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Your Guide to Retirement: FAQs About Bonds

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Your Guide to Retirement- FAQs About Bonds

Bonds are an important part of your retirement portfolio, and the closer you get to retirement, the more of them you should have. 

Nevertheless, beginning investors often have a number of questions about bonds. 

Here’s what you need to know.

If I Invest in a Bond, How Much Money Can I Make Off It?

That depends on the issuer and the bond’s maturity—that is, the length of time it lasts and pays you interest until the principal is returned to you.  Generally speaking, longer terms pay higher interest rates.

As far as issuers go, the less stable ones will generally offer a higher interest rate to you. 

This is to attract you as an investor, since you know there is a higher chance that this particular issuer will fail to make its bond payments. 

For the absolute safest bet, go with Treasury bills, which the United States government issues.

What Do the Returns Look Like Compared With Stock Returns?

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As you can see, stocks are the clear winner return-wise.

Why Then, are Bonds Considered Better for Retirement?

  • Bonds provide you with a stability that stocks cannot, so having at least some bonds in your portfolio cushions you against major stock losses.
  • Bonds provide regular income in the form of interest payments
  • Bonds are incredibly secure. U.S. Treasuries are second only to cash in liquidity and safety.
  • There are bonds which are non-taxable. While their yields tend to be lower, the lack of tax may cancel out this difference for individuals in higher tax brackets.

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How About the Risks?

Inflation poses a serious risk to bond holders. 

The cost of goods and services goes up over time—the payout from your bonds do not. 

Long-term bonds run a serious risk of not keeping up with inflation.

With all but the most stable bonds—U.S. treasuries—there is a risk that the issuer will default on its payments. 

This risk is particularly magnified with junk bonds, issued by borrowers with such a poor credit rating that it will be unsurprising if they fail to make payments to you at all.

Should you choose to sell your bond before its term is out, you should be aware that bond prices are subject to market pressures and rise and fall just as stock prices do.

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The above is a sample from Barclays Indices on the web, which gives information related to the latest movements in bond indices.

The price of bonds tends to have an inverse relationship to interest rates—when one goes up, the other goes down, and vice versa. 

If your bond has a very long term, and you wish to sell it early, there is a good chance it will not cost what it did when you bought it, which may or may not be a good thing for you.

I’ve heard of TIPS—What Are They?

  • TIPS stands for Treasury Inflation-Protected Securities
  • TIPS’ rate of interest is not as high as other Treasury bonds
  • However, the face value of TIPS is changed to keep up with the consumer price index.
  • Thus, inflation no longer poses a risk, as the face value and interest of your TIPS go up to match.

What Should I Put in my Retirement Portfolio?

You should diversify with bonds the same way you would diversify with stocks

A good spread would be amongst high-grade corporate bonds (avoid junk bonds) and Treasury bonds. 

If you are in a high tax bracket, you may also want to look into municipal bonds, as their interest is tax-free.

How Do I Buy Bonds?

You can choose to buy almost any kind of bond through a broker, same as stock, though the transaction costs may be a whole lot higher.

For TIPS or U.S. Treasuries, it’s better and cheaper to buy from the Feds, as no broker is necessary for this transaction. 

The federal government offers these at auction fairly regularly.

If you would like to look into the details, a good place to start is the TreasuryDirect Website, which among other things contains auction schedules like the example below:

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If you are a small investor, look into mutual funds for diversification purposes. 

Getting good diversification through individual bonds tends to cost $25,000 to $50,000, whereas bond funds will open you up to owning stakes in dozens of bonds for far less.

Which Should I Buy—Short-Term or Long-Term Bonds?

For a higher interest rate, go with longer-term bonds as opposed to shorter. 

An example is, the difference between 30-year Treasury bonds and five-year Treasury notes—the former pays at least a percentage point more in interest. 

The reason for this discrepancy is that the longer the life of the bond the greater the chance of erosion by inflation or interest rates.

For the majority of long-term investors, bonds that last from one to ten years are in a good sweet spot, as they have decent yields but less volatility than their longer or shorter-lived peers.

How Heavy Should My Portfolio Be In Bonds?

This depends on where you are in your life and career. 

As a younger, working individual, you should put more emphasis towards stocks for their higher returns. 

However, the older you get and the closer you are to retirement, the more you should move towards bonds for their stability and guaranteed income.

How Will My Bonds Be Taxed?

Some bonds generate taxable income. 

Corporate bonds, for instance, will always make taxable interest payments. 

Treasuries, however, only garner federal taxes while being exempt from local and state taxes.

Municipal funds are also free of federal taxes, and may be free of local and state taxes when bought in-state. 

Retirement accounts may also offer tax savings.

Conclusion

Bonds are an important tool to have in your retirement arsenal. 

