Oct 292018
 

Short Term VS Long Term Bond Funds

Earlier this year I put together a list of high quality bond funds for readers to check out. There was a lot of good feedback, but some people questioned why I didn’t include any short term bond funds in my list. More recently reader Carla also asked about my indifference to them.

Well, to be Frank, I would have to change my name. 😎 But rather than doing that I will answer Carla’s question. 🙂

Retirement portfolios are usually associated with long term planning. Short term bonds tend to be less volatile and less sensitive to interest rate movements. But since I don’t plan to sell any time soon, short term volatility doesn’t really affect my bottom line. On the other hand, long term bonds pay a higher interest rate (or coupon) which more than compensates for the higher volatility in the long run. For evidence of this, let’s compare 2 bond funds with different durations.

Comparing Returns of ZCS and ZLC

For consistency purposes we’ll isolate the duration variable and look at the following 2 funds.

  • BMO Short Bond ETF (ZCS)
  • BMO Long Bond ETF (ZLC)

Both funds are from the same company, and hold corporate bonds. The only key difference is the duration of bonds they hold. Below shows the annual total return of these funds from Morningstar, highlighted in yellow.

bond fund comparison between short and long

As we can see, over the last 5 years the short term bond index fund (ZCS) returned only 2.21% per year. The latest inflation rate number from Statistics Canada is 2.2%. So holding a short term bond fund such as ZCS would have earned an annual real return of 0.01%. I think we can all do better than that. 🙂

Meanwhile the long term bond fund (ZLC) returned 6.21% per year on average. Even the 1 year return shows that long term bond fund ZLC came out ahead. Keep in mind this is during a rising interest rate environment, which should hurt long bond funds more. But short bond fund ZCS currently has a weighted average coupon of only 2.91%, while ZLC’s is at 5.29%. The longer investment time horizon we have, the bigger the difference in returns we should see between ZLC and ZCS. 🙂

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Jan 222018
 

Why Bonds Are So Important

A fundamental skill to successfully managing wealth is knowing how to diversify our assets. This means we must own both equity and fixed income, with the correct weighting and balance. There isn’t a single solution that fits everyone’s situation. But in general bonds help to protect our wealth against volatility when the stock market goes crazy, which it tends to do once in awhile.

Some kind of mix between safe assets such as bonds, and growth assets such as stocks, has proven to work very well in good economic times and bad. For example, a mix of 80% stocks and 20% bonds in a diversified portfolio would have returned about 8% on average over the past decade, which is not bad since that includes the stock market crash of the 2008 financial crisis.

Financial problems are often cited as the number one reason for divorce. But having some solid bond exposure can bring stability to a relationship. It’s clear that couples are more likely to stay together if they have strong bonds. 😎

The Best Bond Exchange Traded Funds

So what’s the best way to buy bonds? Personally I like to invest in bond ETFs, which hold individual bonds so I stay diversified within this asset class. The following funds are the best Canadian bond ETFs to buy for investors looking at a medium or long term time horizon. I’m no expert but these funds are the best in their categories that I can find. 🙂

  • BMO Aggregate Bond Index ETF (ZAG) 
    A broad index fund that holds both government and corporate bonds. Very diversified.
  • BMO Mid Corporate Bond ETF (ZCM)
    An index fund that holds only corporate bonds with maturities between 5 to 10 years.
  • iShares Canadian HYBrid Corporate Bond Index ETF (XHB)
    Holds lower quality corporate bonds (Mostly BBB rated) with a minimum maturity of 1 year.
  • Horizons Active Corporate Bond ETF (HAB)
    Actively managed corporate bond fund that seeks moderate capital growth and generate high income.
  • BMO Long Corporate Bond Index ETF (ZLC)
    An index fund that holds only corporate bonds with maturities over 10 years.

Here’s a table so you can easily compare all of them. 🙂

Comparing Bond ETFsZAGZCMXHBHABZLC
Price/unit on Jan 2018$15$16$20$11$18
Gov’t / Corporate %72 / 280 / 1000/ 1000 / 1000 / 100
Net Assets (billions)$3.4$1.4$0.5$0.6$0.4
MER (fees)0.14%0.34%0.51%0.60%0.34%
Weighted Avg duration7.5 years6.3 years5.9 years6.2 years13.3 years
Annual yield3.00%3.10%4.00%3.10%4.10%
Avg YTM2.50%3.30%4.00%3.20%3.90%
% Credit AAA410020
% Credit AA3213051
% Credit A173303861
% Credit BBB1054805138
% Credit BB or Lower002000
1 year total return1.5%1.2%3.3%2.6%5.9%
3 year avg return1.4%2.3%3.3%2.5%3.4%
5 year avg return2.7%3.6%3.9%3.2%5.1%
Additional informationMorningstar: 4

Federal 37%
Provincial 35%
Corporate 28%
.
.

