Fixed Income Investments for Maximum Income

If you need income from your fixed income investments in 2020, you need to accept greater risk in return. On the extreme end, junk bonds will offer a much higher interest rate than AA or AAA bonds, but you run the risk of losing your capital. Market Watch reported in June 2020 that junk bonds sold in record numbers as companies became desperate for cash. The spread between treasuries and junk bonds has been running at about 5% while the risk of losing your investment with a jun bond runs as high as 60%. In order to protect yourself against loss in this market you need to buy lots of high yield bonds across many companies in order to get the average risk of loss and the average return. Then you can expect to get a higher return and not lose everything. If you want to take this route, the best choice might be to look at a fixed income ETF that focuses on high yield bonds. You can find a list of high yield bond ETFs at ETFdb.com.

Fixed Income Investments for Maximum Security

The most secure fixed income investments are US Treasuries. These securities always offer lower interest rates than less-secure investments but are backed by the full faith and credit of the U.S. government. The best interest rate you can currently get for a 30 year bond is just under 1.5% and for a six month bond, 0.13%. The rationale for accepting such low rates is that you can protect your capital against losses in the stock and real estate markets and even gain more purchasing power over time if interest rates go negative.

Today’s effective yield on AAA bonds is 1.58% according to YCharts. This is a better yield than US Treasuries and reasonably safe as the only AAA US corporate bonds are those issued by Johnson & Johnson and Microsoft. Considering that tech stocks are currently in a downward slide, such bonds might well be a better choice than stocks until the Covid-19 crisis subsides and business gets back to usual. If the USA follows the EU, UK, and Japan into negative yield territory, bonds purchased at 1.5% will be more valuable than their initial prices as well as being safe havens in times of economic peril. How you choose to go with fixed income investments will depend on your need for income as well as your need to protect your capital in a time when the social and economic future is doubtful. As with most investment choices, diversification may be your best protection.

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Immediate Effects of Higher Interest Rates on Your Investments

• U.S. Treasuries
• Corporate Bonds
• Dividend Stocks

U.S. Treasuries and Corporate Bonds

If you currently have U.S Treasuries, AA, or AAA corporate bonds in your investment portfolio, they just became a little less valuable when the Fed raised rates last week. And, if the Federal Reserve follows through with its projections and raises rates twice next year, these investment vehicles will become progressively less valuable. However, if you simply hold your bonds or Treasuries to maturity, you will not lose money on these investments. And, if you wait for higher rates, you will be able to purchase these bonds and treasuries and earn higher interest rates. Ideally, you will buy these when rates peak. Then you will be earning a good interest rate and your bonds or treasuries will become more valuable as rates start to fall.

Dividend Stocks

Dividend stocks like utilities are often considered to be proxies for bonds. So, when rates go up but dividends do not, dividend stocks lose value. Providing that the basic business of the dividend stock does not change, such as with a utility, these investments will perform like bonds and Treasuries. But, if higher rates usher in a recession, many now-strong dividend stocks may take an earnings hit as well. Over the long haul the value of these investments will depend on their intrinsic stock value, in which case the effects of higher interest rates on the general economy will be important.

Longer Term Effects of Higher Interest Rates on Your Investments

CBS News writes that the U.S.’s interest payments are about to skyrocket. This is a big deal because it affects all sectors of the economy, government, and personal finances.

A recent Moody’s analysis noted that persistent high debt, among other factors, would lead to “persistent deterioration in the U.S.’s fiscal strength over the next 10 years.”

High federal borrowing could also crowd out other types of investment. The federal government borrows money by issuing treasuries; the investors who buy them are effectively lending to the government. A very high supply of treasuries could effectively starve other parts of the economy of investors’ money, some analysts say.

“If you issue more and more treasuries, the dollars you use to buy them need to come from somewhere. They could have gone into the stock market, or into other investments,” according to Torsten Slok, chief international economist at Deutsche Bank.

In the article they show a graph from the Office of Management and Budget showing the expected huge increase in payments on U.S. debt.

As the number of US dollar available for investment dwindles the US will not be the first country affected. Emerging markets are already suffering and there is the prospect of massive business failures in China this coming year. Despite Trump’s America First rhetoric, this is an interconnected world and trouble offshore will come back to bite the USA in the proverbial backside as well.

