By now, most investors are well aware of the financials of stocks, bonds, and currencies.
But what about bonds, which are also often the best investments for investing in the long term?
While most investors have invested in stocks or bonds, it’s important to understand how they’re currently performing.
If they’re falling fast, you’re probably not in a bubble, but if they’re still outperforming in a certain time period, you should consider a return.
To determine the relative performance of a bond or stock, a financial advisor will typically calculate the annualized return (ARI) or cost of equity (COE) for the asset class.
These metrics, which take into account inflation, inflation-adjusted dividends, market capitalization, and other factors, are known as a bond-to-stock (BST) ratio.
When looking at a bond’s current price, the bond’s return is calculated based on the current market value of the asset at the date of purchase.
In other words, if a bond was purchased in 2020 for $60, its price would be $70, which is what the bond is worth now.
The bond’s cost is calculated by multiplying the bond price by the total amount owed on the debt at the time of purchase plus the amount of principal the bond has outstanding.
The more you pay on a bond, the lower the cost is.
For example, a $60 bond with a cost of $60 is worth $1,000 at the end of the year, but the bond still has a cost to pay of $70.
As a result, if you have $100 of debt outstanding, the annual interest rate on the bond would be 0.50%, and the cost of the bond in 2020 would be about $100.
In addition, bond yields tend to increase with the market value (MVP) of the security, which in this case would be the price of the bonds’ bond issue price at the closing of the calendar year.
As the value of a security rises, bond costs tend to decrease.
For example, if the current MVP of a $100 bond is $10,000, then a $30 bond would cost $50, and a $50 bond with an annual cost of just $1 would cost just $15.
If the bond issue prices have risen, the cost to repay the debt could also decrease.
That’s because bonds have higher coupon payments, which means the bond holders are willing to pay higher interest rates.
The same is true for bonds that are being issued with higher coupon values, such as bonds that have lower coupon payments.
If you have a portfolio that has a higher annual cost to invest in bonds, the more of the debt you are willing and able to pay down, the better.
The longer the debt is outstanding, and the more you borrow, the greater the payoff.
Bond-to-$10-year bonds have a lower annual cost than bonds with lower cost-to, so if the bond issuer is paying a lower rate, the portfolio’s payoff is greater.
This chart from Equifax shows the bond- to-earnings ratio of U.S. Treasury securities in 2020, which was based on an index of the 10-year Treasury yield (T1).
The index uses the five-year yield to determine how the bond rate is calculated.
The lower the yield, the higher the return.
For this example, the T1 was $0.50 and the annual cost was $1.00.
As shown, the investor has a $1-billion portfolio with $10-million in debt.
The investor’s annual payoff was $20,000.
The bond-TO ratio is also known as the return-to or yield-to ratio.
If you have an investment portfolio with an ARI of 0.20%, then the return is 0.80% or $20 per year.
This means that the bondholder is paying $20 in interest per year on the $1 billion portfolio.
If the bondholders are paying less interest on the portfolio, the rate of return is lower, so the investor should consider raising his/her principal amount to pay off the bond.
Another way to look at the bond return is the cost-TO.
This ratio measures the total cost to sell the bond, which can be calculated as the sum of the principal, interest, and inflation-corrected dividends.
If bondholders pay higher principal payments, the market will tend to appreciate.
If interest payments are rising, investors should look for opportunities to reduce their borrowing costs, especially as the bond yields fall.
This is why it’s so important to track bond yields.
The market is often bullish about bonds that were priced in 2016 or 2017, so it’s not uncommon for investors to see returns that are as high as 20%.
In these cases, investors need to be cautious, because they may have overlooked some of the risks that might have gone unnoticed.
Here are some other common ways to evaluate the performance of