Bonds could be a better bet

by Stephen Butler

"Wall of Worry" is said to be the old bugaboo upon which the market rises. In a nation of too much communication, there's no end to a worry wart's source of supply.

If the stock market has exhausted what has been a spectacular climb from the depths of despair, then I'm inclined to pay more attention to the case that bonds, over many periods, have actually performed better than stocks. Of course, we can expect this Internet chatter after a rare 10-year period whereby the market has made essentially no progress.

What this theory ignores, of course, are compounding dividends paid by public companies and little or no inflation during the period. Almost all other 10-year periods with rising markets had the rising tide of inflation raising all the ships. I'm always stunned at how much obvious information is left out of these comparisons by responsible academics or money managers.

Recovery

Over the long term, with the challenges ahead of us, it may be safest to make decisions based on the prediction that markets won't recover to 2007 highs until as late as 2020. If this is the case, then bonds could, in fact, be a better bet than stocks. Inflation takes a toll on longer term bonds, but people betting real money right now are buying 10-year bonds that fluctuate between 3- and 4-percent interest. These are people betting trillions of dollars who believe that inflation is not going to happen.

If bonds do make sense, my favorite categories today continue to be funds of high-yield bonds, GNMA's, short-term corporate, and lately, emerging market bond funds like that offered by T. Rowe Price.

High-yield bond funds were pummeled over the past year, but as a percentage of total assets, the defaults on bond investments were minimal and most continued to pay out at their stated coupon rate. For anyone willing to stomach the decline in capital value that occurred during the panic, the rewards since have been reassuring. For the year, junk bond funds have risen a total of about 40 percent and the current average yield is about 12 percent. A "toe in the water" is one way to consider Vanguard's High Yield corporate bond fund which invests in bonds that are just barely considered junk. Its yield is about 8 percent currently, but this fund represents the oxymoron of "safe" junk bonds.

Inflation

International bond funds like T. Rowe Price Emerging Markets Bond fund offer some of the same higher returns as domestic high yield, but there is the additional advantage of debt in foreign denominations. If we do, in fact, have high inflation in the United States relative to other countries, then sinking dollar values will not impact these foreign bond assets. They will become worth more in dollars. At the moment, the annualized yield on the above-mentioned fund is 8 percent.

So much for bonds. There are still plenty of money managers out there who think the market has room for further advancement. Norman Fosback applies his own "Stock Market Logic" to more than just the title of his book, and he recently declared that the market had room to rise 21 percent over the coming year and a total of 79 percent over the next five years. Floyd Norris, in The New York Times, points out that the seemingly huge deficit into the future makes no assumption for course-correcting. For example, it assumes that we will be spending $100 billion per year fighting wars indefinitely. It ignores the fact that taxes, especially the estate tax, will "snap back" to their 2000 levels which was the deal we cut with our self-indulgent selves when we temporarily suspended them In the first place.

What too much information and the wall of worry should mean to us as individuals is that we are like snowflakes - no two of us are in the same situation when it comes to meeting financial obligations. None of us can predict what will happen in financial markets, but we can decide what is important and make decisions that relate. Older investors should understand how bond funds can improve results regardless of what the market does. Younger investors should never freak out and retreat into money market funds (as many have.) Forget about predicting what the future holds. Assume that it will fluctuate and invest accordingly.

Searching for Something?

Simply enter a keyword or topic to find the expert tip, services or news you are looking for!

News

Sign me up for your Newsletter (or make other subscription changes)

401(k) Today

Designing, Maintaining and Maximizing Your Company?s Plan

Looking for in-depth information on how to design, maintain and maximize your organization?s 401K plan?

Then 401(k) Today by Stephen Butler is the practical, easy-to-read guide for you!

To order your copy today, please call Pension Dynamics at (925) 956-0505