don't Understand Money

Hey, there, real quick, before we jump into the episode, listen, if your earnings treadmill hasn't set you free yet, running faster won't either. Listen, hustle without principles just going to burn you out. So here's what I want for you. I want you to join me for my money machine experience Live. It is three free trainings. Deep dive into how to escape the treadmill and build a money machine that actually works for you. All right, grab your spot here by going to moneymachinelive.com and I'll see you in the free training. I've been a financial expert for over 30 years, and I can tell you the most powerful market in the world. It isn't the stock market. It isn't crypto. It isn't whatever shiny thing Wall street is hyping this week. It's the bond market. See, worth over $100 trillion. It quietly decides your mortgage rate, your taxes, your retirement returns, and it does it without asking your permission. Well, by the end of this episode, you'll know exactly what the bond market is, how it works, why it actually matters, and how it impacts every single part of your financial life. You can actually use it to your advantage. Instead of getting blindsided by it, we're going to break it down step by step from what the bond is, how its prices, what are yields, and how they play tug of war, and to understanding how this boring market can actually be the biggest threat or boost to your money machine. This is building your money machine, where we help you master your money, eliminate financial stress so you can live a life by choice. Because earning more doesn't make you free. A money machine does. And that freedom, it doesn't start with your next raise or your next paycheck. It starts the moment your money works harder than you do. Think of this as a bit of financial education with a side of sarcasm and a whole lot of heart. And. And I'm your host, Mel Abraham. Let's do this.

Here's what you've been told. Bonds are boring. They're for your grandma's retirement portfolio. Yeah, and water is boring until your house is on fire. Bonds are literally the economy's thermostat. They decide how hot or cold the money feels. They set the borrowing costs for everyone. You, me, the government, that neighbor who says in crypto now, okay. And when yields spike, housing slows down, stocks stumble. Even bitcoin gets a case of the chills. Okay, bonds aren't boring. They're actually the boss. The stock market just shakes its can for the tips that's the reality. So what is it? What, what is a bond really? Okay, well, a bond is basically an ilu. It's. It's an IOU and a power seat. You are lending someone money when you buy a bond. It could be the government, it could be a company, it could be whoever. They promise to pay you back and they promise to pay you interest at a specific date. Now, there's components to a bond. There's four terms that we'll throw around here, but they're important to understand, and that is this principal. Now, principal is the money you loan to them. It's what we call the face value of the bond. That's the amount of it. The coupon is the interest they pay you. The maturity is the date they give you the money back. Every bond has a specific maturity on it where you know you're going to get your money back in the interest. And then the yield is what you actually make after factoring in what you bought the bond for. Okay, now here's where things start to get a little nutty or crazy or bends your mind is that there's a relationship between bond prices and bond yields. As the bond price goes up or down, the yield changes. That also can be set a different way. When interest rates rise or go down, it affects the price of bonds. The bond prices will go up or down with it. So for instance, when rates, interest rates are increased, the price of a bond drops. When rates are brought down, the price of the bond climbs. So here's how to think about these things. The face value of the bond, which is what the borrower promises to pay back at maturity, that means that I'm going to buy a bond for, say, $10,000 or $1,000, let's just say. And maybe it's a corporate bond. It could be to Google, I don't know. So Effectively, Google's borrowing $1,000 from me and they promise to pay it back in five years. That's the maturity. So it's that $1,000 you're going to get at the maturity date. The coupon rate is the interest rate that they pay on the bond. So that's a fixed percentage of the principal. So if it's $1,000 bond and that coupon rate is 5%, you're going to get $50 in interest per year. Okay, and so that's how that plays out. Now, how does price and yield come into this? Well, bonds are traded kind of like stocks. And the price of the bond isn't the thousand dollars. It could be but it could be less or it could be more. And the price is where the bond is trading for that day in the market. And it could, like I said, it could be higher or lower than the face amount. So here's how this happens, is that if the demand for the bond drops, the price might fall, the thousand dollar bond might go to $900. But if all of a sudden the demand people trying to buy it on the market goes up, the thousand dollar bond might sell for 1,050. Now how does that impact you? Well, what it does is it impacts the yield. Remember I said that the bond has a 5% coupon rate. And I know I'm throwing a lot of numbers at you early, but it's important to understand this. The actual return you get on the bond depends on what you paid for it. If I paid 1,050 for the bond and I get the $50 a year, it's different than if I paid 900 for the bond and I get $50 a year. So the actual return is based on what I paid for it and how much I get in interest. That's called yield. And if the price changes then, and it isn't at the coupon, then if the price changes, the yield changes. So that, think about it this way. I'm going to get $50 a year on a thousand dollar bond at a 5%.

