Skip to main content
No. of Recommendations: 3

Thanks for the complement. (Flattery will get you everywhere.) But with bond investing –heck, with any investing— it isn’t a matter of “smart”. It’s a matter of simple pragmatics. “Uh, if I do this, what happens?” And just as important: “What do I have to believe about world (and myself) in order for me to act?” Markets are complex enough that any theory will work some of the time, and no theory will work all of the time. So losses are the first fact that has to be accepted. They’re going to happen. Some can be understood retrospectively. Many simply have to accepted as “this is what happened this time”. If gains are adequate, losses become merely a cost of doing business. So, for me, the way to reduce risk is to accept risk and to get paid well for accepting it, because risks can’t be avoided, only managed.

In bond investing, the risk that sends everyone into a panic is default-risk. Behavioral finance offers reasons why. #1, investors give twice as much weight to losses as they do to gains. #2, they give disproportionate weight to near-term losses rather than distant ones. #3, they think concretely, not abstractly. #4, they become ego-invested in the “correctness” of their decisions rather than the effectiveness of those decisions. Etc. The empirically-discovered list of mistakes that investors make is lengthy, and it goes a long ways toward explaining the failure of “average” investors to achieve even average returns and their hostility towards those who do achieve above average ones. (What I call the DeTocqueville phenomenon, that it is un-American to be better than anyone else.)

Thus, they are terrified of default-risk and its near-term concreteness, but mistakenly discount the threat of inflation-risk for its vagueness and non-immediacy. Not everyone will frame the debate that way. But that’s how I see the investing problem. Default-risk is a minor annoyance that is easily managed. Loss of purchasing power is the genuine threat, but even that can be managed as long as gains are multiples of its likely risk. Therefore, from the getgo, one has to push the limits, so as to know where the limits are, both of markets and of oneself. From there, one backs off a notch or two or three, secure in the knowledge that, if need, be one can gear right back up to bleeding-edge performance.

People don’t think about investing that way, but I do. Therefore, one should be constantly pushing, probing, exploring, questioning, learning, expanding, growing, and the low-level stuff becomes increasingly easy and increasingly less important, which is exactly where most investors go wrong. Because they have no high-level testing framework, they can’t do the low-level stuff with grace and ease, because they are trying to walk in someone else’s borrowed shoes, not their own that they crafted over time to fit their feet exactly. (“There are no roads but by walking.”) The investing process is no more complex than taping and mudding dry wall. The actions are simple. But grace and ease only come from practice. But this is America, where instant success is expected and money from financial markets has come to be seen as a “birth right”. My response? Yeah, sure.

So I would urge you simply to jump in. With a background in stock investing, bond investing is a piece of cake. Add a bit of option theory (bonds are a put), a bit of risk-management (proper position sizing), a bit of chart reading, some financial statement analysis, and a whole bunch of screen time (aka, shopping time), and a method of doing things will emerge. There are no two people in this (or any other forum) who do their investing the same way. But as you bum your way around the various forums, you’ll get a glimpse here and there of people who are making a success of it. If asked, most of them say, “Well, I tried a couple things, and then I found something that made sense to me. It seemed to work OK, and I kind of stuck with it.”

Yeah, there are a whole bunch of things a person could learn from me about bond investing just by sitting down besides me at my trading station. But what they’d learn in 2-3 hours isn’t a fraction of what they really need to be shown how to do, which can be summarized in Marty Whitman’s four words: “Buy cheaply. Buy safely.” That’s the essence of any investing. “The rest”, as Rabbi Hillel quipped long ago in a different context, “is merely commentary. Now go and study.”


OK, the preceding is deliberately vague, heart-felt, but vague. As I was doing my bike ride today, a research program popped into my head, prompted by your question of what direction I wanted to take this discussion? Its essence is this: Do stock prices lead, lag, or move in synch with corporate bond prices? If an edge can be discovered, the next question becomes: How to exploit it?, which is mainly a matter of settling on a disciplined exit strategy.

My suspicion is that an investor -and, yes, I'm talking "investing", not "trading"-- can move freely between the two asset classes in a variety of ways and make serious money. So the first step is to do the basic research. The next step is to set up a pilot project. The third step --if the preceding go well- is to determine scalability and to look for simplifications. Bingo. Market-indifferent stock and bond investing done with a primary focus on risk-adjusted real returns. Described that way, the idea is nothing new. It's just a typical hedge fund. The only difference is who's running it and into whose pockets the profits are going.
Print the post  


What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
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.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! 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.