Spotting the Bond Bubbles
HUNT VALLEY, Md. (TheStreet) -- Two common beliefs for those approaching retirement are: the closer you get to retirement, the more bonds you should own; and that when you are retired, bonds should be a mainstay of your portfolio to generate income. These beliefs were created by the misperception of income and safety.
Income is typically defined as "interest and dividends," but income can come in any form of distribution used to live on without affecting the original principal balance. With this interpretation we can include capital appreciation. In other words -- total return. Some would say interest and dividends are safe income, but capital appreciation is not. In some regards this is true, but we must realize, especially now, that interest and dividends are not absolutely safe either. Dividends have been slashed in the past five years, especially in financial securities. Interest rates are so low that only the wealthiest could survive on the cash flow. Total return is now, and has always been, the only proper way to focus on income for a retirement portfolio.
|U.S. Treasury Bonds are considered by some to be the biggest asset bubble since the subprime mortgage fallout of 2008.|
Safety is another story. Most people define safety as "low volatility." Bonds have been less volatile than stocks over the past 100 years and are, therefore, proclaimed "safer." Volatility is the measure of the rise and fall of principal value over a set group of time horizons with the most common being yearly. If the annualized return of a stock went from +30% on the high and -35% on the low and a bond went from +15% to -12%, bonds would be safer than stocks. This is a logical assessment of how one would view an account on an annual basis, but it has nothing to do with risk. Risk is about the price I pay for the asset I get. As the price of an asset drops, the value of the asset becomes less risky; when the price rises, the asset gets riskier.
So, looking at today's environment, where is risk highest and lowest?
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