The US debt is already huge and due to the Trump tax cuts it is going to be a lot bigger. What is really worrying, however, is the size of the debt compared to the US gross domestic product, GDP. The game plan with recent tax cuts was that the resulting economic stimulus was going to raise GDP above 4%. That has not happened despite lower unemployment rates and, until now, a surging stock market. Many point to higher interest rates and their fallout as a reason that the stock market is getting bearish.

More Rate Hikes on the Horizon

Bloomberg writes that we are not going to see the death of rate hikes just yet.

Money markets appear to have completely nixed the idea of Federal Reserve interest-rate hikes in 2019, although the outlook may not be so simple.

As the Fed jacked up rates by a quarter of a percent in their most recent meeting, predictions of no more rate hikes seem to have been more wishful thinking than not.

The Fed is famous for thinking long term and is almost continually at odds with the short term political concerns of congress and the U.S. president. Too-low interest rates have an effecting of distorting markets. Real estate prices escalate because folks can buy more for their dollar due to the lower cost of servicing their debt. Investors tend to bid up stock prices and overheat the stock market. As Investopedia notes, the effect of interest rate changes can take up to a year to be felt.

Interest rates affect the economy by influencing stock and bond interest rates, consumer and business spending, inflation, and recessions. However, it is important to understand that there is generally a 12-month lag in the economy, meaning that it will take at least 12 months for the effects of any increase or decrease in interest rates to be felt. By adjusting the federal funds rate, the Fed helps keep the economy in balance over the long term.

However, the stock market continually seeks to predict the course of the economy and the value of investments. And the stock market has been very volatile and in correction mode. How higher interest rates will affect your investments will be largely negative over the short term as rates go up and the costs of borrowing rise. Over the longer term the risk is tied to the drag on the US economy and US investor caused by an ever-increasing US debt burden as more and more of the results of US productivity are eating up by servicing the debt.

Is there a place to hide as this scenario plays itself out? If you like cash positions when the market is volatile, a smart move is to build a “ladder” of short term AA or AAA bonds or US Treasuries. A bank account is also protected by Federal Deposit Insurance. Then the issue is predicting a market bottom, providing that there is one as the long term effects of mounting US debt play out.

How Will Higher Interest Rates Affect Your Investments? PPT

How Do You Choose Which Assets Classes to Invest In: Stocks

Stocks have two basic things going for them. Over the years the US stock market has outperformed real estate, bonds, and money in the bank. And, the stock market offers liquidity that real estate investments lack. You can buy a stock one day and sell it the next. Try doing that with a piece of real estate! So, why shouldn’t you put all of your investment capital in stocks? If you remember the 2008 stock market crash, the dot com crash, or the various other market crashes going back in time you can see that there can be risk in investing in stocks. There are ways to deal with that risk such as by choosing a range of stocks instead of just one or two and learning to assess intrinsic stock value as a guide to profitable investing.

How Do You Choose Which Assets Classes to Invest In: Bonds

We discussed treasury and corporate bonds in our article entitled how to invest without losing any money.

US Treasury bills have maturities of a year or less. US Treasury notes have maturities from two to ten years. And, US Treasury bonds have maturities of ten to 30 years. Each of these investment vehicles is backed by the “full faith and credit” of the US government. The risk of loss of any of these if held to maturity is nil.

How to invest without losing any money in US Treasuries is to hold them to maturity or only sell them at a profit.

The same approach applies to AAA corporate bonds issued by Johnson & Johnson or Microsoft. These asset classes do not outperform the S & P 500 over the years but they do outperform a lot of individual stocks. If want you want is to keep your money safe, not lose any, and make a decent rate of interest along the way, bonds as an asset class are a good addition to any investment portfolio.

How Do You Choose Which Assets Classes to Invest In: Cash and Short Term Investment Vehicles

If you believe you will need your money fairly soon, you do not want to tie it up in stocks, long term bonds, or real estate. Any of these asset classes may go into a slump and that would mean that you lose money when you take your cash. A good way to get a little interest on your money is to create a ladder of short term bonds or even CD’s at your bank. You will always have cash available when needed. This asset class does not outperform any of the others but it is the most flexible. There are a lot of smart investors who hold cash when they do not trust which way interest rates, the stock market, or real estate prices are going.

How Do You Choose Which Assets Classes to Invest In: Real Estate

Your own home is the real estate investment that you need to make first and foremost. Long term real estate investment is a skill that needs to be developed over the years and hopefully not by losing money along the way. If you want to take advantage of profits from real estate and not sink all of your money into a piece of property, consider REITs which are real estate investment trusts. These are investments you can get  into for a reasonable amount of money and get a good return. And, you do not need to manage the property yourself!

