My preference is for a lower use of bonds than the normal portfolio balancing strategies use. I just find the risks greater than the benefits. This preference increases as yields decline. Given the historically low interest rates we have been experiencing the last few years (and low yields even for close to a decade) I really believe bonds are not a good investment. Now for someone approaching or in retirement I do think some bonds are probably wise to balance the portfolio (or CDs). But I would limit maturities/duration to 2 or 3 years. And really I would pursue high yielding stocks much more than normal.
In general I like high yielding stocks for retirement portfolios. Many are very good long term investments overall and I prefer to put a portion of the portfolio others would place in bonds in high yielding stocks. Unfortunately 401(k) [and 403(b)] retirement accounts often don’t offer an option to do this. Luckily IRAs give you the options to invest as you chose and by placing your IRA in a brokerage account you can use this strategy. In a limited investing option retirement account [such as a 401(k)] look for short term bond funds, inflation protected bonds and real estate funds – but you have to evaluate if those funds are good – high expenses will destroy the reasons to invest in bond funds.
There are actually quite a few attractive high yield stocks now. I would strive for a very large amount of diversity in high yield stocks that are meant to take a portion of the bonds place in a balanced portfolio. In the portion of the portfolio aimed at capital appreciation I think too much emphasis is placed on “risk” (more concentration is fine in my opinion – if you believe you have a good risk reward potential). But truthfully most people are better off being more diversified but those that really spend the time (it takes a lot of time and experience to invest well) can take on more risk.
A huge advantage of dividends stocks is they often increase the dividend over time. And this is one of the keys to evaluate when selected these stock investments. So you can buy a stock that pays a 4% yield today and 5 years down the road you might be getting 5.5% yield (based on increased dividend payouts and your original purchase price). Look for a track record of increasing dividends historically. And the likelihood of continuing to do so (this is obviously the tricky part). One good value to look at is the dividend payout rate (dividend/earnings). A relatively low payout (for the industry – using an industry benchmark is helpful given the different requirement for investing in the business by industry) gives you protection against downturns (as does the past history of increasing payouts). It also provides the potential for outsized increases in the future.
There are a number of stocks that look good in this category to me now. ONEOK Partners LP pays a dividend of 5.5% an extremely high rate. They historically have increased the dividend. They are a limited partnership which are a strange beast not quite a corporation and you really need to read up and understand the risks with such investments. ONEOK is involved in the transportation and storage of natural gas. I would limit the exposure of the portfolio to limited partnerships (master limited partnerships). They announced today that the are forecasting a 20% increase in 2012 earnings so the stock will likely go up (and the yield go down – it is up 3.4% in after hours trading).
Another stock I like in this are is Abbott, a very diversified company in the health care field. This stock yields 3.8% and has good potential to grow. That along with a 3.8% yield (much higher than bond yields, is very attractive).
My 12 stocks for 10 year portfolio holds a couple investments in this category: Intel, Pfizer and PetroChina. Intel yields 3.9% and has good growth prospects though it also has the risk of deteriorating margins. There margins have remains extremely high for a long time. Maybe it can continue but maybe not. Pfizer yeilds 4.6% today which is a very nice yield. At this time, I think I prefer Abbott but given the desire for more diversification in this portion of the portfolio both would be good holdings. Petro China yields 4% today.
When invested in a retirement portfolio prior to retirement I would probably just set up automatic reinvesting of the dividends. Once in retirement as income is needed then you can start talking the dividends as cash, to provide income to pay living expenses. I would certainly suggest more than 10 stocks for this portion of a portfolio and an investor needs to to educate themselves evaluate the risks and value of their investments or hire someone who they trust to do so.
Related: Retirement Savings Allocation for 2010 – S&P 500 Dividend Yield Tops Bond Yield: First Time Since 1958 – 10 Stocks for Income Investors
The fundamental truth right now is that the overall economy in Europe, the USA and Japan is weak and has some serious long term problems. But the connection between that and company weakness is not incredibly strong. Many companies have huge cash hoards, built up through the large profits they continue to make. Yes, the economy entering a serious downturn will hurt many companies. A railroad is going to lose some sales if retail sales decline (and so they don’t have to be shipped). Airlines (historically problematic companies to begin will) will struggle. Banks that pay exorbitant amounts to senior staff have trouble making money without handouts of taking huge risks that then result in more handouts once the risks fail (as usually a bad economy will expose the risks they have taken). Companies that can only do well based on large top line growth will suffer. But that isn’t all companies.
