Are Bonds Still a Good Choice for Safe, Steady Growth

22
Jun

Are Bonds Still a Good Choice for Safe, Steady Growth

Are bonds still a good bet?

If you’ve been paying attention, you’ll know that bonds aren’t what they used to be. Values are declining, risk is up, investors are selling, bond funds are underperforming, and municipal bonds are no longer the safe haven they once were.

With the demise of the bond insurance industry in the financial crisis, credit quality in the market has become a much bigger concern for investors,” reported financial journalist Andrew Osterland on February 28, 2018 for CNBC.com. Earlier in the year, Financial Times noted sell-offs and declared that “the long bond rally could stall—and perhaps even unravel—in 2018.”

While we tend to think of rising interest rates as a good thing for fixed income instruments, bond prices move in the opposite direction as interest rates. Additionally, a bond mutual fund can lose value when the bond manager sells bonds in a rising interest rate environment, while investors in the open market demand a discount on the older bonds that pay lower interest rates. And of course, when bond issuers default, bond values plummet.

Unfortunately, some investors mistakenly believe that bonds can’t or won’t lose money.  During the 2008 stock crash, instead of protecting municipal bond investors, Bloomberg Barclays Municipal Index lost nearly 2.5% in 2008 during the stock crash. “That’s hardly catastrophic, but it might not have represented the resilience that the bond investors would expect.

Municipal bonds have indeed become increasingly unpredictable in recent years. In January of 2018, the Wall Street Journal announced, “Muni Bonds May Not Be the Reliable Bet They Once Were,” advising investors to “understand the risks” and “adjust their strategy accordingly.” The asset class has fundamentally changed since the Financial Crisis, as an increasing number of cities, states, and now Puerto Rico have defaulted on obligations. Furthermore, when municipalities go bankrupt, bondholders must wait in line behind employee pension funds for payment.

Add rising interest rates to the mix and lowered corporate taxes, which decrease incentives for muni-bonds, and we could be in for worsening woes.

So much for bonds as the “safe,” steadily-gaining part of your portfolio!

While bond funds are generally less risky than stock market funds, with more moderated losses as well as profits, investors relying on bonds to provide gains if (or when) stocks fall could be in for disappointment.

Seeking bond alternatives

So if not bonds, then what? It depends on what you were trying to get out of bonds.

If you were invested in muni-bonds primarily for income, we think there are other options worth considering. Private lending—the oldest form of investment around—is alive and well. Private equity funds, bridge loans, land leases, fractional real estate investments and other opportunities can generate regular monthly income. Depending on your situation, immediate annuities might be a good choice.

If you were looking to bonds for long-term safety and stability and reliable tax-advantaged growth, you should give serious consideration to high cash value whole life insurance. Net policy gains for cash value after costs are currently in the 3-4% range for many policy owners, when held long-term. (This does not include an additional death benefit paid to beneficiaries.) When adjusting for the preferential tax treatment (tax-deferred, often tax-free gains as long as the policy remains in force), you’d have to earn upwards of 5 or 6% to match the gains of whole life insurance.

This doesn’t even account for the ability to access your cash by borrowing against your policy instead of withdrawing so you can earn returns in multiple locations.

And if you simply want short-term place to store cash you’ll need a year or two from now, you’re likely better off with an internet bank savings account. Banks such as Discover, Ally, and Marcus are all paying around 1.5% with no monthly fees. CDs can pay a little more if it’s worth it to you to sacrifice liquidity.

What we DON’T recommend you do is simply give up on “safe money” and rely on a portfolio of nothing but mutual funds and ETFs. That’s setting yourself up for failure without a safety net.