Markets

So, Mr. Bond…

By Charles Sizemore  |  January 15, 2020

I admit that I got more excited than I should have when I found out that Daniel Craig would be coming back as James Bond in April’s No Time to Die. I realize I risk getting bags of hate mail for saying this, but I consider Craig to be the best Bond actor in the history of the franchise — even better than Sean Connery.

I know, I know. That’s a bold statement. But I’m standing by it. I’d even argue that Craig is the closest any actor has come to approximating the original Bond of Ian Fleming’s books.

I welcome a lively debate on this. So, feel free to write in and tell me your favorite Bond actor and why.

Alas, I’m not here to talk about James Bond.

We’re looking at the far less exciting bonds — the kind that go in an income portfolio.

Last week, I wrote about where to find retirement income in 2020, and I mentioned corporate bonds. We’re going to continue that conversation today with more focus on the bond market and the role that bonds play in a portfolio.

Not Just About Income

This might sound odd coming from the resident “income guy” in the Charles Street Research office, but bonds are about a lot more than just income.

In fact, with yields where they are today, I’d argue that the interest income is a secondary factor at best.

Bonds — at least the high-quality sort — take some of the volatility out of your portfolio. Unless you’re some sort of buy-and-hold ideologue, you’d likely agree that having 100% of your portfolio invested in stocks at all times is madness.

Yes, stocks “always” rise over time, or at least they have in our experience… but there can be large stretches time when prices move the wrong direction.

In our lifetimes, the stock market went nowhere between 1968 and 1982, and again between 2000 and 2013. Having a portion of your portfolio allocated to bonds allows you to navigates those rough patches. By simply rebalancing your portfolio once per year to your target — generally somewhere in the ballpark of 60% stocks and 40% bonds for most investors — you perpetually buy low and sell high.

Not All Bonds Are Created Equal

Of course, not all bonds are created equal.

There’s a big difference between a “risk-free” U.S. Treasury bond and a highly speculative junk bond.

For our purposes today, I’m looking at quality investment-grade bonds. High-yield junk bonds may offer a higher yield, but they also have default risk and tend to behave like stocks during times of stress. When stocks are in a bear market, junk bonds tend to be in a bear market as well.

If your primary objective is to reduce risk and portfolio volatility, junk bonds aren’t exactly going to help you if they’re crashing along with the rest of your portfolio.

As I wrote last week, AA and A-rated corporate bonds offer higher yields than U.S. Treasurys with only modestly more risk. For example, the average yield of 7-10 year Treasury bond is 1.7% as I write this. The average A-rated corporate bond for the same maturity yields about 2.7%.

That might not sound like a huge difference, but, taking inflation into account, it’s the difference between making money and losing it.

How to Play the Yield Curve

In a normal, healthy bond market, long-term bonds will always yield more than short-term bonds. This compensates investors for the additional risk of waiting for an uncertain future.

But today, the yield curve is exceptionally flat. There’s very little premium for buying long-term bonds.

A 5-7 year A-rated bond yields around 2.4%.

A 7-10 year A-rated bond only yields about 2.7%.

There’s really very little reason to reach for that extra 0.3% yield. The more prudent move is to stay short-term.

Sure, we have no idea what yields will be seven months from now, let alone seven years from now. Every investment decision is an exercise in making educated guesses. I think it’s likely yields will be higher a few years from now, so it makes no sense to tie up your money longer than you have to at today’s low rates.

You know me. I love my dividend stocks, and I consider these to be the bedrock of my income portfolio. That’s why I write Peak Income.

But I also know that during times of market stress, even high-quality dividend payers can get beat up. And dividend payers that seem indestructible have a way of falling from grace.

General Electric (NYSE: GE) used to be a standard holding in a lot of dividend stock portfolios. Had you bought GE for the dividend a few years ago, you’d be sitting on devastating losses today… and your income stream would have taken a hit when the dividend was slashed to near zero.

While they might not be the sexiest investments, make sure you leave room for bonds in your portfolio.

As Warren Buffett likes to say, “The first rule of investing is to not lose money. And the second rule is to never forget the first!”

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Charles Sizemore

Income and Retirement Strategist, Charles Sizemore, CFA specializes on dividend-focused portfolios and building alternative allocations by finding value opportunities outside of the mainstream stock market.

Charles is the executive editor and portfolio manager for Dent Research's premium newsletters, Peak Income and Peak Profits.

He is also a frequent guest on CNBC, Bloomberg TV, Fox Business News and Straight Talk Money Radio, and has been quoted in Barron’s Magazine, The Wall Street Journal, and The Washington Post. He is a frequent contributor to Forbes, GuruFocus, MarketWatch and InvestorPlace.com.

Charles holds a master’s degree in Finance and Accounting from the London School of Economics in the United Kingdom and a Bachelor of Business Administration in Finance with an International Emphasis from Texas Christian University in Fort Worth, Texas, where he graduated Magna Cum Laude and as a Phi Beta Kappa scholar. MORE FROM AUTHOR