Is it time to go big on bonds?
The 10-year Treasury yield popped above 2% in mid-February. It’s since slipped a little lower as investors dump stocks and run to the comparative safety of bonds.
Pushing through the 2% mark is noteworthy, given that yields stood at just 0.5% two years ago. But a 2% yield doesn’t go far when consumer price inflation runs at over 7% per year.
Bonds trading at a negative inflation-adjusted yield aren’t attractive investments. Plain and simple. Even if inflation drops back to more comfortable levels, bonds at sub-2% yield are guaranteed to lose purchasing power over time.
At the same time, it’s reckless to put all of your money in the stock market, particularly when prices are as high as they are today.
What’s an investor to do? To answer that, let’s get back to a basic question: What are bonds good for?
Most people think of bonds as income investments. (Income generation is one of the primary roles that bonds play in a portfolio.) Most bonds make coupon payments twice per year, which makes them an investment of choice for retirees.
But this benefit largely died off. A fixed coupon of less than 2% is not attractive enough right now. Maybe that’s where the second role of bonds comes into play: volatility reduction.
Even at today’s prices, bonds do a decent job reducing volatility. When investors dump risky assets, most stuff the proceeds into something perceived as safe, such as government bonds. So when stocks fall, bond prices rise, or, at least, they hold their ground.
I hate bonds at these prices and yields. We can’t 100% escape them, but in my opinion we can find substitutes for their core functions.
If retirement income is what you need, you can find attractive yields in dividend-paying stocks. Even moderate payers like PepsiCo offer a higher yield than government bonds.
And we can expect the payout to rise over time.
Dividends are also taxed at a better rate than bond interest in most cases.
I take an approach you’re not likely to hear from your financial planner. Rather than buy and hold bonds, why not put some of your portfolio to work in a short-term trading strategy that doesn’t depend on the market always going higher?
There are risks with any trading strategy, but in my view good risk management and sensible position sizing can offset a lot of this.
The fact is, there is no perfect solution in today’s market. We’re left to play the cards we’re dealt. But by incorporating dividend stocks and short-term trading strategies, we give ourselves a fighting chance to secure retirement income and hedge against a major decline in the market.
This post first appeared on March 1 on the Money & Markets blog.
Photo Credit: 401 (k) 2012 via Flickr Creative Commons
This piece is provided as educational information only and is not intended to provide investment or other advice. This material is not to be construed as a recommendation or solicitation to buy or sell any security, financial product, instrument, or to participate in any particular trading strategy.