With long-term interest rates at a high level, is now the time to buy long-term bonds? Here are two significant strategies to help you make money with bonds.
Buying bonds as an in-and-out investment vehicle offers high current yield and a potential long-term capital gain when you buy and sell them in tune with the interest-rate cycle. During these days of high long-term interest rates, bond prices are down sharply with some triple-A issues selling for less than $ 500 each -- a 50 percent or more discount. Bonds sell at a price that will return a competitive yield to investors because the coupon rate is fixed.
Until recently, the interest rate cycle could be predicted with some reasonable accuracy relative to presidential elections. Long-term interest rates were generally low during the fall or presidential election years with a high about two years later.
But our nation's financial tangles have become so complex that the former four-year cycle no longer holds. Nonetheless, we may expect lower long-term interest rates sometime within the next 1 1/2 to 2 years. If rates decline, then bond prices will likely rise. In the meantime, bonds and income stocks are yielding current income in the range of 12 to 15 percent. Buying these interest-sensitive investments is one way of locking in high yields for as long as you hold them or until they mature.
Another strategy calls for purchasing bonds now to provide cash at some specific future date. For example, suppose you needed $6,000 in September 1984 to send a boy or girl to college. You could buy six discounted bonds for, say, each child without running afoul of the gift tax. Coupon interest would be in the range of 5 or 6 percent. But, paying interest to a minor with little other income is the equivalent of 8 to 14 percent taxable interest.
You can repeat the process to buy bonds that mature each year when you need the cash for college expenses. The difference between the $700 purchase price and the $1,000 value at maturity will represent a capital gain -- taxed at far lower rates.
Two cautions: Recognize that most bonds include a call provision. This option permits the issuing corporation or agency to recall the bond at a specified price -- usually face value plus one year's interest. When bonds are selling at a discount, the issuer is unlikely to call the bonds. The issuer would, instead, likely buy the bonds in the open market at a discount. Some call provisions require bonds to be retired through a sinking fund, and these may be selected on a random basis.
Pick bonds of an issuer that will be around at maturity to pay them off. Highly rated corporations such as AT&T offer little risk, but US Treasuries are considered even less risky. More risk is currently associated with municipals, the tax-free bonds issued by cities, states, a nd local taxing districts.