Coping With Bond Calls
If you think the long-term trend in interest rates is up, you should buy callable bonds.
Receiving an official letter from a financial institution nowadays can be ominous. The one I got several weeks ago, though, was merely annoying. It was from the brokerage firm where I keep my IRA, and it said that “a bond in your portfolio is expected to be called on the event date indicated.” I knew immediately that I’d be taking a cut in my income and that I’d need to make still another investment decision. But I knew not to respond hastily and haphazardly. After all, the letter told me, I could choose from among 15,000 income alternatives, including other bonds, certificates of deposit, mutual funds and exchange-traded funds.
Foiled by Freddie. Here’s the back story: In 2008 I bought a FreddieNote, issued by the Federal Home Loan Mortgage Corp. and due to mature in 2012. (Because Freddie Mac became a ward of the government during the financial crisis, I didn’t have to worry about it defaulting on its debt.) The original 4% interest rate was slated to bump up to 4.25% on October 15, 2009, and eventually to 5% in the final year. Instead of giving me the first raise, though, Freddie Mac repaid my principal. The refund now sits in a money-market fund earning 0.01%.
Issuers call bonds when the timing suits them, not the investor. “I never see a lot of calls when there are attractive reinvestment options,” says Ben Muchler, of Boston Research and Management, who manages private accounts for income investors. Issuers typically call a bond -- that is, forcibly redeem it -- so that they can take advantage of a general decline in interest rates. Or maybe an issuer’s finances have improved and it wants to issue new bonds at lower rates. Sometimes, a company sells new stock and uses the proceeds to erase bond debt.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Cost of callability. Except for Treasuries, you can find callable debt all over the bond market. Federal agencies, state and local governments, and corporations all issue bonds with the right to redeem them at a predetermined date. For this privilege, they pay a slightly higher interest rate. A typical callable long-term bond pays at least a quarter of a percentage point more than a similar bond of like maturity. If you think the long-term trend in interest rates is up -- a good bet -- you should buy callable bonds, because you’ll get extra yield and because issuers are less likely to redeem bonds if they have to pay more to issue new debt.
Frustrated by an early redemption, you may react by looking for the highest-yielding, noncallable bond you can buy. A better approach is to think of the proceeds as just another pile of new money to in-vest. The best place to put it could be another bond, a bond fund, an ETF or a ladder of CDs (in any case, I’d keep maturities short in anticipation of higher rates that are likely to materialize later in 2010). If a bygone bond occupied a rung on a bond ladder, you will likely want to replace it with another of a similar maturity and quality.
Another income idea, says Muchler, is to invest in blue-chip stocks. For example, Verizon Communications (symbol VZ) and DuPont (DD) sport current yields of 6.3% and 4.9%, respectively. Although a company’s stock is riskier than its bonds (at least on any given day), the shares of these companies yield more than their bonds, plus they offer a shot at dividend growth and capital appreciation.
The essential message is to avoid overreacting by sacrificing quality and security in pursuit of the same yield. This is not the moment to respond to the demise of a double-A-rated bond by substituting a junk bond or emerging-markets debt. The time to buy the risky stuff was a year ago, when their yields were off the charts. Back then, though, few investors wanted to take risks and few companies were calling their bonds. Yes, calls are annoying. But to be annoyed is not the same as having your portfolio clobbered by something horrible. Like a default.
-
-
Cheap Ways to Cool Your Home in the Summer
Take these smart steps to lower your house's energy bill and cool your home.
By Daniel Bortz • Published
-
Letter from the Senior Digital Editor: Memorial Day Hits
Kiplinger senior digital editor Alexandra Svokos writes for Memorial Day.
By Alexandra Svokos • Published
-
Value Investing Is Back
Value investing beats growth in the long run, and the best way to participate in value is through funds.
By James K. Glassman • Published
-
Best Communication Services Stocks to Buy Now
Despite continued macro headwinds, pockets of opportunity remain among the best communication services stocks.
By Tom Taulli • Published
-
Stock Market Today: Tesla Keeps S&P 500, Nasdaq in the Red
Tesla suspended production at its Shanghai factory earlier than anticipated amid reports of spiking COVID cases among workers.
By Karee Venema • Published
-
Can Stocks Picked by Artificial Intelligence Beat the Market? 3 Stocks to Watch
stocks An artificial intelligence stock-picking platform identifying high-potential equities has been sharp in the past. Here are three of its top stocks to watch over the next few months.
By Dan Burrows • Last updated
-
Dogs of the Dow 2023: 5 Dividend Stocks to Watch
The 2023 lineup of Dogs seems to face thornier problems than in years past. Here are five names to watch for those who adhere to this decades-old income-and-value strategy.
By Louis Navellier • Published
-
3 Bond Funds to Build on a Summer Rally
bonds The market expects consistently lower inflation to arrive sooner rather than later. That's great news for these three bond funds.
By Jeffrey R. Kosnett • Published
-
Buffett Buys More Apple, Chevron, Occidental Petroleum, in Q2
stocks to buy Warren Buffett's Berkshire Hathaway topped off existing stakes in some favorite stocks, cut exposure to General Motors and Kroger, and exited its rump position in Verizon.
By Dan Burrows • Published
-
Income-Investing Picks for a Recession
Investing for Income Some consequences of an economic downturn work to the benefit of fixed-income investors. Here are three fund ideas that fit the bill.
By Jeffrey R. Kosnett • Published