Wanna Buy Bonds? Nope, No and No Again
Once upon a time bonds were hailed as the darling of the investment community. There were the fixed income staple providing reliable interest payments at a competitive yield. It was more then inflation and yet just enough to provide you a return as well. They provided the safe- have nature of GIC’s combined with that sweetspot- the right rate.
A bond is a type of fixed income instrument in which the investor puts up principal usually in increments of 1000$ and the issuing authority provides the investor with annual interest payments at a rate set by the issuer. At maturity your principal is returned along with any of the outstanding interest.
The situation is far from what it used to be. Bonds no longer provide the ability for investors to sufficiently gain in the long term to offset the drop in purchasing power that money experiences. Although they could work for short-term investors who need a quick place to put some cash they seldom provide returns required for financial independence.
A quick glance at bond yields from the Government illustrates this point. 10 year bonds currently offered by the government of Canada offer 1.87% annually for 10 years. Inflation currently is 1.4%. That’s not a great reward for locking in your money for a decade. In Quebec, a 10yr fixed rate bond has interest of 1.10% which increased by about 0.2% annually.
Besides the fact that bonds are not the most glamorous investment tool – today’s ultra-low interest rate environment really does do anything to help the cause. With interest rates at about 0.5% - bond yields as a consequence are also low. Another reason that bonds are getting killed right now is also because the government in both Canada and the US have hinted towards increasing their interest rates. Since bonds and interest rates have an inverse relationship when the interest rate goes up the price of existing bonds will go down. The reason for this is that new bond issues (after the rate increase) will bear a higher interest rate making your bond that you owned before the hike much less worthy. Bonds have also gotten a killing in the past few years as people are turning elsewhere for yields. One area that investors are looking at is reliable dividend paying companies. The reason for this is because a bank stock for example provides the reliable yield of 3-4% combined with capital appreciation (growth in principal) at about 5% ----- far better then what any bond will pay you. The growth is also compounded at a higher rate growing your money faster. A word of caution on this --- since a lot of people have opted for this dividend route- some of the money in dividend stocks currently will move out into bonds once yields come back up to competitive values.
One of the reasons why people fell in love with bonds in the first place is two fold: Firstly, they provided a competitive interest rate which gave out interest payments. Your principal was relatively safe depending on the issuing authority. Secondly, during market turmoil people plough money into bonds to avoid losing money in the market which pushes the prices up.
Another reason why bonds are getting roughed up right now is because many people are chasing yields elsewhere; mainly dividend paying stocks as the yields in bonds are so low.
As the market cools off and the interest rates rise in North America I think bonds will have their day once again but until then they have fallen out of touch with many investors.
The question you have to ask yourself is can you sacrifice your yield? And are you willing to put your money at risk with equities as they are more volatile?
All of the above information is my own personal opinion. Yields for bonds were pulled of epargne placements website and google finance for Canadian bonds. Examples used are for learning purposes only. When I mention bonds I am specifically indicating government bonds not other debt like instruments such as corporate debentures, junk bonds or other debt related instruments. Please consult with a licensed representative and do your research before making any financial decision.
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