Trying to speculate on the commercial bond market is exceedingly difficult and risky. Even the experts often take a beating. But using certain sectors of the bond market as a savings and retirement mechanism can be quite effective. Consider US tax-free municipal bonds (munies). They are safe, with defaults at a miniscule percentage of corporate bonds. And many are backed with third party insurance against defaults. Their returns are multiples of US Treasuries, CDs, money markets and savings accounts. And all distributions are tax exempt with the exception of any capital gains. Not very exciting. Sort of like watching grass grow. But it grows and grows. My own investments in this area are with: https://investor.vanguard.com/mutual-funds/profile/overview/...
edit: And by investing in munies you're also investing in US infrastructure. Munies fund all that stuff. Bridges, fire stations, schools, roads, water treatment plants, ports, electrical grids, etc, etc, etc. Might even make you feel like a good citizen...
Keep in mind there's a hidden gotcha with bond funds like vwalx in that the price of bonds changes over time roughly correlated with expected inflation. If you've been paying attention to vwalx and other bonds over the last month, you'll have seen the price go down significantly as treasury yields have gone up. So there's a risk that while your %yield on invested capital remains the same, the value of your invested capital itself can still drop since you don't own the bonds themselves and aren't holding them to maturity.
That is perhaps only relevant if you plan on selling them. I have no such plans. For me they are an ever accruing "money hose" I can turn off or on as needed...
I don't know. Have we averaged greater than 3.5 to 4.0 percent inflation recently? Those are the current returns from my munies, not counting the tax exemption...
You are likely confusing yield with coupon. The current yield of munis are below inflation. However their coupon rates are determined at time of issue so bonds issued a while ago tend to have coupon rates above inflation. What this means is one can sell these bonds now significantly above face value (and possibly incur capital gain tax). What it also means is that new investors in today's bonds will get below inflation return. This last point is what matters and is what people mean when they say that bonds have negative real yield.
Right. It’s a surprisingly common fallacy that holding to maturity somehow makes one whole despite rising inflation.
One way to expose the fallacy is perhaps by the thought experiment of selling on the secondary market a day or a week before maturity. Prices of any highly liquid bond will have converged toward redemption value, differing by no more than some small epsilon.
Not certain. Many if not most munies are supported by third party insurance, such as Lloyds of London in case of default. And all are supported by the power to tax. COVID is a temporary disruption that will hopefully soon pass. We'll see...
And AIG insured many mortgages. Remember 2008? Insurance is good for small-scale disasters, not large-scale ones like 2008 Mortgage bubble or COVID19.
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For most city level governments, things like Theater, Restaurants, Sport-events, Conferences, Gambling, Malls, Tourism, Hotels, Gasoline Tax (aka Driving), serve as a major leg of their tax revenue.
All of which has been severely restrained by current events.
Are you talking about the recent $1.9T stimulus package? Because there are strings attached to it. Republicans are angry because they aren't allowed to use the money to finance tax cuts. Democrats are angry because they aren't allowed to use the money to pay pension contributions.
Fair enough — I’d wager large city bankruptcies remain quite possible under the next GOP Administration. The most liberal Republican POTUS of my own lifetime said “No” to NYC:
McConnell is on the record saying he doesn't think the government should be bailing out blue states for what he has deemed profligate spending, so no need to look back to 1975.
> “I said yesterday we’re going to push the pause button here, because I think this whole business of additional assistance for state and local governments needs to be thoroughly evaluated. You raised yourself the important issue of what states have done, many of them have done to themselves with their pension programs. There’s not going to be any desire on the Republican side to bail out state pensions by borrowing money from future generations.”
> But using certain sectors of the bond market as a savings and retirement mechanism can be quite effective.
> returns are multiples of US Treasuries, CDs, money markets
Multiples of tiny numbers are still tiny. What role should a muni bond yielding 2% and maturing in twenty five years play in my retirement portfolio? That might not even beat inflation.
Probably none. That's why my link is to a high yield municipal bond fund with low fees. I roll over my monthly distributions and buy more shares. I've never sold or traded a single share. I took Warren Buffett's advice to heart:
"Wall Street makes its money on activity. You make your money on inactivity."
If you look at the price (not total return) history of your selected fund it has significant growth, about 20%, over the last ten years. Bond prices increase when the risk free rate (i.e. treasuries) decreases.
Over the last forty years treasury rates have been more or less steadily decreasing. The ten year treasury was paying over 15% in 1981 and now it’s paying a little over 1.5%.
What this means is that bond investors over that 40 year period have gotten juiced returns—-they got whatever the bonds were yielding plus price appreciation from falling interest rates.
This dynamic was in place for the adult lives of everyone under the age of 60 today. Our intuitions, rules of thumb, and understandings of how bonds contribute to a portfolio we’re all developed in the shadow of this phenomenon.
But now interest rates have nowhere left to fall. The zero bound forces an end to this dynamic.+ From now on not only will bond returns not be juiced they could well be reduced by the opposite effect. From 80 to 40 years ago interest rates more or less steadily increased over that period, causing bond prices to constantly be falling.
+ Negative nominal rates could extend it a few more years but the cash cost of carry is a hard bottom.
"Juiced returns" is a consequence of some investment strategies, but not all. For example, if you aimed to hold a constant-maturity bond portfolio then that involves a degree of enforced trading - you need to sell shorter maturities and buy longer ones as time passes so that you don't end up with a year less maturity for each year the passes (or worse if defaults or other events lead to early calls or early payments without make-whole compensation). Likely you'd have got better than expected returns doing this (but then it was always a bet on falling rates).
But if you'd just bought a portfolio of bonds to give you a fixed bucket of maturities (which is what by far the larger part of the market has usually tended to do) and only reinvested cashflows as you received them from the issuers, you'd have likely underperformed your initial expectations because you faced reinvestment risk.
That lower return probably would have been compensated by inflation also falling for some of that time. But real yields have now been negative for quite a while, so to maintain returns you'd have been forced to accept more risk.
I’d guess that holding bonds until maturity in the form of a bond ladder was more common from 1980-2000, but since then bond funds have become more common.
I think large institutional investors buying credit (as opposed to treasuries - not sure what really happens there now) are still mostly following a buy and hold strategy. But yes, I'd agree that's likely the case for individuals (including through retirement accounts).
edit: And by investing in munies you're also investing in US infrastructure. Munies fund all that stuff. Bridges, fire stations, schools, roads, water treatment plants, ports, electrical grids, etc, etc, etc. Might even make you feel like a good citizen...