Caveat: The following is a thought-experiment, not investing advice.“If I had to put some money to work in corporate bonds today, what would I be willing to buy?”Here is my list and reasons: Aaa/AAA’s: Nothing. Near-by yields are too low, as are far-off yields. But I’d put Johnson & Johnson and Microsoft on a watchlist with the intention of coming to understand the companies while waiting for buying opportunities. Aa2/AAA’s: Nothing. Near-by yields are too low, as are far-off yields. But I’d put Berkshire and Pfizer on a watchlist with the intention of coming to understand the companies while waiting for buying opportunities. But if I really, really had to spend some money in these two rating groups, I’d look at Berk’s 5.4’s of ’18.Aa2/AA+’s: This is a phony-baloney rating group created for political reasons whose sole member is GE and its wholly-owned companies, e.g., Arden Realty. GE’s fundamentals do not merit an Aa2/AA+ rating. However, GE is too large a bond issuer to ignore, and too many good opportunities occur with the pricing of its debt to ignore, either. Just be aware that the reasons the yields are fat is because its debt is risky. Selecting the sweet spots is simply a matter of building yield-curves. The 6.3’s of ’18 (6.21% CY, 6.04% YTM) might be a place to begin. Aa2/AA’s: The only notable name to show up in this group is Wal-Mart. Predictably, their debt isn’t cheap. Nonetheless, it should be tracked in case an opportunity might occur. OK. I’m not going to grind through the whole of the secondary offering list, one rating group at a time. But it’s easy to infer the underlying method: take on the least amount of yield-curve risk and credit-rating risk in exchange for the most amount of reward currently possible. That means starting with the triple AA’s and then working all the way down to the double CC’s. The commonly made distinction between “investment-grade” and “speculative-grade” is neither useful, nor dependable. Corporate bonds are a continuum, not two distinct asset classes. Labels (by themselves) offer no protection against risk, nor do they cause risk. The fundamentals of the issuer are what matter. The evaluation process is the same, no matter the rating: “Do the possible rewards justify the probable risks?” Thus, one shops with the willingness to make whatever compromises have to be made if they can be justified as reasonably prudent. Typically, positions are sized (relative to working capital) as small as possible, so that when better opportunities occur, capital will be available to pursue them. But a disciplined investor doesn’t just sit on the sidelines, only to see that what wasn’t the best of prices has gotten worse. Due to the impossibility of predicting the future, some buying has to be done on a consistent basis, no matter where the current market is. Not a lot, but some, because the constant effort to discover what might be worth buying keeps one current with where prices are and enables one to spot the bargains when they do occur. Some days, one does no buying at all. Some days, one spends all available capital. But the shopping never ceases, because investing success is about consistency of effort and discipline of method more than anything else. The tortoise might not win every race against the hare, but you can bet he will get to the finish line in a timely-enough manner.
Thanks very much junkman. This is a very timely post as I am about to figure out my next steps for reconstructing a 96% cash portfolio. I've never invested in bonds beyond minimal individuals and bond funds/TIPS as part of an asset allocation.FC
FC,Trying to put 96% of your money to work in bonds would be daunting task. It's the classic "lump-sum problem". Does one go all-in now, or average in over time? My suggestion would be to go at it slowly. Decide your preferred market-cycle length in terms of how long it takes you to do a 100% turnover of your portfolio. E.g., if you choose to work with a 5-year cycle, then each year's task is to put 20% of your working capital to work. (Alternatively, cull 20% of a fully-invested portfolio.) For me, for bonds, I find a 10-year cycle to be a comfortable research pace. I tend to initiate one new position per week. (YTD, I have initiated 43 new positions. In 2007 and 2008, I did just under 50 each year.) In 10 years, that would be 500 positions. But a lot of them will have matured, been called, or blown up. So one's actual working portfolio will be smaller, maybe 80 to 100 positions. (E.g., my current position count is 187.)Obviously, when "blue-light specials" are happening, a person spends every penny he can get his hands on, or maybe even buys on margin (provided the margin purchases can be covered within a very short time frame). Conversely, when prices are ridiculously high, one backs away from doing much buying. So the choice of a market-cycle length is a rough guideline, not a fixed recipe. But, depending on one's age, figure that in a lifetime of investing one will go through 3 to 8 market cycles of 5 to 20 years length. The number of positions one wants to deal with is something that also has to be decided. Realistically, 20-30 companies is almost too many to track very closely. So, obviously, tracking 100 plus closely is impossible. But the upside of holding the bonds of a lot of companies is "portfolio robustness". So one has to decide whether one prefers to "index" or to make focused bets. I prefer to index with this difference from the customary meaning of the term. I do not make my entries whilly-nilly. I try to buy when the buying should be done, and I tend to prefer mid-range to long-dated issues. But over time, I end up with better prices than a pure index would offer and just as good diversification by industry, maturity, and credit quality. As for which bond broker, don't use anybody but E*Trade when you're starting out. They offer the best search engine and best access to inventory. Best wishes, Charlie
