Using Bonds Instead of Stocks for Portfolio Income
by Stan Richelson and Hildy Richelson
We believe that municipal bonds are an excellent investment for those individual investors who wish to preserve their principal and generate a predictable cash flow of tax-free income. We consider this to be the case even though yields on bonds have gone down to historically low rates over the last five years.
Although individual investors generally allocate their assets between investments in stocks and bonds, maximizing consistent and predictable cash flow is the most important factor for individuals with retirement income needs, college expenses or other long-term financial objectives.
In this article
- Investing in Stocks for Income
- Investing in Bonds for Income
- Comparing Stocks and Bonds
- Our Investment Principles
- Our Strategies
- How to Monitor Muni Bonds
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Investing in Stocks for Income
Individual investors buy stocks and stock funds (we will refer to both as “stocks” throughout this article) in the hope of maximizing their investment returns as a result of stock appreciation and dividends. The historical return of 9% to 10% is pointed to as their hoped for strategy of success. However, many investors saving for retirement and those in retirement have lost their taste for stocks because of the substantial losses that they have incurred. These losses were due to the dot-com crash in 2000 and the bloodbath in 2008. Two massive stock market crashes in eight years have demonstrated to many investors preparing for retirement or in retirement that stocks offer no guarantees of growing steadily or providing the required predictable cash flow when needed over a long period of time.
A retirement fund must be designed to last for 20 to 40 years. How do you deal with a big crash that results in a 30% to 50% decline in assets when you are no longer working and earning more money? Backtesting your current portfolio against previous crashes is no predictor that your current portfolio will be safe in the future. As financial planner Michael Dubis has pointed out, “Hope is not a strategy.” While there is always the possibility of outsized gains on stock portfolios, do you want to bet your retirement on this outcome?
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Hildy Richelson is president of Scarsdale Investment Group, a registered investment adviser based in Blue Bell, Pennsylvania, that specializes in fixed-income investments. Hildy and Stan Richelson are co-authors of several books on bonds, including “Bonds: The Unbeaten Path to Secure Investment Growth,” Second Edition (Bloomberg Press, 2011).
Discussion
What do you think about Muni Bond ETF's? Nuveen has a few that I have been considering like NMA and NXZ.
These ETFs seem to spread the bond investments among several municipalities and therefore reduce the risk of a single municipal default.
posted 5 months ago by Daniel Lamorte from South Carolina
What is your thoughts on Convertible bonds such as CWB or vcvsx both have low costs and possible upside if stock appreciate.
posted 5 months ago by James Hitchings from Arizona
What is your thoughts on Convertible bonds such as CWB or vcvsx both have low costs and possible upside if stock appreciate.
posted 5 months ago by James Hitchings from Arizona
In Oregon, we face a state income tax at approx 10%. This skews investments toward Oregon munis.
Don't believe you considered the state tax impact on decisions.
posted 5 months ago by Howard Winegarden from Oregon
It seems tax free is the way to go..But, how much more capital appreciation be due to lowering of interest rates..Stocks do make a case for capital appreciation.
What should the balance be?
posted 5 months ago by Larry Felder from Florida
It seems tax free is the way to go..But, how much more capital appreciation be due to lowering of interest rates..Stocks do make a case for capital appreciation.
What should the balance be?
posted 5 months ago by Larry Felder from Florida
It seems tax free is the way to go..But, how much more capital appreciation be due to lowering of interest rates..Stocks do make a case for capital appreciation.
What should the balance be?
posted 5 months ago by Larry Felder from Florida
Daniel,The Nuveen fund NXZ is a standard bond mutual fund, not an ETF. I own NXZ and my worry is that when interest rates start up I will lose principle. With bond funds there is no way to "hold to maturity". I suppose the same applies to bond ETFs.
posted 5 months ago by Nelson Burkholder from Virginia
Nice article, but very general as usual. Not only the State Tax is not considered, but if you get your $ 1.00 back in 15 - 23 years, the inflation has eaten it!
posted 5 months ago by Hendrik Bergen from Texas
why would anyone even consider investing, i.e. throw away money, in municipal "bombs" knowing the worthless office holders, at all levels, spending our tax monies and the principal proceeds from "municipal" bonds?
posted 5 months ago by George from Mississippi
I have 2 of Stan and Hildy's books. I am done with one and now reading the second. These books are very, very good reading. You will learn a lot from them. I am a retirement/financial advisor and incorporate their logic in my practice. Get the books; they will help you. DB.
posted 5 months ago by Don Bowers from Pennsylvania
The article seems to focus on high tax bracket investors i.e. 33% and more. I understand the rationale, that being higher returns compared to taxable bonds and more "bang for the buck" the higher the bracket. BUT I expect that the far majority of retired readers are in lower brackets. Any words of advice for us (other than read the book, which I plan to do)?
posted 5 months ago by Charles Goodwin from Pennsylvania
First let me apologize for not getting back to you sooner.
To Daniel Lamorte:
If you want to invest in ETFs, I favor Vanguard issue due to the special nature of their funds. You can purchase them without a broker, I believe, and Vanguard generally makes a good product.
To James Hitchings:
Don't care much for convertible bonds because they are junk bonds and you are seriously risking your principle.
Yes, we accept the state impact in Oregon is significant. We would suggest that you purchase Oregon high quality bonds, but not exclusively. There are some benefits to diversification. I would prefer that you purchase all high quality Oregon bonds if you were to plan on diversifying into convertibles.
To Larry Felder:
We don't buy bonds for capital appreciation, though investors who purchased them in 2008-2011 have seen a lot of appreciation. We recommend that you purchase them for cash flow. Create a bond paycheck for yourself to support you in whatever you choose to do. Many stock investors have not gotten any appreciation, even when stocks have appreciated due to bad timing and taxes. Have you seriously and meticulously tracked your stock investments? That is the only way you will know if you made or lost money. Bonds at least provide a predictable cash flow so that you know what you earned every year.
To Hendrik Bergen:
The thing about bonds is that you keep getting interest payments, if you don't by zero coupon (deferred payment) bonds. If you don't consume your interest, but reinvest it, you have the opportunity to get an effective higher yield. We view a mild inflation as an upside, not a downside as the media always proclaims, because we can reinvest at higher yields. The maturity of a bond is reduced every year. You do not have to hold to maturity. You can sell if you want.
To George from Mississippi:
You might be interested to know that in July Florida legislature passed a law concerning "malfeasance, misfeasance, and neglect of duty" if members of a local governing body or a school district fail to resolve a state of financial emergency. They can be removed from office by the governor. If Florida set a precedent, other states might follow. You might send a note to your representatives suggesting that they might consider the same. Some states are much more fiscally responsible than others.
To Don Bowers:
Thank you for the recommendation of our book: Bonds: The Unbeaten Path to Secure Investment Growth. I hope that we can work with you in the future.
To Charles Goodwin:
If you are in a low tax bracket, I suggest you look at I-bonds available through TreasuryDirect.org, TIPs from the same source or your broker, taxable municipal bonds, highly rated corporate bonds (not many available currently) and agency bonds. We write about all of these types of bonds in our book.
posted 5 months ago by Hildy Richelson from Pennsylvania
I am retiring to Florida with no state income tax. If I invest in muni bonds from other states I assume there will be no tax due in either jurisdiction.
posted 4 months ago by John Andronaco from New Jersey
I am not too familiar with bonds and Canadian Tax laws' cuts into returns. It appears good to have a steady and consistent cash flow, though small for retirees, strictly in short term situation. Is there Bond Alert site(s) which prompts bond investors of failures or early early warning of death of investments?
posted about 1 month ago by Vaidy Bala from
