Now that 0% interest rates are a thing of the past, bonds finally pay a decent amount of interest. And with the markets predicting rate cuts in 2024, you have a very good chance of earning a strong return on bonds, as their prices will rise if rates fall.

But I have a big problem with the bond industry.

It’s the way most investors buy bonds: bond funds. Since bond prices move in the opposite direction of interest rates, bond funds work well when rates are falling and the prices of the bonds in their portfolios are rising. But when rates rise, those same bonds fall in price and investors get crushed.

For example, the largest bond fund, the Vanguard Total Bond Market ETF (Nasdaq: BND), dropped from a high of $75 to $68 last year before bouncing in October as the markets began to believe rates had topped out. That’s a drop of more than 9%.

The iShares Core U.S. Aggregate Bond ETF (NYSE: AGG), another large bond fund, fell 9.5% from high to low last year.

Both of these exchange-traded funds (ETFs) are still below where they were a year ago.

The two funds have more than $200 billion in combined assets. That’s a lot of money that retail investors shelled out because they thought bonds were safe.

The thing is, bonds are safe… if you buy individual bonds rather than a fund or ETF.

When you buy a bond fund or ETF, you are at the mercy of the fund manager or the index that the bond is tied to. And if you want to withdraw some funds, you’d better pray that the price is higher than it was when you bought it. Otherwise, you’ll end up taking a loss.

But when you own individual bonds, you’re able to plan accordingly so you know when your cash will become available. If you needed your funds in October 2026, for example, you would buy an individual bond that matures before then.

Best of all, you know that at maturity, each bond is going to be worth par value (which is $1,000) no matter where it traded in the past. At maturity, you will receive $1,000 unless the company has gone bankrupt – which is extremely unlikely unless you’re buying the riskiest of bonds.

If you were to buy the iShares bond ETF I mentioned above, the price could be anywhere by October 2026. It could be at $98, which is where it’s at as I write, or it could be at $105 or $80. If you buy it at $98 and it’s at $80 when you need the money, you’ll collect only $800 for every $980 you invested.

Meanwhile, if you buy a bond that matures in October 2026 for $980 today, you will receive $1,000 in October 2026 – plus you’ll have collected interest along the way.

Wall Street makes it very easy to buy bond funds or ETFs. Buying them is just like buying stocks. It’s about as simple a process as there is.

Buying a bond is a little – but just a little – more complicated. Sometimes, there is no market for a particular bond, meaning your broker will have to work to find a buyer or seller for you. If they can’t, you won’t be able to make the transaction. For that reason, you should only buy bonds you intend to hold until maturity.

If the bond’s price climbs or you want to sell for another reason, you likely will be able to, but unlike with stocks, ETFs and mutual funds, there’s no guarantee there will be a buyer.

You can always call the fixed income desk at your broker if you ever get stuck or have questions. Most fixed income desks have very good customer service, as the representatives are usually bond specialists.

Individual bonds provide income and safety for your portfolio. Bond funds produce income only. There is no assurance that you will ever get your money back from a bond fund.

Stick with individual bonds for the fixed income part of your portfolio.

The post The Big Problem With the Bond Market appeared first on Wealthy Retirement.

As a result, one of the most common questions I’m asked is whether investors should lock in these rates for the long term.

I don’t think that’s the right move.

Short-term rates are higher than long-term rates across many kinds of fixed income investments right now, which is the opposite of how things usually are.

You can get 5.39% on a 4-week Treasury and 5.4% on an 8-week Treasury, which is the highest-yielding Treasury. But if you go out to one year, you’ll earn 4.67%. Beyond that, the 5-year Treasury yields 3.89% and the 10-year yields 4.01%. (Keep in mind that all of these rates are annualized.)

The best six-month CD rate is 5.5%. If you lock your money up for a year, you’ll still earn 5.5%. But if you do so for three years, you’ll earn 4.75%, and for a five-year CD, that drops to 4.6%.

In corporate bonds, you can earn about 6% on a BBB rated bond for one year and 7% on a bond with a three- or five-year maturity, but that goes down to 6.48% for a 10-year maturity.

Personally, I would never lock up my money for several years to earn less than 5%.

Now, with respect to interest rates, nearly everyone believes they are going to be much lower by the end of this year.

I don’t.

But even if I’m wrong and rates do fall, they won’t stay low forever. Look at how drastically rates have climbed recently. Only three years ago, the 10-year Treasury yielded just over 1%.

Many investors have anchoring bias. They rely too heavily on previous information even if that information is not accurate or no longer relevant.

For example, retailers take advantage of anchoring bias all the time by offering similar products at different prices, which pushes you to buy the cheaper product – even if it’s not a great deal.