junkman,I want to make sure I understood your earlier post regarding what you've invested so far this year. Does E*trade let you invest in individual bonds rather than lots of five or more? Currently, my bond broker, Muriel Siebert appears to work that way. Scottrade is even worse. They seem to demand a minimum investment of $10,000 in bonds.Also, does E*trade let you buy bonds directly or do you have to talk to a broker? With Siebert, I talk to a broker who will shoot down ideas without really explaining why or telling me where to look to find out why a certain may be way too risky. If I insist, a transaction would be made but most of the time I walk away without having accomplished anything.Thanks again for your instructive posts!
folgore,Working with a bond broker has upsides and downsides. If he (she?) knows the bond market well and loves the investing game for its own sake, then his/her advice can be worth paying for (however they are getting paid, though commish, markups, whatever). OTOH, if he/she is just trying to sell you what they have in inventory and want to get rid of, or what they will receive payment for order flow on, then close the account. You don't need that kind of grief. Investing is hard enough without some ignorant, self-interested salesman taking his cut from your profits and/or disrupting your investing. As to minimum order size, that is set by the underlying desk holding the bonds and by the brokerage firm through whom you are executing. Most boutiques, like Seibert, don't want to handle less than ten bonds. Scottrade has a firm policy of 10-minimum. At Fidelity and E*Trade, minimums can be as small as a single bond. But Fido doesn't quote as much of the market as ET.Within the various maturities of a single issuer, e.g., GE, some bonds might have a 5 min or a 10 min or an 8 min (if that is the whole lot being offered). But, generally, somewhere in the yield curve, there will be an offer flagged (1/1). Also, some days, a 5-min is as small as you'll see for an issuer like Weyerhaueser (5/1). Other days, there will be singles available. (1/1). So, sometimes, patience is needed to get the size/price you need. Charlie
<o>Also, does E*trade let you buy bonds directly or do you have to talk to a broker?folgore,I forgot to answer this part of your question. Sorry. The technically correct answer is "No" and "No". You are not buying the bonds directly in the sense that you not the one who is doing the the deal directly. You are acting through intermediaries. But you don't have to talk to anyone.Let me explain. At all bond brokers I'm aware of (except, possibly IB) the customer transmits his order through what amounts to an email messaging system. The broker's bond desk then acts on the order, which typically takes this form: an acknowledgment of receipt of the order and then a fill, or a rejection. Let's deal with the latter case first. A rejection can happen for several reasons: "bonds already sold", "bad price", "market has moved", etc. The reasons and excuses are many. Lately, I haven't been rejected on any orders. But when I would get rejected and could see in another account that the bonds were still being offered out, I'd phone the broker. But nothing ever was changed. That's the reality of being a small customer. The broker can do whatever he wants to do. Complaining to the SEC isn't going to do any good. You won't get an investigation of whether the broker should have given you the fill or not. Now the good side. The time to get a fill can vary from nearly instantaneous to as much as 5 minutes. If the bonds are in the broker's own inventory, then the fill is fast. If the broker's bond desk has to contact an underlying desk, then the fill happens as fast as the various humans (or machines) all can do their their part of the process. But it should never be the case that you have to call a broker to talk about your order, either to initiate it or to correct problems. The times I have talked to people from a broker's bond department, I've invariably found them to be friendly and competent, no matter the broker. Bonds are what these guys do --they are invariably guys, not gals-- and they like what they are doing, and they are good at it. Every broker has a two-step order process. In the first step, you specify issue, size, and price. In the second step, you confirm or cancel. So there's no chance that a stray mouse click will send an unintended order (as can happen when using a direct-access trading platform). Obviously, I'm giving you a once-over-lightly, simplified version of what actually happens. But buying bond online is very easy and very unproblematic. Like stocks, settlement is T-3 (unless, of course, you're executing through a direct-access broker like IB, but you won't be). E*Trade is where you should start out. Set up a margin account, and don't hesitate to initiate a trade using margin. But as soon as you get a fill, scramble to cover your purchase, so you don't incur their abusive margin rates. Typically, this can be done same-day and real-time with a free ACH transfer from a linked bank account. Again, best wishes, Charlie
