Are Bonds A Bad Investment?
My first investment was the gift of a 500 dollar Canada Savings Bond from my grandparents on my 12th birthday. I think I lost the certificate somewhere between high school and university. Nonetheless, the old adage "buy bonds" seems to no longer apply in today's economy as a sure fire way to secure your retirement income. In fact, financial guru Pat McKeough says "Stay out of Bonds" in his publication, How to Trade Stocks and Make Good Investments in Canada. Does this shift in conservative investing philosophy make the heavily bond invested coach potatoe portfolio and other conservative investing strategies obsolete? Are all bonds off the block or are there certain types of bonds and fixed income investments which continue to be appropriate and acceptable instruments to secure my retirement?
In this issue of TheInvestobot, we'll explore the real story behind McKeough's rejection of bond investments, what type of fixed income investments are available to balance the conservative side of your retirement portfolio, and I'll propose some ideas that may quell the bond-fear breakdown in the old "buy a bond and forget about it" strategy of our parents and grandparents.
What is a Bond?
First things first, what are we talking about? Technically speaking, a bond is an IOU of sorts issued by various government treasuries, companies or international organizations that entitles holders of these investments a coupon payment at periodic intervals until maturity. These coupon payments are typically a fixed amount represented by a percentage of the face value, or a floating rate of return in relation to some index or reference.
This is a summary from Wikipedia concerning bonds:
"Governments issue government bonds in their own currency and sovereign bonds in foreign currencies. Local governments issue municipal bonds to finance themselves. Debt issued by government-backed agencies is called an agency bond. Companies can issue a corporate bond or get money from a bank through a corporate loan ("preferred stock" can be "fixed income" in some contexts). Securitized bank lending (e.g. credit card debt, car loans or mortgages) can be structured into other types of fixed income products such as ABS - asset-backed securities which can be traded on exchanges just like corporate and government bonds".
The difference between bonds and stocks can be simplified to this: Bonds retain their nominal value, stocks may lose value from the date purchased. A bond with a $1000 face value will be worth $1000 at the end of the term. Bonds pay interest, some stocks pay dividends. Governments issue bonds but never issue stocks.
Other Types of Fixed Income Investments
According to TD Canada Trust, investors can purchase the following types of fixed income products in Canada: Government of Canada Bonds, Federal Crown Corporation Bonds, Provincial Bonds, Stripped Bonds, Mortgage-Backed Securities Term Deposits and Guaranteed Investment Certificates. You'll notice that 4 out of 6 of these choices are "bonds". So if we are to heed guru warnings about staying out of bonds, that leaves mortgage linked term deposits and GIC's as the only other way to fill up 25-75% of your investment portfolio depending on your stage in life for conservative investors. Seriously? That seems odd since so many mutual fund and ETF companies tote bond diversification as part of a balanced investment strategy. Some sources include preferred stock as a type of fixed income investment since they usually issue regular dividends.
Why The Negative Attitude on Bonds?
Enter new google search: "stay away from bonds".
In summary of the multiple pages of results that came up, there seem to be three major reasons to avoid bond investing through managed funds and ETF's which boil down to lack of control as to which bonds are purchased, limited returns, and bond fund fees which might eat up any profits in low return investments. There are newer funds which offer no-load fees and low MER's, but the overall sentiment was that your money simply won't grow.
I found this somewhat hard to believe since the average annual return on investment in the TD e-series Canada Bond index fund was just over 5% and many of the low MER ETF's like the iShares XBB which is based on the DEX Universe Bond Index was a modest but acceptable 6.25% since inception. That still pays more that the average 5 year GIC at 3%. So why the negative press on bond investing as a whole. I'm not yet convinced.
Pat McKeough says "STAY OUT OF BONDS"!
Pat McKeough is an intelligent, experienced, revered and highly recommended financial guru, writer, expert and advisor here in Canada. As a subscriber to his newletter The Successful Investor, I received a free report on investing in Canada entitled How to Trade Stocks and
Make Good Investments in Canada. In this primer, Mr. McKeough has written a chapter entitled "Stay Out of Bonds".
McKeough writes that interest in bonds has been revived due to recent market volatility as bonds provide a source of steady income and guaranteed returns. However, according to his analysis, bond prices are projected to fall over the next few years as interest rates inevitably rise due to government deficits. He suggests investing only a small portion of your portfolio in bonds and other fixed-income instruments, and in place, "aim to build a diversified portfolio of well established companies with long histories of rising dividends".
