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Author: junkman02 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35367  
Subject: Bonds versus Funds, Again Date: 11/14/2009 1:34 PM
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It’s absolutely amazing what you can find on the web once you start looking for info. The following long post is from something called the Bogleheads Forum. http://www.bogleheads.org/forum/viewtopic.php?t=44475

Frankly, on a first quick reading, I don’t understand all of it. I’ve ground my way through books on “bond immunization” before, but concluded –-maybe wrongly— that I could bypass the topic in my own investing.

Cuss. I do NOT want to deal with “Duration”, “Convexity”, etc. Just going through the process of finding bonds to buy is work enough. But I’ve been running numbers on my own holding, trying to figure out CAGR vs. YTM vs. Inflation-Discounted Returns, etc. It occurred to me, as soon as I started reading this article, that it is absolutely relevant to the now-lengthy NC muni thread.

It’s a mind-stretcher, but give it a try.
-------------------------------------------------------------

There have been a dozen or more threads in which advocates of individual bonds spread fear that, were rates to drop at exactly the wrong time, you would not get your money back out of the bond fund when you needed it, and therefore buying individual bonds must be safer. In response, others (at least some of whom I would consider experts in the bond market) have responded that as long as your duration is greater than your need for the funds, you will not lose money, and that comparing a non-rolling bond ladder to a fund--equivalent to a rolling bond ladder--is not a valid comparison.

More recently, the final twist on this endless circle has been a claim by anti-bond-fund posters that since at some point you will need the money, even if you are investing for the long-term, at some point you will need the money and your principal will not be safe.

In response to this, I will excerpt and summarize one of the major academic books elucidating how bonds respond to price changes, Fabozzi's Fixed Income Mathematics (1993), pp175-190 or so, the chapter called "Price Volatility Measures: Duration," sub-chapter "Role of Duration in Immunization Strategies." Note that Fabozzi uses the term "immunize" to mean ensuring that the amount that you get out of a "bond portfolio" (the term here can mean either a ladder of individual bonds, a bond fund, or a grouping of bond funds, as long as the duration is the same across types).

"Because the interest rate risk and reinvestment risk offset each other, however, is it possible to select a bond or bond portfolio that will lock in the yield at the time of purchase, regardless of interest rate changes in the future? That is, is it possible to immunize the bond or bond portfolio against interest rate changes? Fortunately, under certain circumstances, it is. This can be accomplished by constructing a portfolio so that its Macaulay duration is equal to the length of the investment horizon."

You'll note that Fabozzi uses bond and bond portfolio interchangeably because there is no difference in how they respond to market conditions. Indeed, the examples he goes on to provide make it clear that the optimal way to meet a future obligation is NOT to purchase a bond or group of bonds which matures when the obligation is due, but rather a bond or group of bonds whose duration is the length of time remaining until the obligation comes due. Since for any bond which pays a coupon, the duration is shorter than the maturity, this means you will wind up selling the supposedly safe bond on the open market, and be subject to the same market pricing that people worry about with bond funds. The reason to invest even an individual bond towards a fixed future obligation based on duration rather than maturity is that you face reinvestment risk on the coupon payments. If interest rates drop, you will not be able to meet your obligation, because you will be making less on the reinvested coupon payments than you expected to. Therefore to ensure meeting your obligation, you will need to invest more than you would otherwise.

"To immunize a portfolio's target accumulated value (target yield) against a change in the market yield, a portfolio manager must invest in a bond (or a bond portfolio) such that (1) the Macaulay duration is equal to the investment horizon*, and (2) the present value of the cash flow from the bond (or bond portfolio) equals the present value of the liability."
The footnote: "* This is equivalent to equating the modified duration of the portfolio to the modified duration of the investment horizon."

Point (1) is what has been advocated here. Point (2) simply means that you should invest enough money to reach your goal!

In his examples, he assumes the market yield changes immediately after the bond is purchased, as a one-time event. This point has been raised in discussions here as well, that if yields constantly increase, you could fail to make up the lost NAV by the time you need the fund's principal. The response in other posts was to suggest that the duration should be lowered smoothly as the fixed need for the money approaches, so that the duration always equals the remaining time. This can be accomplished by moving money from e.g. an intermediate-term fund to a short-term fund over time, in the same way that one rebalances from stocks to bonds over time. The duration of the bond portfolio is simply the dollar-weighted average of the durations of the funds or bonds within the portfolio.

