Generating Income From Bonds

[Marty Miller]

I'm biased.  I'll admit it.  I'm not afraid to tell you that
when it comes to investing in bonds I've paid more attention to Barry
Bonds than investment grade bonds.  Seriously, how could I not
pay attention to the disgraced baseball player?  I lived in San
Francisco for 10 years and I went to Giant's games all the time. 
I watched him hit home run after home run.
He was the local star.  It was exciting to see him out in the
city at restaurants and nightclubs . . . or just on the street. 
I'll be the first to admit, the guy had star power.  He just
exuded an enviable level of confidence.  And he was always
surrounded by beautiful people, fans, and the media.  He brought
a level of excitement with him wherever he went.
It's sad that he disgraced himself and the sport by (allegedly?) using
illegal performance enhancing drugs.
But I'm not a sportswriter, and that's another topic for another day.
What I wanted to discuss was the idea of bonds in your portfolio (and
I don't mean Barry Bonds baseball cards).  I wanted to challenge
the status quo.  So I'm asking the question:
Do you really need to own bonds?
Just a reminder.  I'm a bit biased when it comes to bonds. 
I've always been an equity guy.  Even during my banking career,
the few bond deals I did had significant equity components.  So
I've always been partial to investing in equities, and only equities.
So before I answer the key question about bonds, I want to point out
something very important.
You can lose money in bonds.  You can lose lots of money in
bonds, and it can happen very quickly.  When investors talk about
bonds they normally discuss them as safe stable investments. 
However, the value of a bond is adjusted against prevailing interest
rates.
For example if you own a bond with a 5% interest rate and then rates
fall to 4% your bond will increase in value.  Because you're bond
pays a higher rate of interest, other investors are willing to pay
more for your bond.
But the opposite is true as well.
If interest rates go up, the value of any bond you own will go
down.  Now with bonds, a loss in value is only a loss if you
sell.  You can always hold the bond and collect your stated
interest payments up until the maturity date.
Bonds are traditionally very stable.
They provide fixed rates of return for investors, which is great in
retirement.  This is an important point for anyone hoping to
retire - which should be all of us.  The markets gyrate and you
can't ever be certain that you'll be investing in a bear or bull
market during retirement.
This begs for some stability in cash flows.  Normally, I'd focus
on individual stocks throwing off dividends.  But even dividend
paying stocks have risks.  A dividend can be reduced or
eliminated.  For example, Pfizer's (PFE) paid a dividend
every quarter for more than 100 years, but many now think the dividend
may soon be cut for the first time. 
The obvious solution then is to be prepared to generate some income in
retirement from bonds.
The closer you get to retirement the more bonds you should own. 
But, how much is enough?  One simple rule of thumb - the
percentage of bonds in your portfolio should match your age.  So,
if you're forty, you should have 40% in bonds.  If you're 60 then
60%. 
Nobody's been able to answer my question of what to do when you hit
101?  But I digress.
There are a number of ways to invest in bonds, but this gets
confusing. Bonds have a wide variety of maturity rates, tax
consequences, call features, and in some cases, conversion
features.  I'm sure at some point I'll address these
issues.  But for now let me give you the lazy way to investing in
bonds.
Buy a few Bond ETFs.
You know me.  I like to keep it simple with my investments. 
And iShares is now offering a series of ETFs making it easy to invest
in bonds.  These ETF's allow you to invest in bonds based on
their maturities. 
For example, they have funds focused on bonds that will mature in 1-3
years, 3-7 years, 7-10 years, 10-20 years, and 20+ years.  It's a
good idea to have a mixture of short-term, intermediate-term, and long-
term bonds in your portfolio for diversification.
If you want to add bonds to your portfolio right now, take a look at
the iShares Lehman 1-3 year Treasury Bond Fund (SHY).  It's
yielding around 3.53%.  Longer-term bond funds may offer a higher
yield, but shorter-term bonds like these will hold their value better
if interest rates start to rise.

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