Bond Alternatives

The 10 year US Treasury bond currently yields just below 2%. This compares to an inflation rate that is currently running at just above 3%. If current interest rates and inflation do not materially change, investors will earn a negative real rate of return on their bonds. If interest rates rise, bond investors will experience capital losses on their bond investments. Long term oriented government bonds are unlikely to provide positive real returns with a risk of capital losses if interest rates rise.

So where does one go for a relatively safe, income oriented investment? Corporate bonds are one alternative to government bonds as they typically pay higher interest rates. These higher interest rates are paid to compensate one for the increased risk of default. If one is buying highly rated corporate bonds, the additional interest is usually more than sufficient to compensate for the slightly elevated risk. When implementing this strategy, attention has to paid to the credit risk of the bond portfolio. Buying poorly rated bonds to reach for higher interest rates increases the risk of a credit default in your portfolio.

Another strategy would be to invest in a portfolio of blue chip, dividend paying stocks instead of a portfolio of government bonds. A number of companies have dividend yields that are in excess of 2%. Balanced against the greater volatility of stocks is the potential for dividend increases combined with a more favourable tax treatment. A number of blue chip investment grade companies also have dividend yields that are higher than their own 10 year bond yields. A few examples include TransCanada, Microsoft and Abbott Laboratories.