Fabozzi has the following to say on this topic:
"In the face of changing market yields, a manager can still immunize a portfolio by rebalancing it so that the Macaulay duration of the portfolio is equal to the remainder of the investment horizon."

Finally, there is a caveat, which is that if the shape of the yield curve changes (that is, if bonds of different duration do not all change by the same amount), the immunization will be imperfect. This will result in a loss (practically speaking, a pretty small one) if short-term yields fall (reducing interest on reinvested coupon payments) but long-term yields rise (causing NAV loss which is not compensated completely for by the higher interest rates due to low short-term rates). He suggests a strategy elucidated by Fong and Vasicek in the Journal of Finance, December 1984, to minimize this risk. I would guess that this strategy is likely too complicated for individual investors, and the need is quite small, since this risk is minimal.

Indeed it should be possible to "insure" against this risk by overestimating your actual need by a small amount. This is almost certainly an amount smaller than that needed to "insure" a coupon-paying individual bond in case the interest rate changes on the reinvestment of the coupons. Indeed, in practice what most advocates of the individual-bonds-are-safe philosophy seem to do--quite reasonably so--is use the maturity value of the bond to meet their obligation, and the coupon payments become income or get reinvested into the general portfolio. This is in effect over-"insuring" by the value of the coupon payments plus their reinvested interest.

If even this miniscule amount of risk is too much to bear, and building in a small cushion as insurance against the small loss if the yield curve shifts the wrong way (applicable to either individual bonds or funds, as was discussed) is not possible, then a zero-coupon bond is appropriate.

Finally, I want to thank everyone for the discussions of the past several months about bond funds. As frustrating as the discussions have been, in the end they have forced me to read further and further (and even run the numbers myself) to understand why the experts were in fact correct. As a result I have gone from only the most basic understanding of bond funds to feeling considerably more comfortable with how they will respond to a variety of market conditions. I strongly recommend looking up Fabozzi's book, either at the library or the latest revision.

Thanks everyone, and I look forward to more discussion which will inevitably follow.
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Author: PCScipioA One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29074 of 35367
Subject: Re: Bonds versus Funds, Again Date: 11/14/2009 4:10 PM
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Thank you, junkman. Interesting stuff. For a useful but not exhaustive explanation of duration and convexity, see the later segments of this article: http://www.investopedia.com/university/advancedbond/

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Author: junkman02 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29075 of 35367
Subject: Re: Bonds versus Funds, Again Date: 11/14/2009 4:53 PM
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Au contraire, mon ami. Thank YOU for the link to that Investopdia article. I didn't realize what a good resource they were. Very clean explanations, nicely illustrated, with good examples.

Oh, man. My life just got more complicated if I want to try to apply those ideas to my portfolio (and its 198 bonds). Talk about having to do penance for my sins for neglecting my back-office duties. I was feeling proud of myself for just tracking what I bought, when I bought it, its CY, YTM, YTD gains, etc. ARRGH. No wonder people buy funds and then let someone else do all that stuff for them. :-)

I've got to think about whether I want to play the game at that level. Value investing I understand. You buy cheap and sell dear. With bonds, it's easy to let maturity be the sale date. So the workload of building a bond portfolio is front-loaded, and it emphasizes the shopping or, at least, that's what I emphasize. If I shop good, I consider myself 90% done. I log the bond, do a trading journal write-up, and then forget about the bond except to mark myself to market weekly.

Now I've got to run portfolio measurements, too? Oh, man. I don't know if I like this. I'm going to go for a walk.

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Author: Crosenfield Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29076 of 35367
Subject: Re: Bonds versus Funds, Again Date: 11/14/2009 7:18 PM
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Um.

Will you chide me because if I'd bought that bond instead of this one, I'd have made another $5 a year for the next 20 years?

My approach is to look at what the bond will pay, when it will give me my money back, and how certain it is that I will indeed get my money back. If it is acceptable, I'll buy. I have bonds maturing every year, and collect coupons every month. I don't worry about calls because I don't pay premiums. When bonds are called, I go looking for something else to fill that spot in the ladder.

