April 26, 2011
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Fear of an impending rise in interest rates has many recommending short-term bonds. Such fears are misplaced, however, and investors can better position their portfolios by constructing a ladder of high-quality individual bonds, rather than moving assets into only short maturities.
“It is too risky to go long-term,” the fearmongers assert. “What happens if inflation soars?” That word “soar” probably makes your heart flutter. But should it? After all, birds soar and that is okay, but inflation just increases and decreases – and the parts of the Consumer Price Index that are increasing might not even affect you. For example, if you own your own home, rent increases do not affect you meaningfully.
Soaring is an overstatement.
But it lays a foundation for more fear. What will “soaring inflation” do to the value of your bonds and your retirement plans? To protect you from inflation, the fearmongers recommend certificates of deposit (CDs), short-term bonds, short-term bond funds or step-up bonds.
Certificates of deposit versus Treasury bonds
Retirees frequently opt for certificates of deposit. Their bank is familiar, and CDs are FDIC insured (up to $250,000 per bank), giving comfort that Uncle Sam stands ready to protect them.
The problem is that a 3-month CD yields approximately 0.27%, and a 6-month CD 0.41%.
Instead, whatever kind of investor you are – whether you have $45,000 or $400,000 to invest – you can easily purchase Treasury bonds through www.TreasuryDirect.org and get the backing of the Federal Government directly instead of putting your money in the bank and relying on the FDIC. Using this approach, you can purchase longer-maturity Treasury bonds that currently yield more than shorter-term CDs.
There is nothing wrong with purchasing short-term bonds, except that in the current environment they do not yield very much. A two-year Treasury bond yields less than 1%. The yield curve is currently very steep. You get a lot more return from a long-term bond than from a short-term bond.
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