How to Make Money From Bonds

by Stan Richelson and Hildy Richelson

How To Make Money From Bonds Splash image

Editor’s note: Portions of this article were excerpted with permission of the publisher, John Wiley & Sons Inc., from “Bonds: The Unbeaten Path to Secure Investment Growth,” Second Edition. Copyright © 2011 by Stan and Hildy Richelson.

We endorse a buy-and-hold strategy for bonds because, when following such a strategy, you only need to make one right decision: when to buy.

With high-quality bonds, the variations in a bond’s price while you hold it are not a serious concern because, unless there is a default, you will be paid both your scheduled interest and the face value of the bond at its due date. Long-term bonds experience greater price swings and thus more visceral discomfort than shorter-term bonds; but the ups and downs of a bond’s price should not matter to you if you can hold the bond until it comes due at face value.

When you trade bonds, however, you must make two right decisions to be successful: when to buy and when to sell. We recommend to investors that they avoid market timing and leave this activity to traders who move big positions and watch the trading action all day, every day. Making one right decision of this nature is hard enough; making two is a risky choice.

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Stan Richelson is a representative of Scarsdale Investment Group, a registered investment adviser based in Blue Bell, Pennsylvania, that specializes in fixed-income investments. Stan and Hildy Richelson are co-authors of several books on bonds, including “Bonds: The Unbeaten Path to Secure Investment Growth,” Second Edition (Bloomberg Press, 2011).
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

Owen from California posted over 2 years ago:

Please reword your section on junk bonds and avoiding over-valued bonds. You say that junk bonds that move to 200 basis points of treasuries are over priced, but that makes the reader have to guess whether the desired spread is under 200 basis points or above. I would find it clearer to give a rule of thumb on how many basis points above treasuries that I want to make junk bonds worth the extra risk.


Peggy from District of Columbia posted over 2 years ago:

I have not invested in corporate bonds but have become interested in a select few. I cannot seem to find information on the Internet and am considering a subscription to Investor Pro if it includes corporate bonds information for term, interest rate, and yield for each company. Where is the best place to find this information?
Thank you for your response,
Peggy Smith
psmith44@comcast.net


Charles from Illinois posted over 2 years ago:

Peggy, our Stock Investor Pro program only screens for stocks, not bonds. http://www.investinginbonds.com is a good website for finding information on corporate bonds. I would check with your brokerage firm, as its website may have a bond screening tool. - Charles Rotblut


Dave from Washington posted over 2 years ago:

I am one of those investors, "deathly" afraid of long term bonds and I didn't really see anything in your "Strategies for Reducing Market Risk" that made me feel better.

I realize that I have lost out in the last couple years thinking interest rates could not go lower, but it seems to me that holding a bond for 30 years paying 3%, while the rest of the market is doing 6% would not be much fun either. Nor would selling it and losing half my principal.

It just seems like a tuff place to be right now.

??


Dave from Washington posted over 2 years ago:

What is the advantage of creating your own bond ladder, as oppossed to buying a bond fund and essentially letting the professionals do it? Seems like you would get a lot more diversification from a bond fund, especially for those that are not bond experts.


Chris from New Jersey posted over 2 years ago:

I agree with Dave...how do the various bond funds stack up against a do it yourself strategy...if the difference is just the expense ratio, then my decision is made.


Ina from North Carolina posted over 2 years ago:

My problem is the opposite. I want out of a bond ladder my previous broker set up. I have not been able to get rid of 20+ bond positions because "The Expert" purchased mostly in 1,000 and 2,ooo quantities. More shocking was my "advisor" had 38 options(60%)of my IRA and 2 old American Funds. Needless to say I've moved from there and am using Fidelity to help clean up the mess. Long story. The 20+ bonds I do not want to keep are only traded in 5,000 to 25,000 quantity limits and the company will not deal with 1,000. As above, why have $ tied up for 20 or 30 years at 3% - 5%?

DOES ANYONE have a SUGGESTION how I can dispose of the remainder of my useless ladder? I've talked with the Fixed Income and Bond Desk at Fidelity who have helped me dispose of 2/3 of my ladder but hve no resolution on the remainder.
Never, never, never use a fee based broker even if you're sick or dying. I have yet to total my losses.


