Sunday, June 22, 2014

James Bond-less

I was reading an article in the summer issue of MoneySense magazine about the role of bonds in a portfolio. The author mentioned that during the stock market crash of 2009, bonds helped some investors limit their losses. At that point in the article, about three paragraphs in, I stopped reading since I predicted the author would go on to say that bonds help smooth portfolio returns in difficult times. Although I can't argue that point,  I stopped investing in bonds in late 2007. Despite mountains of "experts" who drone on about the benefits of holding bonds, I don't ever plan on buying a bond, bond etf, or anything of that nature again. 

Over the long-term, which is the period I plan to hold my investments, bonds returns average between 5-6%, while stocks returns average a little less than 10%. Granted stock returns have higher variability, but the rewards (almost double the bond returns) far outweighs the risks for me. Currently, a government of Canada 10-year bond is yielding around 2.3%.  With inflation at 2.3% in May, your government of Canada bond only allows you to conserve purchasing power...and that's if you believe inflation is actually only 2.3%, and assumes it will stay at that rate or lower over the next 10-years. 

Like most investors, before converting to dividend growth investing, I owned bonds. Specificially, I owned province of Ontario bonds, government of Canada bonds, and even a bond ETF from ishares (TSX: XBB). The rates on all these fixed income securities are very low (XBB yields around 3%), and worse yet, the interest income is taxed at the full marginal rate...a nightmare for investors living in Quebec. In comparison, my portfolio yields a little over 4%, and the stocks I invest in have a healthy habit of increasing their yields each year. Plus, the income my dividend growth stocks generate is taxed at a lower rate due to the dividend tax credit. If I ever need to sell my shares, capital gains are taxed at half the marginal tax rate. 

The closest thing I have to bonds in my portfolio are shares in Riocan REIT (yielding 5.2%) and H&R REIT (yielding 5.9%). If interest rates shot up, I expect both of these holdings to decrease in values, and I'm ok with that. In the long-run, I know both REITs are great companies, with portfolios of properties that would be hard, if not impossible, to duplicate. In the event of rising rates, I'd gladly pick up more shares in both entities, as I think their distributions will grow over time, and the value of their well managed properties would follow suit.

Before you add bonds to your portfolio, I think you should ask yourself why you're doing it. If it's for safety, you can always go with a safer investment (CDs/GICs) that wouldn't be impacted by an increase in interest rates. If you're investing in bonds for the income, then why not try a portfolio of dividend growth stocks instead? Not only would such a portfolio give you a higher yield, you could look forward to raises every year in order to bet keep pace with inflation. 

(Full Disclosure: Long REI.UN and HR.UN)

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