McKeough suggests that the right equities/fixed return ratio in your portfolio will depend on your financial circumstances, temperament and how close you are to retirement. He suggests that if you chose to hold some fixed-income investments, stick with Canadian T-bills with maturities of around three months and stay of long-term bonds.
Hunting for Fixed Income Investments
Summary of my research? For the fixed income portion of your portfolio, purchase short term T-bills, GIC's, mortgage-backed securities and solid dividend-paying equity or preferred stock. Here's the breakdown:
1. National Housing Act (NHA) Mortgage-Backed Securities:
This is an investment in a pool of Canadian residential first mortgages which provide monthly interest, a competitive rate of return and good liquidity, which means you can easily convert your investment into cash. NHA Mortgage-Backed Securities are sold in $5,000 denominations in terms of six months to 25 years and are backed by the Central Mortgage and Housing Corporation, an agency of the federal government.
REITs qualify as fixed income instruments if they lend money directly to real estate owners and/or operators or indirectly through the purchase of mortgages or mortgage backed securities. There are ETF REIT's available through iShares, Claymore, BMO and Horizon's. I am going to review these in an upcoming issue of TheInvestobot.
2. Treasury bills and other money market instruments:
Issued for terms of one month to one year with a wide variety of maturity dates, Treasury bills, bankers' acceptances and commercial paper provide higher yields than bank accounts and term deposits. Canadian T-bills with 3 month maturities can be purchased through brokers such as TD Waterhouse.
3. Guaranteed Investment Certificates:
GIC's can be purchased from any bank and most brokers and typically offer fixed term investments of 1 to 5 years with guaranteed interest at the end of the term.
4. Preferred Stock/ Dividend Paying Equities:
Preferred stock is stock that tends to act like a bond because it has a fixed dividend payout but isn't guaranteed if the company does poorly. From Investopedia: "There are a number of strong companies in stable industries that issue preferred stocks that pay dividends above investment-grade bonds. The starting point for research on a specific preferred is the stock's prospectus, which you can often find online. If you're looking for relatively safe returns, you shouldn't overlook the preferred stock market."
ETF's available for preferred stock include: Claymore's CPD and iShares' XSP .
Happy Investing!
My first investment was the gift of a 500 dollar Canada Savings Bond from my grandparents on my 12th birthday. I think I lost the certificate somewhere between high school and university. Nonetheless, the old adage "buy bonds" seems to no longer apply in today's economy as a sure fire way to secure your retirement income. In fact, financial guru Pat McKeough says "Stay out of Bonds" in his publication, How to Trade Stocks and Make Good Investments in Canada. Does this shift in conservative investing philosophy make the heavily bond invested coach potatoe portfolio and other conservative investing strategies obsolete? Are all bonds off the block or are there certain types of bonds and fixed income investments which continue to be appropriate and acceptable instruments to secure my retirement?
In this issue of TheInvestobot, we'll explore the real story behind McKeough's rejection of bond investments, what type of fixed income investments are available to balance the conservative side of your retirement portfolio, and I'll propose some ideas that may quell the bond-fear breakdown in the old "buy a bond and forget about it" strategy of our parents and grandparents.
What is a Bond?
First things first, what are we talking about? Technically speaking, a bond is an IOU of sorts issued by various government treasuries, companies or international organizations that entitles holders of these investments a coupon payment at periodic intervals until maturity. These coupon payments are typically a fixed amount represented by a percentage of the face value, or a floating rate of return in relation to some index or reference.
This is a summary from Wikipedia concerning bonds:
"Governments issue government bonds in their own currency and sovereign bonds in foreign currencies. Local governments issue municipal bonds to finance themselves. Debt issued by government-backed agencies is called an agency bond. Companies can issue a corporate bond or get money from a bank through a corporate loan ("preferred stock" can be "fixed income" in some contexts). Securitized bank lending (e.g. credit card debt, car loans or mortgages) can be structured into other types of fixed income products such as ABS - asset-backed securities which can be traded on exchanges just like corporate and government bonds".
The difference between bonds and stocks can be simplified to this: Bonds retain their nominal value, stocks may lose value from the date purchased. A bond with a $1000 face value will be worth $1000 at the end of the term. Bonds pay interest, some stocks pay dividends. Governments issue bonds but never issue stocks.
