How I Explain Long-Term Bonds

How I explain what long-duration bonds are to someone very new to this type of investment

Photo by Harli Marten on Unsplash

In investing, I use long-term bonds for two objectives: Creating stable income and portfolio diversification. I’ll share more about all that in another article coming soon (sign up for my free weekly newsletter here). This article is dedicated to you for understanding the basics of bonds and some of the jargon.

First up: “long-duration”/”long-term” and “bonds”.

What are bonds?

Bonds are loan agreements between a borrower and a lender. The borrower is also called the issuer of the bond. The lender is the investor in the bond.

The investor gives the issuer their money for a specified length of time. In return, the issuer promises to pay the money back at the end of the agreed-upon period. This future point in time is called the “maturity date”.

During the duration of the bond, the issuer also promises to pay the investor interest. This payment is also called a “coupon”. The interest rate of the coupon is often fixed.

An example is coming up shortly! So read on.

What are long-term or long-duration bonds?

When financial talking heads talk about “long-term bonds” or “long-duration bonds”, they usually mean bonds that mature in 20 to 30 years. When bonds mature in 7–10 years, they’re customarily referred to as “intermediate-term bonds”. Bonds under 2 years until maturity will be called “short-term bonds”.

Fun fact: A long-term bond starts with a long duration, say 30 years until maturity. As the years go by, it will first turn into an intermediate-term bond and then into a short-term bond.

Example: A 30-year bond issued this year (2024) matures in 2054. From 2044 until 2047 it will be called intermediate-term because its maturity is 7 to 10 years out. From 2052 on it will be referred to as a short-term bond as its maturity date is less than 2 years away.

So, in essence, a bond is a promissory note or an IOU. A long-term bond is an IOU promised to be paid back in 20–30 years.

A quick example of a long-duration bond issued by the US Department of Treasury

The US government plans to need money for 30 years, say, to fund social security, build some highways and bridges, or fund the military — without increasing taxes. It wants to borrow it from you and many other lenders.

To do this, the Treasury Department issues 30-year bonds totaling, say, 10 billion dollars. It slices the whole amount up in $100 increments. Each of these slices is called a bond with a face value of $100.

Let’s say a bond offers a 4.5% annual interest rate, paid semi-annually, and you agree to the terms and buy ten slices. You give the Treasury your $1,000 (10 times $100) today and receive the bonds in return.

Fun fact: Nowadays, bond issuances happen in fully electronic form, and no paper is exchanged. Just an email confirmation and an entry in a database.

The treasury now owes you two things:

1. $1,000 to be paid back at maturity (in 30 years) plus
2. $45 per year in interest (4.5% x $1,000)

Interest on US Treasury bonds is customarily paid semi-annually. So, by buying the bonds, you have the right to receive half of the $45 annual interest, meaning $22.50, every 6 months for 30 years, for a total of $1,350 in interest payments — in addition to getting your $1,000 back in 2054.

Will you really get your $1,000 back?

Yes and no. It depends on how long you hold the bond.

Holding your bond until maturity

If you hold the bond until maturity, you will get your money back at face value. That’s the promise of the IOU.

The borrower is legally obliged to pay you back. They will do so unless they have declared bankruptcy.

How likely is a debt default of a bond issuer? It depends.

Governments of large economies such as the US, Germany, or Japan are considered very creditworthy. Other governments or corporations may be less trusted. The higher the creditworthiness of an issuer, the higher the likelihood of you getting your money back.

Why would you ever invest in anything but US Government bonds then? Because lower creditworthiness means that the borrower needs to pay a higher coupon. That compensates the investor for the higher risk she takes.

Fun fact: Your personal FICO score works the same way as a bond issuer’s creditworthiness. The higher the score, the higher your creditworthiness and therefore the lower the interest you have to pay to your mortgage lender, private loan company, or credit card issuer.

By the way, the risk of a bond issuer defaulting on their debt obligations is called “credit risk”.

Holding your bond until you sell it

You don’t have to hold on to the 30-year bond for a full 30 years!

