Can Investors Lock In Safe Fixed Income?
In our recent interview with Chuck Butler, we discussed the challenges of “locking in” safe interest income.
The challenges are tough:
Beating inflation. Currently inflation is around 8%. If your interest rate is below the inflation rate, your money will buy less when the bond or CD matures.
Market timing. Locking in rates makes sense when you are near the top of the market. If rates continue to rise, the resale value of your bond or CD will go down – or you can hold to maturity and receive lower than current market interest rates.
Non-Callable. Currently banks and corporate borrowers are not offering non-callable debt. Should interest rates drop, they will refinance their debt at lower rates. In 2008, banks did that. Retirees, who thought their retirement income was set, got clobbered. Personally, I took a 66% cut in our interest income.
While Fed Chairman Jerome Powell has softened his rhetoric, Chuck feels trying to lock in rates is, “a tricky game to play.” His response to Powell’s recent remarks is to the point:
“There are still some people out there in La-La land thinking the Fed Heads are going to pivot…and reverse their rate hikes to save the stock market, and bonds… I just don’t see how they can think that any longer, especially after Fed Chairman Powell made it perfectly clear that this was not the time to pivot…”
I’m writing this prior to the Fed’s December meeting. Here are some additional reactions to Powell’s remarks.
Wolf Richter reports: (Emphasis mine)
“It was an amazing show today – how markets reacted to headlines that exuded ‘dovish’ somehow after Fed Chair Jerome Powell, speaking at the Brookings Institution, hit all the hawkish buttons: likely a 50-basis-point rate hike at the December meeting, to 4.5% at the top end of the range for the federal funds rate….
But Powell moved the ‘ultimate level’ even higher today than the projections in September. He said, ‘it seems to me likely that the ultimate level of rates will need to be somewhat higher than thought at the time of the September meeting.’
‘It is likely that restoring price stability will require holding policy at a restrictive level for some time. History cautions strongly against prematurely loosening policy. We will stay the course until the job is done,’ he said.
Other Fed governors spoke before him this week, and they agreed with Powell: Even higher than projected at the shocker September meeting, and keeping it there for even longer.”
If the Fed doesn’t get rates above the inflation rate, we can expect bigger problems in the near future.
Peter Reagan at the Birch Gold Group writes, “This Reprieve from White-Hot Inflation Won’t Last Much Longer.” He quotes a CNBC article:
“The consumer price index, a key inflation barometer, jumped 7.7% in October versus a year ago. It rose 0.4% during the month. Both were cooler than expected, a sign inflation may be moderating. [emphasis added]”
Mainstream media and the stock jockeys can claim “happy days are here again” until hell freezes over, but I’m not buying it. I don’t think it is cool losing 7.7% additional buying power over last year…because it was “cooler than expected.”
Paul Volcker raised rates, then lowered them too soon; inflation soared, causing him to raise rates even higher. Interest rates were double digits, well ahead of the inflation rate, and it still took a couple of years for things to get under control.
When the time comes, how can we lock in rates where the borrower doesn’t pull the rug out from under us like 2008?
“The good thing is that with Treasuries, there’s no such thing as callable bonds…. But with CDs and Corporate bonds, where the yields are normally higher than Treasuries, the bonds are known to have callable features, and that would prevent a holder of the bonds from enjoying their ‘locked in rate’ until maturity.
Investors must read the full description of the bond, to know what the features are…. Let that be a lesson to learn for all of us.”
If Treasuries are currently the only debt instruments that are non-callable, when the time comes, how do investors buy them?
Investopedia tells us:
“There are several ways to buy Treasuries.
For many people, TreasuryDirect is a good option. However, retirement savers and investors who already have brokerage accounts are often better off buying bonds on the secondary market or with exchange-traded funds (ETFs). Treasury money market accounts also offer more convenience and liquidity than TreasuryDirect.
- TreasuryDirect allows investors to buy Treasury bonds and bills directly from the U.S. government.
- It is not possible to open IRAs or other tax-advantaged accounts at TreasuryDirect.
- Investors must transfer bonds from TreasuryDirect to banks or brokerages if they want to sell them before the maturity date.
- Some of the other ways to buy treasuries include ETFs, money market accounts, and the secondary market.
- When you buy bonds on the secondary market through a broker, you can hold them in an IRA or another tax-free retirement account. You can also do this with ETFs.”
I’m uncomfortable with ETFs for treasuries. One website says, “The iShares U.S. Treasury Bond ETF seeks to track the investment results of an index composed of U.S. Treasury bonds.” Why pay fund fees trying to track an index? I’d prefer to buy individual bonds and hold until maturity.
I checked my brokerage account and reviewed their offerings:
The rates change regularly. Note, interest rates for the shorter term are higher.
I researched bonds that mature in five years. They were 15 resale offerings with coupon rates ranging from .5% to 6.125%. The yield to maturity (YTM) for all were just under 3.7%. Some were priced below par ($100) while others were above. There were no new offerings.
Chuck confirmed my thinking, buy below par, when they mature you will get more than your original investment back. The interest rates offered are well below the current inflation rate.
How do investors protect the value of their nest egg?
How do retirees pay their skyrocketing living costs?
