Bonds – Are They Right For My Retirement Income?

November 28, 2009 by  
Filed under Bonds Articles

To know if bonds might be right for your retirement planning, you should first understand a few basic things about them.

The majority of people know very little if anything about bonds. In fact, as Robert Kiyosaki mentions many times in his Rich Dad books, most people don’t know the difference between stocks and bonds. They are very different.

When you buy stock you are technically a part owner of that company – or at least a stock holder. You own equity in the company. That is why stocks are also known as equities.

When you buy a bond you are actually loaning your money out to the company or government who issued the bond. Instead of going to a bank and borrowing money, companies and governments issue bonds. So bonds are debt instruments. They are like IOUs.

When a company is considered a high-risk outfit (many times because of a poor credit rating or they are overextended -with too many loans) their bonds are often called “Junk” bonds.

The federal government of the US has probably issued more bonds and T-bills (which is just another form of bond) than anyone else! That is why you will hear that the US is in debt to China. The US did not actually go over to China and borrow money, but China did invest in US bonds and T-Bills. So in effect, they are loaning money to the US when they buy those bonds (and you are too, any time you buy “Savings” bonds – or any other type of US bond).

Since a bond is a type of loan, there is interest paid on that loan. Its interest payment is known as a “coupon.” You may have heard of “Zero Coupon” bonds? Zero coupons are bonds that don’t pay interest payments as you go, but pay it out at the end of the term of the bond. Investors buy zero coupon bonds at deep discounts from the face value, which is the amount a bond will be worth when it “matures” or comes due.

When a zero coupon bond matures, the investor will receive a lump sum equal to the initial investment plus the interest. In other words, the bond was purchased at a discounted face value (similar to savings bonds).

State and local governments also issue bonds. You may have heard of a bond issue to help build a school or some other government building in your area. Those who buy the bonds are actually lending money for the project.

So, should bonds be in your retirement portfolio? I would answer yes. At least a small portion of your nest egg should be in bonds. The closer you are to retirement age, the less risky type of bond you should want (no junk) in your portfolio. You may also want more bonds the closer you get.

You might also take a look at some bond funds or better yet, some bond ETFs. Let experts handle the actual bond picking for you, while you relax with a well balanced retirement portfolio!

Forget day trading stocks and learn how to trade the mini index!

Tax-Free and Treasury Bonds – Good Investments?

November 27, 2009 by  
Filed under Bonds Articles

Tax-free municipal bonds and Treasury bonds are generally for investors with money who want income. Municipal bonds offer interest that is exempt from federal income taxes, while U.S. Treasury bonds are the safest long term debt issues in the world. Whether either are good investments for you all depends on the circumstances.

Sometimes the world of investing gets turned upside down. In 2009 this was the case, in my opinion. If you wanted to earn any kind of interest on your money, you had to turn to bonds. Interest rates were in the gutter and the government intended to keep them there so the economy could recover. Meanwhile some investors were unknowingly putting money at risk by investing in Treasury bonds and municipal bonds. After all, they are good investments aren’t they?

Normally, safe short-term investments pay less interest than their longer-term counterparts. By 2009 this had gone to an extreme. Money invested for the short term was paying virtually nothing. Interest rates were at historical lows, with 30-year Treasury bonds yielding less than 4.5%. That’s a unique set of circumstances the investor should take into consideration.

Would a municipal bond (municipal or muni) and/or a Treasury bond (Treasury) be good investments for YOU? That’s another set of circumstances you need to consider. Older folks with a lump some of cash in search of higher income might consider them. Young people in search of growth have better alternatives. For example, stocks and higher yielding but riskier corporate bond issues.

Then, there’s the question of how comfortable you would be selecting, purchasing and holding an individual municipal bond issue, for example. You can buy a muni or a Treasury bond through a broker; and you can buy a Treasury bond directly from the U.S. Treasury. Most investors I’ve known would rather own a small part of a large managed portfolio of these securities and let professional managers deal with the details.

The simplest way to do that is with a bond fund. Some specialize in Treasuries and others in municipals. If you go this route like most average investors do, pick a bond fund with low expenses. Interest rates are low enough without diluting your income with high expenses.

The advantage of municipals is that the interest income is exempt from federal income tax, tax-free. Normally munis pay lower interest than taxable issues for this reason. Check and compare rates, because at times municipals can be a bargain vs. taxable issues of similar quality.

The advantage of the Treasury bond is that it is the safest one out there. Thus, it pays less income than riskier debt securities. But as a final consideration: all bonds have interest rate risk. If rates in the economy go up, bond prices fall… especially those with long term maturities.

Bonds – Are They Good Investments?

November 27, 2009 by  
Filed under Bonds Articles

Bonds are a security and are generally good investments for the older crowd who wants to earn higher interest rates for income. Bonds also belong in younger portfolios to enhance investment balance. But beware; the Big Bad Wolf may be knocking on the bond investing door.

In 2009 you couldn’t make 1% a year in the safest investments with easy access to your money. Examples include: money market bank accounts, short-term CDs, T-bills, savings accounts, and money market funds. But you could earn more than 6% in some bonds and over 4% in the safest ones in the world, the U.S. Treasury bond. Why not jump on these good investments?

The answer is that bond investing carries risk… more than the average new investor thinks. First, there is credit risk. The issuer of the security could get into financial trouble and fail to make timely payments of interest as promised. Even worse they could go broke. This risk can be greatly reduced by putting your money into a bond fund vs. an individual issue.

Interest rate risk is another animal altogether, and with interest rates at all-time lows the wolf is huffing and puffing at the door of bond investing. Unfortunately, the new investor is likely unaware of his presence and does not sense the danger. In a few minutes, you’ll get the picture.

When you buy a bond you are lending the issuer (like a corporation) money for a promise that reads something like this. “Lend me $1000 and in return I’ll pay you 5% a year in interest. In the year 2035 I’ll pay you back your $1000.” After the issue is originally sold to an investor, it then trades in the secondary market. The good news is that the bond can then be bought and/or sold any time between issue and 2035.

The scary news is that the price or value of the security changes as it trades in the market. When interest rates are falling these fixed-interest-rate investments go up in value. When interest rates go up, interest rate risk can bite you in the posterior… because bond prices (values) go down.

That’s how bond investing works. Picture owning the 5% security we used as an example. As long as the issuer remains financially strong and interest rates remain stable, your investment should be worth about $1000. What would happen if rates in the economy headed toward 10% for similar bonds being issued? Remember, your 5% rate is locked in until 2035.

Only a fool would offer you $1000 for a security that pays $50 a year when any investor could get closer to $100 in yearly income in the open market. There are plenty of fools out there, but no one is that dense. Your investment is headed toward a ½-off sale.

Bonds can be very good investments when interest rates are falling. They are not good investments when rates are on the rise. It doesn’t matter if you are rich or poor, young or old, new investor or experienced. The wolf is knocking on the bond investing door, and sooner or later interest rates will go up. Don’t let interest rate risk take a big bite out of your investment portfolio. Don’t chase bonds just to earn higher interest rates.