Bernard from California posted over 2 years ago:

I like high yield bonds, which have done well for me over the years. I seldom see any constructive discussion of investing in this asset class. I have made a presentation at an AAII meeting and written an article about this:
http://www.wonderfulwebwork.com/documents/Investing_In_High_Yield_Bonds2.pdf


Steve from Connecticut posted over 2 years ago:

I own some convertible bonds that are well in the money. However, one is callable in Apr. '12 and its value has fallen from over
$115 to $105 in the past few months.

How do you assess at what point the time value left on a callable bond is not worth holding onto the bond? Even if the stock continues to rise, the bond is likely to be called at $100 at the call date.


Hildy from Pennsylvania posted over 2 years ago:

Dear Owen from California
It is very hard to tell you how many basis points you need to have before it is worth your risk to invest in junk bonds. Post 2008, high yield corporate bonds yielded as much as 823 basis points or 8.23 percentage point more than comparable Treasuries. Was that a good deal? Only if in retrospect we know that the bonds did not default or lose substantial value. The problem with buying high yield bonds is that they may default, and you may lose some or all of your principal. From our perspective it is not worth taking the extra risk of losing your principal.
One of our California clients worked with a high yield California broker who systematically sold his high quality bonds and purchased high yield Community Development District bonds for him. They are in a very shaky state currently and he cannot sell them. If you want to invest in junk bonds, then your best bet is to purchase a fund.
As we describe in our book BONDS: THE UNBEATHEN PATH TO SECURE INVESTMENT GROWTH, Second Edition, there are many different kinds of junk bond funds. They are not all created equal.


Hildy from Pennsylvania posted over 2 years ago:

Dear Peggy from the District of Columbia,
Corporate bond analysis is like stock analysis. You must have an understanding of the strength and weaknesses of the company, as well as the position of the bonds in the overall debt structure of the company. There are no reasonable sources of information about them. Most corporate bonds are not rated ‘A’ or better by the multiple rating agencies, so you can eliminate them altogether.
I saw Charles Rotblut’s comment that the service you are referring to is for stock screening and will not give you the details about the bonds.
The real issue is why are you interested in investing in corporate bonds in this difficult economy? It is a dicey time to be taking on more risk. There are other alternatives for taxable income. Please check out our book: BONDS: THE UNBEATEN PATH TO SECURE INVESTMENT GROWTH , Second Edition, for other alternatives.


Hildy from Pennsylvania posted over 2 years ago:

Dear Dave from Washington,
There is never an easy place to be in placing your funds in the market because interest rates are either going up or down and there is no way of predicting which way interest rates are going. You might want to check out our article on deciding what to do intitled: The Short Term Route to Long Term Failure. Here is the link to it: http://www.allbondportfolios.com/short_term_to_long_term_failure.pdf. This article discusses your fears about investing your cash and then finding yourself in a rising interest rate environment. There is no perfect solution to this problem. Basically it shows that if you sit for a long period of time in short-term instruments paying next to nothing, it will take you a very long time to catch up even if interest rates rise dramatically. Consider a bond ladder discussed in Chapter 21 of our book entitled BONDS: The Unbeaten Path to Secure Investment Growth, Second Edition.


Hildy from Pennsylvania posted over 2 years ago:

Dear Dave from Washington: The simple answer as to why you should buy individual bonds instead of a bond fund is that individual bonds come due and bond funds do not. Thus, if interest rates rise, and the value of the fund declines, you have lost that principal. The value of your individual bonds may also decline, but every year you hold them they are one year closer to maturing. They will eventually come due at face value.
The extended version of why to buy individual bonds instead of bond funds can be found in our article: Buy Bonds and Not Bond Funds. Here is the link: http://www.allbondportfolios.com/bond_article_11_24_09.pdf


Hildy from Pennsylvania posted over 2 years ago:

Dear Chris from New Jersey:
The decision to purchase individual bonds versus bond funds is not just the expense ratio. That is only part of the reason. You do pay fees annually for the bond fund, including trading costs and other fees, while you pay none for holding individual bonds. You can be more selective in purchasing your individual bonds and don’t have to be concerned about the Alternative Minimum Tax, junk bonds that improve the yield but may lose principal and other concerns. Please read the article cited above. Don’t be concerned about diversification if you buy high quality bonds.