There is a financial market called the bond market. In the bond market, investors with various motivations trade bonds with each other. In jargon, bonds can also be called “debt securities” — just so you know.

Fun fact: The bond market is larger and more liquid than the stock market, even though stocks get most of the press.

What the bond market means for you is that you can dispose of the 30-year bonds you have purchased in the example above at pretty much any time during local market hours before the bond’s maturity for a fair price.

If you want to sell your bond before maturity, you go to the bond market (via your broker) and they’ll quote you a price for it.

Fair price — what does that mean? Let’s see.

The fair price can be higher or lower than the $1,000 you paid for it. It depends on the interest rate of your bond versus the current market interest rate.

Let me explain.

How to know what your bond is currently worth

In the example above, you and the borrower locked in 4.5% for the life of the bond. But interest rates rise and fall, just like stocks go up and down.

If interest rates rise, your fixed-coupon bond will be worth less. If interest rates go down, your fixed-coupon bond will go up in price. I’ll use two visual examples below to explain why that is.

Remember the inverse relationship between interest rates and bond prices: Higher interest rates mean lower bond prices and lower interest rates mean higher bond prices.

The 30-year US government bond yield (“yield” being a synonym for interest rate) fluctuated roughly between 3.8 and 5 percent over the last 12 months. As of this writing on May 17, 2024, it’s very close to our 4.5%-example from above, at 4.541%. You can see this in the following graph.

1-year graph of the 30-year US government bond yield on 17 May 2024 from Investing.com

Example 1: How much value does your bond lose if interest rates go up?

When the general interest rate level for 30-year bonds of the US government rises, say by 0.5% to 5.0%, but you are locked in with 4.5%, wouldn’t you rather have the 5% bond that’s available now? Of course, you would. So, owning the 4.5%-bond has become less valuable.

How much less valuable? Well, 30 years times the 0.5% interest rate increase! That’s 15% less interest over the lifetime of your bond in sum. Or in dollars: You will get 60 times (30 years of semi-annual payments) $22.50 (4.5% of $1,000 per year divided by two because of the semi-annual frequency) = $1.350 in total.

With interest rates at 5% for a new 30-year US government bond, however, you could get 60 times $25 (5% of $1,000 per year, paid semi-annually) = $1.500. You’re losing out on $2.50 per half year or $5 per year, totaling $150 over 30 years.

Therefore, your $1,000 bond is worth $150 less cash flow over time.

So, would $1,000 minus $150 = $850 be a fair price for the bond?

Good thinking, but luckily it’s not quite as bad.

Due to inflation and the fact that you can earn interest with your money, today’s $5 is worth more than next year’s $5. And the $5 next year is worth more than the $5 in the year after, and so on.

The $150 disadvantage spread out over time is discounted to a present value of about $78 at today’s interest rates. So, your $1,000 bonds would be traded at a fair price of around $922.

Calculating the price of a bond on https://www.calculator.net/bond-calculator.html: Enter the face value; then the current market yield for bonds of the same issuer with the same maturity; then add your bond’s fixed coupon rate and frequency as well as maturity date; for simplicity’s sake, use today’s date as settlement date and 30/360 as “Day-count convention” (too nerdy for this article to get into the details of those), then get the price on the right. Use the “Clean” price for your reference (the other values under “Results” are details for another article).

Holding the bond in your brokerage account, you’d likely see the bond’s price to be quoted at about 92.25% or 92.125% for your disposal of the bond. Percentages and fractions of percentages are the usual format of bond prices in the bond market. Simply multiply your bond’s face value ($1,000) by the percentage shown (92.25%) to attain the value of your bond holdings ($922.50).

Example 2: How much value does your bond gain if interest rates go down?

Let’s say now that interest rates have moved down to 4.0% for 30-year US government bonds. Owning the 30-year bond that pays 4.5% is quite a boon then, isn’t it? That will be reflected in its price.

