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Jeremy Owens: Hello, and welcome to On Watch by MarketWatch. I'm Jeremy Owens. Bonds are back. One of the most traditional investment assets all but disappeared out of typical American portfolios for almost 15 years. But now, they're one of the most popular targets for young investors for one simple reason.

Gordon Gottsegen: Anyone who's really been paying attention to what's been going on with the economy probably has heard a lot about interest rates.

Jeremy Owens: That's MarketWatch reporter Gordon Gottsegen. He's talking about the key reason for a surging interest in bonds: surging interest rates.

Gordon Gottsegen: Those were really, really low for a historically long amount of time.

Jeremy Owens: The Federal Reserve had kept interest rates near zero since the subprime mortgage crisis struck in 2007, which made bonds pretty uninvestable. But that changed a couple of years ago.

Gordon Gottsegen: All of a sudden, when inflation was really high after the pandemic, they started hiking interest rates really fast to a point that they haven't been at since around 2007. When the Fed hiked up those interest rates, bonds, which have been around for a long time, suddenly became something safe that you could actually get a return on.

Jeremy Owens: The result, the T-Bill and Chill movement produced a new generation of bond investors. American households now own more treasury bonds than ever recorded. Online platforms took note and began offering greater access to a wider variety of bonds. We are officially in new territory. What do you need to know about bonds? That's today on the show. Bonds have long been part of Americans' investment strategies. If you've ever heard of the 60/40 portfolio, that's a very standard approach to saving that calls for putting 60% of your money towards stocks and 40% toward bonds. But that approach has fallen out of favor in the past 15 years. We figured there was some basic education on bonds needed and called a person who does that for a living. Kathy Jones, managing director and chief fixed income strategist at Charles Schwab has been introducing investors to bonds for decades. She joins us now to explain what you need to know about bonds and how to think about them as part of your portfolio. Kathy, it's really your job to talk to people who are interested in investing in bonds and other fixed income. I have to imagine it was a pretty lonely job from about 2009 to about 2022. Now, we're in this situation where interest rates have gained. All of a sudden, people are interested in investing in bonds. But it's been 15 years or so since these were truly investable assets. How do you introduce them to the concept of bonds, especially people who are familiar with stocks and investing in general but just have never really jumped into bonds?

Kathy Jones: Well, these days, because the yields are roughly around 5%-ish or so for a variety of bonds, I usually start with saying bonds have three purposes in a portfolio. One is to generate income. Right now, there's actually income and fixed income. The second is capital preservation. If you hold individual bonds to maturity, you're going to get your principal back plus your interest payments along the way, borrowing a default. The third is diversification, generally diversification from stocks. It gives you a little bit of an offset to the volatility in the stock market. Tends to calm down your portfolio. I usually say, "Hey, if 5%, over the next five to 10 years, sounds good to you with very little downside risk in terms of losing money, then we should talk about bonds."

Jeremy Owens: Yeah. That five to 10% guaranteed there are bonds that fail, especially treasuries and other things are pretty solid, have been for our entire careers. How do you walk them through having the higher floor and lower ceiling? I think that's the best way for me to explain to people the difference between bonds and stocks. The number one thing for me is you have less of a chance of really losing your money, but you probably don't have the 2X/3X/4X opportunities obviously with a bond that you might have with stocks.

Kathy Jones: Yeah. With stocks you have presumably an unlimited upside, and that, of course, is very appealing. It doesn't always happen that every stock is going to go up after you buy it. But you do have that way to participate in the growth of a company. You own say part of Apple, or GE, or whatever company. You own some equity in that, and you get to share in that. When you own a bond, you're basically loaning money to whatever entity you're buying the bond from. In return, for that loan, they're going to pay you interest and then pay you back your money when the bond matures. It's really very different. One is participating in the equity growth of a company and the other is basically a loan to some entity.

Jeremy Owens: Kathy, you're talking about corporate bonds here, which are different than treasuries. Talk to me about the nuances there.