Coupon rate. But if the price of the bond is $900, I still get $50. But 50 divided by 900 gives me a yield of 5.56% instead of 5% even. Now on the other hand, if the bond that I got was $1,100 instead of 900 or 1,000, then the actual yield I get is 4.55%. So the yield moves based upon the price in which you bought the bond at. Cause we don't necessarily buy it at the principal amount. Okay? So that's why, where we start to understand how interest rates will affect things if new bonds are paying. Like if interest rates start to go up, okay? And new bonds are paying 6% and you have a bond that pays 4%, people aren't going to want it. Demand goes down, price drops on the bond and the price drops on the bond to try and get close to that yield of 6% by paying less. If the new bonds are paying 3% and you have a bond that pays 4%, the price on your bond goes up, okay? So it's this financial seesaw, okay? And, and one side of that seesaw is typically the Fed and The other side becomes your mortgage payment or something else. And so this is really important for someone to understand the dynamics of how interest rates affect bond yields and bond rates, because that will impact everything. The ripple effect of a bond is, is huge. Now, some people try to figure this thing out, and they're not sure about doing this, but why should you care about it? Well, because I think that your financial freedom, your money machine, your freedom number is dependent on what the bond market's doing because it has such a ripple effect on your interest costs, your payments, the stock market, and everything else down the line. So one of the things that I want to make sure you have access to is I have a basic freedom number calculator. It's totally free, where you can go in and calculate what that number is. Your is your target, that destination for your financial freedom. You can put some information in and dial it in. I'm going to put the link down below, but you can get it at melabraham.com forward/number. It's totally free. All right. And then you'll start to see what number you want, what number you need for your financial freedom and independence, and then you can play around and see where bond yields start to affect that. So how the bond market works is the next thing I want to kind of just touch on, because I think that if we don't understand what people do with these bonds, we then don't understand how we can use them to our advantage. Now, bonds are born in what we call a primary market.

That's where they're created. Governments and companies will sell them to raise money. I mean, think about our own government. We have you hear the big talk about the deficit. Our government brings in money from tax revenues. But if that money from tax revenues doesn't cover all the costs, and it doesn't, and it hasn't since the early 2000s. We run at a deficit. Well, how do we pay for that deficit? We borrow money. They borrow it from other countries, they borrow it from our citizens buy by issuing bonds. So governments will issue bonds. Companies that want money will issue bonds also. And bonds. Not all bonds are the same. Some are more risky than others. And the yield will show that or the coupon rate will show that. As the bond, after the bond is issued, though, okay, if you don't want to hold the bond until maturity, there is what's called a secondary market. This is where individual investors, institutional investors, like pension plans and things like that, they can go and buy and sell bonds based on the price in that day. And so a lot of that happens with, with bonds where they're traded on a regular basis. The US treasury holds auctions. And the demand for, it's just like bidding auctions. You know, how much people will bid up will determine the yield on the bonds. And that's the treasury yield. That auction starts to ripple through the pricing and becomes the benchmark for the pricing all the other bonds. So it's literally like a Sotheby's, but instead of art, people are bidding on the privilege to lend Uncle Sam money. That's the bottom line. And they need a lot of money. When you start to look at this, I mean the U.S. the U.S. hasn't run a budget surplus, like I said, since 2001. And in 2024 they overspent by $1.8 trillion. Okay, that's not like a rounding error or I forgot to tip the waiter money. This is like I just bought a Ferrari on my lunch break money. It is a problem that I've done other episodes and other videos on that we need to solve. And there isn't a lot of ways to solve it. But what happens is that in the interim, what are they doing? The treasury issues bonds. The buyers, they're banks, they're pension funds, they're foreign governments, they're your grandma, they're you, they're me. And we buy them because typically we see them as safer investments with a consistent income stream. And so that's the key. Now if ever the US defaults or misses an interest payment, forget your portfolio.

We will have huge problems at that point in time. So we got to get this under control now. That's the first stage in it. But where does it go from there? Remember I said that the treasury start to set the pricing on everything else. Well, you've got 30 day T bills, you got, you know, 10 year treasury yields. Well, the mortgage on your home and the interest rate you pay is typically driven by a Treasury a 10 year treasury yield. It drives mortgage rates. So the higher the yields are, the higher your monthly payments, the higher the interest is. So until the Fed reduces interest rates, but which reduces the rates on the bond market and the bonds and the Treasuries, you end up with a higher mortgage payment with dealing with it. Now it also affects every other aspect of borrowing in your life that means like credit cards and loans. So it may not be the 10 year treasury yield that affects it, but the short term treasury yields will push these up. Credit card interest rates are now in the, in the 20 to 30% range. Okay. Your retirement accounts. If bonds pay 5% risk free, you know, then what happens is that as bonds start to pay more, people start to bail out of stocks. The stock market drops. I mean, you see what happens, that it isn't it. They aren't distinct, unique markets. They interchange and they interplay with each other. And every time the bond market moves, it's like someone's changing the price tags on your life, okay? And you weren't looking, and all of a sudden you open your eyes and things are more expensive. Housing, credit cards, payments. Okay, the stock market. This is why the bond market is so important to understand. Even if you don't have a ton of bonds in your portfolio, we need to understand the dynamics of it. And so, and that also lends itself to why you need to understand your freedom number. Because understanding your destination is important to try to navigate yourself there. Okay? If you know your number, you can look at the current yields and ask, is the bond market offering me enough to hit my goal without taking on extra risk? All right, so make sure that you download the basic freedom Number calculator@melabraham.com Number. The link is below to grab. It's totally free. All right. All right. Now, how do they truly interplay between bonds and stocks? There's this. They're like mirror images in the sense of Treasuries are the risk free rate, okay? They're the calm, they're the cool, they're the steady stocks. They're the drama queens. They go up, they go down. But the difference between the two is that one is considered an ownership interest in a company. When you buy a stock, you own a piece of a company. If I buy a share of Disney or a share of Google or a share of Tesla, I own a piece of the pie, okay? When I lend, when I buy a bond, I don't own Disney. Disney owes me money, okay? And, but so there's less risk with buying a bond in Disney than there is in buying the stock of Disney. And that difference between the risk of buying the bond at, say, a 5% return and buying the stock at, say, an 8% return, that difference of 3% is sometimes called the equity risk premium. And I know I'm getting technical here, but I think it's important to understand.

