Never before have so many investors sat on so much cash for fear of making such a big loss...
And yet, at the same time, never before have we seen so many speculators out there. Just think of the banks and hedge funds with their risk-on, risk-off trades smashing the markets about.
It's no wonder investors are polarised. Which camp are you in? The safety-in-cash camp, or the punt-it-all-on-the-markets brigade?
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Either way, today I want to propose an asset class that can help bring some balance to your portfolio. Call it an antidote to today's polarised markets.
Driving for show... putting for dough
While most of us golfers take pleasure in giving the ball a good whack off the tee, my old buddy Jon isn't bothered...
He pulls out a boring old two-iron and plonks the ball safely onto the fairway (we unfairly invite him to use the ladies' tee!) And as he invariably finds himself helping me forage about the undergrowth in search of my ball, I hear him mutter the same old thing: "Driving for show... putting for dough, old boy."
And it's the same idea when it comes to equities and bonds right now. Equities for show... bonds for dough.
Equities offer all the showmanship. Fantastic companies offering products about to take the market by storm. Brand new innovations to turn the industry upside down. There are exciting takeover battles, mergers and all manner of other stuff for investors to salivate over. And that's just the companies themselves...
Then there's the financial industry, full of show people, newspapers and journals shouting about the latest equities on their radar (yes, some of my colleagues included the most tempting I've seen lately is this one).
These thrilling stock opportunities are fine. I invest in equities myself, if I see something I like. Especially if it has a good story that I can believe in.
But my point is that when it comes to bonds, there's never much of a story. If you're like me, you may salivate over a gross redemption yield, or modified duration... but generally there's not much show' about these steady-Eddies.
And yet, I'm convinced that for many investors this is where you'll find the dough' especially as part of a diversified portfolio.
Even if you're coming at this from the opposite side of things that is, you're the ultra-cautious cash-type', then there's something for you here too. Bonds tend to offer much better yields than cash. Yes, you'll have to accept a bit more risk than with a straight deposit... but I think it's probably worth it.
Are you missing out on bonds?
My gripe is that practically every investor knows and understands equities. They understand cash too. But too many ignore bonds. Now over the years, I've kept coming back to bonds in The Right Side. And each time I do so, another reader or two writes in or places a comment on the website to thank me for flagging up the opportunity in bonds. The message is getting through and that's great.
How about you? Are you in the know'?
My aim today is to convince you that no matter what your investment objectives, there's almost always a bond out there to suit your needs. I'm going to show you three common investment objectives, and show you how a bond can accommodate.
Then, over the coming weeks, it gets better. I'll select some specific bond issues that tie in with each of these objectives. So if you decide you'd like to put some money in bonds, you'll have a few specific ideas to consider.
So let's look at a few investment styles
For the big-hitters: Investors are willing to take on all manner of risk in search of return. Frankly, it's what the authorities want us to do. You can call it the Greenspan/Bernanke put'... that is to drive interest rates down (and inflation up) until investors are forced to pump cash into equity markets.
But there could be a massive amount of risk involved with equity today. And on a dividend yield basis, returns are only marginally better than cash. But still, the yield hungry come to feed at the equity trough.
Getting back to my golfing analogy, it strikes me that stock picking is the classic show-off drive from the tee. If you do well, you can do fantastically well... but if you make a hash of it, you could lose the lot.
My point is that with boring old bonds, you can still make a pile of money... but you can massively curtail risk. Recently I showed you a bond that returns over 11.5%... and yet there's a decent bit of security in there. Basically the bond offers a billion worth of property to secure a £600m bond issue.
Put your hand on your heart and tell me that you are really expecting stocks to return you over 11% year in, year out up until 2018. That's what this bond could do.
Of course, there's still risk... you can't eradicate it. It's all about risk and reward. You don't need to go for an 11% yielder there's plenty on offer across the risk/reward spectrum.
Bonds for the inflation worriers: Okay Bengt,' you say. I can see that risky corporate bonds could be a good idea. BUT bonds fall apart during periods of high inflation...
