In the relatively dry world of finance, one of the valuable functions that bonds (fixed income) provide is to increase the diversification and resilience of balanced portfolios — by serving as a fire extinguisher when times get tough, rather than an accelerant.
They’re designed to make money, but also to manage any potential sparks or flare-ups lit by their flashier equity counterparts. While no one has pulled the alarm in this new realm of negative interest rate policy imposed by certain central banks, it’s still a good idea for fixed-income investors to be aware of their bond holdings; they should check to ensure that, like a fire extinguisher kept in the kitchen, they’re still appropriate and ready to do the job they’re meant to should the need arise.
What’s happening with negative interest rates?
In 2014, the European Central Bank became the first major central bank to shift interest rates into negative territory. The central banks of Sweden, Denmark, Japan and Switzerland followed suit soon after.
During the holiday season, I wrote an article about over-consumption – the gist being that the over-consumption of credit can leave us with debt troubles and how over-consumption of the wrong foods can leave us with harmful health debt.
There’s a general consensus that it costs too much money to eat healthily all the time. While it’s true that natural food products can be quite expensive, especially if you eat gluten-free or vegan packaged foods, there are ways to stretch your dollar at the grocery store.
Meat and produce are expected to see the biggest price jump, with meat seeing a 4.5 per cent increase and fruits and vegetables rising between 4 and 4.5 per cent this year.
A University of Guelph report predicts Canadians will spend an additional $345 on groceries this year. However, there are ways to help offset the rising costs using certain types of credit cards.
Food is getting more expensive and the weak Canadian dollar hasn’t helped. The report notes that for every cent the dollar drops over a short period of time, fruits and vegetables are likely to rise by more than 1%. Unfortunately, more than 80% of all fruit and vegetables are imported.
Going out for dinner is also expected to cost more this year. Food prices in restaurants are forecast to rise between 1.5% and 3.5% in 2016.
In this summer’s series on the 7 eternal truths of personal finance, one of the articles was entitled Be an Owner, Not a Loaner, which reflects the usual financial industry advice that stocks are more likely to generate long-term investment returns than cash or bonds.
There is of course a contrary view to this eternal truth and it’s best contained in the new second edition of David Trahair’s book, Enough Bull, originally published early in 2009, right at the bottom of the financial crisis..
Trahair, a chartered accountant and author, could as easily have titled his book Be a Loaner, Not an Owner, because he’s adamant that stocks (i.e. equities), whether individual or pooled through mutual funds or ETFs, are just too risky for the average person.
The book cover includes a small image of a bull (as in a steer), so clearly the title Enough Bull is a double entendre: as in no more bullish prognostications on the stock market, as well as no more bovine excrement, whether dispensed by the animals or financial advisors.
Skeptical about the financial industry and its central belief in stocksContinue Reading…
Here at the Hub we like to present all points of view. On Tuesday, we ran a guest blog by author and chartered accountant David Trahair about the new second edition of his book, Enough Bull, which explained why he is 100% in fixed-income vehicles like GICs. Today, we do the same thing with a guest blog by Scotia McLeod’s Robert S. Cable, who argues almost the polar opposite in his new book, Inevitable Wealth. We’ll review both books formally in the coming weeks. Meanwhile, over to Bob! – – JC
Stocks beat bonds, hands down
Robert Cable
By Robert S. Cable
Special to the Financial Independence Hub
All of the research I’ve carried out since I began doing this in 1980 and every piece of research I’ve seen comparing stocks to bonds– every single time comes to the same conclusion — that is that stock returns don’t just beat the returns of bonds, stocks clobber bonds. It’s absolutely no contest.
In my book, Inevitable Wealth, I compare 40 years of returns, from 1975 through 2014. I show $100,000 invested in Government of Canada five-year bonds, with money reinvested every five years, to the same $100,000 invested in stocks by way of the TSX Composite Index.
In 1975, those bonds yielded 7.25% so your annual income started out at $7,250. Stocks paid somewhat less, $5,360. Advantage bonds—initially. However just four years later, the dividends paid on stocks had moved higher to the point where the dividends paid on stocks was greater than the bond’s income.
But check out these numbers. In 2014, your bonds paid an annual income of just $2,770, down from $7,250, 40 years earlier. Talk about taking a pay cut! Meanwhile in 2014, stocks paid dividends of $49,560. Your stock income was more than 17 times what bonds paid.
What’s really interesting though is this: while stocks paid a much superior and growing income, they really aren’t income investments. The dividend income paid is simply a by-product of these companies sharing their profits with shareholders.
But as they say, that’s only half the story. We’ve looked at the income stocks and bonds produced. But what about the value of each of these investments over those 40 years?
Stocks beat bonds by 17 to 1 over 40 years
Well, that $100,000 you invested in bonds back in 1975 is still worth right around the same $100,000. If you took inflation into account, your $100,000 would actually be worth more like $15,000. The $100,000 invested in stocks? Well, not including the dividends, at the end of 2014 your stocks would be worth a bit more, $1,732,060. Continue Reading…
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By James Redpath, CFA
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