When you look at companies like Google, Apple, Tesco, Danaher, Amazon even Toyota I really don’t see many problems looking forward. They seem perfectly capable of staying profitable, even growing profits, even in the face of economic decline in Europe, the USA and Japan (if that happens: it is possible, but not certain – very low growth is possible). Companies that have very good prospects at staying profitable, even getting more profitable going forward are hardly the type of investment I want to sell. Especially not to put it in the bank and get 0%, or a money market fund and pay someone for the privilege of having my money.
The options for investing today don’t look so great. But I really don’t see any reason to be concerned about owning stocks that have good prospects to do well even if the quite a few large economies do poorly in the next decade. In fact I am happy to own them. Frankly the biggest worry I have is that the senior executives will loot the owners profits with exorbitant pay (this is not a worry at Toyota and less of one at Amazon). I would worry more about owning index funds in such an environment. But even as bad as things look now, I am not sure they will really turn out as bad as we fear – especially for many companies, for some yes, but many are well prepared for change).
And the prospects in emerging markets look incredibly good to me. Yes they will slow their growth a bit if the large economies stall, but I think it is foolish to avoid investments in China, Singapore, Brazil, Korea, India, Ghana, Malaysia, Indonesia. In fact that is where companies like Google, Tesco, Apple, Toyota and Amazon are going to be making lots of money. Emerging markets are volatile and the companies in them are too. This will continue.
Read more
His point on dollar cost averaging is sensible. Markets go up, more than down, overall [the statistically best approach] if you have a lump sum to invest the best strategy would be to invest it all now. There is added risk with this however, which he would accept. Also it doesn’t change the main reason people end up dollar cost averaging (by default, with retirement savings from each paycheck).
He discusses these ideas, and many more in his book: Debunkery: Learn It, Do It, and Profit from It-Seeing Through Wall Street’s Money-Killing Myths.
Related: Curious Cat investment books – Investment Risk Should be Evaluated as Part of a Portfolio, Rather than Risk of Each Individual Investment – Save Some of Each Raise
This is another article supporting my belief that long term bonds are not investments I want to take on now. The risks of inflation and low yields seem like a very bad combination.
Buffett Says Avoid Long-Term Bonds Tied to Eroding Dollar, quoting Warren Buffett:
…
“I would much rather own businesses,” he said. “It’s very easy to take away the value of fixed-dollar investments.”
By “take away” he mean the government can undertake policies to “inflate” their way out of a budget mess. By undertaking policies that create inflation (drastically increasing the money supply, borrowing huge amounts of money, running huge trade deficits…) the country can devalue the currency, the US dollar in this case, and thus reduce the effective cost of the payments they have to make on long term bonds (because they pay back the loans with devalued, inflated, dollars). I believe he is right and long term USD bonds are a very risky (inflation risk) investing option today. Of course I have felt the same way for the last 5 years. I own very little in the way of bonds – I do own a bit of TIPS (Treasury Inflation-Protected Securities), in my 401(k) – but stopped allocating money to that class in the last year.
Related: Bill Gross Warns Bond Investors (March 2010) – Bond Yields Stay Very Low, Treasury Yields Drop Even More – Who Will Buy All the USA’s Debt?
The biggest investing failing is not saving any money – so failing to invest. But once people actually save the next biggest issue I see is people confusing the investment risk of one investment in isolation from the investment risk of that investment within their portfolio.
It is not less risky to have your entire retirement in treasury bills than to have a portfolio of stocks, bonds, international stocks, treasury bills, REITs… This is because their are not just risk of an investment declining in value. There are inflation risks, taxation risks… In addition, right now markets are extremely distorted due to the years of bailouts to large banks by the central banks (where they are artificially keeping short term rates extremely low passing benefits to investment bankers and penalizing individual investors in treasury bills and other short term debt instruments). There is also safety (for long term investments – 10, 20, 30… years) in achieving higher returns to gain additional assets – increased savings provide additional safety.
Yes, developing markets are volatile and will go up and down a lot. No, it is not risky to put 5% of your retirement account in such investments if you have 0% now. I think it is much riskier to not have any real developing market exposure (granted even just having an S&P 500 index fund you have some – because lots of those companies are going to make a great deal in developing markets over the next 20 years).
I believe treating very long term investments (20, 30, 40… years) as though the month to month or even year to year volatility were of much interest leads people to invest far too conservatively and exacerbates the problem of not saving enough.
