Thursday, August 16, 2012

Trade bonds? Is this a good idea?


If you are reading this post, thinking you want to make money trading bonds, you probably should read another blog.    This blog is for income investors.  However, trading bonds can be a part of income strategy; if you never pay more for a bond than it will return to you at maturity; you can make money trading bonds and earn the interest while you wait.

You know one of the benefits of investing in bonds is they pay you interest every day you own the bond.  When investing for income using dividends, you only get the dividend if you own the stock prior to the ex dividend date.   You could own a stock for 90 days or longer before you get the dividend and if you sell before the ex dividend, you get none of the dividend income.

Today’s news that ten year U.S. treasury rates have increased makes me ask, what does it mean? 

What it means is different for different kinds of investors. 

Mutual fund investors who recently invested  in bond funds could lose principle, although their income may go up a little.   The income investor who owns an individual bond  may see the value of their bond decrease but if they hold that bond to maturity, the holder will have their entire principal returned, provided the bond is of good quality with a low expectation of default.

Income investors that use stock dividends for income will not see an effect until the ten year U.S. Treasury yields more than a dividend machine.   Personally, I would love to have most of my money in government guaranteed, laddered, bonds with a seven percent coupon.    We could get those rates several years ago and it will happen again, I just do not know when. 

Ordinary income investors will probably make no major moves today.  If, however, you have the guts to trade bonds and you think you are getting a bargain you might trade on this kind of news.

            Where is the bargain?  When interest rates go up, bond values go down.  This direct mathematical relationship is indisputable.   If you think interest rates will go down tomorrow or next week, you could buy today and sell tomorrow because tomorrow the value of the bond will go up.

Do you like that kind of drama?  The bargain has to be compelling for me to invest.   However, I will keep my eye on interest rates and we’ll see if this portends of the opportunity to buy better income instruments.

Very Truly Yours,

TheMoneyMadam
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