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Short on Patience; Long On Bonds

The failure of the bipartisan supercommittee to reach an agreement on ways to reduce the nation’s super debt probably came as a surprise to few. Regardless of the outcome, we already knew that the US may need to come under prohibitive austerity measures for the foreseeable future.

In Germany, the one country in the Eurozone that exhibited strength and outperformance while the rest of the region floundered, announced back in June of 2010 its four-year plan of cutbacks. Those plans included “trimming welfare allowances for jobless parents, eliminating 10,000 civil service jobs over four years, and reducing the military, among other measures.” Not surprisingly, many opposed the reductions at the time, calling them unjust and shortsighted.

However, in the first half of 2011, Germany proved to be one of the best performing markets in the world, and the country’s unemployment fell to a 20-year low. Perhaps, despite the tough times ahead of us, austerity could mean good news for investors.

CLICK HERE to read the June 7, 2010 article at Time.com entitled, Will German Austerity Help or Hurt the Global Recovery?

Given that the upcoming decade will likely be characterized by deleveraging* and slow growth, many investment analysts are indicating that corporate bonds could provide a better risk/return ratio than equities. In fact, fixed-income securities posted strong relative returns over the past decade, with Treasury bonds gaining 6.25% and corporate bonds gaining 6.96% annually from December 31, 1999 to December 31, 2010 (as measured by the Barclays Capital Aggregate Treasury Index and the Barclays Capital Aggregate Investment Grade Corporate Bond Index, respectively).

Another advantage for bonds is their low correlation with stocks. High-quality bonds – such as investment-grade corporates and Treasuries – can help diversify your portfolio with the potential for gains when stocks take a dive. You can further diversify your bond allocation at the “sub-asset-class” level with a mix of holdings that includes corporate, government, municipal, foreign, and high-yield securities.

Bonds also offer the concept of “tax alpha” – the difference between the return of an investment portfolio that pays capital gains taxes versus one that does not. An apt comparison is that of the amount of your year-end bonus: Your boss tells you you’ve earned one amount, but the check you receive (after taxes have been withheld) is a much different story.

Hence the appeal of municipal bonds, wherein yields are shielded from federal and state/local taxes of the issuer. One way to improve the tax efficiency of non-muni bonds is by holding them in a tax-sheltered account, such as a 401(k), or variable annuity.

The earnings rates for Series I Savings Bonds and Series EE Savings Bonds issued from November 2011 through April 2012 were recently published. The rate for I bonds bought from November 2011 through April 2012 is 3.06%, and Series EE bonds issued from November 2011 through April 2012 will earn 0.60%.

CLICK HERE to read Fidelity Investment’s viewpoint on Bonds for growth investors, November 23, 211.

CLICK HERE to read the savings bond announcement, Public Debt Announces New Savings Bonds Rates at TreasuryDirect.gov, November 1, 2011.

It’s important to understand how each type of bond is impacted by various economic scenarios, so fee free to contact me if you’d like to discuss enhancing your bond allocation for the coming year.

*To increase financial stability by paying off debt

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