For the last 14 years or so, if investors wanted to make any sort of decent return on their money, they had to buy stocks because high-quality corporate and government bonds were paying next to nothing in interest. Rates had been abnormally low for well over a decade until this year when inflation really started to accelerate as a result of coming out of the pandemic. Now, we have bond yields that can compete with inflation as well as stocks and the best deal going right now is short-term U.S government bonds.
This has really created some healthy competition for stocks. For example, I can buy a U.S. Treasury bond that matures in June of next year that yields 4.5%. Compare that to a high-quality stock that pays a 4% dividend. The bond is a near risk-free investment (unless our country collapses) if held to maturity whereas the stock could be at a lower or higher price at the time that the bond matures next year. For many risk-averse investors, this is a no brainer to buy U.S. government bonds versus stocks in today’s interest-rate environment.
The key to this strategy is to buy individual bonds with short-term maturities (less than 18 months) versus bond mutual funds or bond ETFs. That’s because with individual bonds, you know exactly how long you need to hold the bond to get back 100% of your original investment. With most bond mutual funds and ETFs, the maturity date is open-ended because they continually have to buy bonds as money comes into the fund. This becomes a problem when interest rates rise. Regarding short versus long-term maturities, buying bonds that mature within the next 18 months means less time that you have to keep your money locked up in those bonds. That’s important for investors who might need the money for other purposes or who think that rates will rise and want to reinvest in higher yielding bonds.
An unintended benefit of buying short-term bonds right now is that the yield curve is inverted, meaning short-term bonds are paying higher interest rates that longer term bonds, which is not normal. For instance, a 20-year U.S. bond is paying 4.3% right now compared to that bond we mentioned above that matures next June and is paying 4.5%.
The takeaway here is that short-term bonds can finally be considered again in your investment portfolios as a viable alternative to stocks.
Please comment or send an email if you have any questions. Thanks!
Joe Baker, CFP®
Baker Asset Management, LLC
joebaker@bakerassetmanagement.com