If the sweet spot on the yield curve is right when I already have a bunch of bonds maturing, I look somewhere else. When going through a listing of bonds, I do look at the whole amount available--usually e-Trade will have a couple hundred VA munis. If nothing strikes my fancy I'll look at Puerto Rico. Yes, I'll notice that if I go out just another year or two I'll get 1/2% more interest and MAYBE that will influence me to go longer. Awhile ago there was NOTHING maturing in 2017, and the next time I was buying bonds that's what I looked for.

Sure, I can do the math. Why bother?

That is for mutual fund portfolio managers.

Best wishes, Chris

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Author: junkman02 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29077 of 35367
Subject: Re: Bonds versus Funds, Again Date: 11/14/2009 9:31 PM
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Sure, I can do the math. Why bother?

Chris,

Here’s another snippet from the whole thread:
1) If I have an investment horizon of five years, do I just buy a bond fund with a duration of five years and hold it for five years?

No, you have to shift some money from your bond fund to a shorter-term fund or money market as you move along.

2) If I have an investment horizon of five years, do I just buy an individual bond with a duration of five years and hold that bond for five years?

No, you have to sell some small pieces from your bond every year and balance it with a shorter-term bond or money market as you move along.

3) If I have an investment horizon of five years, do I just buy an individual bond with a maturity of five years and hold that bond for five years?

Yes, that will work. Put the interest elsewhere.

You use different tools for different purposes.


http://www.bogleheads.org/forum/viewtopic.php?t=44475

The point I take away from the discussion of immunization is that, if the investor needs to be assured that a certain amount of money will be available at a certain time, then immunization becomes an important tool. But if scheduling isn’t a consideration, then duration can be ignored. Maybe Dr Tarr will clarify the matter for us.

Why bother with such concepts? Because, like mountains, they are there to climb. I’ve ignored duration up until now. But I’m embarrassed about it, because I ignored a tool that I should have investigated to be certain that I could ignore it.

Yes, choosing to play a “good-enough” game is certainly a choice each investor can make for her or himself. But why not push the limits? Why not climb mountain? The view from the top might be rewarding.

Charlie

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Author: DrTarr Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29081 of 35367
Subject: Re: Bonds versus Funds, Again Date: 11/15/2009 1:42 AM
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As I was reading the original post - I was thinking to myself how this would apply to buying NC muni's for a personal portfolio, where the buyers goal is to construct a ladder IIRC for a retirement portfolio.... And then the compliment from Charlie - maybe I can clariy a bit

Broadly - if you have a specific horizon for your retirement portfolio ladder, duration can be ignored.

Immunization
If I order a yatch, and have to pay for it in 18 months and want to lock away the money to ensure I have the exact amount in 18 months - I would buy a bond with a duration of -> yes = 18 months. Then I know that with the collection of coupon and the final sale of the bond in 18 months I will have the correct change for the marina.

Simplest example would be a zero coupon - you know (barring default)what your return is going to be in 18 months - FACE IT! Duration was matched to time of need.

Now the math only sounds scary - but lets take a little more complex example. You buy a bond with a coupon.

Rates go down and as you collect the coupon you are forced to reinvest the money at a lower rate and so you dont get as much reinvested interest... Happily, what has happened to the "value" of your bond. IT went up, and if the duration matches the time you need to sell it makes up for the amount of reinvestment interest you lost.

OTOH- Rate go up - bonus, you can reinvest and get more money back on the reinvestment of interest, but yet when you sell the bond at the 18 months to pay for the yatch, you will be right back to the correct change for the marina because the bond value has gone down.

Now - think of that in the sense of a ladder where you are going to buy and hold the bonds to maturity. What do you care about the duration?
Duration is just a mathematical fact established because of the nature of the ladder.

I am not going to say duration doesn't matter totally because you may have to liquidate some of your portfolio or you may have an expectation rates will rise you want to keep it short, or rates will fall and you want to go long -but if you have a set time, given the goal of a 7 year defined ladder then for the pure sense of a ladder. I would not let that duration tail wag the yield dog!!!

And since convexity is just a derivative of duration - even further removed..

Charlie - you may consider figuring out the duration of your portfolio and then given the nature of your crystal ball, you would have a good idea of what would happen to the value given certain interest rate scenarios. It might serve you well to climb that mountain. And if you have expectations or 2012 premonitions you could work the duration accordingly. Meaning alot of folks are a little shorter these days..

