Did you know that as interest rates rise, the value of bonds falls? Should you even care about that? Are bonds a good investment for doctors? In this episode, we’re tackling these questions and discussing the purpose of bonds in a doctor’s portfolio, as well as the nuance of our current high interest environment.

Investing for doctors 101: The difference between stocks and bonds

The way I explain bonds from a financial literacy standpoint during my lectures for medical students, residents, and attending physicians that want to learn more about investing, is by breaking down the differences between stocks and bonds.

When you hear about bonds, you typically hear stocks and bonds mentioned as if they’re one unit, but they function differently. Stocks are partial ownership in a company, so if the company does great (or not so great) the value of your stock will follow, whether that’s an increase or decrease.

Because of that, stocks are a high risk, high reward investment, considering the company could also go bankrupt. 

On the other hand, bonds are like an IOU or a loan you extend to whoever you’re working with.

That could be the federal government, a corporation, or your local government. You earn a yield on the money you lend, making yourself the bank in that situation. It’s lower risk, and you don’t get quite as high of a return, but it’s a much more assured return. 

Are bonds a good investment?

Usually the next question that comes up during lectures on investing for doctors is, “Why should I invest in bonds?”

 The purpose of bonds in a portfolio is to diversify. For a healthy portfolio, you want to buoy your asset allocation when your high-risk stocks perform poorly.

Although bonds don’t give you as high of a return – meaning if you invested only in bonds, you would have significantly less money than if you invested only in stocks – they do stabilize your portfolio.

For example, if you bought an index fund today, there’s a chance that the value of that index fund tomorrow could decrease. Over time, 30 years from now, it will have increased. But day to day, month to month, index funds can fluctuate.

When the pandemic first hit, retirement accounts took a hit and the value of retirement accounts decreased. But if you invested in bonds during that time, your portfolio still would have decreased, but it would have decreased to a lesser amount.

Maybe you only lost 20% instead of 30%, or only lost 10% instead of 20%.

And remember, we’re humans doing this personal finance thing. It’s much harder to log into your Fidelity or Vanguard account and see that you used to have $200,000 and now you only have $100,000. It’s really hard to stomach that loss, but if you’ve invested in bonds, you’ll see that, “hey, I decreased in value, but not by as much.”

In that way, bonds help you to stay the course. They help you to not change your investment plan when there’s a recession, when a pandemic hits, when the unpredictable happens.

Our perceptions of bonds may historically vary, but their relationship to interest rates remains the same

Morgan Housel at the beginning of The Psychology of Money makes the point that your view on money is entirely shaped on your experience, your history, and the history of the market as you’ve aged and learned more about investing,

Bonds haven’t been very valuable for a while. The 10-year treasury note peaked in September 1981 when it was earning 16%. So if you grew up in the seventies and started investing in the eighties, you probably love bonds.

 If, however, you started investing in the nineties, or the 2010s – 2020s when the low of yields on bonds was August of 2020 at 0.5%… bonds don’t seem worth touching.

 The reason bonds are relevant right now is because interest rates have changed so much recently, and bonds have a relationship with interest rates. In 2023, interest rates are now seven or 8%. 

 And as interest rates rise, the value of bonds falls.

 If you bought a bond in 2020 at 0.5% and now the 10-year note is yielding 5%, obviously the bond you bought at 0.5% is now less in value. But now that the interest rates are 6 or 8% and we can lock in a 10-year treasury note at 5%, you may wonder, “Isn’t that a great investment?”

 The answer of course is, it depends. It depends whether interest rates continue to rise. If interest rates go back down to 2-4%, all of a sudden that bond that you decided to lock in would be worth a lot more.

 For that reason, some people in finance are saying that right now is the perfect environment in which to buy bonds. Interest rates are pretty reasonable now, and if interest rates drop in the future, then the bond you currently hold will be worth even more. 

Why invest in bonds at all? Making the case for bonds

When it comes to investing for doctors, one of the reasons to have bonds in your portfolio is because stocks don’t always go up. 

Look at what we call “the lost decade” from 2000 to 2009. If you bought a bunch of stocks, 10 years later, they would’ve been worth the exact same value.

But bonds actually increased in value during that time. 

So if you were someone who invested in bonds, your portfolio actually would’ve gone up during that time instead of saying the same. 

Bonds are recommended by those with experience

A lot of the arguments that people have about not investing in bonds at all are usually led by young people, in their twenties and thirties, who haven’t been through a lot of bear markets, or who have just started their investment journey within the last 10 or 15 years.

But one of the best investors in the world, Warren Buffett, says that when he dies and his wife outlives him, he will go to his grave insisting she invest their money as 90% stocks and 10% bonds.

If smart people around you are saying add some bonds, then I tend to listen to people who have a little bit more experience than I do.

They almost a guarantee you’ll have the money you need when you need it

Bonds are particularly great if you need money at a specific time.

“I want to buy a house in five years, how should I invest my money?” Or, “I’m getting married in two years, how should I invest my money?”

Bonds are perfect for either scenario because you can choose a bond that matures or payout your money at a specific time. You’re able to almost guarantee that you have the money you need when you need it most.

Various types of bonds

I would venture to say that 90% of doctors are not buying individual bonds. Most are buying what we call a bond index fund (like a Vanguard Total Bond Market index fund).

But if you’ve heard of the terms of bonds and you’re just curious, there are several different kinds of bonds that you can purchase:

• Corporate bond: you loan money to a corporation or a public company.

   

• Governmental bond: you loan money to the federal government’s agencies, like the Department of Justice, the Department of Labor, or mortgage companies like Fannie Mae and Freddie Mac.

   

• Treasury bond: you loan money directly to the federal government.

   

• Municipal bond: you loan money to your city or state government.

The tax treatments are different for each bond, with some of them being tax-free.

So if you’re an attending physician in the highest tax bracket and you’re trying to not only diversify your investments, but lower your tax bill, then bonds could be an option you look into.

• I bond: you may have also heard of I bonds, which we did a dedicated episode about, Bonds, I Bonds. Is it worth the hype? But in short, I bonds are inflation-protected bonds. 

The role of bond surrogates in investing for doctors

Because interest rates are now 6-8%, people wonder, “If I can get a guaranteed 6-8% return on my debt compared to the 5% I’d get from the government on my bond investment, why not do that?”

This is where personal finance is personal, and you have to make the best decision for you.

Bond surrogates, or alternatives to bonds, can serve the same kind of function in that they give your portfolio some support, diversification, and also stability in your financial life.

Student loan payments could fall into this category, particularly after the pause when it goes back up to 6%. If you have $200,000 in student loans and you’re not going for forgiveness and you’ve got to pay back that money, then maybe it makes sense to prioritize paying off your student loans.

Mortgages could also fall into this category – maybe your home is at 7% and it makes more sense to direct your funds towards paying extra money on your mortgage and have that overall debt decrease.

Summary

Bonds make up an important part of a healthy portfolio when it comes to investing for doctors. They offer financial stability and also provide a kind of psychological boost, buffering the impact of any stock losses and helping you persevere and stay the course of investing. The type of bond you choose to invest in depends on your financial position, preferences, and personality, but don’t underestimate the effect they can have on your overall financial health. 

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