Kathy Jones: The fixed-income world is huge. It's much bigger than the world of equities, but it's also divided up in interesting ways. If you want to buy a GE stock, there's one stock to buy. If you want to buy a GE bond, there's probably, I think, 200 and some odd GE bonds out there issued at different times with different yields, different coupon rates, different maturities, different provisions, maybe backed by different parts of the company. It gets a lot more confusing. Within corporate bonds, there's investment grade, usually bigger companies with bigger balance sheets, more solid cash flow, et cetera. They're rated higher than high-yield bonds or sub-investment grade, or, otherwise known as, junk bonds. Those are issued, usually, by smaller companies that have less in the way of solid balance sheets, so they're riskier.

Jeremy Owens: What are the other kinds of bonds that people could invest in? I think municipal bonds is one that hits me right away, Kathy. What are the advantages and disadvantages there?

Kathy Jones: The advantage of municipal bonds is the tax component is much, much lower than you would get in other types of bonds. They carry lower yields as a result of that. But for people in higher tax brackets, that can be very appealing. Foreign bonds... That's divided between major developed markets, England, France, all of Europe. Then, you can go into emerging market bonds issued by countries that typically are smaller, more growth-oriented countries. Those have higher yields but higher risks as well. I could go on and on for days about the varieties. But that's just a smattering of what's out there.

Jeremy Owens: Well, Kathy, you're loaning money. You're getting interest back on that loan. For that reason, you probably want to bring a little bit more money to the table. I mean, I'm a poker player. I see stocks as the $1/$2 game, while bonds would be more the $10/$20 table. When you're playing with stocks, you can play with a little less money. If you're going into bonds, you probably want to bring a little bit more money. That really brings in allocation strategy.

Kathy Jones: Yeah. Usually, when we look at allocating to a portfolio in any asset class, the sizing of your position/how much you allocate is really, really important to your long-term outcome. When you're young and you have lots of time to invest and participate in that growth, you probably have a pretty heavy weighting to equities. As you get older and losing your principal becomes a big concern, well, then you might want to weight more towards the bond market. You can't ride out a five-year or six-year bear market or whatever it is, wait for it to go down and come back and recover. You may need that money. For people who are nearing retirement or in retirement, typically they want to generate the income, but you want that cash flow to be relatively predictable. Bonds are great for that. Historically, stocks are about eight or nine times more volatile than bonds. Again, if you want to dampen down the volatility in your portfolio, you put some more bonds in there and that offsets some of the volatility in the stock market. I always say people have fun in the equity portion of the portfolio. In the bond portion, you really want it to be boring and just do its work on the side.

Jeremy Owens: It may depend on where you are in your life and whether you need that income or not. I think it's the same way, pretty much, with stocks and dividends that when you're younger and still trying to build, you're pretty much reinvesting those dividends. But at some point, you may start actually taking them out and using them if you need the income, the same way with bonds basically.

Kathy Jones: Yeah. Absolutely. It's really the same principle. There's been some concern lately because correlation between stocks and bonds has turned positive, meaning they're moving together up and down. Historically, there have been long stretches where they moved in opposite directions, which gave you some of that diversification benefit. The question a lot of people are grappling with is have we gone to a different era now where the correlation is positive versus negative, and what does that mean for a diversified portfolio? We could ponder this for years and years to come, or my solution is to say, "Okay, we're just going to assume that the two portions of the portfolio are just going to do their jobs, and whether or not you get that positive negative correlation going at any moment in time is probably less important than is each component doing its job." Is the equity portion giving you growth? Is the bond portion giving you income and stability? If those two things are working, then, I think, maybe overthinking it is not a great idea.

Jeremy Owens: All this talking especially about municipal bonds, Kathy... It brought to my mind a concept I'm calling artisan bond investing. Basically, you can figure out specific bonds you can buy that make sense in your own personal financial life. Let me give you an example. I live in California. My property tax goes up just about every year or two. We have to vote on a new school bond or some other form of bond that is going to get paid for through my property taxes. My first thought when we started walking through this is I could probably go and buy those school bonds on the other side and figure out the size of the purchase I need to make that would cancel out my property tax increase. Is this a strategy people actually use? Am I coming up with something new here, or is this something that people know about and do a lot?

