About the intelligent investor
The weekly column of ‘The Intelligent Investor’ by Jason Zweig, has been published in the Wall Street Journal for about a decade and is published exclusively in Globes. According to Zweig: “My goal is to help you distinguish between the good advice and the one that just sounds good”
About Jason Zweig
One of the senior journalists of The Wall Street Journal. Author of the book “Your Money and Your Mind: How Neuroscience Can Help You Get Rich”, and the editor of the updated version of the bestseller “The Intelligent Investor”, described by Warren Buffett as “the best investment book ever written”
Bonds again take a hit, and that means they can do a better job of protecting the rest of your portfolio from taking a hit.
● The US is on its way to more interest rate hikes, and the shock waves will also be felt in Israel | Analysis
● Sharp declines in bonds and stocks: what does the heart rate index say about the state of the economy?
Investors are once again worried that the Federal Reserve will have to raise interest rates higher, and for longer, to stifle inflation, after dismissing such concerns just a few weeks ago. So long US government bonds have lost about 5% in the meantime since the beginning of February, and the bond market as a whole has fallen about 3%.
Through this gloomy cloud, rays of light penetrate in several places.
If you have bonds or bond funds that you hold for income, your new purchases and reinvested interest can yield higher returns. If you’ve been holding bonds primarily as a layer of protection to keep your stocks and riskier assets from flipping on you, then the sailing is now smoother. The rise in interest rates should also help insulate you against the Wall Street propaganda that says you should hold more junk bonds to strengthen your income.
Change the way you think about bonds
But you will have to change the way you think about bonds. For most of the past four decades, bonds, like stocks, have become an asset that will generate capital gains. Now they are generating income again – a lot of income.
This week you could earn 5.1% on US government bonds for six months, paying no state and local taxes. High-quality municipal bonds yield about 5.5% if you’re in the highest federal tax bracket.
You can also buy TIPS – Inflation Protected Treasury Bonds – that mature in 2043, which will guarantee you a return of more than 1.6% above inflation if you hold them for the next 20 years.
The Fed seems to be in a position to raise interest rates a few more times in an attempt to stifle inflation, so it would be naive to think that it is impossible to absorb more losses on bonds.
Instead, take what the market gives you – and welcome the increased yields on the highest quality bonds as a reminder that you don’t need to listen to attempts to sell you all sorts of sources of “alternative income”.
Until last year, the Fed had kept interest rates close to zero for most of the past decade and a half. Investors became desperate for anything that would give a return of more than 1%. Wall Street issued high yield debt, energy partnerships, emerging market bonds, private credit funds, private real estate trusts, business development companies, floating rate bank loan funds – all of which were sold on the idea that you should take on more risk (and pay higher fees) to get additional income.
But a 5% yield on short-term bonds is like kryptonite to whoever that’s the propaganda they’re selling. “Why chase yield if you’re getting a handsome return on a high-quality, diversified fixed income portfolio?” asks Julie Wirta, senior financial advisor at Vanguard Personal Advisor Services in Melbourne, Pennsylvania.
On top of that, high yields on high quality fixed income assets make risks elsewhere safer.
Let’s say you have a new baby and still have $10,000 left to spend after funding a college savings plan. You can take a little over $7,200 and buy TIPS. They will give a return of 1.63% per annum above inflation – ensuring that the fund will still be worth today’s $10,000 in 2043. It will come in handy for school fees when the boy is 20 years old.
With almost $2,800 left over after investing just over $7,200 in TIPS, buy stocks you think might bring in a higher return — a stock market index fund, undervalued individual stocks, a real estate fund, anything you’ve done your homework on.
If your riskier choices bring in a positive return, that’s great. In the end you will have much more money than when you started.
Income is guaranteed even if the bet component goes down the drain
And even if your bet loses almost all of its value, you’ll still end up with more money than you started with, thanks to the guaranteed growth in TIPS. And if all bets go to zero – you’ll still have $10,000 plus 20 years of inflation – when it’s all over.
A useful “risk calculation calculator” on the DepositAccounts.com website allows you to see how much you need to invest in safe assets and risky assets, with interest rates that you enter into the calculator and for a period of time that you determine, in order at least not to lose money and at best to get a return (the calculator was designed for corporate deposits in banks, But the same math works on TIPS as well).
Another thing to consider: All other things being equal, a rise in interest rates will likely give a boost to funds that invest in commodities and futures contracts. These funds can generate returns from three sources: changes in the market or “spot” prices of assets, selling last month’s contract for more than it costs to buy next month’s contract, and interest income on cash collateral that the funds post to secure their positions.