And while another mountain to climb maybe convexity -OMG - if there is some one who is working convexity into their personal retirement portfolio they either have got enough in the portfolio that they should really try to find a nice hobby (perhaps a 20 year old girlfriend!!) or your hobby is convexity.

d(Price)^2/d^2T

IMHO- bottom line - if you think rates will go up keep the duration short, if you think rates will go down keep the duration long. If your "security" is a 7 year ladder and you don't want to try and predicte the future - duration does not matter!!

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Author: junkman02 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29084 of 35367
Subject: Re: Bonds versus Funds, Again Date: 11/15/2009 1:39 PM
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…if there is someone who is working convexity into their personal retirement portfolio they either have got enough in the portfolio that they should really try to find a nice hobby (perhaps a 20 year old girlfriend!!) or your hobby is convexity.

Doc,

My hobby is bond investing. I fall asleep thinking about bonds. I dream about bonds. I wake up ready to sit down at my computer and write about bonds. They are a hugely interesting in ways a 20-year “companion” would never be. I get myself outdoors two hours a day, rain or shine, walking or biking my miles. So an exercise plan is covered. I get as much time on the water to fish as I want. Friends and family are a walk, drive, or phone call away. I chew through books, the classics and the contemporaries, at a rate of several a week. My woodshop is fully-equipped, and I build a boat a year. Any one of my several income streams could support me. So I don’t need more money, and I like my life. But what I don’t have, unless I create them, is interesting financial problems to solve. Bond investing fills that need quite nicely. But I’m also trying to do it in an informed fashion. That means I study the subject as if I’m going to be taking an exam.

In fact, everyday the market is open an investor might have a pop quiz sprung upon him. Those who’ve done their preps, get a good grade. Those who slacked, get sacked. When the really big final will happen is anyone’s guess. But there’s a group of market commentators (Mauldin, Casey, Bonner, Butler, Taleb, Schiff, Roubini, Rozoff, etc.) who argue from evidence that the US economy is going down hard, and soon. Rather than be one of those who ask “How could this have ever happened?” I want to be prepared. I won’t come out of that exam unscathed. My assets are going to get downgraded, maybe as much as 60% if history is any guide as to how bad things can get. But I want to be one of those who, at the bottom, are already looking where to make their next move as they claw their way back, not because they need to recoup that 60%, but because it is available to recoup if the proper actions are taken.

Investing is a game with no more moral merit than checkers, poker, or black jack, and house odds are comparable, when transaction costs are considered and a realistic rate of inflation is deducted. Investing is also a business, and the 5-year survival rate for those who launch new businesses isn’t good. The odds would suggest that most investors, maybe as much as 90%, will not succeed in achieving a real rate of return after taxes and inflation. For sure, they might have amassed more nominal dollars than they began with. But will they have genuinely increased their purchasing power?

The adverse odds that face investors can be seen as a warning, or they can be viewed as a challenge. So far, I’ve survived multiples of those 5-year trial periods. But the role of luck can’t discounted. (It’s not impossible to flip heads ten times in a row.) But my probably naive belief is that the more I know, the more I can insulate myself from luck, good or bad. So I study, both because it interests me to do so, and because my survival might one day depend on it. So preparation is a hedge that might never be needed. The best course of action would be not to board the USS Titanic to begin with. But birth and fate bought me the ticket, and here I am, sailing the uncharted waters of trillion-dollar deficits, hoping the economy doesn’t hit an iceberg. Do I arrange the deck chairs, or do I don a survival suit and keep myself close to the lifeboats? Knowledge, preparation, and practice are things I can do. Fortunately, I think they’re fun.

Thanks for jumping in with your thoughts on duration and convexity.

Charlie

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Author: DrTarr Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29100 of 35367
Subject: Re: Bonds versus Funds, Again Date: 11/15/2009 8:18 PM
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And there it is~ once again Charlie articulates my point far better than I ever could. Bond investing can be a Chore - a Habit - a Hobby - or even an Addiction!

For those who:
fall asleep thinking about bonds, dream about bonds, wake up ready to sit down and write about bonds Duration and Convexity are sweet~~ a great topic of conversation, even material for that exam..

They are a hugely interesting in ways a 20-year “companion” would never be For bond junkies - Exactly!!!.... And hence, if you are working convexity into a personal retirement portfolio.. Convexity or rather Fixed Income is definitely one of your hobbies.. Knowing that you (Charlie) are passionate about bonds, that is why I say you should go ahead and figure out duration and understand its influence on the value of your portfolio...It is not that convexity is all that much harder once you have figured out duration. And a couple hundred positions is not to diffucult with the Jedi Excel skills you possess.

