A friend asked me over the weekend whether he should buy some long-term corporate bonds offered by Bank of America (NYSE: BAC), a step-up bond starting at 4.75% and rate gets reset every 5 years, while each reset may step up 1%. Since interest rate is so low now, he asked, is it worthwhile to buy these bonds.
Since I have not read the prospectus of the offering, I do not know any details of the deal. So I told my friend that if one intends to hold the security to maturity, does not need liquidity in between, and is satisfied with the 5-7% return during the holding period, it does not really matter (IF the bond does not default!). What he needs to check out though, is the underlying collaterals of the offering (is BOA on the hook, or some trusts it sets up offshore, or some underlying securities BOA holds, etc.), whether the security can be called away, and what he thinks his tax rate will be in the future (and how the government may change that) so he can compare it vs investments in US treasury bonds.
Given that twenty years ago I could not have forseen the two Iraq wars, 9/11, dot-com bubble, or the financial tsunami (where solid, AAA institutions were on the brink of collapse, and some did!), holding any long term fixed-income instrument is not really my cup of tea, especially when interest rate is so low right now, unless it’s just for a trade. If there’s no inflation and interest rates stay low for a long period of time (think Japan), any bond offering (provided that they do not default) with a decent yield could be a good deal. However, if inflation does come back, and comes back with a vengeance due to all the money printing, long-term bond is a sure losing ticket.
Preferred stocks, being a fixed income instrument, has many of the same issues as long term bonds. However, while most people think of preferred stock as a form of perpetual fixed income instrument, there are many varieties of preferred stocks, although they are not apparent to most individual investors. Some of the preferred stocks are convertible preferred, such as Ford Preferred S (NYSE: F-PS), and a list of convertible preferred stocks can be found at 10xreturn’s preferred stock center. Some of the preferred stocks are cumulative, some are non-cumulative, fixed-rate, variable-rate, etc. For some preferred stocks, their dividends are even taxed at a maximum of 15% rather than at ordinary income rates, as in the case of bond interest.
Investors should be aware that most preferred stocks are not perpetual at all. Case in point, JP Morgan’s Series G preferred (NYSE: JPM-PG), inherited from Bear-Sterns, was redeemed in August. All the people who counted on receiving the interests lose out, not to mention those who bought above the called value of $50/share at a premium, when it was called away at $50/share.
So if one were considering investing in long-term bonds, one should also look into preferred stocks, as long as the investor understands the risk in preferred stocks and long-term bonds. Our previous articles on preferred stocks provided a primer on preferred stocks, of which our readers can check out part 1 and part 2 on this site.
This content was originally published at benzinga.com