Is Buying Bonds Really a Good Idea? 20 comments
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The WSJ's Brett Arends has learned his lessons this year, and shares them with us, including these:
4. Invest more, not less. Is that a guffaw from the peanut gallery? I don't blame you. Your savings just fell 40% or more. But higher risk and lower returns means you need to invest more to reach your goals.
6. Your grandma was right after all. A penny saved really is a penny earned. Debt really is dangerous. And an economy where it's easier to borrow $10,000 on a credit card than find a working electrician is heading for trouble.
8. Own plenty of bonds. Yes, they're less exciting than stocks. Turns out, that's the point. There's little use keeping everything in stocks "for the long run" if they kill before you get there.
I do wish that he'd listened a bit more to his grandma. A penny saved is a penny saved; a penny invested is a penny risked. The best way to reach your goals is to save more, and to adjust your goals -- not to put ever more money at risk in a desperate get-there-or-bust move.
As for the bonds, this could turn out to be a really bad time to move into fixed income -- possibly the worst in living memory. Two things we know for sure: interest rates are incredibly low right now, and recovery values given default have also never been lower. A third thing we can be pretty sure about: the number of defaults is going to go up substantially before it starts coming down. Yes, spreads are quite wide, but only arbitrageurs care about spreads. Retail investors care about yields.
Put all that together, and you have a bond market where the downside is vastly greater than the upside. Yields can't fall much further than they have already, and default rates can certainly rise. So why buy bonds? Stay in cash, and you get a very similar yield for much less risk.
Historically, bonds have been the safer alternative to stocks. I'm not sure that's still the case. Stocks are certainly more volatile than bonds, but at least they have unlimited upside, and a couple of spectacular stock picks can make up for a lot of duds. In the bond market, however, a few big defaults can ruin an entire portfolio. So I'd treat bonds as being just as speculative as stocks. Speculative bonds are also known as "distressed", and in many ways we're all distressed now. So if you want to be safe, my advice is to avoid fixed income, at least for the time being.
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This article has 20 comments:
> If you have cash you have the risk of the bank the money is deposited
> and I think that is more that a soverign bond risk.
I'm not sure what country you're writing from, but in the US we have the FDIC, which limits the downside to a couple of days delay in getting your money out in the worst case scenario that your bank goes broke. The FDIC is run by the same people who create the money, so their cash supply is not in question. People just need to be careful not to go above the insured limit at any one bank. A more urgent worry is the possibility of a currency crash or high inflation.
Sophisticated investors may chose to hedge against currency risk by holding other currencies in foreign bank accounts. Investors who do so should, of course, be very aware of the regulatory and deposit insurance environments of those countries. Flipping forex contracts is an option to hedge currency risk while avoiding bank risk, but the additional counterparty risks, costs, taxes, and maintenance reduce the utility of this approach.
stockcharts.com/h-sc/u...=$USB&p=D&b=5&...
As the article noted it's very unlikey that yields will go down much further, so the upside to price is limited, while it's very possible that yields might rise causing the price to drop considerably.
Even a small increase in current yield would drop prices enough to wipe out several years of interest earned on a bond bought today. The risk to reward is far higher for bonds than cash in today's environment.
Rule #1 is return OF capital before return ON capital.
There are better places to put your money now.
The author does not distinguish between Treasury bonds (where a bubble may be in progress) and corporate debt which IS historically undervalued. I expect a higher level from Seeking Alpha.
Capital will hide until fear of destruction subsides. The surest way to not get the Old Maid is not to play the game. There will be a time to buy bonds, but this ain't it.
Some Wall Street perp walks would be nice, too.
I'm confused as to what your exact position is with this article. Granted, Brett Arends' #4 explanation is a terrible justification for investing in equities, but that doesn't mean investing in equities is a terrible idea right now...he's just providing the wrong reason to do so. Since it appears you're advocating a cash position (I had to re-read that part to make sure I wasn't missing some hidden sarcasm), when exactly should investors jump back in, when prices are high again? Long-term portfolios should be buying now, on the way down, not waiting for "safety".
