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On average, what kind of money can be made in bonds, as opposed to stocks or something else?

That’s a good question, right? and maybe even an important one to try to answer. For having long ago dropped out of the stock-game, I have no idea what that asset-class can offer. Supposedly, the long-term average-gain is something around 10%, though, lately, Bill Gross has been saying that stock-investors should expect less going forward, and the permabulls, like Seigel, would probably say that their projections remain unchanged, that the stock casino is where investors should still be gambling with their retirement money. What I do know is this. The money offered by bonds can be decent, as the following distributions suggest.

I have 329 currently-open, currently-performing bond positions distributed across Agencies, Munis, Corporates, and Sovereigns. I made no attempt to ladder maturities, nor did I avoid any credit tranches. If the price was reasonable, I bought no matter whether the bond was 3 years from maturity or 30 and whether it was rated AAA or CCC. All that mattered to me was Ben Graham’s injunction that the price, relative to estimated intrinsic-value, had to offer a reasonable margin of safety. Obviously, I wasn’t always successful. But I’ve had very few positions blow up on me, and none were of a size that was intolerable. So the necessary conclusion is that I’ve been careful, or lucky, or both, over the dozen years I've been focusing on bonds exclusively.

YTM_Bins Distributions

1% 1 0%
2% 0 0%
3% 0 0%
4% 1 0%
5% 5 2%
6% 22 7%
7% 31 9%
8% 53 16%
9% 51 16%
10% 39 12%
11% 23 7%
12% 22 7%
13% 17 5%
14% 13 4%
15% 9 3%
16% 8 2%
17% 5 2%
18% 2 1%
19% 4 1%
20% 3 1%
22% 5 2%
24% 2 1%
26% 2 1%
28% 1 0%
30% 3 1%
35% 0 0%
40% 1 0%
45% 0 0%
50% 2 1%
55% 1 0%
60% 1 0%
65% 0 0%
70% 1 0%
75% 0 0%
80% 0 0%
85% 1 0%
90% 0 0%

A list like the above is relative meaningless. So let’s break it up into chunks, using Graham’s three-fold partitioning: Defensive, Enterprising, Speculative.

What kind of money should a ‘Defensive’ investor be able to pull out of the bond market, even the currently over-bought one? My guess is 5%, +/- 1%, with anything less being equivalent to cash. An ‘Enterprising’ investor would seek gains in the range of 8%, +/- 1%. A ‘Speculative’ bond investor would work in the range of 13%, +/- 3%. A very aggressive investor might work in the range of 21%, +/- 5%, with anything higher being merely ‘lottery tickets’.

As you can see, I try to avoid cash-equivalent returns, nor do I put much effort in trying to achieve ‘Defensive’ ones. The money offered by these categories just doesn’t compensate for their risks. Where I do put half of my efforts (48%) is “Enterprising”, because the research is easy, the risks are manageable, and the money is decent. I allocate nearly the same effort (40%) into “Speculative”, with a scant 10% (by effort or dollars) given to “Aggressive” and/or lottery tickets.

The net-result is that any competent stock investor will beat the returns of any competent bond investor, because the former have available to them far greater upsides. If you want to see a good instance of this, just pull a price chart for CAB from its Nov '08 low. That has proved to be a classic, “10-bagger”, Peter Lynch play that took no brains to spot. I’ve rarely made that kind of money in bonds. It does exist, and I've grabbed some twice in my bond career. But it’s too uncommon to count on. However, if bonds are thought of as ‘puts’, and if those puts are bought at reasonable discounts, then decent-enough, downside-protected money can be made by anyone willing to go shopping and do a bit of research.

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