My first three blogs have focused on the things I like about bonds: predictability and durability. Believe me, I'm not alone in liking these qualities. The last couple of years has seen a stampede into bonds. People horrified by the losses they experienced in stocks have sought safety in bonds. In the process, though, they have triggered a wave of sell-side advice. Bonds, particularly bond funds, say many folks, have overreached. Prices have risen so drastically that there is no further upside. Since rising bond prices means lower yields (this is a constant of bonds, and you should run through the logic until you GET it), bond buyers are taking on very large risks for very small gains.
What do I think? Well, I pretty much agree. If you do what most folks are doing, which is to buy into bond funds, you are asking for trouble. I'll talk much more about bond funds in a future blog. For the time being, just know that I don't like them, and would strongly advise against them, now or pretty much ever. Any time that buying a bond fund would be a good idea is a time when buying individual bonds is a far better one. Period. Just an opinion, of course.
So, what's the knock on bonds? It relates to yield. Bonds often don't yield much, particularly in comparison to stocks (remember that squishy 9-10% figure the pundits cite?). Short term Treasuries (3, 6 and 12 month maturities) have ZERO yield, three years out is still only 1/2%. Even ten year maturities are a measly 2.65%. Only the thirty year treasury (3.875%) offers a shred of hope of meeting inflation and taxes. That's pretty bleak. You won't lose your principal, but its buying power will decline over time.
Corporate bonds are better, but still pretty chintzy over shorter time spans. A Goldman Sachs bond (A rated) will yield under 4% over four years. Not great, but it makes the government bond look sick. Take it out to 2037, and the GS yield is 7.2%. This yield increment over the treasury is the difference between making REAL money and breaking even. So, why not buy a long bond?
Well, the first risk relates to rising interest rates. As demonstrated in my last blog, an increase in rates will trigger a decline in the bond's market price. That's a problem if you need to sell, and a very good reason not to buy a bond if you have a short investment horizon. The second risk is worse: inflation. Right now, we have very low inflation, perhaps even a whiff of deflation. So, the 7.2% you can get by going long is pretty good. You can pay your taxes and still have a nice, real return. Should inflation flare up, though, that real return will decline by the amount of inflation. AND, the bond's price will fall as rates rise. You'll feel bad, and consider selling.
What to do, what to do? If you know the future, it's easy. That foreknowledge in 1980-82 or 2007-2008 would have led you to raise cash, and wait until rates rose to the stratosphere. Then you would have locked them in. In real life, though, nobody knows what's going to happen next. So, I would suggest a method. If you have money to invest, and a long-term bond rate looks attractive in comparison to present inflation, then buy some bonds to snag that yield. Don't bet the farm. If rates rise, don't panic. Buy some more, locking in that higher yield. Keep buying until rates have clearly peaked, then buy a lot, thus locking in near-peak yields. How do you know when rates have peaked? Well, they'll start going down. You'll miss the top, but will probably get in well before the bottom.
This approach presumes that you have money to invest, and will have more in the future. Part of that future money will, of course, come from the bonds you already own. The rest should, one hopes, come from saving part of your income.
Does this work? I'll talk about some analysis I've done of bond investing over various time periods. I think it's extremely interesting, and might put stock investing to shame.
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