Kathy Jones: Yeah. Absolutely. I mean, I used to do it with the electric company. I'd say, "Well, every year, I know I'm going to pay X amount on my electric bill, but they have some bonds outstanding. If I buy a fair amount of the bonds, I can cancel out my electricity costs."

Jeremy Owens: Yeah. I thought of my dad who's a math professor. It seems like a math nerd thing where you can sit there and do all the formula to figure out... "Well, how many bonds would I need to buy to cancel out this increase? How long does that work?" Those things can be interesting and fun for, especially, a certain subset of people.

Kathy Jones: Yeah, the math nerd subset. Yes. We definitely like that. I will admit to that.

Jeremy Owens: Well, hopefully, we find a few more with this podcast. Thank you so much for joining us today, Kathy.

Kathy Jones: Thank you for having me.

Jeremy Owens: We're going to take a quick break. Coming up, we'll talk about how a new generation is investing in bonds. Welcome back. Have you heard of T-Bill and Chill? This is a strategy where investors pile money into treasuries and just let it ride. The approach spread in 2022 when interest rates and inflation suddenly shot higher and introduced a new generation of investors to these types of bonds. Young investors, Gen Z and Millennials, in particular, bought treasuries, some for the first time, and a movement was born. This strategy of safe investing is not really new. I'm looking at you bobbleheads. But the returns were something we hadn't seen in a while. Reddit was buzzing. At TreasuryDirect, a 1990s-era government website, accounts skyrocketed, and investing platforms responded by opening up new avenues to investing in the debt of governments and companies. Now, because of increased demand and the historically unprecedented rate hikes, people are turning to newer sites like Webull and Public to buy bonds directly. MarketWatch's retail investment reporter Gordon Gottsegen joins us to explain.

Gordon Gottsegen: 2021 and 2022 were both heydays for speculative investing. When those speculative investments didn't really pay off, investors started looking at safer things that were much more hands-off. When people started talking about T-Bill and Chill on investing, Subreddits... They were like, "Okay, great. I can put my money somewhere. It'll grow. It's not going to go to zero. I'm not going to have to do anything."

Jeremy Owens: It was really TreasuryDirect where everybody ran to.

Gordon Gottsegen: Oh, yeah. Oh, yeah. Treasury Direct is this old wonky dinosaur of a website where people can go-

Jeremy Owens: Hey, hey, hey. Those of us who remember the 1990s just see it as a bit of kitsch and retro-

Gordon Gottsegen: Yeah, exactly.

Jeremy Owens: It's not a dinosaur for some of us, Gordon.

Gordon Gottsegen: Yeah. Just log onto GeoCities and buy some bonds.

Jeremy Owens: Right.

Gordon Gottsegen: No, but bonds on Treasury Direct allow people to invest directly/own the bonds. People got access to these treasuries through that.

Jeremy Owens: Well, I love TreasuryDirect. As somebody who was on the internet in the '90s, it reminds me of the way we used to be on the internet. Back then, you didn't just have an internet connection and a browser. You had all of this in one.

Gordon Gottsegen: Oh, yeah. Do you remember Netscape?

Jeremy Owens: Oh, of course. Of course.

Gordon Gottsegen: Whatever happened to Netscape?

Jeremy Owens: Netscape got acquired. But since then, the people behind Netscape have become some of the most influential people in Silicon Valley. Marc Andreessen founded Andreessen Horowitz, one of the biggest VC firms out here.

Gordon Gottsegen: Yeah. Andreessen Horowitz led a series A round into Moment, which is a company that's powering the bond buying/bond trading on both Webull and Public. Two of the online brokerages that just offered fractional bonds.

Jeremy Owens: Well, Gordon, I think that's a great place for us to talk about fractional bond ownership. That's something that a lot of these platforms have introduced in the same way that they introduced the sales of fractional shares to give people easier entry into stock ownership. We're seeing the same thing with bonds now.

Gordon Gottsegen: Yeah, that's a big one. One big obstacle with buying bonds is the minimum investment price. If you like a specific treasury and you want to buy it on TreasuryDirect, you may go and then look and say, "Uh-oh. I need $10,000 to buy this specific bond. I don't have that." A lot of brokerages started offering this thing called fractional bonds, lowering the investment minimum down to $100, which is a lot more attainable by an average person who... Let's say they just want to put aside $50/100 per paycheck. They can start investing in bonds much quicker instead of waiting to hit that $1,000 minimum/$10,000 minimum.