How Do You Choose Which Assets Classes to Invest In: Gold

Gold bugs think that sooner or later all paper currencies will be worthless. Thus, the only way to retain any value for the future is to hold precious metals. The problem with gold is that it does not pay a rate of interest and its price goes up and down. If you want to have a little gold as a reserve, just in case, there are to viable approaches. One is to simply wait for the price of gold to plummet and then buy. The other is to use cost averaging. Buy the same dollar amount of gold every month or so. Gold is a valid hedge against catastrophic economic and social events but the S & P 500 has been a better choice over the years.

How Do You Choose Which Assets Classes to Invest In? PPT

US Savings Bonds

These bonds are available in Series EE and Series I. Electronic series EE bonds are purchased via a Treasury Direct account for face value and paper series EE bonds are purchased at their face value. One earns a fixed rate of interest for the thirty year term of the bond. The treasury guarantees that the bonds will double in face value in twenty years.

• Series I bonds sell at face value at interest rates guaranteed to exceed that of inflation.
• These bonds are not tradable.
• The maturity periods can vary. For example, if you buy a bond with a value of $50 for $25, you’ll have to wait at least 17 years to get back your investment from the government.
• US savings bonds are exempt from state and local taxes.
• Federal tax is deferred until the bond is cashed in.
• Interest may be tax exempt if you can document that interest was used to pay qualified higher education expenses and provided that your income falls within federal guidelines for this benefit.
• As with many long term investments you will commonly cash in US savings bonds when you are retired and when your tax rate is low.
• US savings bonds pay interest twice a year and are redeemed at par value at maturity.
• Savings Bonds come in eight values: $50, $75, $100, $200, $500, $1,000, $5,000 and $10,000.

Why Purchase US Savings Bonds?

There are certainly lots of investments that can make a lot more money over the years than US savings bonds. And there are lots of investments that can disappear in a puff of smoke during an economic downturn. US savings bonds are like money in the bank. A good rule of thumb for investing is to first pay off credit card debt, invest in your home, and put six months of savings away for emergencies. Think of US savings bonds in this context.

US Savings Bonds versus Municipal Bonds

Like municipal bonds, US savings bonds are free of state and local taxes. Unlike municipal bonds US savings bonds are less likely to default than when cities like Detroit declare bankruptcy.

US Savings Bonds versus Dividend Stocks

Dividend stocks are a common way to balance the risk in an aggressive stock portfolio. However, even large cap stocks call fall in price or fall out of favor. When markets are falling US savings bonds still maintain their value and pay interest.

Buying US Savings Bonds

Bonds are purchased with a Treasury Direct account. For such an account you need a social security number, a driver’s license, a checking or savings account, and an email address. According to the US Treasury site:

• Minimum Purchase: $25
• Maximum Purchase: $30,000 per person per year
• Interest: 90% of 6-month average of 5-year Treasury security yields, added monthly and paid when the bond is cashed
• Minimum Term Of Ownership: 12 months
• Early Redemption Penalty: Forfeit three most recent months’ interest if cashed before 5 years

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Fundamentals of Investing in Uncertain Times

The famous “blood in the streets” quote always comes up when the market is shaky. Just wait until things are really bad and then buy is the implication. However, sometimes it is not darkest before the dawn but darkest before a healthy stock becomes a penny stock and then goes into bankruptcy. There is a sense that many investment advisors promote that if you money is not working for you, you are losing out. However, cash is still cash and cash gives an investor the flexibility to invest where he wants and when he wants without waiting for a good price at which to sell a previous investment. In investing and the fiscal cliff drama, cash may be a good idea. Treasury bills were great a year or so ago and resulted in profitable investing. However, as uncertainty drives interest rates up the value of currently held treasuries and bonds falls. Likewise the value of high paying dividend stocks falls as interest rates rise. A concern voice by the White House is that playing with the debt ceiling may result in another US debt downgrade and higher rates. At that point money bearing interest in the bank trumps treasuries, bonds, and dividend stocks. What about inflation and the loss of purchasing of money in a bank account? With investing and the continuing fiscal cliff drama a slow loss of purchasing power due to a low level of inflation beats the heck out of substantial stock and bond losses due to higher interest rates and an economy plunged back into recession.

