Observations on doing Lars's tax return (1 of maybe 4); why would anyone have bonds now?

pencil + paper.jpgLars is a professional tax preparer. Actually at this advanced stage of his career as a CPA, he is much more reviewer than preparer; the less senior accountants in his office do the return assembly. He has a couple of peculiarities in the way he does his own return. First, he extends it so he can go over it with some deliberation. Tax season is a crush every year.

And Lars does his return by hand, at least initially. This is so he can see how the income and tax ingredients really go together. After he's done that, he does indeed run it through their software and, since the results are always at least a little different, he learns something from that too.

One thing he notices this year is the tax calculation on dividends and capital gains. These have a maximum rate of 15%, about half that on ordinary income like earned income and interest. The policy reasons for this benefit, Lars recalls, are to soften the double taxation of dividends (taxed both at the corporate and the shareholder level, theoretically at least), and to encourage people to invest. Invest in equities, at least. Not bonds.


This brings him back to thoughts generated in his investment bet with rich Uncle Nils. Lars is not a licensed investment adviser, not even really an expert. But he has done a lot on his own, and seen a lot of what happens to him and his clients. He is developing a strongly negative feeling about bonds.

Lars seems to recall that historically stocks yield, by combination of income and growth, about twice of what bonds give. Say 8% vs. 4%, something like that. Over the last five years they've done about the same, in the 5% to 7% range. This is unusual. Bonds have actually had growth of principal because overall interest rates have gone down, way down. This decline in market rates raises the value of earlier bonds issued with higher yields.

Well this downward trend of interest yields can't go on much longer. How can it? Intermediate-term bonds are actually paying a little less than stocks now! How, Lars wonders, can the good times for bonds not be over, or almost over? Many experts say rates will stay low, but Lars, admittedly less trained and less knowledgeable, has trouble buying it.

And there's the tax thing. As Lars pencils out his own tax calculation, he is reminded that stock dividends, and stock gains, are taxed at only 15%, half the rate on interest income (other than from municipal bonds). This difference will continue in the coming year, although both rates will be higher. Lars is parking most of his bond money these days, in much shorter-term stuff. Doing his tax return, he feels a little big confirmed in that.