What that premium, when we say equity risk premium, is saying, hey, how much more do I have to pay you in a return as an investor to entice you to move from the safe investment.

To this investment that has a little more risk? Okay? And so that's the gap, okay? And that's why when bonds move, the stock market moves, okay? There's mood swings here, okay? That's the thing that. That happens with it. All right? Now that also just. I just want you to see where. Where it connects now. It's. You see how it affects the stock market. Let's also look at how it affects taxes, spending, and debt. We have something called the GDP that we follow, the gross domestic product. This is our production as a. As. As a country. And a ratio you want to look at is how much debt do we have to production to GDP? Now, we want that ratio at below 100%, meaning that we produce more than we owe. But currently that ratio is about 122%. That means that we are borrowing more than we produce as a country. And if we continue on that path, it just widens. And that's what we're seeing with a deficit. And it's like owing more than you make every single year and still applying for more credit cards. That's kind of what's happening. Okay? And a big chunk of that debt is short term, meaning that they're constantly refinancing it at current rates. And as the rates went up, the refinancing was more expensive, which put us even deeper into debt. And so when the rates jumped and interest costs exploded, this is why we have so many people clamoring saying, hey, lower the interest rate, Fed, lower the interest rate. Lower the interest rate. Because then the rates start to shrink, the cost shrink, the gap shrinks, and it has a great impact. But we have to be careful about inflation. So all this stuff comes into play because eventually the government spends more on interest than they spend on defense or even health care. And you know what that means. The solution ends up being higher taxes, more debt, budget cuts. And that makes no one happy, all right? And so this is why understanding the bond market becomes imperative to your investing, to your money machine, to your financial future. So if you. It's not. The bond market isn't some dusty corner of finance. It's literally the steering wheel. You ignore it. You're letting someone else drive your money while they're scrolling. TikTok. Okay? You want financial freedom? You can't just watch the stock market ticker symbol like it's a score word. You've got to understand the market, and the market that controls the cost of money itself and the thing that controls the cost of money itself are bonds. Because when bonds move, everything else moves with them, all right? That's the key. Now, once you have that clarity. You know exactly how to make the bond market work for you instead of against you. You start to understand as you hear people talking, the bonds doing this or the bonds doing that, you don't. You don't slough it off saying, well, I don't have any bonds because I'm young. Because a lot of portfolios don't have bonds until they, until they get higher in years because it's more conservative, it's less risk, you have less opportunity for growth and all that stuff. So a lot of portfolios don't hold it, but it impacts every part of the portfolio. So we need to be aware of it so we can make smart decisions going forward. All right, I hope that this helps. I know I threw a ton at you, a ton of details, a ton of technical stuff. Go back through it because it is hugely important that you understand it, that you navigate through it and that you have thought about it as you're building your money machine on your path to financial freedom. All right, we can do this. We can do this together, but I want your hands on the wheel. We're not going to let the bond market drive your financial plan. All right, let me know what you think. Let me know what your questions are. Let me know how I can support you on this journey. And if you haven't done so already, go ahead and subscribe this channel. Make sure that you download the basic freedom number calculator. I've got the link below and I hope to see you on your road and on your path to financial freedom. And until I do, always, always strive to live a life without losing. See you in the next one. Thank you for listening to the Affluent Entrepreneurship with me, your host, Mel Abraham. If you want to achieve financial liberation to create an affluent lifestyle, join me in the Affluent Entrepreneur Facebook group now by going to melabraham.com group and I'll see you there.

And that's it for this episode of Building youg Money Machine, where we help you learn how to master your money, eliminate financial stress, and live a life of choice. If you found this valuable or helpful to you, here's what I'd love for you to do. If you do me a favor, go to Apple, Apple Podcast, or wherever you're listening to this podcast and rate and review the show. It helps us tremendously to keep us at the top of the list so we can continue to get this information and this message out to people because I truly believe that financial freedom is your birthright. And I want to help each and every one of you claim it. Thanks so much.