by: mutualdecision
Total views: 2
Word Count: 741

Bonds have higher yields then stocks. Bond funds have higher yields then stock funds. This means more current income for you. Bonds and bond funds are safer then stocks and stock funds, according to conventional wisdom. Bonds fluctuate less in value. That's good, too. So what's wrong with this picture? The interest paid on bonds doesn't grow (they're called fixed income securities for a reason), nor does their principal value. As a matter of fact, the real value of their principal declines over time due to inflation. Now, before you jump all over me, yes, there are inflation-adjusted Treasury securities that increase in value with inflation and floating-rate bank loan funds whose yield should increase if interest rates go up (although, bank loan funds are much riskier than Treasuries). Also, you can realize a (usually modest) gain in principal value if you buy a bond at less then its face value and hold it until maturity. There are some managers who through astute analysis, forecasting and trading, add value and outperform a simple buy and hold strategy. However, superior relative performance becomes harder to achieve as you go up in quality, think: High yield ("junk bonds") at one end of the scale and U.S. Treasuries at the other. The same is true for maturities. There's not much a manager can do to create relative value with short term bonds. Value can be created by correctly forecasting (good luck!) interest rates and buying, or selling, long term bonds or through astute credit analysis to determine which companies financial strength will improve, leading to a rating upgrade (if you can do this, you can also pick stocks that will go up in value). Bond funds do have a place in your portfolio. It's always wise to have a cushion for unforeseen expenses or just to be able to take advantage of an opportunity in the market or elsewhere. If you're going to need cash at a certain time for events such as buying a house, college education, or the like, having the safety and certainty of a bond fund is a smart investment. Caveat: if you need funds at a not too distant date don't speculate with a risky (non-investment grade) bond fund, you'll be unpleasantly surprised with its volatility. I fear that too many investors put too much money in bond funds and do so too soon in their investing careers. The income may be reassuring, or even seductive, but the limited appreciation and cumulative effects of inflation must be considered. The current income is nice but neither the income, not the principal increase over time, absent a good fund manger. So what's an investor to do? Find a good conservative mutual fund which invests in high quality dividend paying stocks. Why? Because dividends paid by good companies tend to increase over time. Take Bank of America, for example. (I'm using a stock rather than a mutual fund for this illustration because it avoids having to talk about purchases, sales and capital gains distributions.) In 1997, Bank America paid a $.70 per share dividend. If you bought the stock near its high for that year, you paid $40 per share. Today, Bank of America pays a $2.24 dividend and its stock sells for around $50. Notice, the dividend has increased 3x in the past ten years. The price appreciation hasn't been nearly as exciting, but it has kept pace with inflation. There are a lot of stocks out there, like Bank America, which increase their dividend every (or almost every) year. The investor who bought Bank of America stock in my example has an investment currently yielding 5.6% and I would expect the yield to continue increasing. You can find many mutual funds that invest in high quality, dividend growing stocks. Start by looking at Big Cap Value funds. Many such funds have the word income or dividend in their name. There are lots of good reasons to invest in bond funds, but if you have a time horizon of ten years or more, you'll be better off investing in a high quality equity mutual fund. You'll end up with more principal and more income.

About the Author

Bill Byrnes is a co-founder of MUTUALdecision (http://www.mutualdecision.com). A former investment banker and finance professor, he has been CEO, chairman and served on the boards of a number of public companies. Bill is a CFA with over 30 years investment experience.

---

View PDF | Print View

---

Rating: Not yet rated

--Choose-- 0 1 2 3 4 5

Comments

No comments posted.

Add Comment

You do not have permission to comment. If you log in, you may be able to comment.
Next Article - Day Trading Against System Trading
Previous Article - Online Stock Trading - Stock Trading Strategies

More Related Articles In This Category

1: What are Bull Markets and Bear Markets?
2: What Causes Stock Prices To Go Up And Down?
3: Option Trading - As Risky As The Reputation?...
4: Online Trading; Why I Hate Economists!
5: Online Stock Trading - Is It Right For You?...
6: Is a Financial Market Last Straw Event on the Way?
7: Who Sets a Stock's Price?
8: Compound Stock Earnings Programs - Caveat Investor
9: Stock Exchanges - An Introduction
10: Day Trading The Extreme Sport Of Investing
11: The Fall of the Bond Markets
12: For Stock, Futures and Forex Traders The Biggest Battle To Succeed Is Within, But Why?
13: Do You Run With the Stock Market Herd?
14: Ethanol Producing Companies as Stock Investments
15: Stock Trading Made Too Easy
16: New Bull Market Surge Underway?
17: Tips For Stock Market Trading- Beginners' Guide
18: What's The Difference Between Technical and Fundamental Investing?
19: What is Short Selling and How to Benefit From It?
20: Setting Specific Investing Goals
21: There Is No Place For Emotions In The Stock Market
22: You Will Never Make Money Trading Stocks, Futures Or Forex Part 4
23: Is Insider Trading Illegal?
24: Painful First Quarter for World Financial Markets
25: You Can Be A Stock Market Investor

---

For WebMasters

Link This Article - HTML Code -

<a href="http://americanahost.com/articles/finance/stock-market-investing/too-much-income-can-be-hazardous-to-your-financial-health.html" target=_blank>Too Much Income Can Be Hazardous to Your Financial Health</a>

Link This Article - BBcode -

[url=http://americanahost.com/articles/finance/stock-market-investing/too-much-income-can-be-hazardous-to-your-financial-health.html]Too Much Income Can Be Hazardous to Your Financial Health[/url]

Copy This HTML Code To Put This Article In Your Web Site.