Hildy from Pennsylvania posted over 2 years ago:

Dear Chris from North Carolina:

I am very sorry to hear about your trouble. From what you describe, it sounds like your advisor had a managed account system and divided up the bonds among a number of accounts. We have seen stock accounts like that, but never an account with bonds. Please call me and we can discuss your current situation. You can find my contact information at the website www.allbondportfolios.com.


Hildy from Pennsylvania posted over 2 years ago:

Dear Steve from Connecticut:
The problem with investing in convertible bonds or other junk bonds is that you have to sell in order to get out of your position. All the information has been factored into the price, so every potential buyer knows that the bonds may be called shortly. You needed to sell when the bonds were selling at 115, but then you were happy with your return and did not want to give up the bonds. We are seeing high quality bonds selling at 115 and more due to price appreciation in the market. If you had purchased high quality bonds, you would not be faced with selling them. If you sell these convertible bonds, you will have to pay taxes on the gain and have to pay a spread to sell and another to purchase new bonds. After all is said and done, you might as well hold the bonds until maturity.


Fabio from Illinois posted over 2 years ago:

After years studying bonds, I have been obtaining quite good results using bond ETFs. They are very liquide, traded like stocks (hart patterns use to work well)... and they pay dividends (interests). My question is: which type of risk am I facing using this type of artificial trading instruments? Tks


Rick from California posted over 2 years ago:

I am interested in the mathematical interplay between a "ladder" and a "barbell" strategy. Most sources say "ladder" but no one has mathematical support for the conclusion.

How often are muni bonds called in the real world and under what circumstances?

What is the mathematical interplay between real world calls and duration (since duration is measured by how quickly one receives back their money.,


Hildy from Pennsylvania posted about 1 year ago:

Hi Owen,
If you were to purchase junk bonds on spread alone it would be hard to determine when it was a good time to buy. When junk bonds are not defaulting because interest rates are low and refinancing is easy, then the spreads are small between investment grade and junk bonds. However, when the default rate is rising, then the spreads widen out because your risk is so much greater. Then you are really swimming with the sharks.


Hildy from Pennsylvania posted about 1 year ago:

Hi Dave,
What the pros do is purchase bonds with high coupons and pay the premiums in a low interest rate environment. This gives you a high current cash flow that can be reinvested at higher rates if interest rates turn upward. If you are invested in a fund, the bonds in the fund must be replenished and added to as new people buy in. This dilutes your holdings. Also, bond funds compete with each other for best ratings, which means they may take on added risk that you do not want. Please see our article: Buy Bonds, Not Bond Funds at our website www.allbondportfolios.com.


Hildy from Pennsylvania posted about 1 year ago:

Hi Fabio,
Bond ETFs are really closed end funds that are wearing a new dress. In difficult market conditions, you might be faced with selling below their net asset value.


Hildy from Pennsylvania posted about 1 year ago:

Dear Frederick,
Munis are called all the time, especially if interest rates are low as they are now. Many of the new issues are for refunding outstanding issues. They are also called for other reasons, such as restructuring debt.

There are times when a barbell is attractive, but with interest rates so low on the short end of the yield curve, it is hard to justify buying bonds there unless you might have a need for the cash in the near term.


Gerald Lanois from Florida posted about 1 year ago:

This article would be fine for bonds, for 5-10 yrs ago. Now , it is worthless advice.
Bonds are a terrible investment, and will be for sevral yrs if not longer.
2-3 % payments will not even cover inflation.

AAII should evaluate if this is good advice? I don't think this article is anything but classic, and inappropriate now.

Investors have to move into other market opportuities to earn better returns.

When/if interest rates rise, all the holders of bond funds,cefs, etc, are going to be hurt big time.


Barry from Washington posted 10 months ago:

To reduce complexity, should we only consider non callable bonds?

Where can u get good info on buying and selling bonds when necessary, such as good minimum trade size, trading costs, best buying advice source, cost of advice, who is best to do the trade?


Barry from Washington posted 10 months ago:

To reduce complexity, should we only consider non callable bonds?

Where can u get good info on buying and selling bonds when necessary, such as good minimum trade size, trading costs, best buying advice source, cost of advice, who is best to do the trade?


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