Now as the investment horizon shrinks it is increasing import to look at moving some of the portfolio into assets that are very stable (treasury bills, bank savings account…). Having 5 years of spending in such assets makes great sense to me. And the whole portfolio should be shifted to have a higher emphasis on preservation of capital and income (I like dividends stocks that have historically increased dividends yearly and are likely to continue). And the same time, even when you are retired, if you saved properly, a big part of your portfolio should still include assets that will be volatile and have good prospects for long term appreciation.
Related: books on investing – Where to Invest for Yield Today – Lazy Portfolios Seven-year Winning Streak (2009) – Fed Continues Wall Street Welfare (2008), now bankers pay themselves huge bonuses because the Fed transferred investment returns to too-big-to-fail-banks from retirees, and others, investing in t-bills.
Municipal bonds seem safe. But the incredible long period of irresponsible spending and taking on long term liabilities (pensions, health care costs, infrastructure to maintain) and low taxes and selling off future income streams (to consume today) leaves those bonds with questionable financial backing in many locations. Municipal bond investments should be examined more closely today in light of the problems in the market.
Video shows the State Budgets: The Day of Reckoning by 60 minutes.
Wave of Muni Defaults to Spur Layoffs, Social Unrest: Whitney
Muni experts, including an analyst from Standard & Poor’s, dismissed her predictions, saying the numbers don’t add up.
…
“States clearly have been funding municipal governments—for now up to 40 percent of their total expenditures,” she explained. “As the states become more compromised from a fiscal standpoint, that funding is going to end.”
…
Whitney added that it’s way too soon to see muni bonds as a buying opportunity. But she said that can change quickly.
“When you start to see the first major defaults in this area [the states and cities], when you see more defaults and indiscriminate selling—if you do your research now and figure out who’s protected where and which revenues are protected, there will be great buying opportunities,” Whitney said.
“People are complacent about these defaults. The news about all this isn’t out there yet,” Whitney went on to say. “And only when it is out there, then there will be a buying opportunity [for munis].”
Related: USA State Governments Have $1,000,000,000,000 in Unfunded Retirement Obligations – NY State Raises Pension Age to Save $48 Billion – What the Bailout and Stimulus Are and Are Not – posts on bonds
Chart showing corporate and government bond yields from 2005-2010 by Curious Cat Investing Economics Blog, Creative Commons Attribution, data from the Federal Reserve.Bond yields have dropped even lower over the last 6 months, dramatically so for treasury bonds. 10 year Aaa corporate bonds yields have decreased 61 basis points to 4.68%. 10 year Baa yields have decreased 53 basis points to 5.72%. 10 year USA treasury bonds have decreased an amazing 169 basis points to a incredibly low yield of %2.54. The federal funds rate remains under .25%.
The Fed continues to try and discourage saving and encourage spending by punishing savers with policies to drive interest rates far below what the market alone would set. Partially this is a continuation of their subsidy to the large banks that caused the credit crisis. And partially it is an attempt to find a way to encourage spending to try and build job creation in the economy. The Fed announced they are taking huge steps to purchase $600 billion more bonds in an attempt to lower rates even further (much of the impact has been priced into the market as they have been saying they will take this action – but the size is larger than the consensus expectation). I do not think this is a sensible move.
Savers do not have many good options for safely investing retirement assets for a reasonable income. The best options are probably to hold short term bonds and money markets and hope that the Fed finally stops making things so difficult for them. But that will take awhile. I think investing in medium or long term bonds (over 4 years) is crazy at these rates (especially government bonds – unless you are a large bank that can get essentially free money from the Fed to then loan the government and make a profit). Dividends stocks may be a good alternative for some more yield (but this needs to be done carefully to not take unwise risks). And I think you to look at investing overseas because these fiscal policies are just too damaging to savers to continue to just wait for a decent rate of return in bonds in the USA. But there are not many good options. TIPS, inflation protected bonds, are another option to consider (mainly as a less bad, of bad choices).
It is a great time to take on debt however (as often is the case, there are benefits and costs to economic conditions). If you have a mortgage, and can qualify, or are looking to buy a home, mortgage rates are amazingly low.
Related: Bond Rates Remain Low, Little Change in Last 6 Months (April 2010) – Bond Yields Change Little Over Previous Months (December 2009) – Chart Shows Wild Swings in Bond Yields in Late 2008 – Government Debt as Percentage of GDP 1990-2009 in USA, Japan, Germany, China…
Dividends Beating Bond Yields by Most in 15 Years
Kraft Foods Inc. and DuPont Co. are among 68 companies in the Standard & Poor’s 500 Index with payouts that top the 3.78 percent average rate in credit markets, based on data since 1995 compiled by Bloomberg and Bank of America Corp. While Johnson & Johnson sold 10-year debt at a record low interest rate of 2.95 percent last month, shares of the world’s largest health products maker pay 3.66 percent.