They provide guaranteed income, and while they may not give as high a return as stocks, they are more stable. 

U.S. Treasuries are considered some of the safest investments that there are.

So, however far away from retirement you may be, it is a good idea to become more educated about bonds. 

The more you learn now, the more you will know what you are working with later.

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Dollar Will Plunge 35%, Lose Status As World Reserve Currency

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The US dollar is on the verge of a 35% collapse. It could also lose its status as the world’s reserve currency. This is according to Stephen Roach, a senior fellow at Yale University and the former chairman of Morgan Stanley Asia.

The reason, according to Roach, is the slow decoupling of the US from its trade partners. Along with this, another reason is the rise of China. He says China’s structural reform goes away from a manufacturing economy. Instead, it comes into a more service-oriented economy with a stronger consumer base. This could mean the days of the US dollar being the world’s reserve currency are numbered.

Merely suggesting that the US losing its reserve currency status is enough to bring out the critics. In an opinion piece he wrote for Bloomberg, Roach addresses those critics.

“Scorn has long been heaped on those daring to question the supremacy of the U.S. dollar,” he starts. “As the world’s dominant reserve currency…the counter-arguments were strong and highly political, basically boiling down to the so-called TINA defense – that when it comes to the dollar, ‘there is no alternative.'”

The Role of The Dollar

Roach says that even those that believe there is no alternative to the US dollar when it comes to international trade. The same goes for when the financial markets are being shortsighted.

“Alas, the TINA argument doesn’t stop there. The counter to my case for dollar weakness also rests on the reserve status of the U.S. currency as the linchpin of world financial markets. All trading nations, goes the argument, have to hold the dollar as the price for doing business in an increasingly integrated dollar-based world economy.

“Even so, the dollar’s share of official foreign-exchange reserves has declined from a little over 70% in 2000 to a little less than 60% today, according to the Bank for International Settlements. That downtrend could gather momentum in the years ahead, especially with the U.S. currently leading the charge in de-globalization and decoupling. With America’s share of reserves well in excess of its share in world GDP and trade, such a correction might well be inevitable in an increasingly fragmented, multi-polar world.”

The natural instinct for a weak dollar is to buy hard assets like gold. However, Roach says those markets are simply too small. They will not be able to absorb the tsunami of dollars looking for a new home.

“And although cryptocurrencies and gold should benefit from dollar weakness, these markets are too small to absorb major adjustments in world foreign-exchange markets where daily turnover runs around $6.6 trillion.”

Gold and cryptocurrencies are too small to benefit. Although, Roach says he does expect two currencies to strengthen as the dollar weakens: the Chinese renminbi and the euro.

Can It Be Replaced?

“On this basis, a forecast of a weaker dollar requires some combination of a strengthening in China’s renminbi and the euro…

“The China call is very contentious. From the trade war to the coronavirus war to the distinct possibility of a new Cold War, the negative case for China has never been stronger in the U.S. than it is today.”

“The call on the euro is also counterintuitive, especially for a broad consensus of congenital euro-skeptics like me… I now have to concede that reports of the euro’s imminent death have been greatly exaggerated. Time and again, especially over the past 10 years, Europe has risen to the occasion and avoided a catastrophic collapse of its seemingly dysfunctional currency union. From Mario Draghi’s 2012 promise to do “whatever it takes” to save the euro from a sovereign debt crisis to the recent Angela Merkel-Emmanuel Macron commitment to a Next Generation European Union Fund of 750 billion euros ($855 billion) to address the coronavirus crisis, the great European experiment has endured extraordinary adversity… there is unmistakable upside for the most unloved currency in the world.”

Roach ends his article by pointing out that no country has ever devalued its currency and enjoyed prolonged prosperity.

“If TINA is the dollar’s only hope, look out below… Yes, a weaker dollar would boost U.S. competitiveness, but only for a while. Notwithstanding the hubris of American exceptionalism, no leading nation has ever devalued its way to sustained prosperity.”

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Fed Keeps 0% Rates Until At Least 2022

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Fed Keeps 0% Rates Until At Least 2022

Confirming what many expected, the Federal Reserve announced yesterday that it will keep rates at zero percent for the foreseeable future, perhaps well into 2022.

During a press conference, Fed Chairman Jerome Powell said, “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates.”

The Fed did acknowledge that economic conditions “have improved” in the last few months. However, none of the members indicated an urgency to raising interest rates. In “dot plots,” each member plots their forecast for interest rates. However, in this case, only two of the 17 members saw a case for hiking rates in 2022.

The decision to keep rates at near-zero percent indefinitely is an attempt to get the economy back to where it was before the coronavirus pandemic. During the said pandemic shut down our country and plunged our economic output by an estimated 50% this quarter.

