The Case For Buying Bonds: Living For Free And Other Benefits

The Yin Yang Investor Mindset post talks about looking for opposite investment opportunities whenever one asset class is roaring. I used the sell-off in bonds as an example of finally beginning to build a meaningful muni bond portfolio to earn double taxation free income.

Now I’d like to highlight more reasons why folks who have a large enough financial nut, are within five years of retirement, or are already in retirement should consider allocating more towards bonds.

For over 20 years, I was heavily invested in equity to try and build my financial nut as quickly and as large as possible. However, after a 10-year bull market in equities that began in 2009, I decided to take down risk. As a family-man now, the last thing I want to do is lose money and have to go back to work. 

Find A Purpose For Your Money

If you already live on less than you earn, making more money is meaningless if you don’t earmark a specific purpose for your investment returns or paycheck.

The irony of equity investors making fun of bond investors is that bond investors tend to be much wealthier. Bond investors tend to want to protect the principal they’ve spent decades accumulating.

There’s no greater joy than being able to live freely. Being able to do whatever you want, whenever you want cannot be overestimated. It is amazing. Take my word for it.

But what if you could live freely AND live for free? That would be heavenly. Some people get to do both, but experience no joy because everything was given to them. Good thing most of us have worked long and hard for our money. Reaching a goal based on merit is so much more satisfying.

With the goal of living freely and living for free, I began aggressively paying down mortgage debt in 2015. The property now generates about $3,050 a month in cash flow after all expenses.

Thinking about what you entered……..
You are in!

What I realized back in 2017 was that investors could buy the Aggregate Bond Market through ETF, AGG, and live for free!

And with interest rates collapsing again in 2020, it behooves everyone to refinance their mortgage and take advantage of close to all-time low interest rates. If you held onto your bonds since 2017 and refinance your mortgage today, you would absolutely be living for free.

The Case For Investing In Bonds

Since 1989, the worst year for the aggregate bond market was -2.9%. I was surprised when I saw this graphic by PIMCO, one of the largest bond managers in the world, because I was under the impression that 2008-2009 was such a bad period that bonds sold off more than -2.9%.

Domestic and foreigners were selling all US dollar denominated assets indiscriminately because it felt like the entire US financial system was going to collapse.

the-case-for-bonds

The reality is, if you had bought the iShares Core US Aggregate Bond Fund AGG you would have done just fine during the biggest financial meltdown of our lifetimes. See how stable the Aggregate Bond Fund has performed over the past 10 years.

Aggregate Bond Index Historical Chart (AGG)

Case Study For Buying Bonds

Of course history is no guarantee of future performance, but lets say the AGG stays flat over the next 10 years – one could earn a 2.375% gross annual yield. It’s not amazing, but guess what? 2.375% is the exact interest rate on my recently refinanced 5/1 ARM that expires on August 1, 2021.

Below is a snapshot of my originally $981,000 5/1 mortgage that closed on August 1, 2016. I paid down about $131,000 of principal to refinance $850,000. The original monthly mortgage payment was ~$4,333 due to a larger principal balance and a higher 2.625% interest rate. Now the monthly mortgage is $3,303.55; $1,621.26 of which goes to principal.Mortgage Refinance

Latest mortgage refinance

To live for free, all I’ve got to do is invest $850,000 in AGG after the recent sell-off. There’s just one problem. I don’t have $850,000 lying around. I could sell off other investments to create this “live for free arbitrage,” but I don’t want to just in case my other investments return better than 2.375% and the bond market sells off even more.

But, what I can do is focus on making NEW money in order to build a position in AGG to slowly chip away at living for free. The beauty of this strategy is that there’s a two-pronged attack.

On the one side, I’m building a bond position to get to $850,000. On the other side, I’m automatically paying down the mortgage through monthly payments and random extra principal payments so that I DON’T have to amass an $850,000 live-for-free bond portfolio!

How fun is this challenge? So fun for a financial enthusiastic.

Historical Muni Bond Index Returns

Given I’ve got a higher risk tolerance, I’m building a California Municipal Bond fund position as part of my bond portfolio mix. CMF has a ~2.5% double tax free yield, equivalent to over a ~4.3% gross yield based on my tax rate. CMF is more volatile than AGG and has corrected by a maximum of 10% over its lifetime. But a 10% correction fits nicely with my risk-tolerance. Any more than a 10% loss feels too painful for me.

Who wants to just live for free when one can actually get paid to live in a cozy house and potentially make money from a house that inflates with inflation over the long run? With CMF, I earn a gross adjusted yield of almost 2% over my 2.375% mortgage rate. I’m willing to take more risk for this even better scenario.

Build Your Money Army

The Case For Bonds: Stocks versus Bonds Performance 1999 - 2000

I hope people get motivated to earn more and save more. If you check out the chart above, you’ll see that the Vanguard Long-Term Bond Index Fund has done quite well compared to stocks – practically even performance actually, with less volatility.

Further, when stocks are melting down, as they are with the coronavirus in 2020, bonds can actually play offense and make you a lot of money. Take a look at this chart below with various bond funds and ETFs.

Bond fund performance 2019-2020 coronavirus

Having a Money Army work for you so you don’t have to is a good scenario. If your Money Army can also allow you to live for free, even better!

To recap:

1) Having a purpose for your money makes saving, working, and investing that much more fun and meaningful.

2) The aggregate bond market’s worst annual decline since 1989 was only 2.9%. Those of you who are near retirement, in retirement, or looking for less volatility in their investment portfolio should consider increasing bond exposure after the recent sell-off. There are no investment guarantees. Bonds can continue to sell off. We’ve only seen that bonds are much less volatile than stocks.

3) There are all different types of bonds with varying levels of risk and return profiles. US Treasury bonds are the least risky, followed by municipal bonds from states with strong balance sheets. Emerging market high yield corporate bonds are some of the most risky e.g. Greek bank bonds. Bonds provide diversification, income, and potential return.

4) For those in a 33% or higher federal marginal income tax bracket and who also live in a high income tax state such as California (13.3% top rate), Oregon (9.9%), Minnesota (9.85%), Iowa (8.98%), New Jersey (8.97%), Vermont (8.95%), District of Columbia (8.985%) or New York (8.82%), municipal bonds provide better relative value. If you don’t like munis, AGG offers the total bond market exposure.

5) Make sure you have a diversified portfolio that matches your risk tolerance. We could very well be at a turning point in the US bond market’s 35+ year bull run. Unlikely, but possible. After significant moves in any asset class, it’s always good to give your investments a checkup to compare your current allocation to a recommended allocation. You may be surprised at what your results might find.

6) Check the latest mortgage rates online now. Interest rates have continued to decline (see chart below) and the proper market is finding a healthy support. If you’ve been looking to refinance or buy property, the window has opened up. Credible has the largest online platform where lenders compete for your business. Check them out for a free mortgage quote today.

Interest rates collapsing in 2020

Here’s an example of running one of my investment portfolios through Personal Capital’s free Investment Checkup tool. With the selloff in bonds as interest rates have risen in 2018 and the rise of stock market volatility, I have happily increased my bond allocation. Earning risk-free higher returns is wonderful. When you’ve made a lot of money since the global financial crisis, a good idea is to keep it!

Personal Capital Investment Checkup

Updated for 2020: The 10-year bond has collapsed all the way down to 0.7% in 1H2020 from 3.28% in October 2018 due to coronavirus fears

Thinking about what you entered……..
You are in!

Contact links
David Mead 

Freelancer for Structural/Civil Engineering projects 
Upwork - Click HERE 
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You can see my projects on youtube or on my Google Drive account
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