Investment Decision: Weighing the Options Between Corporate Bonds and Stocks
In the past few decades, a significant shift has occurred in the way individuals approach retirement planning, largely due to the transition from defined benefit (DB) pensions to defined contribution (DC) plans such as 401(k)s and IRAs.
In a defined benefit pension, the retirement benefit is predetermined and guaranteed by the employer, leaving employees with less direct involvement in investment management and market fluctuations. However, with DC plans, individuals are responsible for funding their retirement and managing their investments, including decisions about asset allocation and bearing market risk.
This shift has led to a greater focus on investment performance, particularly market price movements, as individual retirement outcomes depend on the growth or decline of their investments. Navigating complex trade-offs involving market volatility, longevity risk, economic factors, and investment costs has become essential for achieving adequate returns.
One common objection to income investing, a strategy gaining popularity, is the perceived risk of credit. However, credit investing, which involves collecting interest payments and returning principal at maturity, is considered more predictable than equity investing. In fact, it is possible to earn an "equity return" of 9-10% per annum through income investing in corporate credit, without relying on capital gains.
Some solid, well-managed high-yielding funds with recent high returns include Barings Global Short Duration High Yield, Ares Dynamic Credit Allocation, FS Credit Opportunities, Saba Capital & Income, PIMCO Access Income, PGIM Global High Yield, and PaxS.
Interestingly, the typical equity investor already holds the stock of many companies that issue high-yield credit. These loans and bonds are higher up the corporate balance sheet than equity, meaning they must be paid first. High-yield credit, often referred to as "junk," is issued by mid-cap and small-cap companies.
Annual corporate default percentages are typically in the low single digits, rising to 5-6% in a recession and 10-12% in a severe recession. Despite this, the losses resulting from a 6% default rate are only about 3%, while even in a severe recession with a 10-12% default rate, the losses would only be half that, or 5-6%.
This shift towards income investing has encouraged investors to become more engaged with the specifics of investment products. For example, they now scrutinize expense ratios and historical performance rather than relying on a guaranteed pension payment. The example of comparing costly actively managed funds to low-cost index funds underscores how investors now must evaluate the cost versus expected benefit of their investment choices.
Many investors who have switched to income investing report better sleep, less fixation on short-term price movements, and a sense of creating their own growth. Income- both current and future- is the main driver of a security's value, making income investing a lower risk, less exciting, but potentially more rewarding way to earn steady cash flows through reinvesting and compounding.
This change in investment strategy has been a response to the evolving landscape of retirement planning, with individuals taking a more active role in managing their investments to secure a comfortable retirement. As more and more people transition from traditional investment strategies to income investing, it is clear that this shift is here to stay.
- As individuals take on more responsibility for funding and managing their retirement investments, they are turning to income investing as a strategy for achieving more predictable returns.
- In the realm of personal finance, investing in well-managed high-yielding funds, such as Barings Global Short Duration High Yield and Ares Dynamic Credit Allocation, can offer an "equity return" of 9-10% per annum, without relying on capital gains.
- In response to the transition from traditional retirement plans to defined contribution plans, investors are increasingly focusing on the specifics of their investment products, considering factors like expense ratios and historical performance to secure a comfortable retirement.
