I need some yield!
This is the battle cry of investors who have become frustrated with the low yields that the Fed’s zero interest rate policy has created.
This is the battle cry of investors who have become frustrated with the low yields that the Fed’s zero interest rate policy has created.
Indeed, last week saw the 10-year Treasury bond yields fall to near-record lows. This holding, the backbone U.S. bonds for most fixed-income investors, fell below a yield of 1.5 percent. And Federal Reserve chief Ben S. Bernanke gave rather dour testimony to Congress about his expectations for a weak economy in the near future.
The impact also was felt in equities, where, perversely, the bad news led to a stock rally. The traders’ assumptions — Yeah! The economy is getting worse! — was that more weakness will beget another round of quantitative easing. That excess liquidity has a tendency to goose stocks higher.
But it is in the bond market where some very odd things are occurring. Buyers of the 10-year Treasury are agreeing to lend Uncle Sam money for a decade and receive a piddling interest payment of 1.5 percent. That is barely above inflation in the depressed environment, where price rises have been modest. It is reasonable to expect higher inflation in the future, but when that will finally hit is anyone’s guess.
Given these low, low yields, perhaps it is time to revisit some of the basics about owning bonds, bond funds and ETFs (exchange-traded funds). We can also explore what alternatives exist regarding yield and generating income.
The most important thing you need to know about bonds is that they are essentially loans to some entity. As such, there are three main elements to any bond:
Quality: The credit worthiness of the borrower.
Duration: The length of the loan.
Yield: What the loan pays you in interest.
As is always the case in investing, there is no free lunch. If you want higher yield, you are either buying riskier bonds or lending money for a longer period of time (you can also use leverage, making a riskier investment even riskier).
There is something terribly disconcerting about so many people “discovering” bonds AFTER a 30-year bull run in fixed-income instruments.
My point of view on bonds as investments or income sources is simple. Here are five points to know:
1 Ladder: Owning individual bonds in a ladder — meaning a series of bonds that mature in successive years — is the correct way to own fixed income. By laddering bonds (2014-15-16-17, etc.), you are not tying up money for too long. If and when rates go up, you get to reinvest the specific holdings as they mature with higher yielding issues (note that if this happens, inflation is probably higher).
At present low rates, I prefer to keep my bond ladders to no longer than seven years. (This is much preferred to bond funds.)
The impact also was felt in equities, where, perversely, the bad news led to a stock rally. The traders’ assumptions — Yeah! The economy is getting worse! — was that more weakness will beget another round of quantitative easing. That excess liquidity has a tendency to goose stocks higher.
But it is in the bond market where some very odd things are occurring. Buyers of the 10-year Treasury are agreeing to lend Uncle Sam money for a decade and receive a piddling interest payment of 1.5 percent. That is barely above inflation in the depressed environment, where price rises have been modest. It is reasonable to expect higher inflation in the future, but when that will finally hit is anyone’s guess.
Given these low, low yields, perhaps it is time to revisit some of the basics about owning bonds, bond funds and ETFs (exchange-traded funds). We can also explore what alternatives exist regarding yield and generating income.
The most important thing you need to know about bonds is that they are essentially loans to some entity. As such, there are three main elements to any bond:
Quality: The credit worthiness of the borrower.
Duration: The length of the loan.
Yield: What the loan pays you in interest.
As is always the case in investing, there is no free lunch. If you want higher yield, you are either buying riskier bonds or lending money for a longer period of time (you can also use leverage, making a riskier investment even riskier).
There is something terribly disconcerting about so many people “discovering” bonds AFTER a 30-year bull run in fixed-income instruments.
My point of view on bonds as investments or income sources is simple. Here are five points to know:
1 Ladder: Owning individual bonds in a ladder — meaning a series of bonds that mature in successive years — is the correct way to own fixed income. By laddering bonds (2014-15-16-17, etc.), you are not tying up money for too long. If and when rates go up, you get to reinvest the specific holdings as they mature with higher yielding issues (note that if this happens, inflation is probably higher).
At present low rates, I prefer to keep my bond ladders to no longer than seven years. (This is much preferred to bond funds.)
by Barry Ritholtz, The Washington Post | Read more:
