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I’m always talking about dividend stocks, and I continue to believe they’re the best income investments around. That’s why my recently-published 2009 Annual Forecast Issue contained a whole slew of new dividend stock recommendations.
However, I don’t want to give you the impression that I totally ignore bonds. I think they’re a great way to diversify any income portfolio.
The problem right now is that interest rates are pitifully low, particularly on long-term Treasuries. Meanwhile, the risk involved with many of the higher-yielding bond categories is still very high.
Like many of my colleagues here at Weiss, I suggest you largely steer clear of longer-term Treasuries (as well as high-risk corporate and municipal bonds) right now. Someday in the near future, I think we’re going to see longer-term Treasury yields rocket higher. And then will be the time to consider starting to snap them up.
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But that doesn’t help anyone looking to put together a diversified list of bonds right now. So here’s my suggestion …
Consider Laddering Your Bond Portfolio,
With a Heavy Bias Toward the Shorter Rungs
“Laddering” is a good way to hedge your bond portfolio against any sudden change in interest rates. After all, it’s much like the concept of dollar cost averaging into stocks.
It works like this: You buy bonds with various maturities. Then, as they mature, you re-invest the proceeds into new bonds at the highest rung of the ladder (i.e. with the longest maturities).
The approach allows you to always put some money to work at current rates while protecting other portions of the portfolio. So if rates are falling, you have some of your money in longer-dated bonds. If rates are rising, you get to keep buying at higher and higher rates.
No, you never get to plow all of your money in at the exact right time. But rarely can anyone time markets so perfectly anyway.
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| Laddering helps your bond portfolio survive big swings in interest rates. |
How “tall” should your ladder be? Only you can decide on the upper limit of the bond maturities you’re going to purchase, but I wouldn’t recommend going out too far right now. As I mentioned, you won’t be getting a big enough return for the risk.
Instead, you might want to keep the majority of your fixed-income money in very short-term Treasuries or even a Treasury-only money fund.
If you want to buy individual Treasury bonds of varying lengths, plan on holding each bond until maturity. Remember, Treasury bond prices will fluctuate over time but as long as you hold for the duration, you will not lose money. Riskier bonds (corporates, munis, etc.) don’t offer the same guarantee.
Of Course, There’s an Even
Better, Simpler Way to Ladder …
Another option is eschewing individual bonds altogether, and using mutual funds or exchange-traded funds instead.
While you won’t have a ladder in the traditional sense, you will get good diversification both in length and types of bonds held.
For example, let’s say you have $100,000 to devote to fixed-income investments. Well, you could put some of the money into each of the following four mutual funds:
- Fidelity’s Ultra-Short(FUSFX) fund, which is like holding bonds of a few months in duration.
- Vanguard’s Short-Term Bond Index (VBISX), which is like holding bonds that will mature in two years.
- Harbor Bond Fund (HABDX), run by the legendary Bill Gross, this fund holds bonds that mature around the five-year mark.
- Vanguard’s Long-term U.S. Treasury fund (VUSTX) with bonds that go out around 10 years.
Keep in mind, there are plenty of other good bond funds out there … I just cited these four as examples. You could also consider using some of the new bond exchange-traded funds that have hit the market in recent years. They tend to carry even lower expense ratios and are easily bought and sold.
The remainder of your fixed-income money could be put into other bond-like investments at the lowest parts of the ladder, too. For example, Treasury-only money market funds and CDs would provide additional diversification, and allow you to buy more longer-term bonds when yields get more attractive.
One last thing to consider is inflation-protected securities — such as TIPs and I-Bonds. In my opinion they’re looking pretty attractive right now. It might be worth your while to add some of these into your laddering strategy.
But no matter what you do, the idea right now is keeping your money spread out so that a move in rates doesn’t leave you high and dry … and making sure you’re more weighted toward the short-end of the maturity range.
Best wishes,
Nilus
About Money and Markets
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Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Tony Sagami, Nilus Mattive, Sean Brodrick, Larry Edelson, Michael Larson and Jack Crooks. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Kristen Adams, Andrea Baumwald, John Burke, Amber Dakar, Michelle Johncke, Dinesh Kalera, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau and Leslie Underwood.
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