Thanks again, Charlie!I think I will have to follow your advice and set up a new account with E*Trade. E*Trade actually was my first online brokerage account back in 1999. Then for a time, they became fee happy putting all sorts of fees on small accounts and I transferred my funds elsewhere. Based on what I see now, they only require an account balance of only $2000 and their commissions are lower than they were 7 years ago.Regarding bonds, E*trade's site states $1 per bond for a minimum of $10. So apparently, you can buy an individual bond albeit for a $10 fee, which is still very reasonable. Muriel Siebert has a minimum charge of $35. ($3.50 per bond)
folgore, At E*Trade, if the account size is less than $10k, then a $40/quarter fee is asssessed. If assets are over $10k, then no fee. So $10k is the real minimum. By contrast, at Fidelity, the fee-less minimum is $2,500 and the per-ticket commission on bonds would be $8 (instead of E*Trade's $10). However, Fido quotes far less of the secondary corporate market than E*Trade, so much so, that it isn't worth setting up an account with them. An alternative to E*Trade would be Zions Direct (aka, Bonds for Less). They quote nearly as much of the market as ET. Their per-ticket commish is $10.95, and I have no idea what the minimums on assets are (even though I have two accounts with them.)In buying bonds, there are two costs to be concerned with: commission and price. Commissions vary from broker to broker, as do prices. Thus, it makes no sense to save a buck or two on commish at one place but pay a point or two more on price (a point is $10, right?) than one would have to do elsewhere. Bottom line? Right now, E*Trade is the overall cheapest and bestest. However, they are far from perfect. As Ron reports, the platform that E*Trade makes available to its customers varies capriciously. I can download an offering list directly into Excel (which facilitates building yield-curves). He can't, and E*Trade's tech support was unable to resolve the difference. There are workarounds. But be prepared to have to use them. Bottom, bottom line? If you're just going to be buying an occasional single bond, it won't matter who you do business with. OTOH, if you want to get serious about building a bond portfolio, then you need a decent bond broker and the willingness and intention to commit a couple hundred thousand and 20-30 years to the project. That's how investing in individual bonds make sense, over the long haul, year after year, good markets and bad, so that statistical averages can be captured. Otherwise, stocks make better sense, and (these days) ETFs even better sense due to the ease and low costs of getting in and out and the instant diversification they offer. Individual bonds can be traded. But they are best used as buy-and-hold vehicles, and long-dated bonds typically offer better value than short-term ones. So, depending on your age, your maturities will outlive you (unless, of course, the bonds are called or blow up, both of which will happen). The preceding is just an opinion, and everyone will have their own. But it's my belief that it will be a rare investor who can do more than one thing well. So people become stock guys, or bond guys, or currency guys, etc, but they don't mix the two or three or four. If they want better than average results, they focus on one asset class (or technique) and become very good at it. If they want just middling results, then they do the standard "a-bit-of-this, a-bit-of-that" approach. So the question you should ask yourself is "How serious do you want to get about bonds?" If you intend to commit serious money and time to the project, then set up an account with E*Trade and begin to plan a "rest-of-your-life" campaign. Dabbling on the fringes will result in one of two things: no better results than a bond fund would offer, or more grief than you ever wanted. To make good money in bonds, you've got to be pushing the limits of the asset class. But to survive for the long haul, you can't be making irresponsible bets. (You'll blow yourself up.) So success means learning to balance risk and reward, and that takes practice and time. Best wishes, Charlie
What about the LAZY index investor who doesn't want to "get serious about bonds"?On the equity side, lazy is easy and lucrative. Just use one to several index equity funds or ETFs and one has a great stock portfolio that only needs to be looked at about once a year and rebalanced every 1 to 5 years.Is there a good lazy way to invest in bonds?
