Thursday, October 11, 2012

why I don't like bonds

Honestly I think bonds suck.

Now I'm not talking about the Canada Savings Bonds of yesteryear...  They were attractive in the 70s and 80s because of the sky-high interest rates.  At the time, the rates were above the rates of inflation so you actually made money with them.  Now?  Don't even think about it...  Not only do you get an interest rate that doesn't match inflation, the money you get back when you redeem the bond has deflated as well.  So they really are lose-lose.

What I'm talking about today are the "big boy bonds" that trade on the markets.  They are (should be were... but still are) viewed as a safer alternative to stocks. Now the same deflationary pressures exist so the money you get back when the bond matures is no longer worth what it was.  Additionally the value of the traded bonds fluctuates relative to market forces and how much time the bond has left to maturity.

The tax implications of these bonds also sucks.  Not only does your principal lose value due to inflation, the meagre returns are taxed just like you had flipped burgers to get it.  I must digress though, for an investor in my tax bracket this doesn't add up to a hill of beans.  But if you do have taxable income, then bonds really aren't for you at all.

As an investor in Canada if you're looking for a safe place to put your money?  I would stick to the banks.  Not actually putting the money in an account at the banks mind you... buy yourself some shares of your favourite bank and you will laugh all the way to the bank for years to come.

Full disclosure:
I own BNS, and ZWB.  (An ETF that holds all CDN big banks and writes covered-calls on them too)

If you bet the farm on my advice, it's your own damn fault.  Do your own research.  My opinions are mostly bile, pith, and vinegar.  If you don't want to take responsibility for your own buffoonery, then why do you think I should be left holding the bag for your troubles?  If you're looking to sue me for your idiocy, then I'll happily mail your lawyer a copy of my last notice of assessment.  It clearly shows that I'm not worth their time.  (They will however take your retainer fee and not refund it)


  1. I have BNS too. Great stock. I think the banks are a pretty good bet right now. I like REITs and other types of real estate investments too because they will hold their value over the long run. I don't have individual bonds because I can't afford the spreads on them but I have about $1000 in XBB, a bond ETF. It has done okay in the past, but I mainly hold it for diversification purposes as I don't have any other fixed income right now. Canada's inflation rate is only 1.6%. But when the days of higher inflation come, I plan to get rid of it.

    1. I was thinking about XBB... but it doesn't look attractive to me right now. We will be the first G7 nation to start raising interest rates and since XBB is mostly a collection of CDN government debt, the unit price will only get punished.

      I have recommended some of it to some of my friends who are older and are looking for more capital safety. Although I think Canadian REITs serve them better since they have no trouble understanding the business model and it's pegged to property valuation.

  2. I do like bonds, but that is partly my stage of life. The bonds I like are muni bond funds - tax free and giving better interest now than any bank I know of.

    1. We have no such things up here. Municipalities in Canada are not legally permitted to carry debt.

      Only the provincial governments and federal governments can issue bonds and they are all taxable like income. (Unless you have them in one our our "registered" accounts which have strong limitations on money in and out so small investors like myself will NEVER have enough money in them to bother)

  3. I think bonds have there place for some people. If you have the right mix they can help you have a more diversified portfolio. With that said i don't currently own any bonds. REIT are great but I don't know much about that bank.

    1. ZWB is an ETF of ALL of the large Canadian Banks. Thanks to our protectionist federal laws, NONE of them are going to be bought out, nor will any of them go bankrupt due overzealous bankers.

      The Canadian banking system was praised many many times by the IMF and other international governing bodies during the past financial crisis as to how banks should be run. (Lots of capital, simple rules, strong limits, and protective federal law) Tie this together with a population that does NOT have any other choice (so banks can charge the fees they want without customers flying the coop) and a complacent Canadian mentality. This means these banks will be strongly profitable now and for years to come regardless of what the financial markets do.

      As a Canadian, we really don't have any choice with our banking. You need to have an account with one of the big banks. There just aren't any other options.

  4. at one time.. the rates on bonds were much better. but you are right, today-- they are well below inflation..

  5. Interesting take, definitely depends on where you are in your life. You don't really have much of a choice if you're close to retirement but for everyone else, I think a minimal amount of bonds is just fine. I just bought 5k of i-bonds in the us, but that was more due to the fact that it provides the highest guaranteed return of any investment out there right now.

    I do like your idea of investing in banks though, seems like they're all too big to fail right?? Not sure if I have the balls to put a big chunk of my money there though, not yet at least :)

  6. If you're close to retirement, I would advocate that you stay even further away from bonds... They do NOT have the ability to provide a decent income, nor can they keep up with inflation and to top it all off, the taxation on the pitiful income you do get from them is taxed just like you had earned it. If you're close to retirement, your money has to last you 25+ years. (based on today's average retirement numbers).

    So a REIT heavy portfolio will generate a better income, be much more tax friendly (often paid as "return of capital"), it will stay in pace/beat inflation and will grow with the inevitable increase in property value.

  7. Maybe you need to do some research on taxes: bonds and REIT's are both taxed in the same manner(in fact individual bonds are tax exempt in certain situations). I have articles on both on my site.

    Assuming both are in a tax advantaged portfolio though, why would taxes matter? REIT's rarely make sense in a taxable account so I'm not quite sure what you're alluding to. How would an REIT heavy portfolio have performed in 2005-2008, I would not want to have 90% of my portfolio in REIT's at that time...

  8. Hi Harry, you didn't read the fine print in my blog. I'm Canadian, and the tax rules that I know and deal with are for Canadian investors.

    In Canada REITs have the ability to depreciate their assets against their distribution. This from a tax perspective it's called "Return of Capitol" Which means it's 100% tax free. However since it's accounted as giving you your money back, this means your average cost per share goes down. So when you sell the units it's taxed like a capitol gain. In Canada, capital gains are taxed at only 1/2 of your base income tax rate. Where as bonds are taxed at your full rate.

    So, many REITs in Canada will give you tax free income which means your tax returns stay low, which means you qualify for the poverty-stricken government grants for old folks. (Old age pension, and the Guaranteed Income Supplement) When you sell it, you have control of how much you want to sell and when to manage your tax implications.

    Plus, there are NO tax exempt bonds in Canada. You pay the full smash no matter who you are, no matter what you invest. (Unless they are in one of your "registered" accounts)

    Does that clear things up as to why I'm so hateful of bonds?

  9. As for the performance of Canadian REITs during the 2005-2008 time frame, yes the unit prices tracked down with the markets. But the ones that I like (and currently own) all paid out their distributions like clockwork. The ones I owned I HELD through, and within 6-18 months (depending on the REIT) they had recovered ALL if not MORE share value. Plus, add to that the distributions that they kept paying.

    Canada did not suffer like the USA during the 08/09 collapse. NONE of our banks failed. NONE of our banks stopped paying dividends. NONE of our banks fired anybody, and NONE of our banks lose a wink of sleep.

    They did have a VERY limited exposure to the US mortgage market, but our laws up here forbid them from getting into the same nasty trouble.

    Our government has even continued to tighten the regulations regarding mortgages and loans.

    A little regulation made Canada a boring place to look (which is why you didn't notice) but at the same time, it let us chug along doing the same old same old, regardless of the insanity that brought the US Cap markets to it's knees and dragged the rest of the world down with it.