EPS 21 - Bond Basics: Credit, Risk, and the U.S. Debt Ceiling

In this episode, Jerry clears up a mix-up from the last release (where the wrong audio played about gold instead of bonds) and dives into the U.S. debt ceiling and how it ties directly into bonds and credit ratings.

Jerry explains the debt ceiling in everyday terms—like paying off a credit card—and why a U.S. default would affect ordinary people, including Social Security recipients. He then connects this to bond investing, showing how credit ratings work for both individuals and countries, why high ratings keep borrowing costs lower, and why downgrades (like the U.S. experienced in 2011) matter.

Listeners also get a practical walkthrough of:

• How bond ratings are structured (AAA, AA, A, BBB… down to junk).
• The three major credit rating agencies (S&P, Moody’s, Fitch) and why their grades carry weight.
• The role of bonds in a diversified portfolio, including income, risk balancing, and tools like bond ladders.
• Real-world examples—like Wachovia’s collapse in 2008—to show how bond risk plays out.
• Differences between U.S. Treasuries, corporate bonds, and municipal bonds, along with how taxation works.

The episode wraps with a reminder that bonds are not “risk-free” but remain a powerful tool for stability, income, and diversification—if you understand their basics and risks.

💬 Have a question or comment? Contact Jerry here

Transcript

UNKNOWN: 0:01

So,

SPEAKER_00: 1:06

This is Jerry. Welcome to the Pink Money Podcast, where we talk about all things related to money from a gay perspective. And first off, I guess I just want to apologize to those who listened to my Bond Basics podcast that I put out. And I didn't realize that when you listened to it, it was actually talking about investing in gold. So that was definitely my mistake. Big thanks to everybody who pointed that out to me. Technology is not always my friend, and that was proven very dramatically last week when, again, I was made aware that gold was the topic for bond investing, which it's not. So here we go again. So really what I'm talking about here is what you keep hearing currently all over the news today about the U.S. debt ceiling. So this is just... constantly being discussed and you may or may not really care um about it a whole bunch uh i mean like even my mom i think she has a bare bones basic understanding of it but to her what really matters is as i would mention to her is if the u.s were to default on its debt obligations then that would potentially impact her social security check meaning she won't get it So in a very basic sense, the U.S. debt ceiling is just saying, hey, you know what, we've incurred this debt, Congress needs to authorize the money, basically write a check for it, as if when your credit card payment comes due, then you write a check and pay it off. So in this case, the U.S. needs to do just that. If they don't, then they go into default just like you would if you didn't make your credit card payment. So... What that really means is, again, this is just something that should be a no-brainer. It's not something that's debated back and forth by anybody. It should be just, this is what we do. Nevertheless, it's coupled right now with spending, and the Republicans are saying, hey, you know what? We're not going to authorize the money to pay that bill if we don't create a new budget that focuses on spending. Although the two don't really have anything to do with each other, it's just saying this is a tactic that they're using in order to create leverage so that they can get an agreement by the Democrats and the White House to increase the debt ceiling so we can pay the debt. So that's just it in a nutshell. If you want to learn more about it, of course, you can go online. What this really means in terms of how it relates to bonds is that by not paying your debt, that it affects the U.S. credit rating. So just like if you didn't pay your debt and you started to default on your credit card payments, your car payment, etc., then your credit rating will go down. So currently 850 is like the best score that you could really have in terms of a credit rating. And it goes all the way down to fives and four hundreds. You know, maybe I think it's about 20, a little over 20% of the U S population has a credit score over 800. And I think it's like maybe 16% or so that people have negative credit and everybody else falls somewhere in the middle. But the credit rating of a country is important, just like the credit rating that a corporation has. That's important as well. And the reason that it's important is because, just like you, the higher credit rating you have, then the lower interest rate you will pay. So if you take out a loan, you want to buy a car, or you want to borrow some money from the bank, the higher your credit rating is, then the lower risk the bank assumes you are, and the better, more favorable terms that are going to extend to you. Similarly with an organization, whether it's the U.S. government or a corporation, the higher their credit rating is, then the investors who buy their bonds will typically... demand or accept a lower interest rate because there's lower risk. The riskier the asset or the security is, then the higher the interest rate is demanded by the investors because there's a greater chance of risk or default. So high risk, high interest rates, low risk, low interest rates. So if I was an investor, It depends on the level of risk I was willing to accept. So if I wanted essentially no risk, I would either buy something like a certificate deposit, right? They're most often FDIC insured, and there's no risk. What the money you put in is the money you get out, and you just receive the interest, okay? If you buy a bond, then there is essentially... some element of risk because there's no 100% guarantee that this entity will give you your money back. Now, if you're buying a U.S. security, you know, a treasury bill, note, bond, et cetera, then you are saying, hey, I trust the United States to give me my money back. I don't really think there's a whole lot of risk. But if you say that, then you would want to check the credit rating of the U.S., Just like if