Dividends4Life: Is Now The Time to Consider Long-term Bonds?

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Is Now The Time to Consider Long-term Bonds?

Posted by D4L | Thursday, December 18, 2008 | 9 comments »

The price of bonds moves inversely with interest rates; that is as interest rates move up, the price of bonds goes down and as rates go down, the price increases. Thus, conventional wisdom would lead you believe there is not much upside in bonds with today's low interest rates. Or is that really the case?

If the federal reserve follows what Japan did in 2001 by purchasing of government bonds to revive the economy, it could drag down long-term rates after short-term rates hit zero. This is a possibility raised by Fed Chairman Ben Bernanke.

Japanese commercial banks cut back on lending and became huge buyers of government bonds after the stock and real estate bubble burst. Kazuhiko Sano chief fixed-income strategist at Nikko Citigroup said:

“After the injection of public funds into Japanese major banks in 1999, domestic bank holdings of JGBs kept rising until 2004 or 2005. Their behavior may give hints on the future actions of U.S. banks.”
According to Akihiro Nishida, senior fixed-income strategist at Mitsubishi UFJ Securities:
“The Fed has already aggressively intervened in the market to lower yields or crush yield spreads in an effort to influence prices that have been distorted. Who knows, yields could hit zero if the Fed becomes so aggressive and says it will purchase Treasuries in unlimited amounts, though I don’t think that would happen in one leap.”
This may be a good time to consider adding long-term or intermediate-term bonds to your income portfolio. If you don't want to hold the bonds directly, you might consider an ETF or bond mutual fund. Here are two of each that I am looking at (yields as of 12/16/2008):

Vanguard Long-Term Bond ETF (BLV) - Yield: 5.28%
The Fund seeks to match the investment performance of the Lehman Brothers Mutual Fund Long Government/Corporate Index. Holdings include:
  • Corporate Notes/Bond 51.5%
  • Treasury Notes/Bonds 40.2%
  • Government Agency Securities 6.5%
Vanguard Intermediate-Term Bond ETF (BIV) - Yield: 4.63%
The Fund seeks to track the performance of the Lehman Brothers 5-10 year Government/Credit Index. This index includes U.S. Government, investment-grade corporate, and international dollar-denominated bonds with maturities between 5 and 10 years. Holdings include:
  • Corporate Notes/Bonds 49.6%
  • Treasury Notes/Bonds 35.8%
  • Government Agency Securities 14.3%
Baird Intermediate Bond Fund (BIMSX) - Yield: 5.39%
The Fund seeks an annual rate of total return, before fund expenses, greater than the annual rate of total return of the Lehman Brothers Intermediate Government/Credit Bond Index. Holdings include:
  • Corporate Notes/Bonds 41.3%
  • Government Agency Securities 21.7%
  • GNMA and Other Mtg Backed Securities 19.5%
  • Treasury Notes/Bonds 13.0%
Artio Total Return Bond Fund (BJBGX) - Yield: 5.39%
The Fund seeks to maximize current income consistent with the protection of principal by investing in a non-diversified portfolio of fixed income securities. Holdings include:
  • GNMA and Other Mtg Backed Securities 55.3%
  • Corporate Notes/Bonds 40.2%
  • Asset Backed Securities 6.8%
  • Government Agency Securities 2.7%
A drop in treasury yields is not a certainly even if the fed starts buying. The down side is you may end up holding a relatively safe investment yielding 4.5% to 5.5%. In this environment, that would be a nice problem to have if you have room for bonds within your asset allocation.

As always, you should never act solely on a recommendation. You should perform your own research and reach your own conclusion before buying or selling an investment security.

Full disclosure: No position in the aforementioned securities.

- Fed's next move could squash long-term Treasury yields

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  1. Anonymous // December 18, 2008 at 7:49 AM

    I am not a big beliver in bonds, in today's market, they usually have the volatity as some of the safe equities and without the growth potential.

  2. Anonymous // December 18, 2008 at 9:23 AM

    The TLT etf yields about 3.9% right now. I guess the bond market bubble will be the next one to burst..

    As for fixed income allocations, I like keeping it in CD's, which don't appreciate if rates drop, but always have your principal protected, even if rates were to increase..

    If you are a total returns investor, a 50/50 allocation of SPY/TLT could be ok for you.. If you are a dividend investor, however, then rising dividend stocks are the way to go!

  3. Anonymous // December 18, 2008 at 12:39 PM

    Good overview, but I suspect treasuries are the next bubble to burst, too. You're correct though in my view that the Fed is going to try pull down long-term rates.

    If I can be permitted a rare link, readers might like the case for bonds being in a bubble here:


    For a dividend investor, I wonder if the utilities provide a decent compromise. The yields look low compared to general market yields (compressed) but I believe they also were massively bought in Japan's deflation. But at least you get some potential upside if things don't turn more inflationary, too, compared to bonds which would be massacred at these yields.

  4. Anonymous // December 18, 2008 at 1:03 PM

    Bill M: I have only 10% set aside for bonds and I have never made it it up that that amount.

    DGI: I believe there will be many bubbles to burst before this is over with. Stocks and bonds generally run counter to each other, but I can't stomach anything more than a 10% allocation. I view CDs as cash, not investments.

    Monevator: Utilities have been good to me the last couple of years, and as noted in Dividend Investing vs. S&P Index Fund they outperformed the s&P since September 1997.

    Best Wishes,

  5. Anonymous // December 18, 2008 at 1:09 PM
  6. Anonymous // December 18, 2008 at 1:52 PM

    Thanks for the link. Re: Your article, I think as you say it's very hard to do those sorts of things honestly. (It doesn't stop me trying either).

    I set up a paper/model high yield (dividend) portfolio of UK stocks around November last year and I'm dreading going back to it because value/dividend stocks have been hit so hard in the past 12 months. I suspect if you'd done that analysis at the end of 2007 you'd have got a different result.

    Re: Utilities, in the UK at least they've performed so well in the past few years (and held up reasonably well in the recent bear) that you can't help feeling they're due an upset. But I hold a water and an energy utility, and I regret the top-slicing I did with them, too!

    I'd suspect I'd prefer them though as an each way bet on inflation / deflation, to government bonds.

    Have you looked at corporate bonds? They're being touted as the big opportunity by some, but I can't help thinking if bonds do well from here, equities will soar. But they do look very cheap from a spread against government's perspective.

    No good in a new Great Depression, of course.

  7. Anonymous // December 22, 2008 at 11:40 PM

    Wow. What an irresponsible and/or ignorant post. If you lead just one naive person to buy into long or even intermediate term treasuries at these prices you'll have done much harm.

    As has been pointed out here by others the prices have been pushed up (and thus yields down) to ridiculous levels from which you can lose a heap of money with very little possible upside potential.

  8. Anonymous // December 23, 2008 at 6:19 AM

    Gardener: You think 5+% for a long bond will stick in this environment?

    Best Wishes,

  9. Barry Ritz // December 25, 2008 at 7:13 AM

    I am hesitant about placing my money in long term Treasuries. When investors start taking flight from Treasuries in a market upswing, the bubble burst can be rather nasty.

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