How I Invest Our IRAs
Happy Monday! Summer’s over, so I’m back to a three-post-per-week schedule. Maybe. 🙂
If you’re a regular Money Counselor visitor or have explored the Investing category of this blog, you know I’m wary of stocks. I think stock investing is far riskier than most small investors believe, mainly because most small investors have been duped by clever Wall Street marketing. After two crashes of nearly half in 13 years, I got tired of being beat over the head. Actually I began easing our investments out of stocks between the two crashes, but the latest stock debacle in 2008-09 and my evolving assessment of how Wall Street operates pretty much sealed the deal for me: I’m out, mostly, for good.
If Not Stocks, What??
I don’t necessarily advocate the investing strategy I’ve chosen for you because everyone’s circumstances and aims are different. (You might give my ideas a little thought, however. Otherwise I’m wasting my time here! :-)) But invariably when I write about avoiding stocks, someone always asks, “if not stocks, what??” Though indicative mainly of how effective Wall Street’s marketing has been, it’s a fair question, and I’ve written a few posts with ideas (see for example Invest in You!, Slow Money, Self-Directed IRA, and Income From Your Home.) But I’ve never written about what I do—with Ms. Money Counselor’s blessing, of course!—with the money in our IRAs.
How I Invest Our IRAs
First, we do still have about 5% of our IRA money in stocks, specifically the Vanguard International Growth Fund. With any luck, I’ll sell that before Wall Street once again collapses under the weight of its own built-up greed and graft. If not, losing half (again) of 5% won’t delay our retirement.
Beginning in January 2008 I began investing our IRA money in moderate and high yield bonds. The total portion of our IRAs in these bonds varies month to month, but it’s probably been as high as 50% of all the money we have in our IRA accounts. I know what you’re thinking: “This idiot thinks junk bonds are less risky than stocks?!?” Whoa, let’s hold off on the name-calling for a bit, and hear me out.
Here’s what I buy:
→ $20,000-$25,000 batches of individual corporate bonds
→ that mature in fewer than 12 months (this was originally 6 months, but the economy has improved),
→ offering a yield-to-maturity of at least 1% (most are significantly more), and that
→ pass my screen with respect to likelihood of default.
I always hold each bond until maturity, so I don’t care whether the bond’s current market value rises or falls. I keep the time to maturity fairly short—originally 6 months, but now 12 as the Great Recession has eased—to minimize the likelihood that something goes horribly wrong with the economy or the bond issuer before my bond is redeemed. When a bond matures, I get the $1,000 face value and a final interest payment. Most corporate bonds pay interest semi-annually, so if the bond’s maturity date is more than 6 months from the date I buy the bond, I’ll get an interest payment before maturity as well. (Of course the accumulated interest is reflected in the bond’s price when I buy.)
1%? That Sucks!
I use a minimum yield-to-maturity screen of 1%, but most bonds I buy yield significantly more. In the current interest rate environment, that means I’m buying some junk bonds, no bonds with high credit ratings, and mostly bonds just above the traditional junk rating of Baa for Moody’s. I’ve tracked the average interest rate I’ve earned making these investments since January 2008: it’s about 2.6% annualized. I’m satisfied with that considering the tax is deferred, we’ve been in a very low interest rate environment, and I consider alternatives like stocks too risky.
Now before you lecture me about keeping up with inflation, etc., let’s remember:
- Cumulative U.S. inflation for 2008-2013 is 8.6%. My average annual return of 2.6% compounded annually over 5 years works out to 13.7%. (Of course I live in Canada, but let’s not split hairs, eh?) If inflation rises, long-term interest rates will rise as well, and I’ll earn more.
- In January 2008 the S&P 500 index was about 1550. The index closed last Friday at 1692, up 9.2% over 5 years and after bottoming at 683 in early 2009. Maybe you don’t mind such hair-raising rides on the way to a modest, and easily undone, return; I do.
- The highest APR 5-year CDs today pay about 2%. Now that’s a good point! If I’d known short-term interest rates would stay near zero for 5+ years, I may have bought a 5-year CD back in 2008 (assuming I could have gotten 2%) instead of chasing these bonds. My ability to predict the future is not so hot.
How I Buy Bonds for Our IRAs
Before we were evicted, I could buy individual corporate bonds through our E*Trade IRA accounts. Our IRA account transfer to Charles Schwab is just about complete, and I’ve been able to explore Schwab’s investor website. I’ll be able to buy individual corporate bonds in our new Schwab IRAs, but for some reason the Schwab bond search screen allows Moody’s credit ratings only as low as Baa3 while E*Trade let me search for bonds with a Moody’s credit rating as low as C. In other words, it doesn’t look like I can buy junk bonds through Schwab. I suspect Schwab’s liability attorneys are behind this restriction, but I’ll have to inquire if there’s a way around it. If not, I don’t think it’ll be a big deal because I’ve bought few bonds rated lower than Baa3 anyway.
At the moment my junk bond portfolio is smaller than usual because I didn’t want any transactions pending while the account transfer from E*Trade to Schwab is going on. Here’s what I own today (screenshot from the spreadsheet where I track this enterprise):
These all have a fairly low yield-to-maturity (YTM); I’ve done better, but it takes time to do the research.
My first bond purchase occurred on January 10, 2008. Since then I’ve held a total of 101 different bonds for varying periods of time averaging 135 days. I hesitate to report this for fear of activating a jinx, but I’ve so far suffered no defaults. We came close during the meltdown when GMAC teetered on the brink but was saved by a bailout. Since witnessing how rapidly even staid financial companies like Lehman Brothers can collapse, I never buy bonds issued by financial entities, period.
What Do You Think?
So that’s it. Am I crazy? Is this a highly risky strategy with a return that does not justify the risk? Will a default inevitably zap me? And will I then never hear the end of it from Ms. Money Counselor?