As someone who invests in and recommends bonds – I recommend all kinds of income investments, not just dividend stocks – I’m excited about the prospects of rising interest rates.
With rates at record lows and everyone clamoring for yield, it’s been very difficult to find quality bonds paying decent yields. I’ve had to go through many haystacks to find the occasional needle.
One of my skills as an investor is patience. I don’t make trades or buy investments because I am bored, am antsy or fear missing out. When I played baseball, I waited for the right pitch. I didn’t chase balls out of the strike zone. As a result, I had a high on-base percentage and scored a lot of runs. I do the same with investing.
My patience has served me well. I have never taken a loss on a bond, both in my personal account and in any recommendation I’ve made for readers.
But as rates rise, I expect more pitches down the middle of the plate. It will be easier to find bonds that pay a reasonable rate of interest.
Here are the kinds of bond pitches I’ll be looking for:
Fastball. I’m looking for bonds with fast maturities. I’ll go out five years for the right bond, but I prefer maturities of one to three years in order to take advantage of higher yields down the road.
Change-up. Batters get fooled by change-ups, which are disguised as fastballs. As a result, they swing too early. In the bond market, many investors are grabbing whatever bonds they can find so their money isn’t just sitting in cash earning nothing.
Patient batters sit back on the change-up, wait for it to come to them and smack it all over the field. A patient investor will wait for the right bond with the right yield to come along. Generally speaking, I want to earn at least 3.5% per year on a bond, and if a bond’s rating is BB or below, more than 4%. Preferably higher.
Cutter. These pitches are known to break bats. But in bond investing, I’m okay with a bond whose rating has been cut (downgraded) as long as my own financial analysis shows the issuing company has the ability to pay off the bond at maturity.
The default rate among U.S. high-yield bonds (also known as “junk” bonds) was less than 1% in 2021. So the odds of getting your money back at maturity are extremely good.
Splitter. This pitch sinks hard. Sometimes the ball is described as falling off a table. I love to find distressed bonds whose prices have dropped, but only if I believe they will make it to maturity.
You earn a big yield (usually well into the double digits) and have potential for a large capital gain if the bond matures at par. Just as a batter risks swinging and missing on a splitter, investors have to be comfortable taking on risk with a distressed bond. But when you connect, the returns can be enormous – even better than those in the stock market.
Major League Baseball’s players and owners are fighting again, so we don’t know whether spring training will start in a few weeks as scheduled.
In the meantime, I’ll patiently stand in the batter’s box, elbow up and weight on my back foot, as the bond market throws some fat pitches over the plate that carry higher yields than we could have gotten just a few weeks ago.
I’m looking forward to taking more swings this year than I was able to last year.