I recently posted an column at: MarketWatch.com titled: “Why Individual Bonds Remain Very Attractive” While investors are bailing from bond mutual funds – a wise move, individual bonds do offer protections against rising interest rates not found in bond mutual funds.
My overall prediction is that rates cannot go up dramatically. With every 1% increase in interest rates, the added amount the government must pay to just pay the added interest cost on the Federal debt, increases by about $180 billion. For perspective, the “sequestration”, the mandated cuts put into place that get the blame for everything bad in the economy, only cut spending by $42 billion (and prevented another $43 billion of spending increases). Simply put, the government and the Federal Reserve have a lot at stake to keep interest rates relatively low for a very long time. That said, a ½% increase across the board seems likely – but only if the economy continues in a positive direction. I think this is a big “if”.
The short version of the MarketWatch article is that many investors think that a bond’s value is fixed, and that they are stuck holding a bond to maturity. The reality is that a bond’s value will naturally increase in value through the first half of its life. This allows a bond investor to sell their bonds at a profit after a short holding period. If rates don’t increase. But even if rates rise, a bond will likely return to its par value several years before its actual maturity date.
For example I was recently quoted an Ohio municipal 10 year bond, Aa2 rated and insured, a ten year maturity, and a 3.655% yield to maturity. That is a federal and state tax free interest rate. If interest rates do go up ½%, the face value of the bond will drop below purchase price for the first 3 ½ years or so. But by year 5 the bond should be back to what an investor would pay for it today. So in effect, your 10 year bond has come a 5 year bond – paying 3.655% tax free. That is a pretty good deal.
If you own bonds and want to know when an optimum time would be to sell them, contact my office and we will run the analysis for you. If you need more income, or just want to diversify but don’t know where to go, give us a call and we can explain what bonds can do for you, even at a time when everyone is cashing in on their bond funds.