But these are only for folks who have that passion. IF your goal is a FI ladder I would give odds it is not enough of a passion. The marginal utility of studying duration for those who are not as passionate is infintesimal, studying convexity is 0. But, for guys like you charlie - when you can share what makes some MBS have negative convexity with a friend.. Oh ya. Like setting sail in a boat you built!


d(FI)/DT

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Author: junkman02 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29101 of 35367
Subject: Re: Bonds versus Funds, Again Date: 11/16/2009 12:02 PM
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Bond investing can be a Chore - a Habit - a Hobby - or even an Addiction!

Doc,

You, in turn, articulated the matter far better than me, which is why the back-and-forth of discussion is worthwhile.

To use a culinary metaphor, there is “meat-and-potatoes” bond investing, and there is “haute cuisine” bond investing. I think of myself as a “bistro” kind of guy and would fall somewhere in between in terms of goals and styles. Or to use a rock climbing metaphor, I want to be a little more subtle in my climbing than “bolting” my to the top, but I don’t want to “free-climb” it, either. I’m definitely going to use fall-protection, but I’m also interested in “first ascents”.

So, yeah, the investing choices I make have as much to do with “style” as anything else. How I do it matters to me more than just quantitative results. I expect to get paid for the risks I take, and to get paid well. But the game itself is what matters to me. The money will come if I’m good at what I do.

Charlie

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Author: temsike Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29102 of 35367
Subject: Re: Bonds versus Funds, Again Date: 11/16/2009 12:46 PM
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What about those of us who are EXTREMELY LAZY investors? I want my portfolio to contain both equities AND fixed income.

Lazy equity investing is VERY EASY and very profitable:

1. Decide on your equity/fixed income mix depending on your age and risk tolerance. A strategy that lets older people sleep at night is to keep your age as a percentage of fixed income assets.

2. Buy ONE (a lumper) to several (slice and dicer) INDEX EQITY mutual funds or ETFs.

3. Rebalance once a year.

Lazy fixed income investing for me is more difficult and complicated. I've found that using a 5 year US treasury / CD ladder is best for laziness but not for the best yield. It's also psychologically nice because one doesn't see any fall in NAVs because one holds all CDs/Treasuries to maturity.

Using INDEX bond funds can also be a good lazy way but one must be aware of the bond funds' "duration" because that's how much your NAV will drop percentage-wise for every 1% increase in interest rates.

There is NO WAY that I'm going to invest in individual bonds.

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Author: junkman02 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29105 of 35367
Subject: Re: Bonds versus Funds, Again Date: 11/16/2009 2:20 PM
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What about those of us who are EXTREMELY LAZY investors?

temsike,

What about them? Your point is what? That you've made a choice for yourself that you think is appropriate? Congrats and best wishes. I don't share your opinion, which is something that shouldn't upset you. (To each, his own, right?) But since the point has been raised, I'll respond.
--------------------------------------
[Note: the following is merely a working draft, not a finished paper.]

Compared with the ease of buying individual bonds, buying bond funds is a very challenging task. You’d think the opposite would be the case. But I’d argue it isn’t. With the former, you have to get very few things right in order to make a profit you can “take to the bank”. With the latter, you’re faced with timing problems that are magnitudes larger.

To buy an individual bond and make a profit, you simply have to make a ballpark estimate default-risk and inflation-risk and buy accordingly. Then you sit back and clip your coupons for as much as the next 30 years. With bond funds, unless you’re willing to go all-in initially, you have to devise a method of adding to your position. Dollar-Cost Averaging (DCA) is a typical response. Constant-Share Purchase (CSP) is another. Edleson has argued that Value-Averaging (VA) is superior to both, because it offers market-timing advantages without the hassles usual associated with market-timing.

http://en.wikipedia.org/wiki/Value_averaging

Explanation: In VA, you use account-value-reversals to determine the size of your periodic purchases, which are increased. You use surplus account-gains to decrease your periodic purchases (and/or harvest profits). This means you are “buying cheap and selling dear”, which is also the goal of DCA and CSP. But VA seems to offer an edge, argues Edleson, when back-tested on either historical or simulated data. But the bottom line with VA is that you are varying your bet size according to market conditions as they become reflected in your account values. In money management terms, you are employing a Martingale strategy, which is a sure road to ruin.

http://en.wikipedia.org/wiki/Martingale_%28betting_system%29...

