No. of Recommendations: 4
Years ago, tired of answering repetitive questions about bond basics, I urged the creation of a "Bond FAQ" along the lines of faq's that are widely available in other fields, such as for programming languages or artificial neural nets. At the time, no one else wanted to share the work, so I backed away from the project and let it die. Recently, Lokicious did yeoman's work and posted a comprehensive version, and volunteers have assisted with its editing and expansion. My participation was solicited, but I backed away, arguing that (1) any basic fact about bonds or fixed-income investing should be looked up in one of the many, very adequate introductory books there are or at any of several, very excellent web sites, e.g., Investopedia, Wikipedia, and (2) the things that beginners really need to know --and which typically can't be found in reference sources-- are especially the things that cannot understood by reading a FAQ. Instead, a "proper" answer to such a question depends on the getting the questioner to understand the assumptions that underlie his question, which is a process that quickly gets deeper into investment theory than a beginner has either the interest or the ability to deal with. His question can be answered, but the answer is a heavily-evidenced, closely-reasoned monograph, not the quick paragraph or two he thinks will be sufficient. Furthermore, the proposed answer is provisional, because no one can ever offer a complete theory of investing/investments. Instead, they can offer bits and pieces that might be useful, but which --most definitely-- are provisional, because the future --which is the true "subject matter" of investing-- is unknowable.

Let me give a tiny example of what I mean, by quoting a snippet from the bond FAQ:

The upshot is that it is very difficult to predict what will happen to interest rates, even if we can identify specific factors that contribute to supply and demand (such as foreign governments buying Treasury Bonds and mortgage securities, flight from stocks to bonds during panics, looming end of the Social Security surplus, government deficits, demand for mortgages, etc.). [emphasis added]

The smart-aleckly answer, but the "correct" one, is that it not merely very difficult to predict interest rates, but it is impossible to do so, because it is impossible to predict anything and to achieve more than random success from such predictions. (That's the primary epistemological fact: the future is unknowable.) Most definitely, the inability of humans to make useful predictions hinges on a very strict definition of "predict", which is a word (or process) that can be contrasted with "forecasting", which merely makes probabilistic statements about future events, rather than absolute ones. That distinction might seem like quibbling, but the consequences are profound, because the distinction between predicting and forecasting becomes a means of judging what can reasonably be known and how the consequences of being wrong have to be managed within an investment conext.

Let's do a tiny bit of editing.

"The upshot is that it is very difficult to forecast what will happen to interest rates, even if we can identify the specific factors that contribute to supply and demand."

Now, my question is this: How many assumptions are being made in that seemingly simple statement? How many of them are testable? How many of them are wrong or irrelevant? At the very least, an assumption is being made that it is only supply/demand factors that drive interest-rate changes (instead of, additionally, policy changes and other factors as well), and an assumption is being made that forecasting interest rates should not be attempted and, besides, it is argued --but not by me-- that no one can do it successfully. My take on the matter is this:

#1 Useful interest-rate forecasts are within the abilities of ordinary investors. If a person wants to do the needed work, he can obtain the benefits that a good-enough forecast will provide.

#2 OTOH, it is never necessary to forecast interest rates. (They can be lagged, rather than led.) If a person wants to avoid forecasting, then the use of trend-following methods will provide timely-enough information about the present direction of interest rates to make good-enough investment decisions.

#3 Forecast interest rates if you want to, or don't forecast them. The choice is yours, and each choice will have consequences as to how other things in your investment plan can (or can't) be done.

Those claims depend on this further assumption: the would-be investor is willing and able to write an investment plan and then to follow it. But this is something few investors do for themselves. Instead, they accept the “conventional wisdoms” about investing, and then they work within its framework, thinking they are making fully-informed decisions. But a person who asks a question such as "Can interest rates be predicted, and how would I do it?" is really asking a more basic question: "How will I know if your answer can (or should) be trusted?" The answer, obviously, is that unless the questioner has already figured out the answer to his own question, he won't know the merits of anyone else's answer. So, ultimately, the questioner has to write his own bond faq.

Of what use, then, are investment faq's? Not their content, which must vary because each investor is unique, but possibly their broad approach, which is a reflection of the quality of their writer's thinking. That's why faq's should be read, to see how others deal with solving problems that might be similar to ones a person has to solve for himself. Often, if the approach is clear-cut, it can be leveraged. Either a wholesale knock-off can be done, or the approach can be modestly changed and then adapted to new purposes. If the approach isn't clear-cut or is obviously flawed, often enough what is of value can be salvaged, which saves having to reinvent the whole approach. Instead, just parts of it have to be fixed and can then be re-applied to old projects or to new ones. So faq's should be written, which raises this question: what is the purpose of the present bond faq? How is it --in its present form-- a better source of information about bonds and FI investing than what can be found elsewhere? Everytime I try to read it –-and here I'm only speaking for myself-- I find it to be either misleading or useless for two sorts of failures: its acceptance of assumptions that can be falsified and its failure to ground itself in the realities of actual investing. My conclusion is that the document is too broken to be fixable.

I make that criticism not to disparage the efforts of those who have created the bond faq or contributed to it, but to better understand what my own relationship to it should be. I am an experienced bond investor, but I do not know even a fraction of what I should know, the bulk of which is already readily available in an abundance of reference sources. Instead of a bond FAQ --or perhaps in addition to it-- should there be an annotated bibliography? Again, I would demur. Finding an answer to a basic question about bonds is no different than trying to locate answers to basic questions in any field. It is a matter of basic reference skills and basic reading-comprehension skills. But what is done with the information so gathered is another matter. That requires "critical thinking" skills and, especially, some experience in the subject field. So faq's are a Catch-22 situation. The faq's of others are most useful --and can best be evaluated-- by those who can write their own. And faq's, by their nature, tend to be so compactly written that newbies are overwhelmed by them, which is why I would direct all beginners to the already published literature, which tends to take a discursive, multi-media approach to introducing the basic terms and concepts of the field. Those resources need to be a beginner's first stop. Then, having mastered that material, a person might be ready to deal with faq's such as this forum's members might produce with their inevitable and arguable, embedded assumptions.

Charlie
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