You may be at a ballgame where a large beer costs $18 but a regular beer is $14. That $14 Michelob doesn’t sound so bad now, does it?

Or when you’re looking at a $60 stock and it drops to $55, you may think it’s a steal… even though some fundamental research would suggest that it is still too expensive.

The low rate world that we lived in for several years has made today’s rates seem juicy. But historically, they are not high at all.

Going back to 1962, the average yield on the 10-year Treasury is 5.87% – quite a bit higher than where it is today.

The same is true for inflation. We got used to near-zero inflation for years, so today’s 3.35% still seems high. But the long-term average inflation rate is 3.28% – right about where we are today.

I believe fixed income should be an important part of everyone’s portfolio because it can provide ballast when stocks tumble and it can generate safe income. But unless interest rates really take off and get to very high levels, I do not recommend locking your money up in bonds with maturities longer than a few years – and certainly not in any long-term bond mutual funds that are guaranteed to lose money if rates rise.

I have a lot of my cash in Treasurys and CDs that mature in one year or less. Those vehicles are great places to keep your short-term cash.

Sure, if rates drop, you could miss out on some extra interest for a few years by not investing in longer-term bonds.

But even if rates do fall, I expect it to be part of a normal cycle in which rates and fixed income yields are constantly fluctuating. I don’t suspect we’re going back to a zero interest rate or even low rate environment anytime soon.

The post Don’t Make This Fixed Income Mistake appeared first on Wealthy Retirement.

The market expects the Fed to cut interest rates six times this year, which is a head-scratcher considering the continued strong employment numbers, rising wages and record holiday retail sales we’ve seen recently. It is highly unlikely that the Fed will lower rates that many times unless there is a major event that sends the economy careening.

The central bank will not cut rates simply because it has stopped raising them. (Keep in mind that zero or near-zero interest rates are not the norm.) And Fed Chair Jerome Powell won’t send interest rates back down just because inflation has slowed. He’ll need to see an economic downturn.

Lowering rates without a recession would fan the flames of inflation again, and Powell does not want to go down in history as the Fed chair who allowed inflation to return.

And while a recession certainly could occur, there are no signs that it will. So even if we do see a recession in 2024, it will be later in the year – too late for the Fed to squeeze in six rate cuts.

Who Can You Trust?

The markets still don’t seem to be in agreement on this issue.

The market for fed funds futures, which are futures contracts based on interest rates, is pricing in a 62% chance of rates being lower by March. By June, that number increases to 99.9%, and by November, the fed funds futures market calculates the probability of at least one rate cut to be 100% – a sure thing.

But the yield on the 10-year Treasury, which is a general proxy for interest rates, tells a different story.

Back in May, despite the fed funds futures indicating a 99% probability of a rate cut by March 2024, the yield on the 10-year Treasury began a huge move from 3.3% to a high of 5%. So the futures market was forecasting a recession, but the bond market was predicting an overheated economy that would lead to more inflation.

Then, after tagging the 5% mark, the 10-year Treasury yield promptly dropped like a New Year’s resolution in February. In just two months, it slid all the way back down to 3.8% – more in line with the fed funds futures market.

Since the end of the year, however, the yield has climbed back above 4%. The rally has been only a few weeks long, but if it continues, it should make investors at least question whether the rate cuts are in fact written in stone.

Anytime sentiment is so extreme – and a 100% probability of a rate cut is certainly extreme – it makes me strongly consider the alternative view.

There is no reason for the Fed to cut rates anytime soon, especially as early as March. And I see very little probability of six rate cuts by the end of the year.

In fact, I expect interest rates to be fairly stable this year. That’s one of the 10 big predictions that I made in the 2024 Forecast Issue of The Oxford Income Letter, which just hit inboxes today.

In the issue, I discuss the market, world events, the presidential election and the best stock to buy in 2024. And I guarantee the stock is not one that you’d expect.

The post Will the Fed Really Lower Rates in 2024? appeared first on Wealthy Retirement.

On Friday, as stocks were moving higher and interest rates were plummeting, we were discussing the day’s market action.

M: Feels like the market wants to melt up.

C: Market is telling Powell to go jump in a lake.

Full disclosure, my buddy Chris used much more colorful language than that. The language used on the trading desk could make a Samuel L. Jackson rant after stubbing his toe seem tame. But since we keep it classy here at Wealthy Retirement, we’ll leave it at “go jump in a lake.” You probably get the idea of what he was saying.

Inflation has come way down from the near-double-digit readings we saw just a few months ago. It’s currently at 3.2%. And Fed Chair Jay Powell has been steadfast in his insistence that the Fed will tame inflation and will not back off until the mission is accomplished.

But a quick look at interest rates tells you the markets aren’t too worried about future rate hikes.

