My 1st Million At 33 - yes, you can do it too

Most people invest in bonds because they want to have stable fixed income. Because the performance of bonds is very stable, it also serves to reduce the volatility of the overall portfolio. Depending on the weighting from 0% to 100%, you can reduce your stock volatility correspondingly. With regular re-balancing between your stocks and bonds, you should be able to “sell high and buy low” in your stock portion, and use your bonds as a stable source of income.

Everything sounds good so far. But the most attractive feature of fixed income is also the biggest problem for bonds. The income is FIXED. It does NOT increase as time goes on, and as inflation keeps reducing your principle and interests into nothingness. Since inflation is almost always there, you got a real problem especially when you investing long term in the long term bonds.

Normally, this problem is resolved through obtaining higher interest yield on your bonds to compensate for your inflation risk. Assuming that your obtained yield is always higher than the inflation rate, you will not have a problem. Your actual income from bonds however should be on an after-inflation basis, and after-tax for that matter.

Vice versa, if economy is undergoing a phase of deflation (usually caused by economic recession or depression), it is very advantageous to invest in bonds. Not only you get a fixed income while everything is falling off the cliff, but also your purchasing power of your principle just keeps getting better. From 1980 to 2001, US and the world in general have experienced one of the best era in terms of economic prosperity. It was an extended era where nominal inflation rate is relatively low while the economic expansion keeps going strong. In the spring of 1980, when Fed Chairman Volker hiked interest rate to stratospheric 15% in the attempt to save $US from further depreciation and to put a stop on double digits inflation rate, it was actually close to the peak of inflation. At the peak of inflation (or interest rate usually), the bonds reaches a very low value, while the bond yield reaches a very high point, it is the best time to invest in bonds. At that time, if you have invested in bonds, you could have locked in some 10% to 15% annual yield rate for the length of the bond you purchased (like 30 year treasury bonds).

After almost 20 years of bull market in bonds, I personally believe that we are embarking an era where inflation rate is heightened (at least for US), which will force the bond interest rate to stay high if not going higher. Study the following inflation chart from inflationdata.com, a great site for historical data research:

You can see that inflation rate has broken the downward trend line, and started to trend up.

In the coming years, I believe that bonds are probably not the best investment because of the huge debt overhang on $US. To go in the reverse gear on investing bonds, one can actually “short bonds” by borrowing a big amount of a fixed term loan, such as home mortgage. Assuming that bonds are not good investment, “shorting bonds” by having a mortgage will be actually good (assuming that you have the capability of sustaining the mortgage payment, even when you lose your job for an extended period). The next thing which is a more risky move is to invest in the anti-bond investment, which is gold & silver, and natural resources in general. You can click on both to find out how to invest in them. In any cases, I would suggest that instead of investing your money in bonds which generate a fixed income, you should probably invest into a dividend-paying stock, preferably tied its dividends to the price of natural resources. Yes, it may go up and down a lot more. But in the long term, your dividends can go up as the inflation goes up and the price of the natural resources goes up too. Here is a list of high yield dividend stocks, yield from 6%+ to almost 20%, mostly tying their dividends to price of gas/oil, or its related business.

Protection of your inflation-adjusted principle is the most important thing in investing. There are times for bonds, but probably not now. You may argue your case for investing in TIPS, treasury inflation-protected securities which have interest yields indexed to CPI. But I cannot trust a Fed that hides M3 money statistics, nor a government that uses hedonic adjustments on CPI to bail you out of inflation. In case you still decide to invest in them (for a short time), here are all the posts in the same bond investing series:

1. Intro to Investing in Bonds: Fundamentals
2. Intro to Investing in Bonds: How-to
3. Intro to Investing in Bonds: Risk Factors
4. Reasons for (Not) Investing in Bonds