Stay away from high-yield junk bonds
May 4, 2012 7:56PM
Updated: June 7, 2012 8:09AM
D ear Mr. Berko: I know from previous columns that you don’t approve of investments in those high-yielding mortgage stocks like American Capital Agency, CYS Investments, Hatteras Capital and others paying 15 percent to shareholders. My broker suggested that some friends and I buy a portfolio of high yield 10 percent or better junk bonds and use his firm’s margin account that will charge us 3 percent on the money we borrow. He showed my friends and me how to make 25 percent to 40 percent doing it this way. He believes this is safer than buying CYS or Hatteras because the return is higher and gives us a bigger cushion if interest rates rise. But he doesn’t think interest rates will rise for at least three years according to what the FED is saying. We all are retired (with modest means) and I’ve been asked to write you for your opinion. Our broker talks a little above our heads, so could you explain to us just how this would work? Also, please tell us what you think and please recommend other high yielding corporate bonds yielding 10 percent to 12 percent that we can buy in addition to those our broker likes.
Dear TG: This low-interest rate environment has encouraged rampant speculation among lots retired folks who, because they have no earned income, are going be hurt badly when the market moves against them, and it will when they least expect it to. This broker is a first-class sleaze ball, his slinky is kinked and he’s proof that evolution can go in reverse. And “no,” I will not recommend high-yield junk bonds for you guys because I won’t be a participant in your lemming-like potential financial suicide.
Here’s the rub. I don’t trust any brokerage to keep your interest rate at 3 percent. And because this is an election year and because the party in power will do everything within its power to remain in power, I don’t trust the Fed’s numbers on employment, inflation, industrial capacity, inventories, consumer confidence, housing, etc. And I don’t trust the Fed to keep interest rates low after the election. Again, for illustrative purposes, if the Fed raises rates rise by 1 percent, the market value of your bond will fall from $8,000 to $7,300, causing you to lose $700 in principal, reducing you equity from $2,400 to $1,700 and erasing all your interest profit plus some. Then, adding insult to stupidity, Sockit-Tume will demand that you add that $700 loss (in cash) back to your account plus another $500 or so, depending on its margin requirement. Only the big shots at Goldman Sachs, Morgan Stanley, UBS, JP Morgan, Citigroup and Merrill Lynch, who are kissing buddies with the Fed, know when interest rates will rise. I doubt they care to share this privileged information with folks like us.