I have thought for years that when I reached a certain milestone in my finances that I would begin to diversify. Time has marched on and I see that milestone on the horizon. I am ashamed to say that other than the very basics I am not familiar with bonds and of course not prepared to begin participating. Would the community please recommend books and other resources? I currently trade with ETrade and optionsXpress. Is there/are there online brokers who cater more to bonds?ThanksLouisianaFool
LF, E*Trade is an excellent bond broker, offering plenty of inventory and reasonable commissions. Zions Direct is comparable. But if E*Trade is where you have an account, begin your learning there. For a start, click on the <Research> tab at the top of their page. Then click on <Bonds> in the line below. Then click on <Search & Trade>. Then click on the bright yellow-green button that says <View Results>. Ignore the list of bonds that is produced. Instead, look to see if there are three buttons at the bottom of the list that say <Edit Search> <Download>, <Build Ladder>. If so, your evaluating will be easier, because you can do it in a spreadsheet without having to scrape web pages to get the data into Excel. (Explanation: Older accounts have the three buttons. Newer ones don't. One's operating system makes no difference.) Failing that, do a 30-day, free trial demo of Zion Direct's search-engine. That's the key to bond investing, learning how to use a search engine to find what should be bought and to filter out the rest. Also, it helps hugely if you create for yourself a clear understanding of how to measure the impact of inflation on bond yields so that you don't deceive yourself as to much you are buying. (Explanation: There is a huge difference between nominal YTM and spendable YTM that long maturities exacerbates.)If you want a beginner's book (for vocab and basic concepts), Sharon Saltzgiver Wright's Getting Started in Bonds is as good as any. It's now in its second edition, and cheap copies are available from eBay. (Either edition is as good as the other). In the world of bond commentary, three names stand out. Bill Gross is too important not to pay attention to, and Marilyn Cohen is a shrewd, highly risk-adverse, but nonetheless very aggressive manager who offers would-be bond investors good guidance through her books, columns, and interviews. The third name worth tracking is Danial Fuss and the gang at Loomis Sayles, especially their thoughts on multi-sector bond investing.But the bottom line is this. Just because the conventional wisdoms argue that older investors should rotate money toward fixed-income doesn't mean it should be done. As other conventional wisdoms also argue, "It all depends". And the converse might be true as well. No one argues that anyone should run an all-bond portfolio. But that's exactly what I do, and I kick serious butt in terms of results achieved. (Returns for 2009 were 33.6%, for 2010, 19.9%, For 2011, they are on track for something in the 10%-15% range.) What bond-investing does require is a lot of capital and a lot of patience. The upside is that if it is done well, there is very little downside. The downside is that there is very limited upside. On average, you can expect stocks to provide about a 3.5x advantage over bonds. However, because bonds are puts, they (generally) let an investor sleep well at night. So what I'd suggest is this. Bonds, as an asset-class, are hugely interesting and reasonably profitable. But if you're already meeting success with other instrument and methods, why go looking for trouble? Right now, the bond market is very expensive and one step away from blowing up. Charlie
LF,I dont think the bond market will blow up.....could be wrong though....I think if you use bonds for a long term buy and hold strategy to produce income......inflation over the long haul will eat you alive.....your retirement will be down the drain......on the other hand.....there have been a few more recent threads on trading bonds......which were great threads.....and a thread on perferreds which were worth while......both of those threads centered on Charlie's thoughts with some input by others......for this board those thoughts are the crux of what is possible and what is stupido risk....unnecessary unwanted harmful risk......they say while you are young take risks to get ahead.....and when you are older go conservative......just be conservative.....if someone faceless in the market is selling you risk.....run for the hills.....it is a fool's errand.....Dave
Opps. I was thinking 'Amazon' but wrote 'eBay'. This is a link to Wright's book: http://www.amazon.com/gp/offer-listing/0471271233/ref=tmm_pa...Another into that is worth reading (but a bit expensive to buy) is Barnhill's High Yield Bonds: Market Structure, Valuation, and Portfolio Managements http://www.amazon.com/High-Yield-Bonds-Structure-Strategies/... But most libraries can borrow the book for you if they don't have it on their shelves.