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Stimulus in China

China has used economic stimulus by the government to support its lagging manufacturing sector over the last few years since the onset of the 2008 recession. Interest rates have been kept low and the government has poured money into infrastructure projects. Chinese economists predict a rise in economic growth into the eight percent range. An optimistic read of the situation is that China specifically and Asia as a whole are in the recovery phase of a traditional recession. If fundamental analysis of the Chinese manufacturing increase is consistent with a routine economic cycle it could well be time to buy Chinese manufacturing stocks. As with the USA and Europe, investors are well advised to watch what happens as government stimulus tapers off and the Chinese manufacturing sector must grow on its own.

Bull or Bear on Chinese Stocks

Despite a generally favorable response to the announced Chinese manufacturing increase, the composite index of stocks fell on the Shanghai market. This may be a matter of buying on anticipation and selling on the news. Over the long term a major issue for China is the ability of the world to buy more and more Chinese products. Europe had been China’s number one customer. Now, as the Euro Zone lingers in debt and recession Chinese industry needs to look elsewhere for customers. Raw materials are always a concern for a growing industrialized economy. As China extends it political as well as its economic clout, it hopes to secure customer bases as well as access to raw materials. However, as the USA found out over the years, being perceived as the country with all of the power and money puts a nation in a different light. The political as well as economic cost of buying favors and getting access to raw materials as well as markets can become costly and become a burden on those at home. If you are investing in foreign stocks, Chinese stocks certainly deserve a look. But, remember Japan at the end of the 1980’s. The nation seemed to be set to take over the world. Then a set of handshake, good old boy, loans was disclosed and the Japanese economy went flat line for over a decade. China is still not a transparent society. The apparent Chinese manufacturing increase sounds good but just how good is the data? Investors in China are advised to constantly do their homework and check their results.

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Austerity measures were agreed to by Euro Zone members with the intent of reducing national debts. However, these same measures have been a significant drag on economies across the continent. Spain, for example, has a twenty-five percent unemployment rate and Greece has never come out of the 2008 recession. Voters in France brought a socialist into power as we noted in our article, Return to Socialism in Europe Drives Stocks Down . Times certainly did not seem right for investors to invest in a Euro Zone recovery. Then the Greek people voted in their second election in a month. When things have been looking their worst Greece elected enough legislators from “pro bailout” parties to form a legislative majority. What this means for Greece is that it will likely stay in the European Union and deal with the various austerity measures required for its bailout funds. What it means for the Euro Zone, the Euro, and the world economy is that the much feared domino effect of financial collapse in Greece followed by Spain, Portugal, and then Italy has been forestalled. For those to subscribe to the well-known blood in the streets view of investing this might be the time to recognize that things may well have been at their worst and may be on their way to recovery. If that is the case where does an investor look to invest in a Euro Zone recovery?

We recently suggested that one might invest in Euro Zone junk bonds . Nations along the Southern tier of Europe are paying significantly higher rates of interest than what Germany pays to borrow money. If, in fact, the Euro Zone is going to pull though, interest rates will fall and investors will reap healthy profits from investments in bonds. If you are considering investing in Euro Zone stocks there are a large number of strong companies to consider. Many have been unfairly devalued due to the current economic crisis. Do diligent fundamental analysis of multinational companies like Siemens and Roche Pharmaceuticals and reap the rewards of things coming back together in Europe as you invest in a Euro Zone recovery. As always do your own analysis and consider this article as food for thought and not direct investment advice.

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A History of Junk Bonds

When considering whether or not to invest in European junk bonds let’s think about how junk bonds got their name and how profitable trading in junk bonds once was. Michael Milken went to prison in 1990 after a plea bargain and agreeing to cooperate with prosecutors in an insider trading, securities fraud and racketeering case. Part of his plea was to never to engage in securities trading again. Prior to that time Mr. Milken made a billion dollars over a four year period in the 1980’s which was by far the highest compensation for a corporate executive. Mr. Milken was influenced by the fact that a sufficiently large collection of high risk bonds was priced in such a way as to make it more profitable to own than investment grade debt. Mr. Milken was largely responsible for trading of high yield bond bonds in which the diversity of the portfolio and high yield of individual bonds protected investors against the likely default of a predictable percentage of debt in the portfolio. With the Milken experience and diligent fundamental analysis in mind investors may well want to consider whether to invest in European junk bonds.

How Many Bonds from How Many Countries?