Your 4.5% coupon bond with a face value of $1,000 pays 60 times $22.50 interest (in sum $1,350 over 30 years). A new 4.0% coupon bond would only pay $20 per half year, totaling $1,200 over 30 years. Your bond is $150 better!

So, would $1,000 plus $150 = $1,150 be a good price?

You guessed it: The general idea is correct. But a little adjustment is needed. The $150 advantage is spread out in 60 payments over the next 30 years and is therefore worth less in today’s dollars.

The present value of the $150 advantage over time is discounted to about $87. So, your 4.5% 30-year bonds with a face value of $1,000 would be worth almost $1,087 in a bond market where similar bonds yield 4.0%.

Calculating the price of a bond on https://www.calculator.net/bond-calculator.html: Enter the face value; then the current market yield for bonds of the same issuer with the same maturity; then add your bond’s fixed coupon rate and frequency as well as maturity date; for simplicity’s sake, use today’s date as settlement date and 30/360 as “Day-count convention” (too nerdy for this article to get into the details of those), then get the price on the right. Use the “Clean” price for your reference (the other values under “Results” are details for another article).

You’d likely see your bond’s price be quoted at about 108.50% for your disposal of the bond. As in Example 1, that’s a little less than its fair value to allow the bond dealer a little profit for his or her service to buy the bond from you at your convenience.

Fun fact: As seen in the two examples above, an interest rate decline will increase a bond’s value more than an interest rate increase of the same magnitude would depress it.

The 30-year 4.5% bond gained 8.7% value with interest rates half a percent lower while it lost only 7.8% of its value with interest rates half a percent higher.

By the way, the risk of a bond’s price going up and down when interest rates fall or rise is called “interest rate risk”. It is only relevant for you if you may need to sell the bond before its maturity date.

Thanks for sticking through this topic of bond basics until here. Good job!

Despite long-term bonds currently being a bit out of fashion, they are very useful for two investment objectives: creative reliable income and portfolio diversification (spreading investment risks). Therefore, I use them regularly in my personal portfolio as well as when I invest for my clients.

I’ll expound on these two use cases for long-term bonds in another article coming soon (sign up for my free weekly newsletter here).

Shine your light Cristof

Three Ways to Work with Me:

1. Book a ​1-hr Investing Coaching​ for customized advice about your investments.
2. Start a ​Portfolio-Session​ if you want to invest yourself but need comprehensive professional advice right now.
3. To delegate investing your money entirely, my “done-for-you” Investment Management service may be the right thing for you. Explore it with a ​free consult call​.

This article is intended for residents of the United States only. Not all of the products and services mentioned on this site may be available in your state.

The information in this article is not an offer or solicitation of an offer to buy or sell specific securities. Nor is it an endorsement or recommendation of the specific securities mentioned. It does not constitute personalized investment, financial, legal, or tax advice. Nor should it be misconstrued as a solicitation of investment advisory services. It is for informational and educational purposes only and presents the author’s interpretations and opinions which are subject to change without notice.

Research for this article was done thoroughly from sources the author believes to be reliable and trustworthy, but the author cannot guarantee that the presentation is complete or correct.

Investments in stocks, ETFs, and other securities can lose value. Fair value estimates may deviate significantly from market prices. There is no guarantee that this information will lead to investment returns or profits. Historical results and analysis are not a guarantee for future results. Model portfolio returns may not be achievable by all investors.

Each person’s situation is unique. Please seek professional advice from the qualified financial advisor of your choice about your investment decisions, and your attorney and accountant concerning legal and tax questions.

My firm Pine Ridge Wealth LLC (PRW) is an investment adviser registered with the State of North Carolina. PRW may only conduct business with residents of the states and/or jurisdictions in which it is properly registered.

Neither PRW nor its representatives are affiliated with the issuing companies or fund sponsors mentioned in this article. However, PRW and its representatives may own, plan to own, or otherwise have an interest in individual securities mentioned in this article, and may benefit from you buying these particular securities.

For further information, including PRW’s current full-disclosure brochure, see www.pineridgewealth.com.