Why Buy Bonds, Especially Now?
When Interest Rates on Cash Balances Don’t Keep Up, Future Purchasing Power is Lost
By Tom Kirk, CPA-PFS, president and Founder, FirstWave Financial
Here are the main reasons people are saying not to buy bonds now:
- Interest rates are at an all-time low
- Rates are expected to go up in the near future
- When interest rates go up, existing bond values will go down
- Why invest in something that will likely lose value?
While these statements are true, consider a few alternatives:
- Keep your money in cash
- Invest in the equity market
But each of these alternatives has their own issues and problems:
- Cash on deposit at a bank, while insured up to federal limits, is earning close to zero interest – 0.2% on my bank saving account last time I checked. Since this is less than the rate of inflation, I am losing future purchasing power. The cost of things I will buy in the future (e.g. cars, clothes, food) is going up in price faster than the money I will use to buy them. So I will either have to purchase less of these things or spend more for the same stuff. A friend of mine calls this “going broke slowly.”
- The stock market is at an all-time high. The S&P 500 has experienced a six-year period of increasing value during which time it has almost tripled from its lows in early 2009. The global economy seems to be in good and improving condition but, after such a long period of positive returns, some pullback would not be unexpected, even if only temporary.
So what is a person to do? Each of these types of investments (bonds, cash and equity) seems to have real failings. But in fact they each play an important role in your overall investment portfolio.
- Cash is the perfect vehicle to fund your liquid reserves. These are the dollars that would be necessary to pay for three to six months of your living expenses.
- Bonds can be used for the money that you think you will need sometime between one and five years from now. But not just any kind of bonds. Short-term, investment grade, low cost bond funds are specifically designed to weather the expected increasing interest rate environment without significant loss of value, while paying you substantially more interest than you will get on your cash in the bank.
- Equities (stocks) are a good place to invest the money you don’t expect to need for five years or longer. Based on historical performance, even if the stock market takes a breather from its recent advances, it is likely to be higher in five or more years than it is today. A broad diversification of domestic and foreign, large and small, value and growth companies will help you capture that future performance.
Be sure to consider your unique risk tolerance. All this goes out the window if you are an investor who follows the crowd, buying after the market has risen, and selling after it falls. That’s a way to go broke quickly. It would have been better for you to keep your money in cash and go broke more slowly!
About the Author: Thomas L. Kirk
CPA-PFS President, Founder and WealthCoachTM
- Certified Public Accountant
- Personal Financial Specialist
- Financial Planning Association Member
- University of Florida, BSBA