Lesson 3: Bonds and Cash: The Boring Part of Your Portfolio
Objective
By the end of this lesson, you’ll be able to:
- Explain what a bond is and read its three key numbers.
- Understand why bond prices fall when interest rates rise.
- Choose where to keep cash so it earns something.
- Know what job bonds and cash do in a portfolio, and what they can’t do.
Introduction
Not Every Dollar Wants a Roller Coaster
Back in Unit 2 we suggested keeping about 20% of your money in cash savings, and Unit 3 mentioned bond ETFs in passing. This lesson fills in the blanks. Bonds and cash are the calm end of the pond. They won’t make you rich, but they’re what lets you stay invested in stocks without losing sleep, and they’re where your emergency fund should live.
Main Content
1. What a Bond Is
A bond is a loan. You lend money to a government or a company, they pay you interest on a schedule, and at the end they give your money back. Three numbers define it:
- Face value: the amount you lent and get back at the end. Often $1,000.
- Coupon: the yearly interest rate on that face value.
- Maturity: the date you get your money back.
Example: Duck Co. issues a $1,000 bond with a 5% coupon maturing in 10 years. You get $50 a year for 10 years, then your $1,000 back. Boring, predictable, and that’s the point.
2. Who Issues Bonds
- U.S. Treasuries: issued by the federal government. Considered the safest investment in the world, because the government can always pay in its own currency. Short ones (under a year) are called T-bills.
- Municipal bonds: issued by states and cities. Interest is often free of federal tax.
- Corporate bonds: issued by companies. Safer companies (“investment grade”) pay less interest; riskier companies (“high yield,” or less politely, “junk”) pay more because there’s a real chance they won’t pay you back.
More risk of not being repaid = higher interest. Same tradeoff as everywhere else in investing.
3. The Seesaw: Rates and Prices
Here’s the part that confuses everyone. Bond prices and interest rates move in opposite directions.
Say you own that Duck Co. bond paying 5%. Next year, interest rates rise and new bonds pay 7%. Nobody wants your 5% bond at full price when they could buy a 7% one, so if you sell early, you have to drop the price. When rates rise, existing bond prices fall. When rates fall, existing bond prices rise.
If you hold the bond to maturity, none of this matters: you still get your $50 a year and your $1,000 back. The seesaw only bites if you sell early, or if you own a bond fund, whose price moves every day.
Longer maturities swing harder. A 30-year bond reacts to rate changes far more than a 2-year one.
4. Bonds for Beginners: Funds
Buying individual bonds takes bigger amounts and more homework. Most beginners use a bond ETF or index fund, which holds hundreds of bonds at once. A broad U.S. bond fund is a reasonable default. Just remember its price moves with rates, so it isn’t the same thing as cash.
5. Where Cash Should Live
Cash in a regular checking account earns roughly nothing. Better homes:
- High-yield savings account: easy access, insured by the FDIC up to the legal limit, and pays many times what a checking account does. The best spot for an emergency fund.
- Money market fund: offered by brokerages, holds very short-term safe debt, pays about the same as high-yield savings. Convenient if you already have a brokerage account.
- Certificates of deposit (CDs): you lock money up for a set time for a slightly higher rate. Fine for money you know you won’t need until a specific date.
- Treasury bills: short-term government debt. Safe, and the interest is free of state income tax.
Ducky rule: an emergency fund of three to six months of expenses goes in high-yield savings or a money market fund. Not in stocks. Not in a bond fund. Somewhere it will be worth the same next week.
6. The Job They Do
- Cushion: when stocks drop 30%, high-quality bonds and cash usually don’t. They’re what keeps you from selling stocks at the bottom.
- Dry powder: cash on hand lets you buy when everything is on sale.
- Income: bonds pay interest whether or not the stock market is in a good mood.
The classic split is “60/40”: 60% stocks, 40% bonds. Younger investors with decades ahead often hold far fewer bonds, because they have time to ride out stock crashes. The right mix depends on your time horizon and your risk tolerance from Unit 2.
7. The Risk Nobody Sees: Inflation
Cash feels safe, but prices rise over time. If your savings earn 1% while prices rise 3%, you lose 2% of buying power a year without ever seeing a red number. That’s why cash is for emergencies and near-term goals, and stocks are for the long run.
Activity: Make Your Cash Work
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Find the interest rate on your current checking or savings account.
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Look up today’s rate on a high-yield savings account and on a 1-year Treasury bill.
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Calculate what $1,000 would earn in a year in each of the three.
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Decide where your emergency fund should live, and move it if the answer isn’t “where it is now.”
Reflection Question: How many months of expenses do you have set aside right now?
Summary
Bonds are loans with a coupon and a maturity date. Their prices move opposite to interest rates, which matters if you sell early or own a fund. Cash belongs in a high-yield savings account or money market fund, not checking, and the emergency fund never belongs in stocks. Together, bonds and cash cushion your portfolio and give you dry powder, at the cost of losing ground to inflation if you hold too much for too long.
Key Takeaways:
- A bond is a loan: face value, coupon, maturity.
- Rates up, existing bond prices down. Longer maturities swing more.
- Treasuries are the safest; high-yield corporate bonds pay more because they might not pay at all.
- Emergency fund: three to six months of expenses in high-yield savings or a money market fund.
- Too much cash for too long loses to inflation.
Quiz Time!
Next Lesson
Lesson 4: Spotting Scams, Hype, and Bad Advice
The pond has foxes. Next lesson: pump-and-dumps, “guaranteed returns,” paid influencers, and the six-question smell test that keeps your money where it belongs.