<h1>Too Much Income Can Be Hazardous to Your Financial Health</h1><br><br> <br><br> Bonds have higher yields then stocks. Bond funds have higher yields then stock funds. This means more current income for you. Bonds and bond funds are safer then stocks and stock funds, according to conventional wisdom. Bonds fluctuate less in value. That's good, too. So what's wrong with this picture? The interest paid on bonds doesn't grow (they're called fixed income securities for a reason), nor does their principal value. As a matter of fact, the real value of their principal declines over time due to inflation. Now, before you jump all over me, yes, there are inflation-adjusted Treasury securities that increase in value with inflation and floating-rate bank loan funds whose yield should increase if interest rates go up (although, bank loan funds are much riskier than Treasuries). Also, you can realize a (usually modest) gain in principal value if you buy a bond at less then its face value and hold it until maturity. There are some managers who through astute analysis, forecasting and trading, add value and outperform a simple buy and hold strategy. However, superior relative performance becomes harder to achieve as you go up in quality, think: High yield ("junk bonds") at one end of the scale and U.S. Treasuries at the other. The same is true for maturities. There's not much a manager can do to create relative value with short term bonds. Value can be created by correctly forecasting (good luck!) interest rates and buying, or selling, long term bonds or through astute credit analysis to determine which companies financial strength will improve, leading to a rating upgrade (if you can do this, you can also pick stocks that will go up in value). Bond funds do have a place in your portfolio. It's always wise to have a cushion for unforeseen expenses or just to be able to take advantage of an opportunity in the market or elsewhere. If you're going to need cash at a certain time for events such as buying a house, college education, or the like, having the safety and certainty of a bond fund is a smart investment. Caveat: if you need funds at a not too distant date don't speculate with a risky (non-investment grade) bond fund, you'll be unpleasantly surprised with its volatility. I fear that too many investors put too much money in bond funds and do so too soon in their investing careers. The income may be reassuring, or even seductive, but the limited appreciation and cumulative effects of inflation must be considered. The current income is nice but neither the income, not the principal increase over time, absent a good fund manger. So what's an investor to do? Find a good conservative mutual fund which invests in high quality dividend paying stocks. Why? Because dividends paid by good companies tend to increase over time. Take Bank of America, for example. (I'm using a stock rather than a mutual fund for this illustration because it avoids having to talk about purchases, sales and capital gains distributions.) In 1997, Bank America paid a $.70 per share dividend. If you bought the stock near its high for that year, you paid $40 per share. Today, Bank of America pays a $2.24 dividend and its stock sells for around $50. Notice, the dividend has increased 3x in the past ten years. The price appreciation hasn't been nearly as exciting, but it has kept pace with inflation. There are a lot of stocks out there, like Bank America, which increase their dividend every (or almost every) year. The investor who bought Bank of America stock in my example has an investment currently yielding 5.6% and I would expect the yield to continue increasing. You can find many mutual funds that invest in high quality, dividend growing stocks. Start by looking at Big Cap Value funds. Many such funds have the word income or dividend in their name. There are lots of good reasons to invest in bond funds, but if you have a time horizon of ten years or more, you'll be better off investing in a high quality equity mutual fund. You'll end up with more principal and more income.<br><br> <h3>About The Author</h3> Bill Byrnes is a co-founder of MUTUALdecision (http://www.mutualdecision.com). A former investment banker and finance professor, he has been CEO, chairman and served on the boards of a number of public companies. Bill is a CFA with over 30 years investment experience.<br><br> Keywords: <b>bonds, stocks, maturities, junk bonds, investing, financial plannin</b> <br><br>Article Source : <a href="http://americanahost.com/articles"><b>Articles Directory</b></a></br> Article URL : <a href="http://americanahost.com/articles/finance/stock-market-investing/too-much-income-can-be-hazardous-to-your-financial-health.html" target=_blank>Too Much Income Can Be Hazardous to Your Financial Health</a></br> Article Category : <a href="http://americanahost.com/articles/finance/stock-market-investing/">Stock Market Investing</a></br> Article Author : <a href="http://americanahost.com/articles/profile/mutualdecision-343.html">mutualdecision</a>

---

Article URL : Too Much Income Can Be Hazardous to Your Financial Health
Article Category : Stock Market Investing
Article Author : mutualdecision