Douglas Goldstein's  Instablog

Many people believe that bonds are safer investments than stocks. They think bonds can be counted on to provide set semi-annual interest payments and, upon maturity, return full face value. While this is generally correct, there is more to consider before buying bonds.

Keeping Up With Inflation

Even with today’s relatively low inflation rate, the purchasing power of your principal in a fixed-income investment can be lowered depending on the rate of tomorrow’s inflation.  For instance, if you have NIS 1000 and want to buy a new television set today, you might have enough funds. But, if the inflation rate is 3%, then next year the same set would cost NIS 30 more. If, today, you invest the NIS 1000 and earn 3% on your money for the year, you will have no problem buying the set next year. But if current one-year rates are less than 3% then you might not have enough to make the purchase next year.                                                                               

 Taxes Will Lower Your Purchasing Power Even More

Interest received on many bond payments is normally taxable, thus reducing the buying power of each payment.  You may still outpace inflation, however, even with the taxes, if your bonds yield returns that are well above the inflation rate.

Consider the fact that many people own fixed-income investments and have accompanying reinvestment programs. They choose these programs because they don’t need the current income and think that by reinvesting their income they will be able to keep up with inflation.  It is important for these re-investors to remember that regardless of being reinvested or not, paying taxes on earnings lessens your real return.

Ways to Fight Inflation

Since inflation can take a heavy toll on your principal and interest, be sure to consider inflation-fighting techniques for your portfolio. One way to do is by having a mix of equities which will hopefully grow along with - or often outpace - inflation, added to a group of floating rate income investments. And remember, especially if you are counting on regular payments, that dividend checks from stocks, as well as interest checks from bonds, add to your total yearly income. In any event, though, be aware that there are risks involved in equity (stock) investing, and you should be sure to discuss it with your financial advisor before you get started.

Don’t make decisions based solely on obtaining the highest nominal yield.  Instead, consider whether an investment will retain a relatively stable value and provide fairly predictable earnings.

Douglas Goldstein, CFP®, is the director of Profile Investment Services. He is a licensed financial professional both in the U.S. and Israel. He offers securities through Portfolio Resources Group, Inc., Member FINRA, SIPC, MSRB, NFA, SIFMA. Accounts carried by National Financial Services LLC. Member NYSE/SIPC, a Fidelity Investments company. His book Building Wealth in Israel is available in bookstores, on the web, or can be ordered at: profile-financial.com (02) 624-2788 or (03) 524-0942.