If one decides to invest in European junk bonds he will want sufficient diversity in his bond portfolio to mimic what Michael Milken did years ago. He will want questionable debt that offers a very high yield. Thus German bonds are out of the question as they are the Euro Zone gold standard and offer a low yield. Spanish bonds are yielding about 6.3% and Italian ten year debt is yielding around just over 6%. German bonds on the other hand are going for 1.4%, the European safe haven for bond investors. As always more than a little investment research is necessary to profit from this sort of situation. But, if you firmly believe that the Euro Zone is not going to fall apart and that Germany, France, and the rest will find a solution it may be time to consider how to profitably invest in European junk bonds. Buy when rates are high and profit when things settle down and rates go lower. As always this is a discussion meant to encourage thinking about profitable investing. We are not recommending that anyone ignore European debt or that they go ahead and invest in European junk bonds.

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What Is a Bond Ladder?

A bond ladder is an investment device wherein investors purchase bonds (or treasuries or CD’s) with relatively short maturities. To hedge interest rate risk with a bond ladder an investor can have all bonds mature at the same time or stagger the maturity dates. For example, an investor may purchase 1 year bonds, CD’s, or treasuries. He can buy them all at once and have them mature all at one or he can stagger them so that a forth mature every three months. In either case he will not get caught with long term securities that become devalued as interest rates rise. The down side when one decides to hedge interest rate risk with a bond ladder is that he is usually not holding long term bonds when interest rates fall. Thus he does not benefit from bond appreciation to any great degree. If your answer to what is a good investment in this environment is that it has to be a conservative investment, then to hedge interest rate risk with a bond ladder may be the ideal choice.

Balancing an Investment Portfolio

Consider this. The economy is improving and there may well be some very good long term investment options just around the corner. But, the European debt dilemma could come back with a vengeance or a spectacular crash of the Chinese real estate bubble could through the world economy back into recession. So, hedge interest rate risk with a bond ladder with the fixed income part of your investment portfolio. The older you are and the closer to retirement you are the larger portion of your portfolio should be allotted to such a conservative approach. Dividend stocks or the big cap and stable variety are also a standard conservative approach. If you are looking to hit a home run by investing in penny stocks in this market, however, make sure that your fundamental analysis is sound and that you keep up to date with market sentiment.

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Pension obligation bonds were a great idea for about a minute and a half in 1985 when the city of Oakland, California used them. Oakland issued tax exempt bonds at a prevailing rate for tax exempt bonds and then turned around and invested the money in vehicles such as Treasury Bills offering higher rates of interest. The Federal Government then passed a law making this sort of arbitrage by municipal and state governments illegal. As these folks could no longer issue tax free bonds for the sole purpose of reinvesting at a higher rate of interest the idea of pension obligation bonds seemed to go away. Fundamental analysis would seem to tell us that, without the ability to issue tax free bonds at lower interest rates, states should avoid these vehicles.

However, when interest rates when down and the stock market surged in the 1990’s the idea of pension obligation bonds returned. The idea was to borrow now and pay later with the promised returns of a booming stock market. At the time these states were able to issue taxable bonds at prevailing interest rates and gain more in the market. These states thought they were picking new winners with the booming market. Remember the Dot Com bubble? We have had two market crashes since the early 1990’s with the Dot Com bubble burst and the more recent market crash. Now the states that believed so strongly in a booming market are looking at these bonds again as a means of pushing debt obligations into the future. As of the end of 2009 California has issued roughly $13 Billion, Illinois $12 Billion, Oregon and New Jersey $4 Billion each, Connecticut, Pennsylvania and Wisconsin $3 Billion each, Michigan, Texas, and New York $2 Billion each, and so forth in these bonds.

The Center for Retirement Research (CRR) at Boston College has just issued a report on Pension Obligation Bonds written from the perspective of the states who issue them. We would like to look at these bonds from the viewpoint of anyone who might want to invest in them. According to RRC public pensions are less than 80% funded requiring over $200 Billion over the next five years to make up the shortfall. States that are already having trouble handling their budgets are looking to push more debt into the future. The sad fact is that, according to CRR, virtually no pension obligation bonds issued since are in the black. If your choices are investing in oil when the world needs energy, investing in beer when the world needs a drink, investing in gold as economic chaos threatens, or investing in bonds issued by states that are heavily in debt and sorely in need of fiscal discipline what do you do?

States are in a bad fix with huge obligations and diminished resources as tax revenues have dropped. They need to do something and pension obligation bonds may well be a good choice, for them. You, however, have money for stock investing in many different types of stocks. You can invest in options, futures, or foreign exchange. State and municipal bonds have traditionally been considered safe investments. The day may come when these bonds are considered junk bonds. It is probably a good idea to look elsewhere for long term safe, profitable investments.

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