Receiving dividends is one of the best joys in life, but you can make it even better. As much as I love the stock market, it does have its ups and downs.
One of the best ways to counteract (or hedge) the unpredictability of the stock market is to invest in something more solid and consistent—like bonds.
Welcome back to the Dividend Investing 101 series (101, 102, 103, 104, 105), where we create a balanced portfolio that delivers outstanding income.
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Why add bonds to your dividends? Stocks and bonds usually move in opposite directions. Today, because interest rates are moving at an unwieldy pace, they are moving similarly.
Let’s examine the theoretical version of how stocks and bonds should interact. When stocks are up, say during a bull market; people want in on the action.
Everyone wants to jump into the S&P 500 to capture those sweet capital gains. People migrate from the safety of treasury bonds to get in on the stock market’s action.
However, when stocks suffer 20-50% drops during a bear market, people want the safety and consistency of treasury, municipal, and corporate bonds.
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Investing in income—always. As an income seeker, you can follow the yields. Today, blue-chip dividend stocks and treasury bonds are both juicy.
You can get a nice 5-Year Treasury Note at 4.35% and Antero Midstream (AM) at 7.8%. So there are lots of options to place your money today.
But, to invest for the long-term, you must look toward the future. You must understand why bonds can help you achieve your goals for retirement and beyond.
Understanding interest rates. Bonds are susceptible to interest rates, especially treasury bonds.
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If you buy a five-year Treasury Note at 5%, its price can change due to current interest rates set by the Federal Reserve. Bonds trade on the bond market, which is at least twice as big as the stock market.
The par value of a bond is 100; this is its price upon creation. However, as interest changes, the price of your bond will change.
The goal is never to sell stocks because they can appreciate over time. Therefore, bonds can assist in times when stocks are trending down.
For example, let’s say you have a $1,000 5-Year Treasury Bond at 5%. The stock market has lost 40%, so the Federal Reserve lowers interest rates to 1.5%.
Your bond price increases because people want a safe 5% yield. You could sell your bond for $1,200.
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My experience buying bonds. I made the mistake of purchasing some 30-Year Bonds during the pandemic. The yields were between 1% to 1.5%. These bonds are worthless in this 5% yielding environment.
So you must take the time to learn about bonds, interest rates, and stocks to buy at opportune times for each.
The purpose of the 60/40 portfolio. The purpose of the 60/40 portfolio is to maximize returns over a 30-year retirement.
The 60/40 portfolio’s creation was for people selling shares of mutual funds, 401K, and Roth IRAs; the intent was not for dividend investors to use it.
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However, we can take away a lot from the 60/40, mainly using bonds to protect our stock investments. I intend never to sell stocks, but treasury bonds carry no personality.
We can quickly move in and out of treasury bonds through the TreasuryDirect website. If I can sell a bond for profit in a time of need, I will do so without remorse.
Finding your risk tolerance. You don’t need to have 60% stocks and 40% bonds; all that matters is that YOU are comfortable with your investments.
We call this your risk tolerance. If you worry about stocks or are well into retirement, you may want an 80% allocation of treasury and municipal bonds.
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If you love to invest in stocks and don’t mind the risk, you may keep 90% in stocks. It’s all up to your goals, needs, and investment philosophy.
How to invest in bonds. I recommend having some bonds outside the stock market, with Treasuries being the easiest to purchase. Here is my guide on how to buy Treasury Bonds.
You can also find bond funds on the stock market, but they trade on emotions. It’s best to find a yield you love from each fund and buy only when they achieve it.
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For example, let’s say you only want to buy Vanguard Long Term Bond Fund (BLV) when it’s over 4%. That would be a good metric for your purchase versus the price.
You can also purchase bonds in Closed-End funds like PIMCO’s PDI, PDO, and PTY. However, these funds are highly leveraged and move in various directions.
I would use closed-end funds only for income, not as ways to hedge or protect a portfolio. The best way to protect and hedge is outside of the stock market.
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Is the 60/40 dead? You will hear that the 60/40 is dead or ineffective today. That’s because the Federal Reserve kept interest rates low from 2008-2022.
It was hard to find bonds that paid over 2% during this time, with most years between 1-2%. Everyone rushed into stocks because of cheap money, and stocks were in a bull run for almost 15 years.
Now, with the return of bonds over 5%, you can get a safe yield against riskier stocks. And if the Federal Reserve ever lowers rates to zero, your 5% bonds will be priced to sell high.
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Conclusion. Bonds are boring, but you can make them more interesting using high-yield bond reinvestments.
The idea is to diversify away from 100% stocks while still earning a safe yield. Yes, you can use a high-yield savings account, but their interest rates quickly decrease against a drop from the Federal Reserve.
You can use a Certificate of Deposit, but the interest rates decrease the longer the duration. Banks don’t want to eat the extra interest if rates go down.
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However, buying a 30-Year Bond at 4% will lock in your rates for 30 years. If, during those 30 years, you can get a great price, it may be a good time to sell.
I love dividend-paying stocks and love to purchase more when prices are down. However, if I need an infusion of capital for daily life, I love to have bonds to sell.
That’s why they make a great addition to any portfolio. 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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