Well, yes they do.
Most bonds pay a fixed rate of interest, so if inflation strikes and market rates go up, then you're stuffed. You'll be stuck getting your fixed, say 6%, coupon while everyone else moves onto higher rates. And as the bond gets less appealing, so its value and market price goes down.
For the record, I'm not too concerned about rising rates just now. But if you are, and inflation protection is your concern, then there are bonds out there that can help.
There are loads of corporate bonds offering yields much better than cash, and yet giving inflation protection through an index-linked coupon. National Grid offers one. And I have previously written about an interesting linker' provided by RBS.
The safest of the safe. A cash holder with immediate access: I know there's a growing crowd of you out there that aren't looking for big hitting equities. I've seen the rise in sales of cash Isas over recent years. And I've seen how investors are prepared to accept negative interest rates (after inflation) just to keep cash on-call' if it's required.
But there are loads of bonds available from robust institutions like Tesco, or electricity and water providers offering interest rates of around 5% or more. Not that exciting I know, but frankly it's double the return many cash accounts have been paying for years now. And there's nothing on the horizon to say things are about to get any better from an interest rate point of view.
With a bond, not only can you double the interest you're earning (interest is paid gross and if held in an Isa remains tax free), but you can sell your bond at any time to release cash. There are NO interest penalties. When you sell your bonds you'll get the market rate PLUS whatever interest is owed on them.
Let me just explain how that works...
Though you buy and sell bonds through your standard stockbroker, they work a little differently to shares. With shares the value of the next dividend payment is wrapped up in the share price. But when you buy bonds, your broker will effectively quote you two prices.
First he'll give you the price for the bond itself, and then for the accrued interest'... that is, you'll have to pay the interest that the bond has earned since it last paid out. Don't worry of course you'll get that back the next time the bond pays its coupon.
At the same time, if you sell your bond, the person buying it will have to pay you whatever interest has been accrued since it last paid a coupon.
Now, I should point out the risks in holding bonds.
Risks to be aware of with bonds
First is that, unlike cash, the value of your investment could fall. If Tesco, National Grid, or whoever hit financial problems, then the value of your bond could fall. But to my mind, this risk is small... frankly I've got more faith in Tesco than I have in any of the banks!
A sudden rise in interest rates is very likely to hit the bond markets too. But then again, a prolonged zero-interest-rate environment could add value to your bonds.
Also bear in mind that, just like shares, there's a spread (ie, the difference between the buy and sell price). So if you know that you need your cash within say, a year, then you'll probably be better off leaving your money on a cash account.
The other thing you must also bear in mind is that, unlike cash, retail bonds aren't covered by the Financial Services Compensation Scheme (FSCS) in the event of bankruptcy of the issuer, you may not get all (or any) of your money back. Yes, you stand ahead of equity holders in the queue, but unless the bond has decent security backing, you may be in trouble. The way I see it, the opportunities bonds present as part of a balanced portfolio outweigh these risks.
Go get an Isa now
If you haven't set up your Isa for this year yet, then why not do so now? You'll find a few ideas for Isa providers here.
And stick with me and I'll show you some bonds you may want to consider over the coming weeks and months. It's worth noting that these bonds can be held in a stocks and shares Isa, where you can tuck away twice as much (tax-free) as with a cash Isa.
I'd love to get an idea of how many Right Side readers are investing or thinking of investing in bonds. Any thoughts, please share them below.
And if you're just not interested in bonds, that's OK. I'll still write about other opportunities. I'll still flag up stock tips from colleagues and other strategies I think are worth taking a look at.
This article is taken from the free investment email The Right side. Sign up to The Right Side here.
Important Information
Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.
Managing Editor: Frank Hemsley. The Right Side is a regulated product issued by Fleet Street Publications Ltd.
Fleet Street Publications Ltd is authorised and regulated by the Financial Services Authority. FSA No 115234. https://www.fsa.gov.uk/register/home.do
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