What about the LAZY index investor who doesn't want to "get serious about bonds"?On the equity side, lazy is easy and lucrative. Just use one to several index equity funds or ETFs and one has a great stock portfolio that only needs to be looked at about once a year and rebalanced every 1 to 5 years.Is there a good lazy way to invest in bonds? Wow. Are you saying that you have never heard of a bond fund?AM
AM:<iWow. Are you saying that you have never heard of a bond fund?Of course I've heard of bond funds. I use three indexed bond ETFs for my fixed income portfolio.My fixed income port:40% BND (US bonds in US$)40% BWX (non-US bonds, developed countries, non-US$)20% PCY (non-US bonds, emer mks countries, non-US$)When I suggested this strategy to a beginner on this board, Charlie (junkman) chewed my head off.
AM:<iWow. Are you saying that you have never heard of a bond fund?Of course I've heard of bond funds. I use three indexed bond ETFs for my fixed income portfolio.My fixed income port:40% BND (US bonds in US$)40% BWX (non-US bonds, developed countries, non-US$)20% PCY (non-US bonds, emer mks countries, non-US$)When I suggested this strategy to a beginner on this board, Charlie (junkman) chewed my head off. ----------------------------------------------No one should chew your head off.Everyone has different needs and different reasons for how they invest and what they invest in.Bond funds have many advantages over individual bonds.They also have disadvantages. You just have to figure out what is most important to you.I, personally, currently own 5 different bond funds.It's not only the lazy person's way to invest in bonds -- it's the non-bond-expert's way of doing it. If you don't know what you are doing -- and I mean REALLY know what you are doing -- it's always best to leave the doing of whatever it is to the experts.Since I don't know what I'm doing, I leave it to the experts. Some people really get a lot of enjoyment out of studying up on this kind of stuff. My eyes glaze over. What should be straightforward and simple, isn't. When anything gets complicated, grab tightly to your wallet.I like the simplicity of bond funds. If, for whatever reason, I want out - I'm out. Immediately (well...at the end of the day). If one batch of bonds is not performing as I would like - pow! I move all my money to a different fund.But since you have heard of bond funds...I'm wondering why you asked about a lazy way to invest in bonds. How much lazier could you get than using my method? ;o)AM...oh yes! I think ETFs are too volatile -- that's why I (mostly) avoid them.Disclaimer: I am SO not an expert wrt bonds that you should take anything I say about them with a very suspicious eye. ;o)
Foreign bonds are available. But I wouldn't mess with them except within the framework of a fund.Corporates is another matter, as is defining "diversification". For that, Chapter 20 of Barnhill's book offers as good an answer as any I've seen for its critique of attempts to simplistically apply concepts that might be appropriate to stock portfolio to bond portfolio.If the purpose of "deworsification", as Buffet calls it, is to protect against ignorance, then the better techniques are either proper due diligence and/or proper position sizing. Diversification, however one wants to define it, comes in a poor third and should be a very minor concern compared to buying properly in the first place at a deep enough discount to create a margin of safety.Yes, the mutual funds tout "instant diversification" as one of their talking points. But grind through their schedules of holdings sometime and run correlation tests. What they preach and what they practice are worlds apart. They make very focused bets whose correlations tend toward 1.0 when their holdings come under stress. Thus, when diversification is most needed, they cannot offer it. That, too, is easy to document. Just pull the historical data and run the tests in Excel. ("Been there, done that" many a time.)temsike,If the preceding post is the one you are referring to, then I wasn’t “chewing anyone’s head” except that of the mutual fund industry who (generally) will lie shamelessly (about risks and returns) in order to gather assets. But as fast as putative reforms could be enacted, the fundies will evolve new strategies. So the only effectively way to regulate abuses is for shareholders to walk. That said, for a lot of people, funds –-no matter how imperfect they are-- are a useful tool, and whether to use them