This is just the flipside to the arguments I saw back in Nov '07 from all the "long-terms", the ones that were deriding those of us who clearly saw the writing on the wall and preserved our profits above 13000. We were called spineless or speculators back then, and now we are being lumped in with Mr. Arends who seems to have slept through a few basic investing courses. Buy low (that's NOW).
Aside from that, during periods of deflation (like now) the real rate of interest rises, sometimes dramatically as it is now.
For example, in the 3 months to November, CPI fell at a 10.4% annualized rate. So if your AAA corporate paper earned 5.5%, your real rate of return over the period was 15.4% annualized.
When you write that conventional wisdom is that bonds have been safer than stocks, then add, "this may no longer be the case," you are assuming that today's global financial crisis is transformative unlike any other in history. I think not. We have short memories and great financial havoc has besat this country many times before, not just in the 1930s. True, each recession and depression is different, but one thing they have in common is that each ends and the normal rules of investing and safety return.
That being said, consider that a few insightful and far-looking buyers in the Great Depression purchased defaulted general obligation municipal bonds. They understood that at some point the issuers had to pay off those obligations. New York City, Florida, etc., could not be liquidated. Consequently, fortunes were made by investors who understood the difference between short and long term risk and who, above all else, had the means and the PATIENCE to wait it out. To invest in U.S. Treasuries right now, I agree, may be the worst possible time. But it is wrong to tie long-term Treasury investments in investment grade (versus distressed) bonds. Both general obligation municipal bonds and investment grade bonds may ebe the best long-term investments (vis-a-vis speculations) available today.
Yes, I know most of us have serious doubts about Moody's and Standard & Poor ratings, but they assess the financial risks of companies on the whole very well, with a few huge exceptions notwithstanding such as AIG. Still, when one invests in bonds in companies such as CT or GE and holds them until maturity, that would be be more prudentfor a conservative investor (more than ever will be around for the than in vesting in stocks and holding them for the next decade.
Nonetheless, your article expressing investors be cautious when it comes to bonds is correct, but the thesis does not extend to the entire class as you have suggested.
> Bond don't make sense when you can have 7-8% dividend investing in
> great companies. Altria, ultimate recession proof company, pays 8.5%
> dividend!
That is about what the YTM would be on 10 yr Altria debt and the interest/principal payment is not discretionary like a dividend. A lot of good companies have had great dividend yields until they were cut.
However, high quality corporate bonds may be one of the best buying opportunities seen in years (or decades). Yields are high, and yield spreads to treasuries are at all time highs. The easy way to play this is to buy Vanguard's Intermediate Term Investment Grade Fund (VFICX), yielding over 6%. If your willing to take on a little more risk, I like Loomis Sayles Bond (LSBRX) yielding almost 10%.
As corporate bonds recover in value, there a good opportunity to make solid capital gains on these funds.
On Dec 31 04:18 PM dcb wrote:
> If you are looking to buy a bond fund it's too late because they
> have gone up too much and now the downside risk is greater than the
> upside. If you can build your own portfolio then you maintain the
> upside. I bought about 450K of bond funds at the height of the credit
> squeeze, and I'm happy to hold the LDQ, and investment grade funds
> I got at 87 that are trading at 100. At this point I'll loose more
> in taxes by not holding. After ZIRP there was no benefit, although
> european corporates may do well as the ECB is further expected to
> lower rates. This may also be the case with emerging market debt,
> but after it has run up I wouldn't be buying edd right now
Broker's love to sell this "investment" however, because it has a fat continuing 12-b1 override for them. This is all to say that investing is like walking over a minefield. Your own research is the only mine detector you have.
On Dec 31 09:57 AM PastTense wrote:
> What are "the better places to put your money right now"?