If you are looking to build a retirement portfolio or you simply have a big aversion to risk, you probably have your fair share of bad-rates-certificate-of-deposits (CD’s) or low interest bonds. Regardless if you are a US or Canadian citizens, interest rates for fixed income investments are very low. One of the only options left is to turn over dividend investing. Unfortunately, this investing strategy doesn’t provide capital protection. So if you want to keep investing is safe investments such as CDs and bonds, you are stuck with very low rate. But (because there is always a “but”), did you know that there are some good bonds on the market? The only problem is that you just don’t have access to them: you are stuck in hell with low interest rate while higher interest rate bonds go to heaven….
Why Higher Interest Rate Bonds Go To Heaven
If higher interest rate bonds exist, how come you have not heard of it? How come they don’t show on your brokerage account when you search for them? Because you are a mortal and that good bonds are kept in the secrets of the Gods… literally. The only difference is that I am not referring to some mythic God of money but rather to the Gods of Wall Street and Bay Street.
Everybody Has to Bring the Bread on the Table
The first reason why you see your bond interest rate cuts is because everybody has to make a living. Therefore, when you purchase a bond on the secondary market, you pay a “hidden” commission. It is sort of a hidden fee since there is no way for you to know exactly how much the bond issuer is really paying for the bonds. Then the financial firm issuing the bonds on the market takes its cut and finally, your broker or brokerage firm will take an additional cut. We estimate that 0.50% to 1.50% can be “loss” between the original bond issuing and what you can get on the market from your brokerage account. Mind you, with such low rates and high competition on the market, I guess that what you left on the table is more likely around 0.50 than 1.50%…
But there is more to this story. In fact, the best bond issues don’t get to be sold to us, mortal. They are kept by the issuing firms for either or both their book or their best clients (which are usually institutional such as pension plans or multimillionaires). They get the best rate in town, while we pick what is left under their buffet table. It’s sad, but it makes sense. If you can buy for 50M$ worth of bonds, there must be some compensation for it, right?
Can You Speak with the Gods So They Can Grant You With Higher Interest Rate?
Don’t kill your sheep yet to make the ultimate sacrifice; there are ways you can get a better rate on your bonds! In fact, there are a few ways of getting those rates in your portfolio:
a) Buy a bond mutual funds
b) Buy a bond ETFs
c) Go in Private Management
d) Deal with a “high end” broker
While the last 2 solutions are kept for richer investors (private management usually starts around 500K to 1M$), mutual funds and ETFs are pretty effective for smaller investor like us.
Why hesitating between a high MERs bond mutual funds instead of picking up a ETFs? I’d say that some bond managers might be able to pull out an ace faster than an investment blindly following an index. However, this is not a guarantee that your fund manager will be able to beat the ETFs. On top of that, there are also actively managed ETFs which have an investing strategy with a much smaller fee.
In order to select the right investment vehicle for you, I’d suggest you look at the past performance and its volatility. You’ll be able to see if your ETFs or mutual funds can perform over 5, 7, 10 years. It’s not always that easy but chances are that both performances would beat the 3% over 5 years you can average at the moment!
I personally don’t invest in bonds at the moment as I am a fairly aggressive investor considering my asset allocation. So I would be curious to know how you manage your fixed income if you have any?
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Man, I hope no one is signing up for 0.5% bonds…
You may want to look at getting into some bonds yourself. Even for an aggressive investor like yourself (I am one as well), it’s not only reduced risk but also increased returns to own a small position in corporate bonds. IF you haven’t read it before, check out The Intelligent Asset Allocator by William Bernstein. He has lots of data to back this up. I bought 5% bonds shortly after reading it.
Nearly all of my bond holdings are in two funds. 25% of my entire allocation sits in the Vanguard Total Bond market ETF, and then about 5% is kept with the Pimco High Income Fund. I make adjustments to these amounts when there is market fluctuation.
Having bonds doesn’t change your investing style to conservative. I think it actually gives you a tool to take advantage of bad markets because you have a reserve asset set aside for that purpose. I believe our current monitary environment will eventually be inflationary, but God only knows how long that will take. You should still own some bonds during the wait.
I agree that the best place for most investors is in bond ETFs. The total bond ETF mentioned above is a great place to park some bond money. If you think you might have the interest rate rise timed correctly you might want to put some in a shorter duration fund such as CSJ. I also stick a small amount in PFF ( a trust preferred fund) yielding 7% but somewhat volatile.
Bonds aren’t easy to play these days.