has to be an individual choice. For the typical 401k owner, funds are their only choice. So they have to learn to use them as effectively and as appropriately as they can. Are there lazy ways to invest in individual bond bonds? For sure. Simply wait until prices are absolutely compelling to do your buying. How frequently do those buying windows occur? Maybe once every three to five years. Meanwhile, for a person who has to (or chooses to) put money to work in bonds, more work is going to be required. Across any asset class, there are Easy/Lazy/Simple ways of doing things. In normal markets, those can be very effective ways to put money to work. But when markets become distressed, those purchases become vulnerable and/or prices move against the position. At that point, most people become very uncomfortable with their earlier-made decisions and regret not having put a bit more thought into them. So the trade-off seems to be this: “worry now, or worry later”, and that, too, has to be an individual choice. The “bonds versus bond-funds” debate amounts to a very pointless religious war. Each side musters evidence and arguments, but both sides are losers to the extent they don’t pay attention to a lot of other facts like the needs of individual investors and the opportunities offered by markets. With proper structuring, nearly any investment technique and/or asset class can provide excellent risk-adjusted returns. So investors have more choices available to them than they could ever possibly explore. So two things happen. Everyone touts their own favorite technique (as they should), and the fundies try to talk everyone into buying funds (as they should, too), because variety and competition are Good Things. I don’t argue that everyone should buy their own bonds, nor do I argue that no one should buy bond funds. But I do argue two things (1) Whether one does one or the other (or both), one must be an informed investor, and (2) There will be a correlation between informedness and results. Sheer, dumb luck can get a person a long way in the investment world and might never run out. But that isn’t the smart way to bet. If one’s intention is a lifetime of better-than-average, positive, investment results, not merely the relative results that come from “owning the market”, then it takes a lot of hard work to find a simple, easy, lazy way of achieving that. But it can be done. For corporates, a game-theoretic approach, rather than a classic, fundamentalist approach, is as close to lazy as it is possible to get. (And, no, I’m not going to spell out how to do it. But anyone who understand options --which is what bonds are-- could piece together an effective approach.)Best wishes,
Thank you Charlie. Putting together a good fixed income or equity portfolio using individual bonds and stocks requires a lot of financial knowledge, hard work, and confidence in one's abilities--especially when everything is going to hell. It takes a lot of time also.OTOH putting together a good fixed income or equity portfolio using indexed bond and stock funds or ETFs is easy; does not require an ability to read financial statements; and the only buying and selling that needs to be done is to rebalance the portfolio's main (stocks/bonds) and sub-main components (lg, small, foreign stock/bond funds/ETFs) every one to five years.At least for stocks, the lazy way, i.e. taking the market average via index funds or ETFs turns out to be a very, very smart strategy. As far as my stock investing goes, I am a convinced disciple of John Bogle and William Bernstein.The big question here: is a lazy, fixed income strategy, using indexed bond funds or ETFs to obtain the market average return, a very very smart strategy also?
The big question here: is a lazy, fixed income strategy, using indexed bond funds or ETFs to obtain the market average return, a very very smart strategy also? A key point to note is this.When you buy bonds, you are buying fixed income instruments. As long as the company doesn't go out of busy you are receiving regular preset coupon (FIXED INCOME) amounts based upon your initial (or aggregate of all purchase) amounts.When you buy Bond Funds, you are buying shares of a pool of money that has been / will be invested in fixed income instruments, but which will result in a very UNfixed income to you the buyer.One is not inherently better than the other, but they do behave very differently from one another.Scott
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