The yield on the 10-year U.S. Treasury has come all the way down from 5% in mid-October to under 4.2% as of this morning. That’s a big move in a short amount of time.

Markets tend to be forward-looking mechanisms. They generally forecast about six to 12 months into the future. That’s why you sometimes see stocks bottom and start to rebound while the economy is still in a recession. When that happens, it signals that the recession is likely to end soon. Similarly, when stocks fall while things are booming, that tells you the good times might be about to end.

The rapid decline in bond yields suggests to me that the market believes the Fed is done raising rates and that the Fed’s next move will be a reduction in rates, not a hike.

The futures market agrees. According to the fed funds futures data, there is a near-zero probability that the Fed will raise rates in 2024, and it is a near certainty that it will lower them by late next year.

Now, markets are not always right. Things change, data fluctuates and investors respond accordingly. But generally speaking, it pays to listen to what the markets tell you, because they are a good barometer of what is likely to happen.

With stocks climbing and interest rates falling, my interpretation is that inflation is fading and the Fed should be close to finished with its rate hikes.

Should that occur, Jay Powell may find he has more time to relax… perhaps at a lake.

The post The Real Truth About Interest Rates appeared first on Wealthy Retirement.

If rates decline next year (as many are expecting), that should lead to profits as well, as bond prices move in the opposite direction of interest rates. So if rates fall, bond prices will rise.

Furthermore, bonds are less risky than stocks, because bondholders are guaranteed to get their money back at maturity unless the underlying company goes bankrupt. Stockholders have no such guarantee. But in exchange for the higher risk of owning stocks, equities owners typically make more money over the long term.

Today, however, there is a unique opportunity to generate long-term stocklike returns with almost no risk. And to make it even sweeter, the IRS can’t put its grubby hands on the money.

Some municipal bonds (also known as munis) are currently paying more than 5%.

Now, you may be thinking, “Wait a second… 5% is nice, but it’s hardly a stocklike return.”

And you’d be right… partially.

Since 1971, the S&P 500 has generated an annual return of 7.6%. But don’t forget that dividends and capital gains are taxed, so an investor wouldn’t have taken home the full 7.6%.

Most muni bonds, however, are tax-free. You don’t pay any federal tax on the income, and if you live in the state that issued the bond, you don’t pay any state tax either.

So when you look at a muni bond, you have to figure out the taxable-equivalent yield to see whether it makes more sense to buy a taxable bond with a higher return or a tax-free muni bond with a lower return.

Today, you can buy a Missouri Highways and Transportation Commission (CUSIP 60636wnu5) May 2033 bond that has a yield to maturity – a common way to express a bond’s annual return – of 5.42%. In other words, you can expect to earn about 5.4% per year for 10 years tax-free.

To calculate the taxable-equivalent yield, you simply divide the bond yield by 1 minus your tax rate.

You can also find free taxable-equivalent yield calculators online, such as this one. But let’s go through the math on this bond so you can see what I’m talking about.

Let’s say you’re in the 32% tax bracket. We take the 5.42% yield to maturity and divide it by 1 minus 0.32, or 0.68. So 5.42% divided by 0.68 equals 7.97%. You’d need to earn more than 7.97% per year in a taxable investment to beat this particular muni bond.

Remember, stocks return an average of 7.6% before taxes. This muni bond returns 7.97% on a taxable-equivalent basis for bondholders in the 32% tax bracket. That return is guaranteed, and the bond has a very high rating of AA+, which means there is almost no chance of default.

The risk with bonds is opportunity risk. By owning this bond, you are guaranteed a 7.97% annual taxable-equivalent return for 10 years, so if stocks have a big decade, you could miss out on some gains. Of course, if we hit a nasty period, stocks may return less than your bond or even lose value.

There are a few other things to keep in mind. First, your money would not be locked up for 10 years. You could sell the bond anytime you wanted. You just wouldn’t be guaranteed the same return if you were to sell early. It could be higher or lower depending on the price at which you sold the bond.

Also, the taxable-equivalent yield will depend on your tax bracket. If you’re in a lower tax bracket, then the taxable-equivalent yield will be lower, so there may be some better deals out there in taxable bonds and stocks. If you’re in a high tax bracket, then muni bonds become more valuable.

Finally, you can generate even greater returns by buying bonds that have lower ratings, but when it comes to munis, I wouldn’t buy anything rated lower than A. After all, one of the attractive features of munis is the certainty that you’ll be paid back in full at maturity.

It’s definitely worth your time to make sure you understand muni bonds. I recommend you look for some good opportunities to generate tax-free income and returns with almost no risk.

The post Buy Muni Bonds to Protect Your Cash From Uncle Sam appeared first on Wealthy Retirement.