A problem I worry about a lot is how to pick bonds quickly, so I can get on with the rest of my day. To be fast, one’s due-diligence procedures have to be simple and explicit. That means mechanizing as much of the search and vetting process as possible. Everyone is going to have their own way of doing things, but this is what makes sense to me. (1) From the 30,000 or so bonds that brokerages brag they can offer, grab just the ones that seem to offer a real-rate of return after taxes and inflation. (2) Of those, dig into just the ones offering a return commensurate with their risks. (3) Of the ones that pass that test, only bid for those that can be bought in a size appropriate for one’s account. Step Three is trivial and needs no discussion. Step Two is mostly qualitative work that I’m scrambling to quantify. Step One is something anyone could do for themselves, though few attempt. So let’s work through some of the underlying ideas. If you know the Price, Coupon, and Maturity of a bond, then you can use standard formulas to estimate its Yield to Maturity (YTM). If you back commissions into price, then you can improve your estimate. If you back taxes and inflation into your numbers, you begin to get close to a concept I call grocery-store money, namely, how much yield the bond might really produce in terms of spendable income. Once taxes are paid and inflation is discounted, it makes no difference no matter whether your gains come from the coupons or the difference between your entry and exit price. Both gains (if they exist) are going to spend the same, and the only thing that matters is your tax-adjusted, inflation-adjusted Total Return, and writing the spreadsheet formulas needed to estimate what that might be is no biggie. But the reason for creating those formulas for yourself is this. Once set up, and once practiced often enough to become second nature, they are a fast and simple way to help keep yourself out of trouble, because you won’t be fooled into thinking that somebody’s such and such of sometime offers a fat yield when, in fact, that bond is going to lose you your purchasing-power once taxes are paid and inflation is subtracted. In other words, the faster you can screen out the garbage, the more time you can spend on the details of bond-investing that really matter. Have a good weekend.
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