Optimistic Outlook

The outlook from Fed members is for real GDP to contract by 6.5% in 2020. This comes with an unemployment rate of 9.3% by the end of the year. The members are much more optimistic about 2021. Members projecting an unemployment rate down to 6.5% and real GDP reaching 5%.

There are already positive signs, with last week’s controversial jobs report showing 2.5 million jobs were added in May.

Powell cautioned, however, that the millions of jobs lost will unlikely return quickly, if ever.

He says that many businesses may simply not reopen. Alternatively, he also says that jobs eliminated during the pandemic may not exist in the “new world order.”

The Federal Reserve keeping rates low while printing trillions of dollars to help the country recover from the coronavirus pandemic. With this, there are some very real fears that inflation is going to spiral out of control. Many fear that this will soaring well above the Fed’s target of 2%.

Thus far, the Fed members seem unconcerned about the possibility of runaway inflation.

Plans and Expectations

The average Fed member expects inflation (as measured in core personal consumption expenditures) of just 1.0% in 2021, increasing slightly to 1.5% in 2021.

The Fed will also continue to do its part to keep liquidity in the markets by buying up assets including mortgage-backed securities and Treasurys. The FOMC told the New York Fed to keep purchases “at least at the current pace,” which indicates about $80 billion per month for Treasuries and about $40 billion per month for mortgage-backed securities.

These actions along with other quantitative easing measures have inflated the Fed balance sheet to a record $7 trillion, a number that Powell has indicated he is comfortable with.

During a webinar hosted by Princeton University a few weeks ago, Powell said that the Federal Reserve has “crossed a lot of red lines that had not been crossed before and I’m very comfortable that this is that situation in which you do that and then you figure it out afterward.”

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Stocks Rally as Oil, Jobless Claims Rocket Higher

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Stocks Rally as Oil, Jobless Claims Rocket Higher

The stock market rally continued yesterday with the Dow Jones Industrial Average jumping 2.24%, the S&P 500 gaining 2.28% and the Nasdaq up 1.72%.

Investors felt optimistic after President Trump tweeted that he had spoken with Saudi Arabian Crown Prince Mohammed bin Salman. Many were hoping that both Saudi Arabia and Russia were willing to end the price war and mutually agree to cut production by at least 10 million barrels per day.

“Just spoke to my friend MBS (Crown Prince) of Saudi Arabia, who spoke with President Putin of Russia, & I expect & hope that they will be cutting back approximately 10 Million Barrels, and maybe substantially more which, if it happens, will be GREAT for the oil & gas industry!” Trump tweeted.

However, some experts are doubting the reality of cutting production by such a significant amount.

Edward Marshall, a commodities trader at Global Risk, told The Wall Street Journal, “It’s physically impossible for Saudi Arabia and Russia to get 10 million barrels a day off the market—they’d burst their onshore storage and fill every ship in sight.”

News also broke that Saudi Arabia called for an emergency meeting of OPEC and other oil-producing countries. The country called for a meeting to talk about how they can stabilize the oil market. Prices have been in freefall since the last meeting ended without a production agreement beyond April 1.

This was enough to send oil prices rocketing higher. West Texas Intermediate crude gained as much as 34% intraday before settling at $25.32 per barrel, a 24.7% jump. This is its largest single-day percentage gain in history.

Even with prices moving higher, it may not be enough to prevent bankruptcies in the oil and gas sector. This wave of bankruptcies was kicked off by shale driller Whiting Petroleum Corp. on Wednesday.

Jobless Claims Set Record

The market’s rally yesterday came in spite of some very bad news early in the day. Initial jobless claims for the week ending March 28 came in at 6.6 million. This figure is nearly double the previous week’s then-record of 3.2 million.

To put this number in a historical perspective, prior to the last two weeks, the previous record number of claims in a single week sat at 665,000 in March 2009 during the Great Recession.

To put it simply, this week’s initial jobless claims number was equal to the total claims filed during the entire Great Recession.

Chris Rupkey, chief financial economist for MUFG Banks, wrote in an email, “We knew that massive job losses were coming because of reports that many workers were unable to file a claim for benefits even after waiting on line for hours. Everywhere you look Washington and state governments were not prepared for the rapid spread of the virus and the devastating damage that would be done to the economy if businesses were shut down and workers sent home.”

He added “In a normal recession, job layoffs build over the many months of recession until they peak. In this pandemic-based recession, the job losses are immediate where the economy’s weakest hour is right now.”

Why was the market able to rally despite historically bad jobless claims?

JJ Kinahan, chief market strategist at TD Ameritrade, says it’s possible that the market knows it’s going to get worse. He also mentioned that this number won’t seem as bad in the coming weeks.

“Overall this is a little bit of a victory in and of the fact that it was such a bad number and the market did kind of shake it off. It is also the market preparing for a lot more bad numbers.”

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