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Author: trader2012 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35387  
Subject: Looking for Bonds (Part 1) Date: 11/21/2012 12:14 PM
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Looking for bonds to buy is no different than looking at fruits or vegetables at the grocery store. “Is the price reasonable compared to what else is offered?” So, let’s work through an example.

Despite what the BLS reports monthly, consumer inflation --as it is experienced at the household level-- is probably running around 5%. Therefore, to buy bonds offering less than one’s own experienced inflation-rate cannot be considered ‘investing’. Clearly, it is something else, such as ‘cash-management’, wherein one’s chief concern is the return of nominal-principal, rather than a return on that principal. Cash-management is a game we all have to play if for no other reason than it is prudent to carry an emergency fund equal to at least 3-6 months of living expenses. Additionally, depending on one’s risk-management strategies, a chunk of cash might have to be carried as part of one’s normal investment-portfolio.

But only the truly rich afford to be 100% in cash, and only they can substitute a cash-management strategy for their whole of their investment strategy. The rest of us have to accept risk to our capital, because we need (or want) to make it grow. The rich, by contrast, have the luxury of being able to spend down their capital over their lifetime. So they can accept the tiny returns offered by CDs, TIPS, and other such principal-principal instruments.

Also, it can be assumed that a householder’s average, marginal, Fed-State tax rate is around 25%-30%, not the effective 13%-15% tax-rate of the rich. Therefore, for a small investor, an investment gain of 8% is merely a break-even rate of return. To accept less is to choose to lose money (aka, to choose to lose purchasing-power).

In today’s bond market, 8% can’t be found unless on is willing to accept credit-risk. Furthermore, given the Fed’s promise to keep interest-rates low at least through 2015, even 5% can’t be found unless one is willing to accept credit-risk. Therefore, the bond-game has become much simpler. You can choose the trading-game of making interest-rate bets, or the investment-game of making credit-worthiness bets.

Though there is no material difference between the two approaches --and no difference at all between ‘investing’ and ‘gambling’ --, I try to conduct my betting operations as an ‘investor’, not as a ‘trader’, and certainly not as a ‘gambler’ (in the pejorative sense of that word), though I do try to be a ‘quant’ to the extent that I can, which is just a fancy term for ‘gambler’. In other words, no matter the asset-class one is trafficking in (stocks, bonds, commodities, whatever) , and no matter whether one calls oneself an ‘investor’, a ‘trader’, a ‘speculator’, or a ‘gambler’, in all cases, bets are being made about unpredictable events. Depending on the accuracy of one’s predictions (aka, ‘forecasts’), money will be made or lost. So the process of making those bets is hugely important, and it’s a process that doesn’t get sufficient attention (except in the trading literature, and only then by those who worry hugely about ‘risk-management’).

[..to be continued another time by working through a typical day’s bond-offering-list, showing how I attempt to vet bonds and then execute or back away.]

Charlie
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