A bond is a debt security in which the issuer agrees to repay borrowed money with interest at fixed intervals. Bondholders have a creditor stake in the company. Technically, bonds do not pay dividends, but instead they pay interest. However, bonds are an important allocation for many income investors, thus I chose to include them in this series. There are certain things an informed investor needs to understand before purchasing bonds.

Interest rates play an integral part in determining the current value of a bond. Interest rates and the price of a bond are inversely related. The longer the time until a bond matures, the more susceptible its price is to changes in interest rates. Consider two bonds, one that has a maturity of 30 years and another with a 7 day maturity. If after both bonds are sold, interest rates go up one percent, the price of both bonds will decline since new investors expect to earn the prevailing interest rate. However, the interest rate decline will affect the price of the 30 year bond more than the 7 day bond, due to the longer period of “lost” earnings. It works the same in the other direction – if interest rates drop the bond holder will sell it at higher price which lowers the yield to the market rate.

In summary, longer-term investments have lower rate volatility at the expense of higher price volatility. Therefore, the term of the bond purchased should be dictated by your long-term investment goals. If your goal is capital preservation, short-term is the most appropriate investment. If an investor is willing to hold a bond until it matures and values lower rate volatility, then a longer-term investment will likely better meet this investor’s needs.

Like preferred stocks, many investors choose not to research and buy individual bonds. Instead, they have opted to make their bond investments in funds. Consider the following bond funds:

Vanguard Long-Term Bond ETF (BLV) – Yield: 5.16%
Vanguard Long-Term Bond ETF seeks to track the performance of a market-weighted bond index with a long-term dollar-weighted average maturity. It maintains a dollar-weighted average maturity consistent with that of the Index, which generally ranges between 15 and 30 years.
- Total Assets: $2.9 billion
- Expense Ratio: 0.14%
- Holdings: 40% US Corporate, 39% US Treasury, 8% Foreign Corp, 5% Foreign Govt, 8% Other
- Distributions: Monthly

Vanguard Intermediate-Term Bond ETF (BIV) – Yield 4.32%
The investment seeks to track the performance of a market-weighted bond index with an intermediate-term dollar-weighted average maturity.The fund maintains a dollar-weighted average maturity consistent with that of the index ranging between 5 and 10 years.
- Total Assets: $9.8 billion
- Expense Ratio: 0.14%
- Holdings: 45% US Treasury, 37% US Corporate, 9% Foreign Corp, 5% Foreign Govt, 9% Other
- Distributions: Monthly

Vanguard Short-Term Bond ETF (BSV) – Yield: 2.74%
The investment seeks to track the performance of a market-weighted bond index with a short-term dollar-weighted average maturity. The fund’s dollar-weighted average maturity is not expected to exceed 3 years
- Total Assets: $9.8 billion
- Expense Ratio: 0.14%
- Holdings: 52% US Treasury, 24% US Corporate, 14% US Agency, 8% Foreign Corp, 2% Other
- Distributions: Monthly

Vanguard Total Bond Market ETF (BND) – Yield: 3.98%
The investment seeks to track the performance of a broad, market-weighted bond index. The fund maintains a dollar-weighted average maturity consistent with that of the index, ranging between 5 and 10 years.
- Total Assets: $68.8 billion
- Expense Ratio: 0.14%
- Holdings: 33% Mtg Pass-thru, 29% US Treasury, 19% US Corporate, 7% US Agency, 12% Other
- Distributions: Monthly

Invest Grade Corp Bond (LQD) – Yield: 5.44%
The investment seeks results that correspond generally to the price and yield performance, before fees and expenses, of the iBoxx $ Liquid Investment Grade index. The fund typically invests at least 90% of assets in the bonds of the underlying index, and at least 95% of assets in investment-grade corporate bonds.
- Total Assets: $12.2 billion
- Expense Ratio: 0.15%
- Holdings: 82% US Corporate, 18% Foreign Corp, 0% Other
- Distributions: Monthly

