NEW YORK (TheStreet) -- With the confirmation hearing of Janet Yellen this week, Quantitative Easing has once again become the most popular topic of conversation in the financial media. We are hearing renewed complaints about how the Fed's creation of an artificially low interest rate environment is hurting -- in some cases destroying -- the dreams of retirees and savers. This argument is not only ignorant but misses the true risk to this American demographic.
I believe the true risk to the 80-year-old owner of bonds and CDs is not that their income stream today is so low, but that they are being given a once-in-a-lifetime trading opportunity and missing it. When interest rates -- and therefore yields on newly issued debt -- decline, the price of existing, higher-interest paper improves.
So even as the current options for fixed income investment and reinvestment (as bonds mature or are called) look about as appealing as the Griswolds' Christmas Turkey, something much juicier may be appearing in the "unrealized gain" column of these portfolios.
Below is a chart reflecting the interest rate on the 10-Year U.S. Treasury Bond going back twenty years.
You can see that as recently as 1995, Uncle Sam was paying 5 percentage points more than he is today to borrow your money for ten years. Of course a 10-year bond issued in 1995 has long since matured; however, many other types of debt are issued at rates based on the 10-year Treasury. Some of these investments -- Corporate Bonds, Government Agencies, and Municipal Bonds -- may have appreciated dramatically for those who purchased when rates were much higher. That appreciation, though, is temporary and should be treated as such.
The long-dated Treasury Bond Index (TLT), for instance, has doubled over the past ten years.
Just this week I reviewed a prospective client's portfolio, more than half of which was made up of intermediate- and longer-term municipal bonds. Many of her holdings pay a coupon of 5.00% or more and are trading well over 100 cents on the dollar -- sounds great, right? Well, the coupon payment is simply a percentage the bond issuer is obligated to pay the investor each year. If you bought 100 bonds with a coupon of 5.00%, you will get $5,000 each year. If a bond's price moves higher due to declining interest rates, this has no positive (or negative) impact on your annual income.
Keep in mind that many factors -- duration, credit quality, call features (to name a few) -- influence the prices of bonds in your portfolio.
Take the money and run:
If your portfolio looks anything like the one described above, you are probably feeling pretty good that you have "made money in bonds" -- something only Bill Gross and Jeff Gundlach are supposedly able to do. But when it comes to putting new money to work in fixed income, you may be feeling frustrated that "they just don't make bonds like they used to." You may be cursing Ben Bernanke, and now Janet Yellen, for not taking your future income needs into account.
Consider putting your frustrations aside and tackling this problem systematically. Sure, a bond with a 5.00% coupon looks great in retrospect -- but what if it's trading at 115 cents on the dollar? Couldn't that extra 15% (three years' of income) be put to more effective use today? Remember, that's not yours to keep if the bond gets called or if you hold to maturity. Why not provide yourself with options by taking the three years' of income, plus your principal, by selling the bond today? This would allow you either the flexibility of investing a larger amount of principal in a more productive asset class, or just waiting until a better fixed income opportunity arises.
There is an element of comfort in knowing "at least I'll get my principal back" when the bond matures. But to whom does the extra 15 points belong? That depends on how long you wait.
"Yeah, but I don't want to pay taxes on those gains...."
This is a legitimate argument against, but perhaps you can take a loss elsewhere in your portfolio to offset the gain. Plus, long-term current capital gains rates aren't particularly high. Or maybe you have tax loss carry forwards from years past. Every client's situation is a little different, but selling some bonds today may be a proactive alternative to your current fixed income strategy.
At the time of publication the author is short TLT.
This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Adam B. Scott is a founder of
, a fee-only Registered Investment Advisor based in Los Angeles. A veteran of Morgan Stanley and UBS Wealth Management in Beverly Hills, Calif., Adam uses his extensive market knowledge and macro-level analysis to implement customized solutions for high net worth private clients. Adam is an avid tennis player and skier, and volunteers his free time to the Fulfillment Fund, the Tufts Alumni Association and coaching local youth sports.