The combination of record-low interest rates, potential profit growth of 36 percent this year and a slowing economy has forced investors into the relative value reversal. For John Carey of Pioneer Investment Management and Federated Investors Inc.’s Linda Duessel, whose firms oversee $566 billion, it means stocks are cheap after companies raised payouts by 6.8 percent in the second quarter
…
S&P 500 companies’ cash probably has grown to a record for a seventh straight quarter, according to S&P. For companies that reported so far, balances increased to $824.8 billion in the period ended June 30 from the first three months of the year, based on data from the New York-based firm.
Cash represents 10.2 percent of total assets at S&P 500 companies, excluding banks and financial firms, according to data compiled by Bloomberg. That’s higher than the 9.5 percent at the end of the second quarter last year, 8.4 percent in 2008 and 7.95 percent in 2007.
“The economy is slowing down, but productivity has been so great in this country and companies have been able to make good profits,”
10-year Treasury note yields were as low as 2.42% last month. The combination of continued extraordinarily low interest rates and good earnings increase this odd situation where dividends increase and interest yields fall. Extremely low yields aimed at by the Fed continue to aid banks and those that caused the credit crisis a huge deal and harm investors.
Money markets and bonds are not attractive places to invest now. Putting money in those places is still necessary for diversification (and as a safety net – especially in cases like 401-k plans where options are often very limited). Seeking out solid companies with strong long term prospects that pay reasonable dividends is a very sensible strategy today.
Related: Where to Invest for Yield Today – S&P 500 Dividend Yield Tops Bond Yield: First Time Since 1958 – 10 Stocks for Income Investors – Bond Yields Show Dramatic Increase in Investor Confidence (Aug 2009)
U.S. Investors Regain Majority Holding of Treasuries
Mutual funds, households and banks have boosted the domestic share of the $8.18 trillion in tradable U.S. debt to 50.2 percent as of May, according to the most recent Treasury Department data.
…
The biggest jump in demand this year among domestic buyers of Treasuries has been commercial lenders. Bank holdings of Treasury and agency securities increased 5 percent to $1.57 trillion last month, according to the latest data available from the Fed.
…
The Fed’s decision to hold its target for the overnight lending rate at a record low has made it possible for banks to borrow at near-zero interest rates to finance purchases of longer-term and higher-yielding Treasuries while lending less.
I must say, unless you are getting special government interest free loans to invest in treasuries (like those that caused the credit crisis are) it seems crazy to me to invest at these low rates. In retirement, it probably does make sense to have some just as a diversification measure but other than that I would certainly reduce my holdings from what they would have been 10 years ago.
If politicians or the fed would just give special favors to me to borrow billions and essentially 0% and then lend it back for more I would take that deal.
But if I am not granted the welfare Chase, Goldman Sachs, Citibank and the rest are (with huge amounts of free money and bailouts if their bets fail) buying extremely low yield government debt is not an investment I want. I don’t think betting on deflation is not a bet I want to take. Inflation seems a bigger risk to me. But people get to make their own decisions, and we will see which investors are right.
Related: Paying Back Direct Cash from Taxpayers Does not Excuse Bank Misdeeds – Can Bankers Avoid Taking Responsibility Again? – What the Financial Sector Did to Us
Buffett Expects “Terrible Problem” for Municipal Debt
Berkshire’s investment portfolio included municipal bonds valued at less than $3.9 billion as of March 31, down from more than $4.7 billion at the end of 2008. The company had a maximum of $16 billion at risk in derivatives tied to such debt, according to the company’s annual report for 2009.
…
Buffett said last month that the U.S. may feel compelled to rescue a state facing default after the government committed $700 billion to bail out financial firms and automakers. “It would be hard in the end for the federal government to turn away a state having extreme financial difficulty when they’ve gone to General Motors and other entities and saved them,”
…
About $14.5 billion of municipal bonds defaulted in 2008 and 2009… Many those were securities backed by revenue from nursing homes, property developments and other projects without claim to government tax revenue.
…
Defaults by local governments with the power to raise taxes are less common. Jefferson County, Alabama, defaulted on more than $3 billion of bonds backed by sewer fees after the deals grew more costly in the wake of the credit crisis in 2008. Vallejo, California, filed for bankruptcy in 2008 after its tax revenue tumbled.
Related: USA State Governments Have $1,000,000,000,000 in Unfunded Retirement Obligations – Buffett on Need to Reduce Government Deficits – Politicians Again Raising Taxes On Your Children