Thursday, March 15, 2012

Stay Away From Bonds For The Next 20 to 30 Years

Bonds do well when interest rates decline.

Interest rates have declined steadily for the past thirty years. Thus, bonds have done quite well during that period.

Although interest rates may decline again this year, their days are numbered.

How do I know that? Because rates aren't that far from zero now, and someday the economy will resume solid growth.

And as the economy recovers, which it will, interest rates will increase.

In fact, rates will increase before the economy resumes substantial growth.

While we don't know when that will happen, we do know that it will happen.

When rates increase, bond values will decrease. It's that simple.

But don't take my word for it. Listen to the experts.

Why stocks will beat bonds over the next 20 years says this about why stocks represent the better investment alternative:

"“The equity market doesn’t have to do too well to beat the bond market,” said Roger Ibbotson, a Yale University finance professor and founder of investment-data pioneer Ibbotson Associates, a unit of Morningstar.

Indeed, coming years may begin to see a more normalized investment picture, in which U.S. stock buyers are rewarded for taking risk and equities outperform bonds. Typically the 10-year Treasury is the starting point to measure this “equity risk premium,” which for more than eight decades has given stock investors around four percentage points of return over the prevailing Treasury yield."

Why bonds aren't attractive investments compared to stocks is described by another investment expert:

"Still, right now stocks, particularly dividend payers, look more attractive than bonds — especially if down the road there’s resurgent inflation, which whittles away fixed-income returns.

“The bond outlook is extraordinarily bad,” said Jeremy Siegel, a Wharton School finance professor and author of the best-selling “Stocks for the Long Run.” Bonds are in vogue and overvalued, much as stocks were at the end of the 1990s, he said. After 30 favorable years of declining yields and rising prices, the best case for bonds over the next couple of decades is a return of “zero” after inflation — and more likely a negative outcome, Siegel predicted.

If interest rates climb in future years, as is likely from today’s very low levels, the prices of existing bonds with lower rates will fall. The impact may be felt more keenly by holders of bond mutual funds and exchange-traded funds than by investors who have bought individual bonds. The latter have the option to collect their bonds’ full face value at maturity, while bond funds don’t mature."

Even in normal investing times (whenever that is), bonds typically don't earn as much as stocks. There's about a 4% yearly advantage for stocks compared to U.S. treasury bonds.

For perhaps the next several decades, as rates increase and the stock market gains its footing, that 4% annual rate of return advantage for stocks should be even higher. That's the best bet as interest rates will be increasing.

Even as interest rates declined, stocks outperformed bonds the past thirty years. Of course, that hasn't been the case lately. The future will tell a different story, however, and rising rates will mean a poor performance for bond returns. Rates aren't likely to rise for some time, of course, but their long term direction will be up.

Accordingly, on a secular basis, staying away from bonds is as close to an investing no-brainer as possible. That's due to the fact that stocks usually perform better than bonds, even when rates aren't low, but when they are, it's hard to justify any position in bonds at all.

That's especially true when, as is the case today, solid dividend paying blue chip stocks offer current yields higher than the interest rates paid on bonds. And have sound prospects for earnings growth and increasing dividends in future years as well.

As a long term investor, that's more than good enough for me.

Thanks. Bob.

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