Avg coupon: 3.2

$6,300 to DRIP

Morningstar: 5

Energy 31%
Financial 26%
Real estate 12%
Commun 12%
Other 19%

Avg coupon: 3.5

$6,300 to DRIP

Morningstar: 3

Energy 30%
Commun 23%
Industrial 17%
Financial 13%
Other 17%

Avg coupon: 4.7

$6,200 to DRIP

Morningstar: 5

Financial 43%
Energy 18%
Infrast 16%
Commun 10%
Other 13%

Avg coupon: 4.0

$4,200 to DRIP

Morningstar: 5

Infrast 43%
Energy 33%
Commun 10%
Financial 7%
Other 7%

Avg coupon: 5.4

$5,600 to DRIP

 

  • The Average duration refers to how sensitive the ETF is to changing interest rates. Longer duration bonds offer higher yields, but are also more sensitive to interest rate movements.
  • The weighted average yield to maturity (YTM) includes the interest payments and any capital gain or loss that the investor will realize by holding the bonds to maturity.
  • The Credit rating is how risky a bond is. The lower the rating, the more likely the company is to default on its debt obligations.

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Dec 262017
 

Year In Review

It’s been a year since I began investing in the peer to peer lending platform Lending Loop. I was anticipating a return of 8% when I first wrote about it. However things turned out better than I expected. I started the year with $20,000 and have earned just over $2,000 in interest now. So my year to date return is currently about 10%. I’m really happy with that! 🙂 Here’s a recent snapshot of my account.

Here’s what my account looked like back in June.

I currently hold about 40 different loans. I usually commit about $500 to $1,000 per new loan. Each company has a different credit rating based on its likelihood to pay back debt. The table below shows how Lending Loop categorizes the risk bands.

I generally invest in the range between B and C rated loans. The interest rate I receive on the investment should be high, but I don’t want super risky loans with high rates of default. I do my research on a company before I invest so I do not automatically put money into every C+ loan that Lending Loop offers. I don’t have any A or A+ rated loans because the rates of return on those after fees are too low for me.

The reason I was expecting only 8% annual return is because I had factored in loan defaults that would cut into my gross interest earnings. However, across my ~40 different loans not a single one has defaulted yet. 😀 Phew. Thank goodness for that. *Knocks on wood* But I’ve only been on this platform for 12 months. Most loans in my portfolio have a lifespan of 24 to 36 months. So as time goes on I should probably expect to see some defaults, but hopefully not a lot.

 

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Aug 172017
 

Holding some cash for emergencies or opportunities is a sound idea. But having too much cash sitting around instead of putting the money into investments can be financially unwise.

Like most things in life, there is a cost component to cash – which is that cash usually produces lower returns than other asset classes such as stocks or bonds. One advantage of holding cash is to deflect volatility in a portfolio. But with a longer time horizon investors can manage volatility by using fixed income vehicles instead of cash. Long term corporate bonds from large, stable companies such as Enbridge pay 3.5% or higher annual returns, easily beating the interest earned in a savings account. 🙂

According to investment management company, BlackRock, people who have allocated their money towards cash or cash equivalent assets actually lost purchasing power in the past. The value of their savings slowly whittled away at 0.8% per year on average between 1926 and 2014. This gives a whole new meaning to cash poor.

Holding cash for one or two years isn’t a big deal because the loss is very small. But over time it can build up to significant loss of buying power. The longer the investment time horizon, the less cash investors should consider holding. For a multi-decade horizon and high return objectives, which is the strategy I’m personally using, having excess cash savings would be a liability because it produces negative real returns. Sometimes the risk is not being aggressive enough with our investment plan and losing out on easy gains.

According to a survey by State Street’s Center for Applied Research, globally retail investors are holding 40% of their assets in cash. Uh oh. If someone has 60% of their portfolio in bonds, and the rest in cash then they could be making zero progress with their portfolio after inflation and tax.

If I’m sure I won’t touch my money until I retire, then I should take advantage of my long time horizon. This is why I don’t keep more than 1% of my net worth in cash, unless I’ve earmarked savings for a large, specific purchase. 🙂

 

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Random Useless Fact

Jul 132017
 

Lending Loop Update

Earlier this year I blogged about investing $20,000 in a peer-to-peer lending platform called Lending Loop. My goal was to make 8% return overall, net of fees and write-offs. To be frank I was a little apprehensive at first when I learned about the high interest rates.

I wondered if it was really possible to earn 15% or higher rates of return consistently. Being greedy, I decided to give Lending Loop a try. I primarily invested in B and C loans because they are relatively safer, although the returns are lower than loans in higher risk categories.

Here’s what my Lending Loop portfolio looks like after half a year of investing. This screenshot was taken at the end of June.

As we can see I have made about $846 so far. Yay! 🙂 That’s about 4.2% return, or 8.5% annualized return. This is very much in line with my expected 8% return I had initially set as my goal. I have invested in roughly 30 different loans so far on the platform, each loan averaging $700 of principal. Thankfully none of them have missed a payment yet so I’m really pleased about that. 😀

If this trend continues I should be able to earn a double digit return by the end of the year! But this rosy picture assumes there are no defaults on my loans for the next 6 months. 🙂 Anyway, I will update again at the end of the year so we shall see what happens.

Unlike investments in a tax advantaged account, my Lending Loop returns will be taxed at my marginal tax rate, which is about 30%. This means if I earn 8.5% from the P2P investment, I will only end up making roughly 6% return after tax. To me 6% after tax is pretty good and certainly beats many alternative options out there. 🙂 As interest rates are starting to climb slowly in North America, fixed income investments such as Lending Loop should continue to be attractive for investors looking for yield.

 

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Random Useless Fact:

Due to the lower surface gravity of Mars, if you weigh 100 pounds on Earth, you would weigh only 38 pounds on Mars.