LF,Investopedia is your friend. There is great deal that can be learned from those articles. As Charlie pointed out the bond market is not an easy place right now to make money. It can be done but it helps to be a seasoned bond investor with a system already in place. The good news is now would be an excellent time to learn because there is no rush to jump in the market. Your not missing the boat. If you have investing skills from other asset classes leverage those into your bond investing. If you know how to research stocks then you are 3/4 the way to researching bonds; you have the company stuff down you just need to figure out pricing and position sizing. I'm not a huge bond fund fan but if you have a good skill set for evaluating funds then you could leverage that into learning more about bonds and evaluating CEFs(which I think are a better form of funds for bond investing). There is nothing wrong with paper trading for a while to experiment without any money actually on the line. This approach works for some and not for others. As Charlie points out, just because the industry says we should start rolling more and more into bonds for every year after 50 does not mean that is actually good advice. The real game is conserving capital and not exposing retirement money that we will need soon to too much risk. Just because it is a bond does not mean its automatically less risky. It is counter to much canned advice but occasionally there is less risk in a basket of solid dividend paying stocks then in a bond market chock full of overpriced bonds. Each individual responds to the many different kinds of risks we find in investing differently. Manage your risks in a way that you find both prudent and understandable. The bond market is a fascinating market full of opportunities. Its not that hard to learn the basics and the lingo. It does take some practice and discipline to be a consistent winner. The same pitfalls exist here as in other markets. There is that odd desire to chase performance or to become overly aggressive trying to make up for mistakes. Slow and steady wins the raceGood luck and feel free to ask any question that your bump into as you try to figure this thing out.jack
Thanks all, definitely seasoned advice. Have ordered books and will begin paper trading after I have something of a grasp on this. Great point about the present environment, I'm not one to jump in just to test the water when a toe in the water will do.
LF, Jack's advice is solid and sound. If he suggested paper-trading, then that's what you should do. But, frankly, I don't know how it could be done with bonds in any meaningful way, due to the following problems:(1) Atrociously-wide spreads.(2) A frequent dearth of offers and bids for outstanding issues.(3) Onerous, minimum-position sizes getting in. (4) The frequent near-impossibility of getting out, as in, no bids for the bond you're trying to sell. (5) The near-impossibility of obtaining historical data more than a year back. (6) The near-impossibility of doing conventional technical work (MA cross-overs, etc.)With stocks and Forex, paper-trading is simplicity itself, and there are many places where it can be done with virtual cash and real-time data. But nothing similar exists for corporate bonds, agencies, or munis that I'm aware. For treasuries, one could use futures contracts as a proxy for individual bonds. But it's going to be tough to "dip a toe" in a virtual bond market, because one doesn't exist. In lieu of that, I'd suggest that you begin to learn how to screen for bonds using E*Trade's search-engine. Also, begin to set up a go/no-go check-list for yourself of what a prospective bond must meet in terms of min yield, min credit-quality, max maturity, presence/absence of tax and structural features, as well as a couple of benchmarks that let you guage where bonds are trading relative to their short, intermediate, and long-term trends.
Charlie,Fair critique, let me try to clarify. I'm not suggesting running any sort of back testing. As Charlie points out there are large hurdles to attempting to back test. Personally I find little use in back testing, lots of sweat to find out that markets behave like markets. I'd suggest that you begin to learn how to screen for bonds using E*Trade's search-engine.This is where I would suggest you begin. Find a bond that interest you and do your research. If you decide its a winner then "paper buy" it and put it in the spread sheet. If need be start an buy order and then do not complete it if that will give you more specifics on the cost. Once on the sheet you need to track it as if you bought the bond. If you care about monthly price shifts then track them. If don't, then don't bother. Neither choice is wrong. Sometime down the road you do need to analyze your buy with a critical eye. You may find out that although you did not think you needed track monthly price changes you now find that you wish you had or you did and you found it to be a waste of your time. Either way you now have an opportunity to fix it. As you dig for potential winners you will run across many of the issues Charlie points out. As you do you can begin to tweak your actual costs for the bonds. You will also begin to tweak your expectations. The important part in the beginning is not the annoying mechanics of bond trading but can you find a bond you think is a good buy. Its kind of like buying a car; you can find the right car and you can find the right price but can you find a dealer willing to sell it to you for that price. Having confidence it what you are willing to buy and at what price will make negotiating all the mines in the field that Charlie points out a bit easier when you actually get to the point you want to dip a toe.(1) Atrociously-wide spreads.When we buy in less than the positions the bigger wheeler dealers in the game prefer we don't get the best price. If we want 1-4 and someone is selling 20 they may not want to sell to you at all or they will increase their asking price because you are going to make it more difficult for them to get rid of the other 16. (2) A frequent dearth of offers and bids for outstanding issues.Unlike stocks when the number available are gone they are gone. Sometimes someone will see the price movement and join in to unload theirs but there is not always a seller for what you want to buy. What you researched yesterday can be gone by today. (3) Onerous, minimum-position sizes getting in. Bond desks like lots of 100 or "round lots". That is $100,000 of face value of the issue. Any time we get under 100 things can and will go less smoothly. Charlie and many others are quite successful in picking up ones and twos but they take more effort and we don't get the same price as those trading tidy round lots. (4) The frequent near-impossibility of getting out, as in, no bids for the bond you're trying to sell. As hard as it is to buy in small amounts it is just as hard or harder to sell them. Buy and hold to maturity is often the primary plan of the small lot bond buyer. You can find buyers but it often takes a great deal more time, patience and perseverance and the bid ask spread bug is going to likely bite again.(5) The near-impossibility of obtaining historical data more than a year back.(6) The near-impossibility of doing conventional technical work (MA cross-overs, etc.)I don't bother with these things. I am not a technical approach type investor and I am for more concerned with what is next over what happened prior. Everyone needs to find their own way. Work what works.jack
