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Subject:  Maximizing Your Bond Returns Date:  10/1/2012  1:35 PM
Author:  trader2012 Number:  34425 of 35623

There’s a really bad video being hosted on Yahoo Finance’s Breakout in which Jeff Macke interviews Larry Swedroe who is supposedly giving viewers “some tips and words for the wise [sic] on how to maximize their bond investments”. Swedroe attempts to make three points.

(1) Understand your fees.
(2) Use Mutual funds or ETFs.
(3) Be Conservative.

His first point is merely a very outdated rant against “markups” and worth no further consideration, because anyone who pays an avoidable markup is an idiot who deserves to be fleeced, though I'll freely admit that not all markups are avoidable, such as us odd-lotters constantly must endure for being forced to bid up in the book to obtain our sizes, and I’ll get back to this business of “fees” in a moment.

His second point follows from the first. He argues that ” Rather than going out and buying one bond or another [investors should be] using bond ETFs or mutual funds. The "funds-versus-individual- bonds" argument isn’t an “either-or-thing”. As has already been endlessly discussed in this forum, “it all depends” on the would-be investor’s intentions, skills, and assets. If you have little cash, few skills, but want exposure to the risks and rewards of fixed-income instruments, then buying derivatives (aka, bond funds) is an easy way to do it. The products that Vanguard markets are excellent. The bond ETFs are excellent. The closed-end bond funds are excellent. The open-end bond funds are excellent. Any or all of them, if bought correctly, could make their owners serious money, just as buying individual bonds could make their owners serious money.

Swedroe’s third point is where his (or Macke’s) misunderstandings of bonds really show themselves.

Although less risky than stocks in theory, bonds aren't a surefire way to avoid market volatility. With Treasury rates effectively stuck at zero, investors tend to "stretch for yield" as Swedroe puts it. There is no free lunch on Wall Street. If you want returns you have to take risks. In this environment a junk bond may only have a yield of 7% and contain much of the risk of a common stock. When the risks show up, as they always eventually do, the illusion of safety disappears. These bumps in the road can come as a jolt to conservative bond investors unaccustomed to volatility. Swedroe says this makes bond holders susceptible to giving in to the urge to panic and sell at the lows --an action from which he says you may never be able to recover.

To buy bonds to obtain ‘safety” is to fail to understand what the asset-class can and can’t do, what a would-be investor can and can’t do, as well as the meaning of “safety”. You don’t obtain ‘safety’ by avoiding ‘market volatility’. Volatility (aka, uncertainty) is what makes profits possible, and no one but the truly perverse objects to ‘