Jeremy Owens: Really the difference is these are direct bonds. Most investing in bonds, when people still invested in bonds back in the early 2000s before the housing crisis and the interest rates came down for 15 years, was through ETFs, bond mutual funds. But now, they're getting access more to direct bonds.

Gordon Gottsegen: Exactly. People, before, would have access to bonds through ETFs, through mutual funds. A lot of people may already own bonds without realizing that. That's because their company provided 401k/has these target date funds. That means that the financial companies providing those target date funds will put a little bit of money into stocks, bonds, fixed income. But what has changed is now the ability to buy them direct more easily. Through investing in bonds directly, these are your bonds. There's a lot more customization, a lot more benefits, and freedom. It was just harder to do that before.

Jeremy Owens: I can't help but giggle a little bit at this, Gordon, because it is basically getting toward what has always been the suggestion from every financial advisor I've ever known about... "Oh, you put 60% of your money in equities. Put 40% into bonds." That disappeared over the last 15 years. It's come back, and we've just found this new way to do the same thing we used to do with brokers and with our financial advisors 30 years ago.

Gordon Gottsegen: Exactly. But the difference here is that there are less obstacles in the way to do that. I think owning bonds directly does allow a lot more freedom for investors to say, "Okay. Well, I want to add some customization of when these bonds mature, how much yield I get." We're seeing a lot of retail investors, who maybe like to play around with stocks, pick more speculative-grade bonds in order to get higher returns.

Jeremy Owens: Right. That's basically a junk bond.

Gordon Gottsegen: Yeah. The same investors who are really into AMC say, "I'm going to buy some AMC corporate bonds because I believe in this company. But I also want access to higher yield than treasuries." I think that's also an undercurrent to a lot of retail investor groups. A lot of retail investors say, "I don't really trust these big financial institutions. I think I know more about AMC than they do. I'm going to take this bet that AMC isn't going to default on this loan, and as a result, I'm going to get access to those higher yields."

Jeremy Owens: Yeah. Then, you actually have a full portfolio that's not just your shares of AMC, but at least you have a little bit of variance in there. Again, just goes back to the entire school of investing that we've been taught. It's just the new way to do it. Thank you so much for laying it out for us, Gordon. We'll talk to you again soon.

Gordon Gottsegen: Thanks for having me.

Jeremy Owens: Before we go, it's time for what we are watching: a look at the news you need to know for the rest of the week and beyond. First, if you've enjoyed this episode about bonds, there are several related stories to dive into on MarketWatch. We have a glossary of bond investing terms you may have heard on this episode along with charts and details on how investing in bonds is different than stocks. Make sure to check those stories out. If you have any remaining questions about investing in bonds, please reach out to us with them at onwatch@marketwatch.com. Corporate earnings season is in full swing after the big banks kicked us off. Coming up, Netflix will give us the temperature on streaming services Thursday afternoon after telling Wall Street this spring that it will stop providing subscriber numbers after this year. Up next, we expect big reports from Google, Tesla, Starbucks, and potentially Microsoft next week. Retail sales data released Tuesday showed a marked slowdown in consumer spending. But there's much more to it. Declining gas prices and a hack that took out car dealers nationwide were largely blamed. Sales rose after removing those factors. Still, there's certainly been a decline for consumer spending in recent months. Can back-to-school shopping turn that trajectory around? We'll discuss that next week. That's it for this episode. Thanks to Gordon and Kathy. To keep following the latest on bonds head to marketwatch.com. You can subscribe to the show wherever you get your podcasts, and please do. If you like what you heard, please leave us a rating or review. It really helps others discover the show. Let us know what you want to hear from us. You can reach us at onwatch@marketwatch.com. The show is hosted by Jeremy Owens and produced by Alexis Moore and Jackson Cantrell. Isaac Gaines mixed this episode. Melissa Haggerty is the executive producer. We'll be back next week with a new episode. Until then, we'll be watching.