BUYING BONDS Are For Conservative Investors

buying bonds BUYING BONDSBuying bonds is known as a strategy for conservative investors. However, there are many reasons why people buy individual fixed income ideas. I’ll go over a some of them below:

INCOME STREAM- All bonds, including Treasuries, Municipals, and Corporates have set dates when they mature and pay interest to bond holders. When buying bonds for clients, many financial advisors suggest that a laddered portfolio is the best way to go. This strategy not only reduces interest rate risk, but provides predictability of income from the portfolio as well.

TAXATION- Buying bonds for the wealthiest Americans is a little bit different than your standard diversified account. Many high net worth individuals seek the tax benefits that Municipal Bonds provide. For instance if you purchase a bond that is issued in your home state, they are exempt from state, local and federal taxes. U.S. Territory bonds like those issued from Puerto Rico or Guam for instance, also carry the same status. Also keep in mind that buying bonds in General Obligation issues is less risky than purchasing Revenue Bonds. Although most G.O’s carry a lower Yield to Maturity.

BUYING BONDS: Safe Investment

SAFETY and SAVINGS- Some investors tend to get involved in buying bonds for the first time because they have an upcoming event in their lives. Buying a home or paying future college tuition’s are two common examples. In these two instances, many investors simply set aside funds that are deemed to be super safe, and match the maturity of the bond to their time of purchase or payment.

DIVERSIFICATION- We touched on this above, but to give more detail, investors often use financial planning models in their approach to the markets. These models often differ depending on market conditions, or simply because of the brokerage firm, or newsletter that the client uses or reads. A standard approach for many who are buying bonds and looking to reduce stock market risk is owning 80% equity and 20% fixed income.

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Would that Signal a Bottom for Penny Stocks?

investing bonds Is the Bond Market the Next Bubble?Every market has a bubble. Those bubbles exist, whether the market goes up or down. Because we have all heard the saying that “There is a bull market somewhere”. Right now that bull market is in the bond market. Investors have been drawn to this asset class for many different reasons. For some it was the “flash crash” for others it’s been poor returns in equities. The poor economy, and high unemployment are other factors in the interest
in debt market.

This interest is so evident that it’s basically flattening the yield curve and the 10 year yield is nearing the January, 2009 low. Investors are also pouring money into debt mutual funds at alarming rates. My sense is that this could signal a bottom in the equity market. History has shown us time and time again that when retail investors pile into a sector or an asset class, it’s probably near or at the top. It doesn’t matter whether it’s municipal bonds or mining penny stocks. If Joe Public is over weighted a shift the other way has usually been around the corner.

Now why could this be a contrarian indicator to go long microcap stocks ? Well it’s simple. Part of the reason for the light volume in the market has been the shift to bonds. For example if Investor A buy an equity mutual fund. That mutual fund will trade and add volume to different exchanges. Now if that same investor moves those equity funds that were reserved for risk into a high yield bond fund for instance.That simply takes volume away from exchanges like the NYSE and that lack of volume trickles down to the OTCBB. It’s simple macroeconomics.

Since many of us have lived through the internet bubble and others too. You probably get the drift. If history repeats itself, investors will not see the returns that they are looking for in bonds. As evidenced in the past, many of these same investors will eventually shift this money back into the equity market. To me this provides some buying opportunities in the area of penny stocks. The lull in volume has impacted many of these tiny companies. Some have become relativly cheap based on nothing other than lack of interest. Keep in mind that heavy volume is the way low priced companies turn into hot penny stocks. Unfortunately, some of the funds that provide that volume are tied up in bonds. This call might be a little early, but eventually, those funds should come back to stocks. Just be patient.