Emerging Mkts Sovereign Debt (PCY) – Yield: 6.44%
The investment seeks investment results that correspond generally to the price and yield (before fees and expensed) of an index called the DB Emerging Market USD Liquid Balanced index. The fund normally invests at least 80% of total assets in emerging markets U.S. dollar-denominated government bonds.
- Total Assets: $520.3 billion
- Expense Ratio: 0.50%
- Holdings: 80% Foreign Govt, 20% Other
- Distributions: Monthly

20+ Year Treasury Bond (TLT) – Yield 3.95%
The investment seeks results that correspond generally to the price and yield performance, before fees and expenses, of the Barclays Capital U.S. 20+ Year Treasury Bond index. The fund generally invests at least 90% of assets in the bonds of the underlying index.
- Total Assets: $2.4 billion
- Expense Ratio: 0.15%
- Holdings: 100% US Treasury
- Distributions: Monthly

Some authors have minimized the importance of bonds in a portfolio primarily focused on dividend growth securities. You can ignore them, but as the past decade has shown it may be to your own peril.

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

(Photo: Steve Woods)

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.

A recent CNN Money article asked the question, ’Can you count on those monthly pension checks from your former employer?’ and provided the following five things you need to know:

1. Many pension plans are underfunded.
   By law, company plans must have on hand most of the money promised to employees. This wasn’t an problem until the market turned down.
2. But underfunded doesn’t mean “can’t pay.”
   You’re not necessarily on the hook for the plan’s underfunding. Employers must cover their plans’ deficits.
3. It may, however, mean some changes in how much you’ll get.
   If the plan is less than 80% funded, you won’t have the option of taking the benefit as a full lump-sum payment. And if your plan is less than 60% funded, your company may be forced to freeze it
4. You’re at greater risk of losing your job than your pension.
   A company “can dip into cash reserves to fund its pension,” but if there are no reserves, the firm must cut costs, which may mean layoffs. So, ironically, your pension may be safe at the expense of your job.
5. Still, you ought to have a backup plan.
   While you’re fairly safe on benefits accrued, don’t count on future ones. Your goal should be to save enough for retirement to fill the gap between your estimated expenses and what you’ve earned in your pension.

Up until the Delta pension ran into problems, I (naively) assumed what I was owed from my company’s pension plan was an automatic entitlement. However, events over the last five years have shown that when things go wrong, you may only receive a small portion of what was promised in glossy HR pamphlet.

Looking at number 5. above, “you ought to have a backup plan”, I would go one step further and say, “You ought to have a primary plan.” My retirement plan relies primarily on what I have invested and control, such as my 401(k), IRA  and taxable portfolio. I realize that will likely get something out of my pension plan even if a ‘worse case scenario’ occurs, so I count that portion. As for social security, I don’t even consider it in my retirement plan. If I receive anything from social security, I will just treat it as a bonus.

To achieve my retirement goals, I am investing with a defined asset allocation model looks at all my investments in total. In retirement, your portfolio shifts from an investing mode to an income mode by either selling appreciated (hopefully) assets and/or withdrawing dividends for living expenses. My plan is to build an ever-increasing income stream from bonds and dividend stocks such as:

• iShares Barclays 20+ Year Treas Bond (TLT) – Yield: 4.16%
• Vanguard Short-Term Bond ETF (BSV) – Yield: 3.40%
• Abbott Laboratories (ABT) – Yield: 3.50% – Analysis
• Genuine Parts Co. (GPC) – Yield: 4.80% – Analysis
• Procter & Gamble Co. (PG) – Yield: 3.40% – Analysis

As the old adage goes, ‘Everyone has a plan – failing to plan is planning to fail.’  Retirement planning does not have to be complicated, but not doing it will complicate your retirement.

Full Disclosure: Long ABT, GPC, PG. See a list of all my income holdings here.