you wanted to invest in a corporation and you were unsure of its credit risk, you would do your research and determine what the credit rating is of that entity or that particular bond. And then, again, you make your decision. So when we're talking about the U.S. as an entity that has a credit rating, there are really three different credit rating entities involved. I throw in a fourth one that there is Fitch's, S&P, and Moody's, along with Weiss, which I throw in as the fourth one. But the three biggies are S&P, Moody's, and Fitch. So they are the big players out there. They really set the creditworthiness of the institutions. And They use their analysts to decide what the appropriate credit rating is. Most countries, corporations are very protective of their credit rating because it's significant, right? And nobody really wants to pay more in terms of an entity more interest than you have to. You just want to pay, you know, a good interest rate that will entice investors, but you don't really want to pay more than you have to. So, If it's a government, believe it or not, there's just a handful of countries that have a AAA rating. Because ratings by these three entities are rated AAA, which is the highest, AA, single A, triple B, double B, B, and so on. So anything that's... above a b minus is considered investment grade meaning that investors really feel no qualms about investing the chance of default is very low so default is low risk is low most investors will buy it if it's below that then that's non-investment grade or what you call junk bonds and then there is a greater element to risk a greater chance of default higher interest rates are paid so You can buy bonds direct from a corporation or the government, the U.S. government. You can go on U.S. Treasury direct and buy, you know, savings bonds, T-bills, you know, what have you. That's up to you. If you wanted to buy a corporate bond, you could go sometimes to the corporation itself, and you may be able to buy the bond direct if you, whatever reason, decide. You chose that path. But in your brokerage account, then you could buy bonds and hold a bunch of bonds individually in your brokerage account, just like you would own a bunch of stocks. You go out and you decide, hey, I like this company. I'm going to buy their stock. And you can buy a single share, 100 shares, thousands of shares, you know, whatever. Similarly with bonds, you can buy a single bond, a bunch of bonds, you know. Long-term bonds, short-term bonds, et cetera. And you can build your own bond portfolio if you want. And that's just strictly up to you. If you don't really have the desire to go out, do all that research, and build your own bond portfolio, et cetera, then, hey, just buy a mutual fund or an ETF and go about your business. There's long-term bond funds, short-term bond funds, intermediate-term bond funds, municipal bond funds, you name it. And again, the portfolio manager does all that for you and you just put your money in there and you just pay, you know, the expense ratio, not really, you know, seen by you per se, it's just built in. So it just really depends. But let's just say again that you're looking for something that is relatively risk-free, then you would be just looking at a handful of countries. So right now, from my understanding, basically, There's very few countries that have a AAA rating. Australia, Denmark, Germany, the Netherlands, Norway, Singapore, Switzerland, and Luxembourg. The U.S. and Canada used to have AAA ratings, but now they're a notch below that, so they no longer have a AAA rating. And Fitch, I believe, is on the verge of downgrading the U.S. from their AAA rating bond rating, AAA credit rating. They have a negative watch right now in the U.S. because of the potential of the U.S. defaulting unless the Congress, the powers that be, come together and resolve this thing. So it's just saying that it's a negative thing if you lose your AAA rating just like you lose your 850 score. Maybe you're really proud of that and you get downgraded. That would be something that you might... wince about because you know you worked hard to get there so nevertheless um each entity doesn't use a strict you know aaa double a you know single a you know each of them have just slightly different it could be a plus a minus you know etc ab what have you each of them are just slightly different but in general terms you know triple a double a single a etc so The U.S. credit rating, again, was downgraded in 2011 by S&P. It was the first time it ever, ever happened and has not been upgraded by S&P since then. So by U.S. losing another AAA rating by Fitch's, you know, that's just, again, a pretty negative thing. The reason, again, it's negative is because the U.S. has always been kind of the gold standard, and it's always been thought of as risk-free because we have a taxing authority, and the U.S. has just never defaulted. So investors often just put their money in the U.S. because they have full faith that the U.S. will pony up the money to pay their debt, and there should be no reason that the U.S. wouldn't. So I know that when you do certain calculations and you're looking for, in terms of a comparison purposes, a risk-free rate, then usually like a three-month T-bill will be used as a means to substitute for a risk-free rate. Now, who knows what would happen if that, again, were to change. I don't know what you would use. I guess some corporate bond, if there's really any. Because right now, in terms of a AAA rating, by the agencies for corporations. I believe there's only two right now, which is Microsoft and Johnson& Johnson. Even Apple doesn't have a AAA credit rating. So, again, you're in a rarefied company if you have a AAA rating, and I would think it'd be very important by the legislatures, both sides of the House, the Senate, and the Congress, House of Representatives, along with the White House, you know, to get their act together and resolve this. But that aside, when we're talking about bonds again, you can buy all kinds of bonds because entities are issuing bonds all the times, all the times. The entities are issuing bonds all the time. It can be for whatever reason. Let's say if it's