As Keynes noted long ago, ”Markets can stay irrational longer than you can remain solvent”. VA works only if you can keep funding the investment from a side account and if your long bets eventually offer a rate of return greater than the sum of your purchase amounts. Neither of those is likely to be the case during some periods of market history. The odds favor them being being so, that markets eventually recover and do reach new highs. But such a thing cannot be counted on to happen. Or, better, what will be the consequences for you if it fails to happen? That’s what so much of the current debate over “black swans” is about. Yes, huge market moves, to the upside or the downside, are statistical anomalies that can be bet against when the counter-factual assumption is made that prices distribute normally. (I.e., that market returns can be described with “bell-curve” mathematics that have no “fat tails”.) It’s wonderful to be wrong about the fat tails occurring to the right side of the curve, especially when you’re long a security in that fat tail. But what about the consequences of being long a security in the left-side fat tail?

As I understand VA, and as I understand the likely course of markets ahead of us, I do not want to be averaging down on losing positions. That is not to say that, as a value investor, I won’t be averaging into positions. As an investor, I have no better idea of where market will end up in the near-term, or far-term, than anyone else. But I do know what my account size is and how much loss I can sustain before that loss put my long-term goals at risk. Therefore, I can’t keep averaging down until my bet size amounts to betting the farm. Therefore, VA (and its cousins, DCA and CSP) aren’t available to me, because I can’t afford their consequences if they fail.

Fortunately, there is an alternative, an anti-Martingale strategy, which ”…increases bets after wins, while reducing them after a loss.” (ibid.)

OK, that seems to take care of positioning-sizing. Timing-frequency is easy to dispose of. Four good choices would be: weekly, bi-weekly, monthly, or quarterly. Back-testing suggests that purchasing (or re-balancing) more frequently (or less frequently) just brings grief, rather than higher returns. The “only” remaining problem is estimating whether prices are high, low, or trendline. So let’s run some simulations. To do so, we will need to create a universe of “investables”. Let’s stipulate that cash and “cash-equivalents” are not investments. They are places where capital is parked until it can be deployed. Their nominal principal is guaranteed, and a favorable interest-rate might be paid. But they aren’t a means by which capital can be appreciated, except during brief and anomalous periods of market history. To use a metaphor, cash is the barn where you park the tractor you use to plow your fields. The barn doesn’t provide your livelihood. That comes from the fields whose products are subject to the ravages of insects, bad weather, and adverse crop markets. So an investor’s cash is just a tool that enables him to accept the risks that might return profits. (If no risks to principal, then no investment profits.)

The idea that underlies index-investing is that the “average” investor cannot beat the market, because he is the market. Therefore, average returns (minus expenses) can be obtained by “buying the market” through a market-proxy. But there isn’t just one market, there are many, and even a fund that attempts to provide cap-weighted access to all markets fails to be a truly representative proxy. Therefore, most “everything” funds merely try to be a proxy for the “major” asset classes: mainly global stocks and global bonds, some REITs, some commodities, maybe some currencies. If an investor chooses such a fund as his sole investment vehicle, he has created a one-factor investment world for himself in which he is either “in-the-market” of “out-of-the-market” (aka, sitting in cash for having taken his account ”flat”.) E.g., a day trader takes his account flat at end of market day and parks his cash. In this exercise, we aren’t trying to become day traders, nor do we want to squashed flat by the steamroller of plunging prices. So we want to be “active-indexers”: in the market when we “should be” and out of it when we shouldn’t. Or, at least, we would like to do our buying when the buying is cheap and to sit tight when prices are dear.

There’s a trader’s proverb that goes like this: If you’ve got a couple seconds, I can tell you how to become rich. ‘Buy cheap and sell dear.” But if you’ve got a couple years, then I could tell you how to tell when prices are cheap and prices are dear.”

Whether the contrasting pair is “High and Low”, Cheap or Dear”, or “Over-Bought versus Over-Sold”, the problem is the same: How to tell When is Which? What is common to all is direction. In each case, prices are moving up down or sideways. So if our investor bought his customary, monthly purchase of the Global Markets Fund at $25.73 per share last month and this month the fund is trading at $26.01, he can conclude the direction of prices is modestly upward, especially if the prior month’s purchase was at $25.54, or an average monthly gain of roughly 1% per month.

