On to bonds. Not because I use them, but because the traditional financial system presents them as the default prudent choice, and you need to understand what they are and why I do not use them before someone slips them into your portfolio.
What a bond is
A bond is a loan. You lend money to a government or a company for a period, and it gives you back the capital at the end plus fixed interest along the way. It is like lending 100 euros to an acquaintance in exchange for 103 in a year: if all goes well, you make 3; if he does not pay, you lose the 100.
Government bonds: the myth of safety
Government bonds are called “risk-free”. That is false. They carry default risk, and it is not theory: Argentina, Russia, Greece, Lebanon. In March 2012, the holders of bonds from Greece, a euro-area country, took a 53.5% cut to what they had lent. When a state does not pay you can lose a large part of your capital, or all of it.
And even if it pays, there are two other risks. Inflation: if it pays you 3% and prices rise 4%, you lose purchasing power. And interest rates: if rates rise after you buy your bond, new ones pay more than yours, and if you need to sell early you have to sell cheaper. In 2022, when central banks raised rates, the US bond index lost 13.01%, its worst year since it was first calculated, in 1976.
Corporate bonds
Corporate bonds are more honest. A solid company issues debt to grow and pays you slightly more interest than a state, because, in theory, it is riskier. But think it through for yourself: which is more likely to default, Microsoft, rated AAA with decades of growing profits, or a country with a deficit every year and debt that keeps rising? If you are going to hold bonds, better to lend to a real company with a real balance sheet.
My underlying objection
Even so, my problem with bonds is the same. Risk has to be measured against what you can gain. In a bond the most you can make is little, interest that almost always barely beats inflation, and the most you can lose is everything. Risk of total loss in exchange for a minimal real return: it does not pay off for the long term.
When they do make sense
For money you will need within a year or two, for example to buy a car, a short-term bill or bond can serve to park it with some interest. But that is not investing, it is parking. For everything else, gold does the job of protection with a much more honest risk profile, as we see in the next module.
Next: Module 7. Gold, silver and commodities. Course contents.