Bond Investment Advice
Investment bonds may not be the place to invest money safely in the coming year. With the United States Federal Reserve maintaining a loose policy on money since the late 1990s, inflation has been kept low, but is indicating a period of rise in the near future. Investing in bonds in today’s market is almost exactly the opposite of the market 25 years ago when investing in Treasury bonds was a much better idea than stock market investing. While today’s market does not necessarily show a tendency to lose much in short-term bonds, it is not showing much likelihood of strong gains either.
If you were to invest in a ten-year Treasury bond today at a 3.29% yield, you could lose 11% in two years based on an eight-year Treasury bond yielding only 5% in two years. Add in the effect of inflation and your loss is even greater. Due to the Treasuries low yields, there are investors who are now purchasing junk bonds, as the interest rates are higher and can protect you from inflation. Unfortunately, there is no protection from rising interest rates. Overleveraged (debt-ridden) companies are typically the ones issuing junk bonds, which means that rising interest rate will cause an increase in defaults. Therefore, junk bonds are not worth investing in as the risk is doubled on rising interest rates and could face a potential default on the bond.
Bonds have historically offered stability, but for the short-term, high dividend yielding stocks are the better investment. Make sure of course that the companies you are investing in are not overleveraged! Interest rates do not affect the stock market like earnings prospects do, and the dividend yield is usually much more than even the diciest of bonds. Another option is to invest in funds that are exchange-traded and thereby attached to prices of Treasury bonds such as ProShares UltraShort 20+ year Treasury bond. [6]
Investment bonds can have some advantages, but it is important to consider the following factors: charges, investment performance, and tax. Many times, there are hidden charges associated with your investment bond as they split that charge over the life of the investment, making it seem much smaller that it’s actually price. On the day following your investment, if you were to ask your financial counselor what the charge would be, you would see just how much they could be.
From the performance perspective, investment bonds are limited at best. To overcome this apparent disadvantage, some companies will offer a larger variety of investment bonds. This does not actually overcome the low yield, despite the spread. The tax break also is not always what it is cracked up to be. Often the only tax break you see is a measly 5% of your investment back as income each year for 20 years. Other tax issues are that a 65 year old who cashes in the investment could be penalized greatly as this is considered additional income.
As investment bonds do carry some advantages, it is worthwhile to discuss your options with your financial counselor or advisor when planning for inheritance tax and trust fund arrangements.