UnThreaded | Threaded | Whole Thread (5) | Ignore Thread Prev | Next
Author: charliebonds Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35367  
Subject: Re: Barnhill’s Book Date: 9/19/2010 12:45 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 2
Frankly, I’m surprised this post has earned a favorable reception, given that its intent was more provocation than instruction. But my point about the necessity and benefits of a sound investment plan were right on the mark.

Ten years ago, in the hay days of the tech bubble, when everyone and his cousin was throwing money at every no-earnings, piece-of-trash IPO brought to market and making a killing, I said to myself, “there’s gotta be a better way to make a few bucks from markets, because the current frenzy can’t end well.” So I started poking around in bonds, and I was surprised by what I found. The debt of companies with tangible assets and good-enough earnings was being discounted enough to offer a real-rate of return (after taxes and inflation). The yields weren’t even half of those offered by tech stocks, but they were good enough. So I dug into the asset class, and served my apprenticeship.

Now, a decade later, that choice seems wise. According to whomever wrote the article in this week’s issue of Barron’s on PIMCO’s roll-out of a mutual fund dedicated to global junk bonds, ”junk bonds have out-performed stocks over the last decade with 54% less volatility.” I haven’t yet had time to check the truth of his assertion. But doing so should be straight-forward. Just pull the data from Yahoo Finance on the relevant benchmarks and then import it into Excel and infer their respective volatilities from their standard deviations, which Excel will compute.

But that was then, and now is now. Is junk-bond investing still a good idea? I’d argue it is, and for the same reason it was a good idea back then. There are two ways money can be made in bonds: by betting on the direction of interest-rates, and by betting on the direction of credit-risk. The two are related. As interest-rates rise or fall, credit-risk (in a general sense) is exacerbated or eased. But what really matters to a credit-risk bet is the issuer’s specifics, just as what matters to a stock bet is both the broad economic picture but, more so, the company’s specifics. Thus, success in either depends on good due-diligence, with the former being more forgiving, due to the fact that bondholders stand higher in the credit line than equity holders and the fact that bonds mature (aka, are a put). Therefore, for a stock bet to do well, the company has to do well. But for a bond bet to do well, the company merely has to survive. That’s a lesser goal, and with it comes lesser returns, of course, on average, about 3.5x less. In other words, if you can expect to make 7% from a bond bet, buying the company’s common ought to offer around 25% over the same holding-period but, also, with proportional greater volatility.

So that’s the trade-off. Either bet is risky, but one is more worrisome. Right now, of course, due to demographics and a lot of other factors, money is flowing out of stocks and flooding into bonds, distorting valuations in ways that can’t end well. But if stocks are what one knows, then one sticks with stocks, just as if bonds are what one knows, then that is what one sticks with, because trying to change horses in mid-stream will offer the worst of both worlds: selling low and buying high. So my advice remains the same. Figure out who you are and then pick an investment method that matches your personality and stick with it. Financial success has little to do with the supposedly-objective numbers and nearly everything to do with how you will manage the risks of making decisions under conditions of uncertainty. In other words, how you manage Fear and Greed will determine your success, and the only way to deal with them in a rational, productive is with an investment plan that is based on who you are as an individual human being with a unique personality and temperament.

In creating a plan, you aren't trying to convince yourself you aren't scared of losses. You should be scared of them. The plan enables you to deal with your fears so that you can make probabilistic bets which are likely to pay off, on average and over the long haul, just as your plan also serves to keep greed in check so you aren't making bigger bets than is prudent, on average and over the long haul. In short, the purpose of an investment plan isn't to make the best money for you that might be achieved, but to keep you in the game long enough that you can learn the game well enough that good-enough returns can be achieved. Or as Buffet has advised on many occasions, "Don't do anything brilliant. Just try to avoid doing anything really stupid, and you'll make money."

Charlie
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post  
UnThreaded | Threaded | Whole Thread (5) | Ignore Thread Prev | Next

Announcements

Pencils of Promise - Back to School Drive
"Pencils of Promise works with communities across the globe to build schools and create programs that provide education opportunities for children."
Managing Your Wealth
Our own TMFHockeypop from Rule Your Retirement fame on the TV show Managing Your Wealth.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
Community Home
Speak Your Mind, Start Your Blog, Rate Your Stocks

Community Team Fools - who are those TMF's?
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and "#1 Media Company to Work For" (BusinessInsider 2011)! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.
Advertisement