EC Why Buy Bonds?

Realizing you are wrong about a basic belief is tough. The last two weeks we discussed “The Bond Fund Risks Your Broker Won’t Tell You” and “Closed-End Bond Funds, Friend or Foe?”

We concluded holding top-rated bonds is OK – individually, not in a publicly traded fund. Fund managers, chasing high returns, take risks I’m not comfortable with. If bonds are downgraded, or default, the Net Asset Value (NAV) of the fund would drop and could take years to recover.

I planned for this bond article to be positive, showing readers how easy it is to build a do-it-yourself bond portfolio. Unlike a brokerage sponsored bond fund, you would buy, hold, collect interest and when they mature – repeat the process – with minimum fees and risk. We are investors, not interest rate speculators.

My parents relied on FDIC insured Certificates of Deposit (CDs). They used to beat inflation, providing around 6% interest. Corporate bonds paid more interest to compensate for the higher risk.

Start with safety first.

Bloomberg’s warns A $1 Trillion Powder Keg Threatens the Corporate Bond Market: (my emphasis)

“Bloomberg News delved into 50 of the biggest corporate acquisitions over the last five years, and found…. By one key measure, more than half of the acquiring companies pushed their leverage to levels typical of junk-rated peers. But those companies, which have almost $1 trillion of debt, have been allowed to maintain investment-grade ratings by Moody’s Investors Service and S&P Global Ratings.

…. To avoid tipping over the edge now, they will have to deliver on lofty promises to cut costs and pay down borrowings quickly, before the easy money ends.”

It’s estimated that $2.5 trillion is invested in BBB grade bonds. Bloomberg warns over $1 trillion should be rated as junk bonds, but are not because of “lofty promises”. Need to look elsewhere.

I looked for safer, high-grade bonds. Here is a screenshot from my online broker:

Fixed Income Offerings Chart

Uh-Oh! Houston, we have a problem! What happened to the “higher interest rates to compensate for higher risk?” FDIC insured CDs are paying more than corporate bonds until you get down to the A level.

A five-year CD is paying 2.85% and a Corporate A bond is 3.05%. A $10,000 CD would pay $285 in interest annually. The A bond would pay $20 more. Whoopie! That won’t cover dinner for two at Wendy’s, our favorite fast food joint.

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Cynthia Decker 7 months ago Member's comment

Great read.