Recently I read a couple of articles in Yahoo Finance and The Wall Street Journal looking at bonds both from a historical perspective and future prospects. Here are some key points from the articles:

• As of June 30, U.S. stocks have underperformed long-term Treasury bonds for the past 5, 10, 15, 20 and 25 years.
• Using data from research firm Ibbotson Associates, large-company stocks have returned 9.2% annually over the past 40 years through the end of June, versus 8.5% for long-term government bonds.
• One of the article’s author, Jason Zweig, calls into question the validity of data used in Jeremy Siegel’s book  “Stocks for the Long Run”.
• The long-playing Treasury-bond rally seems to have petered out.
• With Washington pumping out $2 trillion in net new Treasury offerings this year, fear is growing of a vast oversupply that will send prices plummeting and yields—which move in the opposite direction—soaring.
• Bill Gross, the head of Pimco Total Return fund, predicts that federal debt as a share of gross domestic product, now 45%, could balloon to 300% over the next 10 years.

What does this mean for the income investor? At the macro level, not much. Our investing strategy should not be swayed by the latest headlines.  Headlines are designed to incite two emotions – fear and greed. Acting on these emotions will often lead you to do just the opposite of what you should be doing.

Should We Give Up On Stocks?

Not hardly. Consider what it took for bonds performance to “equal” equities. A decline in the world’s economy and equities not been seen since the Great Depression, coupled with a bond rally driven by the lowest interest rates in generations. In short, equities fell to the level that bonds ascended to. Both stretching what was previously considered “normal.”

Should We Give Up On Bonds?

Conventional wisdom would tell you that bonds have only one direction to go, down.  However, if you have followed your asset allocation model, you are likely close to where you need to be allocation-wise and if bonds begin to fall, it will create opportunities to buy at lower prices with higher yields. If you are not fully allocated, like many of us, a planned and steady movement over time will allow you to enjoy the effects of dollar-cost-averaging.

Currently, I am under allocated in bonds and it is my plan to steadily purchase bonds each month until my allocation is in line. To do otherwise would be a form of market-timing, which is contrary to my investing strategy.  My bond preference is for intermediate and longer-term issues. Here are some bond funds that I have either purchased or am considering:

iShares Barclays Aggregate Bond (AGG) – Yield: 4.28%
The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the United States investment grade securities markets as defined by the Barclays Capital U.S. Aggregate Index.

Vanguard Long-Term Bond ETF (BLV) – Yield: 5.37%
The Fund seeks to match the investment performance of the Barclays Capital Mutual Fund Long Government/Corporate Index.

Vanguard Intermediate-Term Bond ETF (BIV) – Yield: 4.55%
The Fund seeks to track the performance of the Barclays Capital 5-10 year Government/Credit Index. This index includes U.S. Government, investment-grade corporate, and international dollar-denominated bonds with maturities between 5 and 10 years.

iShares iBoxx $ Invest Grade Corp Bond (LQD) – Yield: 5.49%
The Fund seeks investment results that correspond generally to the price and yield performance of a segment of the U.S. investment grade corporate bond market as defined by the GS $ InvesTop Index.

iShares Barclays 20+ Year Treas Bond (TLT) – Yield: 4.11%
The Fund seeks investment results that correspond generally to the price and yield performance of the long-term sector of the U.S. Treasury market as defined by the Barclays Capital 20+ Year Treasury Index.

Longer term bonds could see significant price declines as interest rates rise to, or exceed, historical norms.  Before making any investment decision you should consult your financial adviser and understand the risks involved.

Full Disclosure: Long AGG, BLV, LQD. See a list of all my income holdings here.

I came across Kimberly Palmer’s article titled “The Future of Social Security: Not Good“. My first response was ‘No duh!’  After giving it more thought, I came to the conclusion that my reaction is probably in the minority.

I suspect most people believe that the U.S. government will not let Social Security fail. This is the same government that deemed certain large companies ‘too big to fail’ and dragged other unwilling participants into the fray.  BB&T’s (BBT) Chairman and CEO, Kelly King has been very outspoken on how the government has managed the TARP debacle. And now the government is ‘helping’ the auto industry. Watch out Detroit!

The U.S. government has become too big and too ‘helpful’ to the detriment of its citizens. The government should spend more time providing for the common defense and less time promoting the general Welfare (pun intended).

So, what are your retirement plans? Are you going to rely on the government to print your social security check and the money backing it up, or will you choose to take charge of your future and prepare for it? As it is with most things in life, those that prepare for retirement will find more success than those that don’t.  It is really not that hard when you start young.  Here are three simple steps:

1. Live on less than you earn. (another ‘No duh!’ statement)
2. Invest the rest using a sound asset allocation model.
3. Pick solid, conservative, low-cost investments.

Number 3. on first blush may seem complicated, but it doesn’t have to be. For those that don’t want to make investing their hobby, they can focus on a few good funds like Vanguard’s S&P Index Fund (VFINX) and Vanguard’s Long-Term Bond ETF (BLV).

