Blurring the Line

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

Over the years, CNBC has served investors well by providing timely and accurate business news. But when the network blurs the line between hard news and commentary, and opinions are accompanied by misstated or misleading assumptions, it undermines the ability of investors to make sound decisions.

A case in point is an often-heard pronouncement by Maria Bartiromo, one of the network’s long-time anchors. On countless occasions, she has stated that it’s common knowledge that stocks outperform bonds over the long run.

On its face, it seems she is simply parroting an innocuous dose of conventional wisdom.

But according to research by Ibbotson Associates, as reported in “USA Today” last year, bonds actually outperformed stocks over the past 30 years. Ibbotson’s bond index, comprised of a broad cross section of bonds, returned 11.03% per year on average over the previous 30 years, compared with a 10.98% return for the S&P 500 during the same period.

Though the edge was modest, it debunked a popularly held notion blithely spread by commentators and advisors and a fundamental assumption behind the financial decisions of legions of investors.

Apples vs. oranges

Equally troubling is another seemingly common sense but ultimately misleading pronouncement by Bartiromo’s colleague, Jim Cramer. Cramer, host of the frenetic show “Mad Money,” animatedly discussed recently the value of owning equities as opposed to the folly of buying 10-year Treasury bonds yielding 1.75% (another stocks vs. bonds comparison).

Without a crystal ball, it’s impossible to know whether Cramer will be right, but he’s attacking a straw man, making a ridiculous and disingenuous comparison on a show directed toward individual investors.

Perhaps Cramer doesn’t know that individual investors don’t buy 10-year Treasury bonds yielding 1.75% (which have an after-tax yield of approximately 1.05% for investors in the top tax bracket). That would explain his enthusiasm toward equities in his analogy.

But it would be considerably more challenging to make his case for stocks if measured against quality tax-free bonds yielding 4.00%, equivalent to a taxable yield of 6.60% for investors in the top bracket. This is a guaranteed and not hoped-for return from an investment-grade creditor.

On that, he is silent.

A skewed view for investors

Unfortunately, there is precious little talk in the financial media on the value of municipal bonds and their steady stream of tax-free income. For commentators, the stock market’s gyrations provide a daily dose of fresh fodder, but it may present a skewed view of prudence for individual investors.

Even when attention is directed to the tax-free bond market, the talk is usually dominated by two trains of thought: “wait for interest rates to rise” or “be careful of the imminent Armageddon in the muni market.”

Meanwhile, interest rates over the years have declined or remained steady, and as we all know now, the widely heralded predictions of catastrophic events never materialized (see: “Thanks, Meredith“).

Newcomers to the bond market may have trouble distinguishing between the news and the noise. Veteran muni investors, on the other hand, have developed a long-term perspective and are accustomed to ignoring daily market swings and hyperbole (see: “Back to Boring“).

They’re not looking for excitement and don’t worry about the financial media’s sometimes distorted perspective. Instead, they prefer to sleep well at night, knowing their interest clock is always ticking.

James A. Klotz

President

James A. Klotz is the President of FMSbonds, Inc.
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Apr 17, 2013

Please note that all investing entails risk. Fixed income securities are subject to risks that will affect their value prior to maturity. Some of these risks can be related to changes in market conditions, issuer creditworthiness, and interest rates. This commentary is not a recommendation to buy or sell a specific security. All references to tax-free income refer to U.S. federal income tax. Income earned by certain investors may be subject to the Alternative Minimum Tax (AMT), and or taxation by state and local authorities. Please consult with your tax professional prior to investing. For more information on these topics please click on the “Bond Basics” link below or search by keyword at the top of this page.