Luckily there’s a proven way for you to stay ahead of inflation, just like 20,000+ investors are doing right now…
Here’s how you can be one of them. Click HERE for more information.
What about TIPS?
I found offerings for Treasury Inflation Protected Securities (TIPS).
Investopedia explains: (Emphasis mine)
“The principal value of TIPS rises as inflation rises. Inflation is the pace at which prices increase…as measured by the Consumer Price Index (CPI)….
TIPS are a popular asset for both protecting portfolios from inflation as well as profiting from it because they pay interest every six months based on a fixed rate determined at the bond’s auction.
However, the interest payment amounts can vary since the rate is applied to the adjusted principal or value of the bond. If the principal amount is adjusted higher over time due to rising prices, the interest rate will be multiplied by the increased principal amount. As a result, investors receive higher interest or coupon payments as inflation rises.
Conversely, investors will receive lower interest payments if deflation occurs.
- Treasury Inflation-Protected Security (TIPS) is a Treasury bond that is indexed to an inflationary gauge to protect investors from the decline in the purchasing power of their money.
- The principal value of TIPS rises as inflation rises while the interest payment varies with the adjusted principal value of the bond.
- The principal amount is protected since investors will never receive less than the originally invested principal.”
The government is offering to pay lenders a small amount of interest and guarantee the bonds will appreciate at the published rate of inflation. When the bonds mature you receive the greater of the inflation adjusted value of the bond or par value. Should the Fed make good on their 2% inflation promise, you should see some appreciation.
You will never receive less than you paid for the bond; however, in deflationary times you will receive less interest.
Historically I have been critical of TIPS. I disagree with Investopedia and brokers. Their wording misleads clients, telling them it offers portfolio protection from inflation. That is not true: TIPS only protect the amount invested from inflation, and no more. TIPS don’t offer umbrella portfolio protection like gold does…historically rising more than the inflation rate.
The income is taxable. Buying TIPS in a taxable account guarantees you will NOT keep up with inflation.
If you own TIPS in a Roth IRA, which is not subject to income tax, TIPS will yield a small amount of interest, while the principal is inflation protected. With a traditional IRA or 401k, your withdrawals are taxed.
My broker had no new TIPS offerings, but there were several available in the resale market.
One offering for 25 showed a price of $99.9089 (below par value). It also showed, “Estimated Total – $32,155.44.” The seller collects the accumulated inflation appreciation since the bond was issued. When you buy aftermarket tips that have appreciated, you could lose some money before they mature.
They recommend new offerings because your principle is protected. He said the next auction for TIPS is December 15th. I can buy them online or call their bond department when they are available. The shortest term available is 5 years.
I’m not thinking about locking in rates and gambling that the Fed has capitulated and will pivot, reducing rates. They have a long way before they bring inflation under control. When the time comes, unless there are non-callable CDs, treasuries will have to do.
I’m keeping my metals and metal stocks; however, I plan to buy a small number of TIPS in my Roth account, with the understanding that the inflation protection is limited to what I invest.
A little help means a lot!
Seven years ago, I vowed to keep our newsletter FREE! I plan to keep my promise.
It’s an expensive, time-consuming hobby, but also a labor of love.
Recently a reader asked why I didn’t charge for our weekly letter. I explained that I want it available for everyone. Some readers may be on limited budgets and may benefit the most from our advice.
He pressed on with his questions. How much does your letter cost? How many readers do you have? He concluded, “If each reader paid $10/year, you would be fine.
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On The Lighter Side
We are headed back to Indiana for a couple weeks for Christmas. This will be my last column, for the year. We will publish our annual mentoring article sometime over the holidays.
I hope everyone has a great holiday season, and that 2022 has been good to you. While we have had many ups and downs, it’s been a good year. The family is doing well and we are looking forward to 2023.
When we return, we will start radiation treatment for a spot on my lung. We may get lucky and only need 5 treatments instead of 35 like we had last year. The goal is to get that all behind us in order to head back to Indiana in May for grandson Braidyn’s high school graduation.
Jo and I wish everyone a Merry Christmas. In the words of Wolfman Jack, “See ya on the flip side!” Happy New Year!
Quote Of The Week…
I’m going hog wild today and will link three quotes together”
“Life is like riding a bicycle. To keep your balance, you must keep moving.”
— Albert Einstein
“It doesn’t matter how slowly you go as long as you do not stop.”
“A good life is when you assume nothing, do more, need less, smile often, dream big, laugh a lot and realize how blessed you are for what you have.”
Friend Rob G. supplies us with some cute definitions:
- Esplanade (V.), to attempt an explanation while drunk.
- Balderdash (N.), a rapidly receding hairline.
- Oyster (N.), a person who sprinkles his conversation with Yiddishisms.
- Bozone (N.): The substance surrounding stupid people that stops bright ideas from penetrating. The bozone layer, unfortunately, shows little sign of breaking down in the near future.
- Sarchasm (N): The gulf between the author of sarcastic wit and the person who doesn’t get it.
- Caterpallor (N.): The color you turn after finding half a grub in the fruit you’re eating.
And my favorite:
- Hipatitis (N): Terminal coolness.
Until next time…
“Economic independence is the foundation of the only sort of freedom worth a damn.” – H. L. Mencken
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