First published at Marketwatch.com http://www.marketwatch.com/story/bond-strategies-for-low-rates-and-rising-inflation-2014-06-16
Interest rates fell far this year and could stay low for some time. The world is awash with liquidity as central banks around the globe maintain highly accommodative monetary policies.
The yield on the benchmark 10-year U.S. Treasury bond started 2014 at 3% and has since fallen to around 2.5%. The 10-year yield bottomed below 1.45% in 2012. Jeffrey Gundlach of the DoubleLine funds thinks that there’s a 30% probability that we will retest the 2012 lows , which were the lowest yields in over two hundred years — going back to the beginnings of U.S. Treasury debt.
Low yields create problems for retirees who need income as they try to maintain their purchasing power. According to the Bureau of LaborStatistics, inflation, as measured by the consumer-price index, or CPI, is running at 2%,which is just about where the Fed wants it. If inflation is running at 2%, your income has to increase by the same amount each year to maintain purchasing power and 2% seems like a pretty easy number to keep up with. But, is inflation really that tame? The 2% number is for all items that they evaluate. However, we’ve seen inflation in specific areas. Utility service for piped gas, for example, increased by 11.8%.
Also, the way the CPI is calculated has changed over the years as people consume different products than they did 30 years ago. If the CPI were calculated the same way today as it was in 1980, we would be seeing some real signs of inflation. John Williams of ShadowStats.com determined that if the same methodology were still in use today, we would have seen an inflation rate of 8.9% in 2010, 10.7% in 2011, 9.7% in 2012 and 9.1% in 2013. That is some serious inflation and a strong rate of return is required just to keep pace.
Retirees have a wide variety of investments to choose from when investing for income. There’s no one-size-fits-all solution; people have to do what’s best for their individual situation. You can choose from stocks, bonds, preferred stocks, MasterLimited Partnerships (MLPs), mutual funds and exchange-traded funds.
Let’s touch on a few strategies for bond investors or for the bond portion of your portfolio.
Three common strategies for investors who don’t want to use mutual funds and would rather own individual issues are: The bullet, the barbell and the ladder.
In the bullet strategy you purchase intermediate term bonds all maturing at about the same time. The intermediate time frame is defined as being about seven to 10 years.
With the barbell strategy, you put about half of your funds into short-term instruments like Treasury bills, CDs and short-term bonds and the other half you invest into long-term issues to get a higher coupon rate. As the short-term issues mature they are rolled over.
The ladder strategy consists of buying bonds with different maturity dates that start in the short term and stretch out as far as you want them to. For example if you wanted a 10-year ladder and had $100,000 to implement it, you’d put $10,000 into 10 different bonds with the shortest maturity at one year and the longest at 10 years. That way you’ll have a bond maturing each year and if rates rise, you’ll be able to reinvest at the higher rates.
The ladder doesn’t have to be 10 years. It could be shorter or longer depending on your goals.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information on his money management service can be found at his blog at www.sellacalloption.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.
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