How To Generate Income From Your Portfolio
The Dynamic Wealth Report
August 15, 2008
Do You Really Need To Own Bonds?
I’m biased. I’ll admit it. I’m not afraid to tell you that when it comes
to investing in bonds I’ve paid more attention to Barry Bonds than
investment grade bonds. Seriously, how could I not pay attention to the
disgraced baseball player? I lived in San Francisco for 10 years and I
went to Giant’s games all the time. I watched him hit home run after
home run.
He was the local star. It was exciting to see him out in the city at
restaurants and nightclubs . . . or just on the street. I’ll be the
first to admit, the guy had star power. He just exuded an enviable level
of confidence. And he was always surrounded by beautiful people, fans,
and the media. He brought a level of excitement with him wherever he
went.
It’s sad that he disgraced himself and the sport by (allegedly?) using
illegal performance enhancing drugs.
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But I’m not a sportswriter, and that’s another topic for another
day. What I wanted to discuss was the idea of bonds in your portfolio
(and I don’t mean Barry Bonds baseball cards). I wanted to challenge the
status quo. So I’m asking the question:
Do you really need to own bonds?
Just a reminder. I’m a bit biased when it comes to bonds. I’ve always
been an equity guy. Even during my banking career, the few bond deals I
did had significant equity components. So I’ve always been partial to
investing in equities, and only equities.
So before I answer the key question about bonds, I want to point out
something very important.
You can lose money in bonds. You can lose lots of money in bonds, and it
can happen very quickly. When investors talk about bonds they normally
discuss them as safe stable investments. However, the value of a bond is
adjusted against prevailing interest rates.
For example if you own a bond with a 5% interest rate and then rates
fall to 4% your bond will increase in value. Because you’re bond
pays a
higher rate of interest, other investors are willing to pay more for
your bond.
But the opposite is true as well.
If interest rates go up, the value of any bond you own will go down.
Now with bonds, a loss in value is only a loss if you sell. You
can always hold the bond and collect your stated interest payments up
until the maturity date.
Bonds are traditionally very stable.
They provide fixed rates of return for investors, which is great in
retirement. This is an important point for anyone hoping to retire –
which should be all of us. The markets gyrate and you can’t ever be
certain that you’ll be investing in a bear or bull market during
retirement.
This begs for some stability in cash flows. Normally, I’d focus on
individual stocks throwing off dividends. But even dividend paying
stocks have risks. A dividend can be reduced or eliminated.
For example, Pfizer's
(PFE) paid a dividend every quarter for more than 100 years, but many
now think the
dividend may soon be cut for the first time.
The obvious solution then is to be prepared to generate some income in
retirement from bonds.
The closer you get to retirement the more bonds you should own. But,
how much is enough? One simple rule of thumb - the percentage of
bonds in your portfolio should match your age. So, if you’re forty,
you should have 40% in bonds. If you’re 60 then 60%.
Nobody’s been able to answer my question of what to do when you hit 101?
But I digress.
There are a number of ways to invest in bonds, but this gets confusing.
Bonds have a wide variety of maturity rates, tax
consequences, call features, and in some cases, conversion features. I’m
sure at some point I’ll address these issues. But for now let me give
you the lazy way to investing in bonds.
Buy a few Bond ETFs.
You know me. I like to keep it simple with my investments. And iShares
is now offering a series of ETFs making it easy to invest in bonds.
These ETF's allow you to invest in bonds based on their maturities.
For example, they have funds focused on bonds that will mature in 1-3 years, 3-7 years, 7-10 years, 10-20
years, and 20+ years. It's a good idea to have a mixture of
short-term, intermediate-term, and long-term bonds in your portfolio for
diversification.
If you want to add bonds to your portfolio right now, take a look at the iShares
Lehman 1-3 year Treasury Bond Fund (SHY). It's
yielding around 3.53%. Longer-term bond funds may offer a higher yield, but
shorter-term bonds like these will hold their value better if interest rates
start to rise.
• Priceline.com
(PCLN) was upgraded to “buy” by Citigroup. The analyst gave the shares a target of $130.
• Bank of America downgraded two investment banks this week, Jefferies
Group (JEF) and Keefe, Bruyette & Woods (KBW). Both firms were moved
from Neutral to Sell.
• Jesup & Lamont initiated coverage on a number of companies in the
water industry including: American States Water (AWR),
American Water
(AWK), and Aqua America (WTR).
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