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Why A Young Investor Should Avoid Bonds For Now

When I turned 13, and had my Bar Mitzvah, I spoke to my father about investing the money I had just gotten as gifts.  Luckily for me that was November of 2009 so I have been lucky to have a pretty good ride. My father sat me down, and had me read about John “Jack “Bogle from Vanguard. I followed his advice. I put 87% in SPY and 13% in AGG. I was going to follow the index. Each year I rebalanced. I took dividends and earnings from summer jobs to add small amounts of Apple, Google, Amazon, and Facebook, but always kept the balance of bond percentage based on my age. After the election last year, with my dad’s approval, I moved 20% of my SPY into XLF (financial deregulation) EFA, and EEM. My logic was to have money more diversified and Europe and Emerging markets have trailed the U.S. for a decade.

Now that I am 21, I have to argue why I should have 21% of my assets exposed to bonds. AGG (Ishares Core U.S. Aggregate Bond ETF) yields 2.49%. The Fed seems set on raising interest rates and over the next 15 years I would imagine they should be higher than they are today. So why put my money in an investment that seems likely to go the other way. I did my homework so that I could go to my dad with good reasons why I wanted to use individual stocks to replace my bonds. I made my presentation and he said yes. I was shocked but excited enough that I want to share my logic with other young investors.

My first idea was to look at great American companies that have raised their dividends since before my 50 year old father was born, and that I know what they do just by hearing their name. My first name was PG (Procter & Gamble).  Yielding 3.15% I know that I will get a higher payout every year and their products are part of my daily life from razor blades and toothpaste to my laundry. I allocated 20% of my bond money to PG.

Verizon (VZ) Yielding 5.27% it has never cut the dividend since being spun off as a separate company and has raised dividend for more than 10 consecutive years. One thing I know is that every friend I have whose parents don’t pay their wireless bill pays this bill first. CEO has said they generate more than enough free cash flow to maintain their dividend and continue to raise it. Also, they will be in the Dogs of the Dow strategy and will be bought by those funds in January. 20% to Verizon as well, and I feel the rollout of 5G and dependency on wireless devices will only enhance their value.

Johnson & Johnson (JNJ) has anybody not used Band-Aids for as long as they can remember. Dividend has been raised for more than 50 years. I find P/E a little high and yield of 2.45% similar to AAG, but am sure company will continue to be a staple to global consumers. With being nervous about valuation I am also using PFE (Pfizer Inc.) yielding 3.62 and one of 5 companies with a AAA balance sheet. In my eyes that balance sheet and dividend make it just as safe as a bond ETF. 10% into each of those names.

Consolidated Edison (ED) Yielding 3.16%, I don’t view it as a cheap bargain but they too have raised their dividend for more than 50 years. More importantly as a New York City resident I am aware that they have a monopoly on electric to New York City. Until that changes I so no reason to invest in bond ETF over a company that has no competition and raises my payout ever year. 10% to ED

Exxon Mobil (XOM) 3.82% yield and raised dividend for more than 50 years. AAA balance sheet. Energy is a necessity that is not being replaced in our daily lives all that soon. XOM 10%.

The last 20% is where I had to really do my homework. I feel it is the 20% piece that will add alpha to my portfolio, and it certainly impressed my dad that I found these names, and my logic behind them. The above 80% is a conservative group of large to mega cap names. They pay a good dividend, and over the next 10-15 years should provide me superior total return to bonds. The next 20% I feel offers incredible income with a chance for growth. Mortgage Reits. I identified two names that I feel offer me a good risk reward, although I will set a stop should the scenario change. I will add 10% of bond money to each name. My favorite is Apollo Commercial Real Estate Finance, symbol ARI. Current yield is 10.05% while trading at only 10x next year’s estimates. As an arm of Apollo Global Management (APO), I know that the people working there are very smart and qualified. The 52 week and 3year range are relatively narrow meaning I should have limited volatility to go along with an above average yield back into my portfolio. The other mortgage reit is Blackstone Mortgage Trust INC. (BXMT). Similar to Apollo it is an arm of Blackstone, another company built upon the best and brightest minds on wall st.  It does have a lower yield at 7.7% but a comment from their last earnings call has me convinced these two names will be much better than bonds for me. Stephen D Plavin, CEO, said”92% of the portfolio is floating rate. A 1.0% increase in LIBOR would increase annual net interest income by $0.26 per share” That equates to a 10.48% increase in their dividend.  I see this as a perfect bond substitute for a young investor who can absorb some risk. I still feel there is more risk to being long bonds at 21 years old although that is a different argument.

I understand my eggs are now in the all equity basket but I feel the total return over the next decade favors dividend yield over bond interest. Of course I can be wrong, but I have time on my side and am willing to take the risk.

Jacob Handel

SUNY Oswego

Disclosure: I am/we are long GOOG, AAPL, AMZN, SPY, VZ, ARI, BXMT, PG, JNJ, ED, XOM.