For those a little more adventurous, a strategy based on an article by Richard Jenkins titled “A simple ETF strategy for beginning investors“ has been quite effective over time. Don’t let the “beginning investors” term scare you away. The goal of this portfolio is to provide diversification over a broad allocation of stocks and bonds by holding five ETFs:  iShares Lehman Aggregate Bond Fund (AGG), iShares MSCI EAFE FD (EFA), Vanguard Total Stock Market ETF (VTI),  iShares DJ Real Estate Index (IYR) and iShares DJ Basic Materials (IYM).

For those comfortable in selecting and holding individual stocks, there is nothing like Dividend Stocks to provide a growing income into the future. Dividend stocks found in many dividend investors’ portfolios include companies such as: McDonald’s  Corp. (MCD) [analysis], Johnson & Johnson (JNJ) [analysis] and The Coca-Cola Company (KO) [analysis].

Finally, you can choose not to prepare. In June 2008, I wrote about a retirement-age couple that would never retire because they chose to live life on the edge and always spent a little more than they made. Over the last year the noose has continued to tighten on Bill and Jackie (not their real names).  Due to the economy and health issues work has been hard to come by. Their house is one step away from foreclosure and on the market with no buyer in sight. Bill needs surgery and the family continues to grow weary of providing for them.

Life is a choice. You can choose how you live, but you cannot choose the consequences of how you live.

Full Disclosure: Long AGG, BLV, EFA, IYM, JNJ, KO, MCD, VFINX, VTI. See a list of all my income holdings here.

On including bonds in your asset allocation:

I have been saying for more years than I care to count not to forget bonds. And start to think about it as a rule of thumb, having your bond holdings equal your age.

Investors come to me and generally say one of two things, either ‘Thank God I followed your advice,’ or ‘I really feel stupid for not having followed your advice.’

On the economy:

We can’t fix our economy now, today. We can move in a direction of fixing it, but when you think about what is happening it’s very obvious: We have to save more.

The old 3% real growth which is the rate the economy has grown at, well I think that is too aggressive. We’re looking at much slower economic times.

On what a slower economy means for investors:

We have had a stock market crash of the largest proportions probably of the last century, with the possible exception of 1929 to 1933. We have had a big stock market crash. Do we have to have another one? I don’t think so.

I would guess the market probably has it about right. I would guess that we have seen the low for the year and maybe the low for this cycle.

On having an international allocation:

Decide where you want to put your money. I would say U.S. stocks, because international will do well and then it will do badly, and the same thing for emerging markets, which will do well for a while and then do badly and then do well again. I just think you don’t need to go beyond U.S. stocks.

On the reported death of asset allocation and buy-and-hold investing:

I am really concerned when I hear people say buy-and-hold is over. Investors, as a group, are buy-and-holders. We own the stock market, all of us together, we buy and hold it. As a group, we all have the same asset allocation. So when you hear someone say ‘It’s a stockpicker’s market,’ well if you picked well, then I picked ill, and as a group it’s the same.’

You can read the entire article here. I don’t agree with everything Mr. Bogle says, but I do think there is a lot we can learn from him. So what can we do to put some of the above in practice?

First, don’t forget about bonds. As recently noted, treasuries and bonds tend to be less risky than equity investments, but have historically under-performed equities. When the market is climbing by double digits, it is easy to question why you are including bonds in your asset allocation. However, when the market turns down, the importance of bonds becomes very evident. I currently hold some old savings bonds (U.S.) and several funds/ETFs in my 401(k) and taxable accounts. My two favorite ETFs are Vanguard Long-Term Bond ETF (BLV) currently yielding 5.6% and iShares Barclays Aggregate Bond (AGG) currently yielding 4.7%.

Unlike Mr. Bogle, I think international investments play an important role in your asset allocation. Due to the complexities in this arena, I prefer to use indexed ETFs to meet my allocation here. In addition to a fund in my 401(k), I currently hold iShares MSCI EAFE Index (EFA) and Vanguard Emerging Markets Stock ETF (VWO). In addition, I am currently evaluating Vanguard FTSE All-World ex-US ETF (VEU).

As  Mr. Bogle alluded to in the article, there are many excellent U.S. stocks to invest in. In this area I prefer to focus on great Dividend Stocks like Johnson & Johnson (JNJ) [analysis],  Procter & Gamble Co. (PG) [analysis], The Coca-Cola Company (KO) [analysis] and 3M Co. (MMM) [analysis].

It seems that ever so many years the market turns down and someone declares the death of buy and hold. Even some go as far to say the Warren Buffett has lost his touch. The buy and hold investors and Mr. Buffett always seen to make a spectacular rebound, and they will once again. In the mean time, we need to focus on acquiring value and maintaining our asset allocation.

Full Disclosure: Long BLV, AGG, EFA, VWO, JNJ, PG, KO, MMM. See a list of all my income holdings here.