Bogleheads

[Doug1]

After taxes, inflation and expenses, it can be difficult to not lose money in fixed income investing outside tax sheltered accounts. A conservative rule of thumb is that the percentage of one's portfolio in fixed income should be equal to one's age. For someone retiring at 55 who has to plan for a 30+year retirement, this means that 55% of one's portfolio should be in fixed income and this should increase with time. If one is withdrawing 4% yearly from one's portfolio, a high allocation to fixed income may cause problems.

What can one do about this? Tax exempt bonds are one solution. Another possibility might be stocks of regulated companies, such as utilities. A legitimate response is that they aren't fixed income.

That response gets to the question of why one invests in fixed income. Reasons include income and liquidity. For me, I invest in fixed income to diversify equity risk. Dividend paying stocks of regulated companies are an imperfect diversifier of equity risk. Neverthless, they do provide some diversification.

I found the following relevant links about bonds versus utility stocks:

http://www.deseretnews.com/article/119462/
http://safemoneymarket.com/a28....-bonds.cfm
http://www.highbeam.com/doc/1P2-1132739.html (I can't get the complete version of this)
http://search.barnesandnoble.c....1580622882 (a title of one chapter of this book is "Why utility stocks may be a better choice than corporate bonds for many conservative investors

I don't have any data comparing the return and volatility of stocks of regulated companies to corporate bonds or stocks in general.

Comments, including criticisms, are appreciated.

[dbr]

A starting point is that it is a fact of life that a person without access to tax advantaged accounts has to pay more in taxes than a similar person with access to tax advantaged accounts. Life isn't fair.

[jsl11]

At one time, I had a small lump sum to invest and I thought that regulated utilities would be a good safe investment. I purchased two individual stocks, one of which was Allegheny Energy. As I recall, my cost was about $19. I held the stock for a long time. In the early years, it performed as expected, with good dividends and a stable, but rising price. Then, during the tech bubble, it went as high as $50. I thought this was great. Then Enron happened and the stock fell to $3. I held on, and eventually sold it for $13. My take on all of this is if you want to use utilities as a substitute for bonds, use a mutual fund rather that individual stocks. Another conclusion is that utility stocks may have more volatility than you might expect.

Jeff

[AzRunner]

Treating utility stocks as a fixed income substitute is a mistake IMO. They may have lower Beta than other stock, but they are still clearly equity.

If you have a 45/55 AA and a 4% withdrawal rate, you will likely be OK going forward, but of course no guarantees.

Tax free municipal bonds make sense only if your tax bracket warrants them. It is an easy calculation to see if the yield from tax free is better than taxable bonds. One thing, nominal Treasuries are free of state tax.

Norm

[sscritic]

Don't forget the experience of the California utilities during the energy crisis as Enron traders ripped off the state.

PG&E filed for bankruptcy protection on April 6, 2001. The share price dropped from $30 in Sept 2000 to $7 and they didn't pay a dividend from Sept 2000 until March 2005.

[chuck-lyn]

Would tax free munis provide any hedge against a run on the dollar?

Foreign investment in US munis should be low if even legal. Hence
to a first approximation, it seems to me that munis should hold up
better than US treasuries if China, et. al quit buying.

Would one of you bond experts please comment?

Cheers,

charlie

[retcaveman]

I Bonds. State tax free, with inflation protection, no risk of loss of principal and no fees to purchase. (Note annual limits apply.)