Bond investing during low rates: independent financial advice
Posted by Don Martin on Mon, Jun 13, 2011 @ 01:32 PM
People worry that bonds don't pay enough to live off of without an investor drawing down his net worth during retirement. Even with that concern I recommend 100% bond portfolios.
The question is always raised about how to get a higher yield, etc. This is not the correct way to approach bond investing. The purpose of bond investing is to have a “sanctuary asset” to ride out the storm. This means giving up the chance to make a lucrative yield in junk bonds and instead accept a low rate of yield in low risk, high quality bonds. The idea is that eventually after QE2 has faded away that stocks P.E. will ratio revert to the mean and thus stocks will crash. Then it will be time to make a decision about reallocating to stocks.
Worried over shrinking bond yields?
If an investor needs more yield it would better to sell off and spend down a sliver of principal rather than gamble with junk bonds in hopes of living off of the high yield. Over the long run junk bonds actually provide a total return that is less than “A” paper bonds.
What fascinates me is when the investment conversation drifts to ideas like “since Treasuries pay 3% then one might as well own a quality stock that pays a 3% dividend”. This is wrong thinking because a stock is not a bond and stocks are 30% to 70% overpriced, thus a stockholder could lose 30% to 70% of principal while collecting a 3% dividend which can be cut at any time. Treasuries are free of state income tax, can be sold with minimal Broker-Dealer spread costs, and are non-callable.
During times when interest rates were very high the “real” inflation adjusted yield was often low and yet people had to pay tax on the entire coupon without adjusting for inflation, so during the 1970’s investors with a 12% coupons made less after-tax and after-inflation than they do today, in some cases. Example: If you earn 12% interest in the 1970’s and lost all of that to inflation at 12% and then paid 40% tax then you lost 4.8% a year. Today a 10 year Treasury at 3%, less 35% tax is about 2% after-tax yield, and some measures of inflation are about 1.5%, so the in some cases people may get a “real” return of 0.5% after-tax today.
I have written "Will rising rates kill bonds?"
My investment opinions can change suddenly. The economy can change suddenly.
Investors should seek independent financial advice.