[Note: the preceding is merely an unedited fragment of a longer piece I'm working on. This whole "bonds vs. funds debate interests me hugely, hence my delving into "duration". etc. I have no idea what conclusions I'll reach or how those conclusions will alter my current investment practices. As I said, I'm exploring, for my own purposes, not trying to be an advocate --at this point-- for one position or the other. But until it can be proven otherwise, I will assert that "bonds versus funds" is a false binary. Both can co-exist in a portfolio quite comfortably. I will further asset that buying individual bonds is an easy and lazy way to invest and that, over the long haul, the more profitable method, all other things being equal. But, like I say, the research needs to be done, not just appeals to anecdotal experience or expressions of personal preferences.

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Author: temsike Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29112 of 35367
Subject: Re: Bonds versus Funds, Again Date: 11/16/2009 9:59 PM
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junkman02
What about them? Your point is what? That you've made a choice for yourself that you think is appropriate? Congrats and best wishes. I don't share your opinion, which is something that shouldn't upset you. (To each, his own, right?) But since the point has been raised, I'll respond.

My point is simple. I'd like to see more discussion of lazy ways to invest in fixed income assets.

I've seen some excellent posts regarding fixed income investing on this board. A lot of it is complicated advanced investing for busy trader types. But a good amount is basic simple FI investing.

I'm a "stick to the basics" type of investor and I like to see the the basics of fixed income investing discussed here.

That's my point.

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Author: junkman02 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29113 of 35367
Subject: Re: Bonds versus Funds, Again Date: 11/16/2009 11:08 PM
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I'm a "stick to the basics" type of investor and I like to see the the basics of fixed income investing discussed here.

I'll offer three points in reply.

(1) In today's interest-rate environment, with Bernanke reiterating today that he intends to keep interest-rates low, simple, basic strategies aren't offering a real rate of return. Don't call it a conspiracy if you want to, but the net effect of current Fed/Treasury policies is to drive fixed-income investors out of "basic" fixed-income markets. Yes, there's been a flood of money into those markets, but for how long will those investors accept such low yields? If a person wants to work within the "basic" fixed-income arena, what choices does he have?

(2) A discussion forum is the sum of its participants. To the extent that those interested in supposed "basic" strategies do not create posts is the extent to which their needs and views will not be represented. It is not my job, it has never been my intention, to represent all view points. I post with exactly one person in mind, me. I write because writing is my way of figuring out the answers I need to move forward with my investing. I post on the off-chance someone else might be struggling with the same problem, too, and would appreciate seeing the scratch work of someone else. There is nothing to prevent you from doing the same. You can speak to any fixed-income topic you choose. Rather than wait for someone to create answers to your questions, create those answers yourself and then post them.

Basic-schmasic. It's all basic. "Buy low, sell high." That's all you need to know except for the tiny little matter of being able to tell when is low and when is high.

(3) This ain't the 50's no more. That simple --even simplistic-- world of deposit accounts and such is forever gone. I don't remember the exact numbers, but the world's combined GDP is something like $68 trillion. But the value of derivatives --most of which no one understands-- has grown to $600 trillion. One can play ostrich and pretend that such unwelcomed complexities don't exist. Or one can knuckle down and start learning how to defend oneself in such a world. I'd love to see a return to "simple, basic, effortless". But it ain't going to happen, because the financial predators --the foxes now in charge of the hen houses-- can't make enough money that way.

To repeat, if you don't like the direction this forum is taking, then take a more active part in the discussions. Of the last twenty or so threads that have been posted, how many of them have you launched? Of those, how many attracted any attention? This is an open market. People vote their interests by participating. Maybe yours is a minor viewpoint, not that it can't regain importance if you are willing to assume leadership.

So that's the challenge I put to you. If you want to read about "stick-to-the basics" investing, then start writing about "stick-to-the-basics" investing. This forum has no limit on "bandwidth". All it takes for a topic to be discussed is for someone to write about it in ways that compel interest. The purpose of The Motley Fool, I'll remind you, is "to educate, amuse, and entertain". Have at it. The floor is all yours.

Charlie

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