We have received a number of e-mails recently from investors who were surprised by an Oct. 1 article in The Wall Street Journal titled “Bond’s Tortoise Outruns Stock’s Hare Over the Last Seven Years.”
The Journal, quoting Lipper, Inc., exposed one of the best-kept secrets on Wall Street: Despite the roaring bull market rally in the late 1990s, U.S. bonds have handily outperformed stocks over the past seven years.
According to Lipper, Inc., there has been a 7.1% annual gain for the Lehman Brothers Aggregate Bond Index compared to 4.5% for the S&P 500 Stock Index over the same period.
Although we are pleased that bonds are earning newfound respect, we are concerned that these types of comparisons have a tendency to distort some important fundamentals of bond investing.
It’s not “either/or”
We have always felt that bonds are too often discussed as an alternative to stocks, rather than as a vital cash-flow component of a well-constructed investment portfolio.
To a tax-free bond investor, these analyses of performance are not only meaningless, they are potentially misleading. The fact that most bonds purchased over the past seven years have appreciated in price is also irrelevant. Bonds are intended to produce income, not capital gains.
The financial media’s insistence on using an equity measuring stick to evaluate bond performance can distract bond investors from their main objectives: earning a stable, dependable stream of reinvestable tax-free income.
Wall Street’s “buy low, sell high” mantra causes newcomers to the bond market to second guess themselves regarding the right or wrong time to commit investment dollars to bonds.
As you may recall, early this year economists and bond fund managers were issuing dire warnings of a new higher interest rate environment. Their advice was to sacrifice the 5% available on long-term municipal bonds and either buy very short maturities yielding less than 3% or park funds in the money market yielding less than 1%.
As we all know, the much-anticipated rise in rates and bond market debacle never occurred, leaving investors who followed this advice unable to recoup the income sacrificed by being in cash.
Muni rates still above historical average
Ironically, while Treasury bond yields hover around 40-year lows, tax-free bond yields have not followed suit. According to the “Bond Buyer,” its 20 bond muni index averaged 4.74% last year.
Those who persist in waiting for higher municipal bond yields should note that this index was lower than 5%, more than 65% of the time between 1900 and 2003 and was lower than 6%, 72% of the time. (This average includes the aberration of the 1980’s when the average yield was 9.02%.)
Today, there are many tax-free bonds in the market yielding as much as taxable Treasury bonds. This means tax-free bonds continue to offer unusual value.
It may sound too simple, but successful municipal bond investors have learned that the best time to buy bonds is when investment dollars are available. They appreciate the magic of compounding interest and understand the folly of parking funds in cash accounts waiting for higher bond yields. They buy investment-grade, long-term bonds to maximize tax-free income on each purchase, knowing this additional income will allow them to take advantage of higher bond yields if interest rates move up.
Veteran bond investors know that over time the value of their bonds will fluctuate, but their interest checks will keep coming regularly.
Is your interest clock ticking?