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  • Writer's pictureIshfaaq Peerally

Are BOND ETFs Good Investments? Invest in TLT ETF?

Since stocks are in a bubble with the Fed buying bonds, does it make sense to do what the Fed is doing and buy bonds? It may seem like a bad idea since the yield on those bonds are low but what about if you're looking for capital gain. The TLT ETF $TLT this year beat the S&P 500 $SPX500 .

The Fed is currently buying the bonds issued by the US Treasury by Quantitative Easing (QE). This is how the Fed prints money. But apart from the Fed, the banks, insurance companies and other financial institutions have to hold bonds too since owning stocks is too risky. These banks buys bonds mainly for the interest payment, the yield. But now with all the treasury yield below inflation rate, it doesn't make much sense owning these bonds. What about owning them for capital gain?

For example, the TLT ETF gained 70% over the past 10 years (80% with dividends). It is not as good as the S&P 500 but it is more stable if stocks are in a bubble that could be a good alternative. To understand if an ETF is a good investment or not, we need to look at the underlying assets. I have looked at the bonds inside the TLT ETF (more details in video).

If you look at most of the bonds inside the TLT ETF, you will see that most of the gains in prices of these bonds have already bond. This applies to bonds that will mature soon as well as bonds which will mature in 30 years. The coupon rates on most of the new bonds being issued are also very low and it is not worth the investment because of inflation.

Most of the capital gains of these bonds already occured in the last two years, which have been very volatile for stocks. We have a market correction in 2018 and a bear market in 2020. With stocks, there's no limit to how high they can go. Stocks such as Netflix or Amazon are valued at more than 100 times earnings. But with bonds, there is a limit since bonds have a fixed income. At some point, bond investors will choose not to buy bonds and buy stocks instead. That's exactly what's happening. They could also buying corporate bonds and then junk bonds but with higher risks.

You could look at corporate bonds for higher returns, for example, the LQD ETF $LQD which contains bonds from companies such as JPMorgan Chase and Apple $AAPL . For higher yields, one could look at a junk bond ETF but the quality of the bond and the companies that issued them are of course, worse.

If we're going to have higher inflation, then holding bonds is not a good idea at all then, why do I hold bond ETFs? This is a better alternative to cash. Since stocks are expensive. Bonds are a good alternative but not the best. The best is still arbitrage. The only reason why I hold these bonds is because arbitrage deals are rare this year but once I find enough good arbitrage deals, it won't make much sense to have so much bonds in my portfolio.

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