Tuesday, October 11, 2016
Only 22% of everyday investors know the most basic principle of bonds
Americans often don't know one of the most basic facts about their own investments.
There are two ways to measure the value of a bond. The first, similar to stocks, is the price you pay for it. The second is the yield, or how much an investor will make in income from the bond.
The two measures have an inverse relationship. Put simply, when the price on a bond increases, the yield falls.
This is typically one of the first things investors should know about bonds and the bond market, but according to a survey by Wells Fargo and Gallup, investors are seriously lacking in this basic knowledge.
"When the survey asked investors what happens to bond prices when interest rates go down, over half (54%) admit they don't know," a release detailing the survey said (there's a direct relationship between bond yields and the interest rates set by central banks). "Only 22% correctly identified the inverse relationship whereby bond prices typically go up when interest rates go down. Another 17% think the two move in the same direction."
Gallup and Wells Fargo asked 1,021 adults who live in a household with $10,000 or more in savings and/or investments about their financial well-being and knowledge. According to the survey, two out of every five American households are above that threshold.
Additionally, it appears that American investors on average think they know more about bonds than they actually do.
"Underscoring the need for more education about bonds, only 31% of investors say they have a very good understanding of the difference between stocks and bonds — another 43% understand it somewhat well, while 26% say not too well or not at all," the survey said.
While knowing the difference between stocks and bonds isn't the same as knowing yield relationships, the disconnect between the 71% of people who don't know about the yield-price relationship and the 26% who actually acknowledge a lack of knowledge about bonds is striking.
Bonds are used in almost every retirement portfolio, and it appears that Americans with investments often don't know how one of the basic components of their portfolio works. So perhaps this is more of an indictment of the general financial literacy of Americans or the ability of financial advisers to educate their clients than anything.