Other Types of Fixed Income Investments
According to TD Canada Trust, investors can purchase the following types of fixed income products in Canada: Government of Canada Bonds, Federal Crown Corporation Bonds, Provincial Bonds, Stripped Bonds, Mortgage-Backed Securities Term Deposits and Guaranteed Investment Certificates. You'll notice that 4 out of 6 of these choices are "bonds". So if we are to heed guru warnings about staying out of bonds, that leaves mortgage linked term deposits and GIC's as the only other way to fill up 25-75% of your investment portfolio depending on your stage in life for conservative investors. Seriously? That seems odd since so many mutual fund and ETF companies tote bond diversification as part of a balanced investment strategy. Some sources include preferred stock as a type of fixed income investment since they usually issue regular dividends.
Why The Negative Attitude on Bonds?
Enter new google search: "stay away from bonds".
In summary of the multiple pages of results that came up, there seem to be three major reasons to avoid bond investing through managed funds and ETF's which boil down to lack of control as to which bonds are purchased, limited returns, and bond fund fees which might eat up any profits in low return investments. There are newer funds which offer no-load fees and low MER's, but the overall sentiment was that your money simply won't grow.
I found this somewhat hard to believe since the average annual return on investment in the TD e-series Canada Bond index fund was just over 5% and many of the low MER ETF's like the iShares XBB which is based on the DEX Universe Bond Index was a modest but acceptable 6.25% since inception. That still pays more that the average 5 year GIC at 3%. So why the negative press on bond investing as a whole. I'm not yet convinced.
Pat McKeough says "STAY OUT OF BONDS"!
Pat McKeough is an intelligent, experienced, revered and highly recommended financial guru, writer, expert and advisor here in Canada. As a subscriber to his newletter The Successful Investor, I received a free report on investing in Canada entitled How to Trade Stocks and
Make Good Investments in Canada. In this primer, Mr. McKeough has written a chapter entitled "Stay Out of Bonds".
McKeough writes that interest in bonds has been revived due to recent market volatility as bonds provide a source of steady income and guaranteed returns. However, according to his analysis, bond prices are projected to fall over the next few years as interest rates inevitably rise due to government deficits. He suggests investing only a small portion of your portfolio in bonds and other fixed-income instruments, and in place, "aim to build a diversified portfolio of well established companies with long histories of rising dividends".
McKeough suggests that the right equities/fixed return ratio in your portfolio will depend on your financial circumstances, temperament and how close you are to retirement. He suggests that if you chose to hold some fixed-income investments, stick with Canadian T-bills with maturities of around three months and stay of long-term bonds.
Hunting for Fixed Income Investments
Summary of my research? For the fixed income portion of your portfolio, purchase short term T-bills, GIC's, mortgage-backed securities and solid dividend-paying equity or preferred stock. Here's the breakdown:
1. National Housing Act (NHA) Mortgage-Backed Securities:
This is an investment in a pool of Canadian residential first mortgages which provide monthly interest, a competitive rate of return and good liquidity, which means you can easily convert your investment into cash. NHA Mortgage-Backed Securities are sold in $5,000 denominations in terms of six months to 25 years and are backed by the Central Mortgage and Housing Corporation, an agency of the federal government.
REITs qualify as fixed income instruments if they lend money directly to real estate owners and/or operators or indirectly through the purchase of mortgages or mortgage backed securities. There are ETF REIT's available through iShares, Claymore, BMO and Horizon's. I am going to review these in an upcoming issue of TheInvestobot.
2. Treasury bills and other money market instruments:
Issued for terms of one month to one year with a wide variety of maturity dates, Treasury bills, bankers' acceptances and commercial paper provide higher yields than bank accounts and term deposits. Canadian T-bills with 3 month maturities can be purchased through brokers such as TD Waterhouse.
3. Guaranteed Investment Certificates:
GIC's can be purchased from any bank and most brokers and typically offer fixed term investments of 1 to 5 years with guaranteed interest at the end of the term.
4. Preferred Stock/ Dividend Paying Equities:
Preferred stock is stock that tends to act like a bond because it has a fixed dividend payout but isn't guaranteed if the company does poorly. From Investopedia: "There are a number of strong companies in stable industries that issue preferred stocks that pay dividends above investment-grade bonds. The starting point for research on a specific preferred is the stock's prospectus, which you can often find online. If you're looking for relatively safe returns, you shouldn't overlook the preferred stock market."
ETF's available for preferred stock include: Claymore's CPD and iShares' XSP .
Happy Investing!