a corporation or and they want to, I don't know, build a new building. So they could go to a bank and they could borrow from them, right? They could do that. Or if they don't want to do that, then they can just issue some bonds. It may be a cheaper option for them and, you know, less risk. So, you know, Who knows? That can be an option that they might exercise. If it's a municipality, let's say wherever you live, they need to do some road work, then they could issue bonds and you could buy muni bonds. There's also tax-exempt bonds that exist out there that are exempt from federal income taxes, and oftentimes people use that. Investors will use that as a way to hold a bond, but they don't want to pay any more taxes than they have to because, in a general sense, interest that you receive from bonds is taxable. It's usually taxable at the federal level as well as the state. Some cities tax it as well. It just really depends on where you live. Or you could buy tax-exempt bonds. Now, would you hold a tax-exempt bond in an IRA? No. No, it doesn't make sense, right? You're already getting tax-deferred growth on the growth of your security, any interest that's paid, any dividends are paid on your stocks. That's all deferred until you... And I'm talking about a traditional IRA. That's all deferred until you take it out. And a Roth IRA, again, it's all deferred as well until you reach that 59 and a half and it's in there at least five years and then everything comes out completely tax-free. So... no tax-deferred bonds are going to be held in your IRA. They would just be held outside of your IRA in your regular brokerage account. So interest in that sense, too, it just really depends. If you buy U.S. government bonds, then those are exempt from state taxes. You would pay federal taxes... on the interest you receive, but you don't pay state taxes. Conversely, you buy your municipal bond from your local entity It's subject to state taxes, but exempt from federal income taxes. Just a reciprocal agreement that they have in place. So it really just depends on, again, if that's meaningful, significant to you. There's a wide variety of ways. Again, you can go about buying tax-exempt bonds if you want to. Even you can buy them within your own state. Let's say you live in New York and you want to buy New York bonds. Then oftentimes they're exempt from state, city, taxes. So that can be attractive to you because the state wants you to buy bonds for whatever projects they're working on. And again, they have that reciprocal agreement. So, you know, you would just pay federal taxes. So it just really depends. So in the sense that bonds are in your portfolio, why would you buy a bond? The reason you'd buy a bond is because you want to receive the interest. You want to either have a low risk fixed income security or high risk income security or everything in between. So some people like bonds for the fact that, again, in a general sense, stocks go up, bonds go down, vice versa. So people like them in their portfolio to balance out their equity portfolio, their stock portfolio. So in that portfolio that you're building, or, again, however you want to do it, 60-40, again, it's just a very, very common, moderate, moderately aggressive portfolio. And the bonds, consider, are the 40% that would be in your portfolio. So those bonds are in there doing their thing, kind of acting as a counterweight to your stocks, and People, again, like the bonds because not only do they pay interest, which is attractive, some people live off that interest and they will supplement their income with bond interest. So if the bond is paying, I don't know, let's just say it's a five-year bond, then you're going to get that interest for five years. Then when the bond is due, then you get your money back. So What happens to your income? It goes away. So you've got to buy another bond. That's why sometimes people will create a bond ladder so that they have maturities that are staggered so they continue to receive that income that they kind of rely on and depend. Again, wide variety of ways to get you there. You know, you probably if you don't want to do it yourself, work with your financial advisor, you know, to create the right strategies so that you can receive that income. Now, bonds certainly are not without their level of risk. I think I've told the story before, but I guess it bears worth repeating right now. I know that When we went through the financial crisis of 2008, I remember speaking with a woman who she received her monthly income from her Wachovia bonds. So she just lived on that income, et cetera, et cetera. She came to rely on it. I know that we tried to get her to diversify. She wouldn't. And then lo and behold, what happened to Wachovia? It went bye-bye. No more Wachovia, no more bonds, no more interest, gone. Good reason, again, to diversify your portfolio. When might another 2008 happen? I don't know. You know, typically every 10 years or so, we have a major significant event. You know, they call it a black swan, a rare, hard to predict event. So they can happen really at any time, but hard to know when, but they do happen all the time. So all I'm saying is the bonds are helpful in your portfolio. You may want to consider them. You can buy them direct through the U.S. government or you can buy them direct through corporations. Depends on how much risk you're willing to accept. High risk, no risk, some risk that you just invest accordingly. Bonds vary in duration. Long duration, short duration, etc. And duration is also a measure of a bond's risk. Something I'm not going to go into in a great depth right now, but I'll probably talk about a little bit later. So... I think pretty much I'm going to leave it right here with my bond basics and debt ceiling. Hopefully this will get resolved and we'll go back to having a very high credit rating or maintain our current credit rating and it won't go any lower and we won't default on any of our obligations because the default would carry a significant amount of risk and create a lot of chaos. So let's just hope that never happens. Anyway... I'm going to stop there. Hope you guys have a great day, and we will talk to you later.