The changing role of bonds in your portfolio

With today’s 7% inflation, many bonds are guaranteed money losers

Ric Edelman: Welcome back to The Truth About Your Future, let's shift our conversation now to the world of investing. As you know, I'm very, very concerned about the bond market. Interest rates have been at historic lows and are now beginning to rise. We're seeing the Fed raising interest rates this year. Many more interest rate increases are expected as interest rates go up, bond prices go down. Just to give you an illustration of this, back in the 1980s, if you took a normal 6040 portfolio, bonds contributed 5% in the total return of that portfolio. Today, bonds are contributing less than 1%. It makes you ask yourself the question, is it worth owning bonds anymore? If we know that rising rates cause bonds to go down in value, why would I want to own long-term bonds? And if those long-term bonds are only paying 2% or 3% anyway, when inflation is 6% or 7%, we have guaranteed money losers. In fact, this explains why muni bonds are off to the worst start since 2011.

So far this year, the S&P muni bond index is down 3%. That means the entire annual yield has been wiped out. The best you can expect to do this year is break even. Why would you want to own an investment where your best-case scenario is earning zero? And look at the pressures that are going on with municipal bonds. Puerto Rico just received court approval to leave bankruptcy. It was the largest restructuring of municipal debt ever. And the court ruled that Puerto Rico doesn't have to repay $31 billion in bonds. This is great news for Puerto Rico. It's great news for its residents. It's terrible news if you were one of those bond owners.

Ric Edelman: You see historically in the past, going back the last 200 years, repaying the bondholders was always of primary importance to governments, because if they ever created a reputation of not repaying the bonds, they'd never be able to raise more money. Well, that is now what has just happened in Puerto Rico. The bondholders got stiffed. Makes you have to raise the question; do I really want to invest in this something? Where the government could decide to renege on its obligations? Not only do I not get my interest, I also never get my principal back? So this is causing some people to say, I'm not going to go into the bond market. I'm going to go to the stock market and buy dividend paying stocks. Good theory. Good idea. But you've got to be careful. Look what AT&T recently did. They cut their dividend in half. Now, the dividend was very rich, 8.5%. Compare that to a bank paying 1% or 2%. And a lot of people bought AT&T stock not because they were thinking the stock would rise in price, but because they loved the dividend.

Ric Edelman: You invest $100, and you get eight and a half bucks in dividends. That's pretty amazing. Until AT&T announced it's cutting its dividend in half, not only did you lose 50% of the income, but the stock also fell 4% on the news. A double whammy. So it's raising questions for investors. Where's the safe place to go? Maybe it's not stocks, maybe it's not bonds. Is it real estate? Well, existing home sales have hit a 15-year high powered by low interest rates. But remember, as interest rates go up, those mortgages go up as well. The monthly payment goes up. And if the monthly payment rises faster than your income, are you going to be able to make the new mortgage payment? Does it mean that new home buyers are being priced out of the houses? Not because the housing price is so high, but because the monthly payment on the mortgage is so high. Does this mean that real estate prices are going to begin to soften? These are the challenges we're facing in 2022.