Bond Strategies for Those Fearful of Inflation
by Stan Richelson and Hildy Richelson
The media warns investors not to buy bonds because inflation is coming, interest rates will rise and the value of bonds will fall.
The brokerage houses “mark to market” your bond portfolio every day, creating an awareness of portfolio valuation in the hopes that you will trade to take gains and sell losses. Depending upon a number of factors, including the frequency with which a particular bond has recently traded, these valuations may be more or less accurate.
In this article
- Inflation Is the Upside Case
- The Case for Premium Bonds
- The Cost of Waiting
- Building a Ladder in a Low- Interest-Rate Environment
- The Possibility of Deflation
- Bond Mutual Fund and ETF Strategies
- Our Personal Investment Strategy
- Be Wary of Esoteric Securitized Bonds
- Bond Strategies for 401(k) Plans
Share this article
Facebook
Twitter
E-mail
SeekingAlpha
Stumbleupon
Delicious
LinkedIn
In the trading process, you incur substantial costs and the brokers make money. You may or may not make any money. In fact, there have been numerous studies showing that if you trade, you lose money. Daniel Kahneman, the 2002 winner of the Nobel Prize for economics, states in his book “Thinking, Fast and Slow” (Farrar, Straus and Giroux, 2011) that “Many individual investors lose consistently by trading, an achievement that a dart-throwing chimp could not match.”
From our perspective, cash flow, not trading gains and losses, is the key consideration for individual investors. However, focusing on cash flow instead of gains and losses requires concentration, because it is a different gauge of success than those normally employed. Cash flow will not start an exciting conversation at a party. When you use cash flow as a measure, sitting in cash waiting for interest rates to go up is not a sensible strategy unless you can correctly forecast that interest rates will go up very soon. If your prognostication is incorrect, you will lose a great deal of cash flow investing at near-zero interest rates in short-term or money market instruments in today’s market.
To read more, please become an AAII member or CLICK HERE.
Hildy Richelson is president of Scarsdale Investment Group, a registered investment adviser based in Blue Bell, Pennsylvania, that specializes in fixed-income investments. Hildy and Stan Richelson are co-authors of several books on bonds, including “Bonds: The Unbeaten Path to Secure Investment Growth,” Second Edition (Bloomberg Press, 2011).
Discussion
I prefer investing in yanguard corporate bond funds withdiferent durations in my IRA hiyield,GNMA,ShTInvGrade etc. over many,many years. Keeps cost low in contrast to buying individual Bonds which are dificult for even the professonal to evaluate and where you are paying hefty brokerage which is generally hidden. I get diversification, good return, and if I hold through up and down interest cycles ive found cycles even out nicely. And i can now time my required MR withdrawls and even tweek the allocations.
posted about 1 year ago by rbasili from Florida
As a new investor I know the initial attraction of bond funds verses individual bonds is the fact that I'm not comfortable screening bonds to make sure I have high quality bonds. US Treasury bonds are easy, but other than Treasuries the fear of purchasing a low quality bond can drive new investors to bond funds (or stick with Treasuries and accept a very low Yield). Do you have articles that you recommend for a new investor on bond screening and the best way for us to purchase individual bonds (like muni bonds)? It would be wonderful to find information about a recommended broker, how to screen for a bond, and how to "shop" for the best price for that bond. Also, recommendations on waiting for a new issue, verses purchasing secondary bonds, and how to "monitor" the bond portfolio to make sure the portfolio doesn't have new default risks (assuming I'm purchasing and holding to maturity).
posted about 1 year ago by Jonathon from Indiana
Seems like a self-serving article. The authors prefer that you do not buy bond funds because they don't make money on them.
I have owned solid bond funds for years, have reinvested the proceeds and sleep well at night knowing that I am well diversified within the fund and the manager (which I choose through Morningstar) is watching over it.
posted 12 months ago by Stephen from New York
I think Renzo,Jonathon and Stephen make more sense to me than the authors of this article!
posted 12 months ago by Ronald from Illinois
It is possible to own individual bonds in 401(k) accounts, which is contrary to what the author says. Some brokerage companies also provide and manage 401(k) accounts and as such offer brokerage services and products like stock, bonds, etc. within those qualified type accounts.
posted 12 months ago by Allen from Pennsylvania
I have never talked to a broker who could show me how to buy an individual bond, period. I prefer bond funds and gladly pay the small fees to have Vanguard manage those for me.
posted 12 months ago by Bobby from Tennessee
I am a bit confused. I can understand how you invest the cash at a higher rate in a rising interest rate environment when the bond matures.
How do you invest the cash flow from the coupons at a higher rate?
posted 11 months ago by Norman from New York
Norman-You use the coupon payments from your bond holdings to purchase new bonds. As yields rise, you will be reinvesting the proceeds from your coupons into bonds with higher yields.
posted 11 months ago by Charles from Illinois
Name your poison it sounds like-- I wonder how Bill Gross would answer . JAFIX fund; 7% with a std. dev. of 2.8; 5-star exp of .71%
posted 11 months ago by Marcus from North Carolina
Well written article that even I could understand. The 800 lb. gorilla seems to be the interest rates kept artificialy low to make easy money available to those in need. Those of us that have saved did not think we would have to take "nothing" for "safe interest" and extremely high risk on other investments. I guess these are good times for the poor as we continue to put in more socialistic systems by our goverment.
posted 11 months ago by Roger from South Carolina
Bond funds are a quasi-stock investment because the funds must keep a constant maturity range. The bonds outside the range must be sold. They never come due. When rising interest rates materialize, bond fund owners are at risk because bonds will have to be sold into a rising interest rate market. This is a disadvantage of bond funds.
Morningstar is a good guide, but the data they are presenting is not always what it seems. John Bogle states that all funds revert to the mean, which means that those with five stars will eventually become lower rated funds. Funds with many stars must be taking added risks to be earning better than average returns. It is important to look beyond the ratings to find out what is in the small percentage of the holdings that is driving the difference.
When you are 80, it is advantageous to purchase high quality bonds with a full coupon (4% or more) and call protection. In this interest rate environment, you need to purchase longer term bonds maturing between 15 and 20 years. This is where the yield is. Hopefully they will be short term bonds, or the principal will be reinvested, when your heirs inherit.
Risks are relative. Longer term bonds still return about 3.5% on tax-free municipal bonds, which is the tax-equivalent return of between 5% and 6% taxable depending upon your tax bracket.
posted about 1 month ago by Hildy from Pennsylvania
