Monday, April 16, 2018

The Problem With Bonds



With all the market volatility lately there have been a ton of articles on bonds and bond investing. Blog posts and newspaper articles on selling stocks and buying bonds. With the prospect of a market crash investors are selling stocks, right?

That is exactly what is NOT happening. Investors are fleeing bonds.

In a recent Bank of America Merrill Lynch survey fund managers have cut their bond allocations to their lowest level in 20 years.

What's happening?

Investors FEAR inflation that's what's happening here. Bond yields have spiked indicating a bear market in bonds is coming. You will lose a lot of value.
Where is our safe haven now? Why hold a 40% allocation?

Everyone, well at least those guys/gals you pay to manage money are moving to CASH.

Say it isn't so. Cash pays nothing and just languishes. If you feel safe then by all means go to cash. I would instead of buying bonds.


Why? the reasons given are many but it comes down to reducing volatility, but does it? 

Do you feel more comfortable knowing you have bonds in your portfolio? 

If you do then OK but I would argue that's a simplistic reason to own them. Perhaps you just want a balanced portfolio and that's great if it's your strategy.

We hold a bond ETF with 1,000 shares of XQB in my wife's portfolio. I don't hold any. When she retires, I will convert that fund into 100% dividend paying stocks. 

The main reason is I DO NOT want to fix any of our income in retirement. I want all our income growing and not fixed to a specific set rate or distribution. Staying ahead of inflation and preserving the purchasing power of our dollars is vital. The last thing I want to do is run out of money as we age.

Fixed income will not grow and you will spend it all as the years go by.


Bond Pros

The bond and balanced investors will tell you that bonds are just a must have as you age and to provide a parachute, a soft landing if you will during times of stock market stress like we're currently experiencing. Some of the reasons they give are;
  • a buffer against market drops. 40% of your PF recommended in bonds
  • diversification with government, corporate and high yield choices
  • steady predictable yield
  • used in most asset allocation models
  • financial advisors always recommend them
  • when rates fall bonds rise in price, so it's a hedge
  • if you want regular interest income, you need bonds

Cons

It's really a reward less risk buying bonds. I mean what is the reward here for taking on a low interest distribution? Rates are rising right now so bonds prices are depressed. 

My wife's XQB Bond ETF has lost a total of 5.4% since purchase and it yields 2.4%. It deposits $43 monthly into her account. The payments have not kept up with the losses. She is out $1200 on the capital investment after distributions.

Better off to have been in cash. Other reasons I dislike bonds or any fixed income products;
  • not enough reward for investing in government debt or high yield
  • low interest payments and there is stagnant growth
  • yields on dividend stocks are higher
  • Warren Buffett is not a fan (good enough for me)
  • sold as fixed income by advisors
  • hard for retailers to buy individual bonds
  • lending money to the government is never a good long term plan
Stocks are not cheap either because we have huge debts both personally and in governments everywhere.

I invest in dividend stocks for the cash flow. The future of that cash flow is all I'm concerned about. Building a steady growing stream for my retirement is my goal.

"The assumption that bonds were a worthy risk damper for long term investors was a huge mistake" - Warren Buffett - Letter to Shareholders Jan. 2018

He previously wrote in 2012;

"Today's bond portfolios, are in effect, wasting assets" 

OK Buffett is a confirmed bond basher but it's best to take advice from  someone who knows a thing or two about investing.

The low bond yields right now are not and will ever be appealing to me as a retiree.


Focus on Great Companies Instead

This is why Buffett says we hold great companies and "our favourite holding period is forever."

The value of the assets you buy is not realized until way out into the future. You have to hold for years before you even realize what's happening. 

Here's another great example of what dividend growth will do to increase your income.

Twenty five years ago Royal Bank's dividend was .29 cents. It's now $3.48. Ten years ago you could buy RY for $25. Friday it closed @ $96. Almost a 400% rise in 10 years.

Hold for the win!

Can you hang on that long to reap those types of gains in cash flow and income?

It also pays a nice steady 3.7% yield. No Canadian bank has ever cut it's dividend EVER.

This is why dividend growth investors shouldn't worry about asset allocation or diversification. Buy good companies in any industry that you know and are comfortable with and hold forever. They will deliver superior returns when compared to mutual funds, ETFs, bonds or any income fund.

My Final Take

A couple things I never do is tell people what to eat or what to invest in. I merely attempt to tell you what has worked for me, what hasn't, what I've tried and what I'm doing now.

Investing in quality companies and holding forever is what I try to do within my RRSP. Boring and a certain amount of neglect is mandatory for your success in investing for income.

Invest in bonds if you feel safe doing so but I would submit they are not as safe as advertised.

Rob Carrick's latest article on bonds and recommending a GIC ladder instead. I don't do GICs either. You can paste the link into your browser for access.

https://www.theglobeandmail.com/investing/markets/inside-the-market/article-should-you-bypass-bonds-while-you-wait-for-interest-rates-to-rise/


...or try this https://tgam.ca/2Hokn7C

It might be behind the paywall but you really should become a subscriber of G&M anyway.

Related Post: Dividend Stocks-The Gift That Keeps on Giving

Recommended Reading:



Del Vicario on Growth Stocks

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