Jack, I “critiqued” your advice to paper-trade for two reasons. I knew you didn’t mean it as the word is generally used when applied to stocks and that you would come back with clarifications and amplifications from which I would benefit as well. Two, it gave me a chance to point out some problems peculiar to bond-investing that have to be dealt with. Let’s create examples of the latter. (1) You find a bond you’d like to buy, but the min is five, and you only have enough cash -- right now-- for one or two. Even though this bond should be bought, you’ve gotta pass. Sometimes it’s possible to do a work-around by pulling the book for the bond and finding a dealer whose min is lower, albeit with a higher price that what is being shown as the inside market. But just as often, all mins for that bond are the same or worse, and the spreads are even wider. You want the bond. You should have the bond in your account. But you can’t afford it. Munis are especially bad about this. Having to go five is bad enough for small account. But the tens and twenties (and more) that are common are real killers of any attempt to achieve diversification from limited capital. (2) You find a bond you’d like to buy. The risks are horrendous, but the reward is fat. As a single position, it would be irresponsible to risk much money on the issue. But as a basket of risks, of which this bond would be only one part, it not only makes sense to buy, but it has to be done, so that one gains exposure to positive “black swans” (rather than just trying to avoid the negative ones). In this case, it makes sense to go one. But five or more doesn’t. Let me give you a concrete example. I shop daily. When an issue I haven’t seen before comes onto the market, I generally spot it. Last December, a tiny lot El Pollo’s 11.75 of ’13 (min one) came onto the market at 87.500. It doesn’t take calculator to know that the yield is fat. So I went into high gear, doing my due-diligence. There were huge negatives, but there were some positive as well. So I sprang for one for a projected YTM of 16.9% and promptly emailed a trading buddy that he should look at it, too. He passed, as I often do the suggestions he makes to me. But it wasn’t an issue he would have noticed that day, and he appreciated the heads-up. Recently, the holding company solicited tenders, and I got out at 103.130 for an achieved YTM of 34.2% over my holding-period. For the portion of the portfolio allocated to high-yields, that isn’t an unusually high return. But if one is allocating assets prudently, those kinds of yields are needed to make up for the losses that are going to be suffered from positions that don’t work out and from the bonds bought for safety that offer miserable yields. In retrospect, it might seem that I could have gone five. But that is exactly the kind of sloppy thinking that gets yield-hogs into trouble sooner or latter. You sip risk. You don't gulp it if you expect your account to survive for the long haul. In the fixed-income portion of one’s portfolio, one can choose to avoid high-yields altogether, for being able to offset the typically very low returns offered by higher credit issues by making use of other asset-classes (typically, stocks), or one can use an risk-allocation strategy such as I do, something like the following: 1-2-3 or 1-2-3-4, where the smallest portion is the most risky, and the larger portion is "safe and boring", so that an overall, average return of 7%-9% is achieved, which is about the upper limit what can be done with a properly-diversified, massively-robust, nearly bomb-proof, fixed-income portfolio. Yeah, some years, average gains are going to tag 20%-30%. But when time-value is stripped out, as it has to be, the long-term numbers are going to be sub-10%. (And if an investor is doing the crazy things Lokicious used to advocate, the numbers are going to be sub-4%, especially these days, and a sure way to squander purchasing-power.) What I’m saying about size is this. Not only is it often hard to buy small, it is always very expensive. “Expensive” kills returns in ways the stock guys no longer have to deal with. What is their average spread these days, a penny? Of the approximately 7,000 stocks traded on the three major US exchanges, the average price is about $17, making a spread of a nickel a mere twenty nine basis points. But an average bond price is near par, and an average spread is about a point and a half. Throw in a commish of another point,, and a would-be bond buyer is already down by 1-1/2%-2-1/2% on a single that might offer him as little as 5%-7% a year. In other words, one second into his ownership, he is already down by as much as a half a year of expected gains. Obviously, the impact of spreads and commish can be mitigated by trading in size and/or going long-dated. But attempting to achieve savings that way bring its own, worse problems, the out-sized risks that come from over-weights and/or massive inflation-risk and/or a dozen other bad things that can happen. So a small bond investor (aka, someone who can’t responsibly buy tens/twenties, due to having less than $1-$2 million to work with) is damned if he/she does and damned if he/she doesn’t. He can't buy big, nor should he. But in order to overcome expenses, he has to take on extra credit-risk. He has no choice if he going to make the asset-class work for him until the time he's becomes big enough to buy big. I could run this rant for a couple thousand more words, making additional points about the hurdles a small bond-investor must overcome. But I’ve gotta get gear together for an upcoming trip, and I owe Joel a reply for his thoughtful critique of comments I made about preferreds. Charlie
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