Reinvesting a portion of your returns is critical to compounding your investment portfolio. As we invest in Treasuries, we should reinvest some coupon payments into similar-yielding products.
But what if we reinvested into much higher-yielding income-focused products like closed-end funds, mortgage REITs, and preferred shares?
Welcome back to The Importance of Treasuries series (Part 1), where we focus on living off our investments.
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What is bond reinvestment? When investors calculate a bond’s total return, they include bond reinvestment. Bond reinvestment presumes you will reinvest the bond coupon payments into a similar-yielding product.
Here is a bond calculator (fncalculator.com) so you can see the calculation yourself. The section where it says compounding is the key.
Most people automatically reinvest their dividends when they purchase blue-chip dividend stocks like Apple (APPL), Microsoft (MFST), and Verizon (VZ).
Reinvesting in bonds can be much more tricky because of their structure. You cannot make your bond “bigger” or “grow” by reinvesting back into it.
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Therefore, we must be much more intentional when reinvesting the income from our Treasuries. For example, the payments from my 30-year bonds go directly to my Wells Fargo checking account.
I need to reroute that money into securities that pay equal to or more than the bond coupon. It is not difficult, but it does take more focus than investing in dividend stocks.
What is high-yield bond reinvestment? High-yield bond reinvestment is a term I created to represent the idea of “reinvesting for more.”
Instead of reinvesting at a rate similar to your bond coupon rate (interest rate), you would reinvest into products with much higher dividend yields.
For example, if you receive payments from a 4%-yielding Treasury Note, you would invest in a Pimco (PDI) closed-end fund that yields 12%.
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Two reasons high-yield bond reinvestment is vital to long-term success. Safety and inflation are two reasons high-yield bond reinvestment is key to keeping your portfolio growing in the right direction.
“Safety of principal” is your number one concern as you head into retirement. If you manage to save $1 million over 40 years, you want to protect a large portion of that nest egg from market fluctuations.
High-yield bond reinvestment keeps your principal safely invested in US Treasuries. You then use the semi-annual payments to invest in higher-yield income products or dividend growth stocks.
However, US Treasuries are not the best way to beat inflation. The Federal Open Market Committee (FOMC or “The Fed”) adjusts interest rates to reflect inflationary pressures.
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Therefore, if inflation sits at 2%, chances are they aren’t going to set the Federal Funds rate at 5%. More than likely, the FFR will be around 2-3%.
So, there are better tools to beat inflation than Treasuries. However, you sometimes can get into a good position with long-term Treasury Bonds.
You may have a 4%-yielding 30-year bond when inflation is at 2%. However, over 30 years, you’ll probably experience 6-8% inflationary periods as well.
Beating inflation. We need products that consistently return 8-10% annually to beat inflation. You can achieve this with growth (index funds) or dividends (income investing).
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High-yield bond reinvestment allows you to take your coupon payments and purchase higher-yielding products to beat inflation while keeping your principal safe.
Let’s look at some inflation numbers versus Treasury payments. Let’s say you invest $500,000 into 30-year Treasury Bonds at 4%. Over 30 years, you will receive $600,000 in coupon payments.
After 30 years of inflation, you receive your $500,000 back from the government. However, your spending power is closer to $250,000. Put another way, you would need $1 million to have the same spending power.
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Now, let’s say you have invested your bond payments for over 30 years. That’s $600,000 invested at 10% over 30 years. You are looking at over $3 million just from the coupon payments. You will still receive your initial $500,000.
For reference, if you invested $500,000 directly into high-yielding products at 10% over 30 years, you would have over $12 million in 30 years.
Learn your risk profile. I personally would invest my $500,000 directly into income-investing products. However, I have a military pension that supports my lifestyle entirely—not everyone has the same luxury.
Therefore, you need to learn your risk profile. How much do you need in your emergency fund? How much do you need in Treasuries and dividend stocks? And how do you plan to beat inflation?
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There is no place that you can hide from inflation; it comes for all of us. If you are reading this, consider yourself among the few Americans taking their finances seriously.
High-yield bond reinvestment is an excellent compromise Between “safety of principal” and inflation protection. You must think of both as you navigate toward retirement.
In fact, the sooner you start living like you are retired, the easier it is to transition into your future life. Some people use the three-bucket approach (emergency, short-term, long-term), others use the 4% rule.
My wife and I made good money in our last year before retirement. However, we began living on $7,000/month to prepare for retirement.
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We thought making the “downgrade” from $20,000/month to $7,000/month would be difficult. However, it was much easier than we thought because we focused on the time we would gain by not working.
Conclusion. All this is to say that you need to start building your future life now. If high-yield bond reinvestment is something you would consider, implement it today.
Start purchasing Treasury Notes or Treasury Bonds every month. As coupon payments come in, purchase income products like closed-end funds, preferred shares, and business development companies.
My wife and I could retire because we already had an income portfolio that paid us $1,500/month, along with rental income and book royalties.
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We were already on our way to retirement before we made the final decision. The main component of compounding is “time.”
If you want to create an income portfolio from high-yield bond reinventing, now is the time to start. Don’t wait until you are 65 to build out your portfolio of bonds and income.
None of us know where interest rates and inflation will be when we retire. We also cannot predict the state of the stock market or the sequence of return risk.
All we can control is our own investing prowess. Treasuries are an excellent investment but still require some follow-on action to beat inflation.
We can let inflation kick out butts, or we can take control and build a 10%-yielding portfolio to keep us on top. Good Luck!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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