We are in a tough period for finding return on fixed income investments with relative safety. We are also experiencing a time where bond funds are losing money versus making money. If you have a bond fund that claims to be a 10-year U.S. Treasury bond fund paying 4% interest (the actual Treasury is only paying 2.5%), you must wonder how they are doing it.
If the fund is a big enough operation, they will buy a million dollars in 10-year Treasury bonds at 2.5%. Then they put the bonds up for collateral and borrow money at 1.5% to buy more Treasurys. Using this example, their return is near 4.5%. However, when interest rates increase and the value of the 10-year Treasury falls, they have to repay their loans that they borrowed at a higher rate.
When you see a bond fund company paying 4% interest, you need to know they are using leverage with high value securities; otherwise, they are buying very risky bonds in their portfolio. One of the most well-known bond fund managers, Bill Gross, of PIMCO has leveraged nearly 20% of PIMCO’s assets. Investors need to be very careful of bond funds at this time. Municipal bond funds are often leveraging this same way.
We feel investors would be better served going to local banks for CDs that pay almost 0.25% better than Treaurys. CDs are insured, so you are not taking on more risk.
Top quality companies like Wal-Mart Stores Inc.(NYSE: WMT) are issuing corporate bonds paying 0.25% more than U.S. Treasury bonds. No matter how safe a company like Wal-Mart is perceived to be, investors should remember, Wal-Mart cannot print money. The U.S. government can.
The purpose of fixed-income securities is to protect principal, which is why we suggest investing in U.S. Treasury bonds. They are as close to guaranteed as an investor can get. We suggest it is better to take on market risk than interest rate risk. Therefore, we do not suggest longer term bonds. As interest rates rise, the value of your bond will decrease, and you will have an investment that is paying less than what you could get elsewhere. We suggest staying short with 2½ year or less government bonds or bank-insured CDs. For all other investments, we suggest stocks.
At Henssler Financial we believe you should Live Ready, which includes understanding the risk you incur when trying to chase higher yields. If you have questions on your fixed investment portfolio, the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or email us at experts@henssler.com.