Q.  With the financial mess that a lot of countries are in (or about to be in) these days I wonder how the experts feel about bonds being a safe investment.  Johnson & Johnson, for example, has a better credit rating than the U.S. government.  Are bonds still safer than stocks?  Gary D.

To retirees, receiving investment income is a prime objective.  With the current higher prices of blue chip stocks it’s becoming increasingly difficult to get a decent yield.  Bonds have always been a key part of an income-oriented portfolio.

Are Bonds Safe?

The face value of government bonds will always be safe because governments have the power of taxation and they can print more money.  Corporate bonds pay a little more because they don’t have that power – so they are inherently riskier – but choosing high-grade bonds (BBB and higher) can reduce that risk.

What is the Risk?

The main risk of bonds is interest rate risk and it’s close cousin, inflation risk.  As interest rates increase, a bond portfolio will drop in value.  If you need to sell before maturity you may lose money.

You can only be sure you’ll get back the face value of a bond if you don’t buy at a premium and you keep the bond until maturity – then price fluctuations won’t matter.

Related: What Are Real Return Bonds?

Most bonds these days are trading at a premium resulting in a capital loss if held to maturity and a reduction in yield.  These losses can only be used to offset capital gains.

  • A Government of Canada bond purchased on the secondary market maturing June 1, 2015 with a coupon rate of 11.25% has a purchase price of 121.81 ($10,000 bond will cost you $12,181) and the yield is a measly 1.00%

Inflation erodes the purchasing value of fixed income payments – the longer the term, the higher the inflation risk.

Today’s interest rates really have nowhere to go but up – but when?  Experts have been predicting interest rate increases for several years now and the Bank of Canada is staying firm.

  • A new issue (April 1/2013) Government of Canada 10 year bond has a coupon rate of 1.5%

You can stick to short to medium terms for a steady income.  But since long-term bonds normally (not always) will have a higher coupon rate it may make more sense to ladder your bonds to help reduce the impact of changing interest rates.

  • GofC  1 to 3 year bonds have an average yield of 1.01%
  • GofC  3 to 5 year bonds have an average yield of 1.2 to 1.24%
  • GofC 10 year plus bonds have an average yield of 2.33 to 2.38%
  • Corporate 10 year plus bonds have an average yield of 3 to 5+%

If you don’t have the funds or the expertise to build a decent bond portfolio, bond ETFs are a good, low cost, professionally managed alternative.

  • iShares DEX Universe Bond Index (XBB) has a weighted average coupon rate of 3.92% and a 12 month yield of 3.22%
  • iShares DEX All Corporate Bond (XCB) has an average coupon rate of 4.51% and a rolling 12 month yield of 3.78%
  • iShares US Corporate Index Fund has a weighted average coupon  of 4.98% and a yield of 3.3%

Conclusion

Bonds can provide a worry-free stream of income.  For higher coupon rates buy high quality corporate bonds (or ETFs) and diversify by company, sector and geography.

Related: Canadian Monthly Income Fund Comparison

Now, I’m in no way an expert and these are just my opinions.

What’s your take?  Are bonds a safe investment today?


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