In an environment of record savings and uncertainty lingering around the delta variant, the desire for safe investments i.e. bonds, has been greater than ever. But, rising inflation has messed up that equation. With inflation running higher than 5%, bank interest rates are a joke. But, even AAA and AA bond yields are not living up to match inflation. And so, investors, in search of better fixed income returns are flocking to lowest rated debt from companies. These are junk bonds. In an effort to get better than inflation returns, fixed income investors are now willing to take the risk with bonds that may pay higher rates but then again, may go under and may not pay at all. On paper, it is great to lock into a yield that is north of inflation rate. But things fall apart when the issuer cannot pay the monthly interest and eventually files for bankruptcy protection. Welcome to the junk bond world where everything is great until it is not.
Future Wealth’s View
Just last week, our article titled “Beware of becoming greedy” was aimed at investors who were not satisfied with stock market returns and were taking ill-advised risks. This week, we have not changed the title of the report but the audience is fixed income investors. It is easy to understand the frustration of a fixed income investor who is getting ~3-4% from his bond investment portfolio when inflation is running at >5%. It is hard to go to sleep at night knowing that you are losing money to inflation every minute you sleep.
But, the answer does not lie in taking a risk into junk bonds and putting one’s portfolio at risk. The diligent choice would be to look at adding some stock exposure i.e. value stocks that provide regular dividends while giving exposure to stock appreciation. For fixed income investors, these are thresholds they have to cross to understand that fixed income does not necessarily mean being tethered to bonds and bonds alone.
As the saying goes “Once you cross that bridge, you will see where the real power lies”.