Daily Gains Letter

Why Bonds and Treasuries Are the Worst Places to Park Your Retirement Fund

By for Daily Gains Letter | Mar 8, 2013

















DL_Mar_8_2013_JohnWith the bull market celebrating its fifth anniversary and the Dow Jones Industrial Average reaching record levels (and erasing losses from the financial crisis), it’s not a surprise to see some investors questioning whether or not they’ve missed the boat.

For those who think they missed the recovery, it’s probably a little unnerving to consider the present market a bull market. While the markets may be performing well, the average American isn’t. Unemployment remains high, as does household debt. Gross domestic product (GDP) is essentially flat. And housing remains fragile.

Those that think they have missed out or don’t want to risk jumping back in at this late stage will have to be content with what they’re getting from the banks (0.5%) or with bonds (3.1%). Neither one is worth celebrating.

How did we get here?

In an effort to stem the economic slide of the U.S. housing collapse that first surfaced in 2005, the Federal Reserve unveiled three different rounds of quantitative easing (QE). Since 2008, the Federal Reserve has printed off trillions of dollars, and it continues to add to that number at a staggering rate each month.

But America isn’t alone. Central banks from around the world are flooding the markets with QE.

The extra dollars pumped into the economy are supposed to spur growth. But they also have the reverse effect, shrinking the buying power of each dollar, which is the driving force of inflation. While inflation is good for businesses and Wall Street, it’s bad news for interest rates and everyday Americans and their retirement funds.

If investors aren’t willing to take some of their retirement fund off the U.S. bond and Treasury sidelines and invest it in the stock market, they could be making a costly mistake.

One recent (and exhaustive) study analyzed the returns of Treasury bills, long-term government bonds, and stocks in 22 countries from 1900 to 2012, looking at the relationship between yields, valuation, interest rates, and real returns.

The study concluded that real returns over the next 20 to 30 years are going to be pretty dismal. They predict that investors who park their retirement fund in long-term government bonds can expect to realize an annual real return slightly above zero percent. Not great, but better than the negative -0.5% annual real return expected from Treasury bills. (Source: “Credit Suisse Global Investment Returns Yearbook 2013,” Investment Europe February 6, 2013, last accessed March 7, 2013.)

The study’s authors contend that today’s low-interest climate will last longer than many expect. With long-term bond yields barely keeping in step with inflation, any increase in rates will translate into capital losses for bondholders.

Those investors who ran to safe assets, like bonds and Treasuries, after the markets crashed in 2008–2009 may be wondering if their portfolio has enough steam to help them reach their long-term financial/retirement goals.

If not, an increase in asset allocation to stocks may be in order. Investors looking for both capital gains and cash flow might want to consider real estate investment trusts (REITs). Many institutional investors (pension funds, etc.) include real estate in their portfolios.

In view of real estate stocks’ record of providing dividends and diversification, investors should consider adding REITs to their retirement plan.

REITs operate commercial properties in every major metropolitan area, so it’s a good idea to decide which kind of REIT is best suited to your investing needs. Health care and shopping center REITs have been the two top-performing sectors.

In the health care field, investors can look at LTC Properties Inc. (NYSE/LTC), which operates health care and long-term care facilities and provides an annual dividend of around 4.8%. Health Care REIT, Inc. (NYSE/HCN) invests in senior living and health care facilities in the U.S. and Canada and provides an annual dividend of 4.7%.

On the commercial front, NorthStar Realty Finance (NYSE/NRF) provides an annual dividend yield of roughly eight percent. Inland Real Estate Corp. (NYSE/IRC) develops shopping centers and retail properties in the U.S. Midwest and provides an annual dividend of 5.8%.

Bonds and Treasuries offer little financial solace to investors looking to fortify their retirement funds. Diversification is key when it comes to retirement investing, and looking into health care and commercial REITs might be a good place to start for investors looking for a steady income and capital growth.

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