It’s no secret that I’m a stock guy – particularly dividend-paying stocks.
There are no investments out there that reliably grow wealth over the long term like stocks.
Over decades, stocks are even safer than bonds, which goes against conventional thinking. Jeremy Siegel’s book Stocks for the Long Run shows that not only do stocks outperform bonds – which is not a surprise – but also, over 10-year periods and longer, stocks’ worst performance was also better than the worst performance of bonds.
Between 1802 and 2012, the worst 10 years for stocks showed a decline of 4.1%, while bonds dropped 5.4%. Over a 20-year period, stocks never lost money, while bonds’ worst performance came in at -3.1%.
So why am I adding bonds to my portfolio?
In the short run, bonds – especially those of quality companies – are safer than stocks.
I Can’t Take Much Risk
I have to start paying college tuition in a few months. My wife and I have diligently saved and invested for 18 years for this moment. Over the next four years, we will pay an insane amount of cash to an institution of higher learning. And I’m not willing to take much risk with that chunk of money.
The closest you’ll come to a guarantee of getting your principal back is an investment in Treasurys. That being said, owning quality corporate bonds is a pretty safe bet.
Junk bonds, the riskiest corporate bonds, have had a default rate of just 2.6% per year over the past five years. That’s lower than the historical average of 4.2%, and the bonds most likely to default were the junkiest of the junk. Bonds rated BB, the junk bond rating closest to investment grade, had a default rate of just 0.18%.
Over the past 32 years, bonds with an investment-grade rating had a miniscule default rate of 0.1% per year. In other words, odds were 1 in 1,000 that these bonds would default. And no investment-grade bonds have defaulted in the past 10 years.
So your chances of getting your money back are extremely high.
When I invest in bonds, I’m not planning on selling them at a profit. If their prices go up and there’s an opportunity to sell them, great – but my bond positions are intended to produce income and protect capital. I expect to hold a bond until maturity.
I buy bonds with short maturities because I need the money soon.
I am creating a bond ladder where various bonds will mature in each of the next few years. I’ll earn some interest on the bonds while the money is invested, and each year, as the bonds mature, the money will become available to pay tuition.
While I love my dividend stocks, anything can happen in the short term. And if the market falls, I want to be able to buy more dividend payers.
Should the bond market tank in the next few years, I really don’t care. I don’t plan on selling my bonds, so the price doesn’t matter to me. When the bonds mature, I’ll cash them out.
Investment-grade corporate bonds are not risk-free, but they are a pretty safe way to earn some interest and count on all of your investment being available to you when you need it, as long as you time it right with the correct maturities. In other words, if you need the cash in April 2021, make sure your bond matures before then.
The good news is the bond market is so large that you shouldn’t have a problem finding bonds with the maturity date you want at the risk level you’re comfortable with.
If you can’t tolerate much risk on your short-term funds, investment-grade bonds are great way to invest.