Unlocking the Mysteries of Bond Investing

Steve McDonald
by Steve McDonald, Bond Strategist

[caption id="attachment_30054" align="alignright" width="220"]Unlocking the Mysteries of Bond Investing Buying many small, ultra-short bond positions in this market is the only way you won’t get crushed when rates turn back up. Avoid long-term bonds and bond funds.[/caption]

Bonds are the answer to most investors’ needs, not their get-rich-quick dreams, but their real needs. So, you’d think the bond market would be doing everything possible to get these survivors of the stock market into bonds…

But they aren’t!

In fact, the bond market seems to do everything possible to keep the small investor out.

The walls, buying restrictions and ridiculous pricing structure of bonds are set up to keep the little guy out of individual bonds and in bond funds. Bond funds that have all kinds of flaws, such as hedging and very long average maturities, the implications of which most investors don’t fully understand.

But investing in bonds can have some real advantages. They’re custom made for investors who:

  • Want returns above what savings or CDs are paying.
  • Are tired of the wild fluctuations of the stock market.
  • Can’t afford any more of the losses they have incurred in the past 10 or 12 years.
  • Need more reliability and predictability in their investments.

But plenty of problems stand in the way of the novice investor who’s simply trying to buy a bond:

Lack of Exposure

Unlike most investments, there are no 24-hour television networks that have a constant flow of bond ideas. And most bond information that does exist consists of the 10-year Treasury, overnight rates and confusing quotes about rising and falling rates, treasury auctions and prices.

Frankly, the information available from all sources – The Wall Street Journal and Barron’s included – is useless! I don’t think I have ever seen a news story about an upcoming corporate bond offering, and if there was one, the offering was sold exclusively to institutions.

Lack of Information

Second, just getting to a page on an online broker’s site to buy a bond is ridiculously difficult.

Go to any broker’s website and click on “Trade Bonds” and you’ll get something that looks like this.

Investing in Bonds

What you’re supposed to do with this chart is beyond me.

To get to any sort of usable information or the next page (which is never clearly marked), you must fill in as much information as the U.S. government wants from folks joining the military.

Here’s a partial list of the information that’s needed:

  • Cusip
  • Frequency
  • Maturity
  • Coupon
  • Yield
  • Price
  • Quantity
  • Current Yield
  • Bond
  • Bill
  • Notes
  • Zero Coupon
  • Indexed

If the average guy knew all this, he wouldn’t need a broker at all.

Even if you can come up with all the information necessary to find some bond possibilities, you usually end up with a list of thousands of bonds and no information about any of them other than their cusips and descriptions.

Lack of Access

Can you imagine having this much trouble trying to find a stock to buy? It’s absurd – but absurd by design – designed by the market to be virtually impossible.

You see, the bond market doesn’t want the small guy. They only want the big money, and they price their bonds accordingly.

If you buy 10, better yet 20 bonds or more, you have your pick of any type of bond and at the best price. But how many people have $20,000 to invest in each trade? Very few.

Try to buy five bonds or just one, and the most likely answer you’ll get from a bond desk is: “We can’t sell one bond,” or “It isn’t worth it to you to buy so few.”

Baloney! What they really mean is they don’t make enough money on a trade that small to make it worthwhile to them.

Plus, the small guy is annoying to the gods of the bond desks. The bond gods don’t like the little guy. They do annoying things like ask questions and expect the people on the bond desk to speak English, not the tree-fort, insider-only lingo they have concocted.

Better Returns Without Leveraging

The fact is you can buy one bond.

Yes, it will cost a little more and you will get a little less if you sell it before maturity. But most stockbrokers know so little about bonds, they don’t know this, either.

And fortunately, the increase in buying price isn’t so great that it makes a significant difference to the average guy. A bond desk will make the increased cost for small bond orders sound like the end of the world, but do the math and it isn’t that bad.

When you buy individual bonds instead of bond funds you can get better returns without any leveraging. Leveraging is one of the biggest unknowns to bond funds investors and it will come back to haunt them.

Buying individual bonds also allows you to buy many small positions in many different industries. This has the same effect as diversifying in your stock portfolio.

As you diversify, you also have the opportunity to spread your maturities over a much shorter range, preferably less than a seven-year average. The best part is you have control of the maturities you hold and you aren’t bound by a bond fund’s prospectus – which can cost you a lot of money when rates run up.

Buying many small, ultra-short bond positions in this market is the only way you won’t get crushed when rates turn back up. Even though we don’t expect any real uptick in rates for about three more years, you can’t risk holding long maturities (in excess of a seven-year maturity). It isn’t prudent!

The Oxford Club is a good place to begin to learn about the benefits of individual bonds. They have a list of brokers called the Pillar One Partners. Many of these brokers will buy as few as one bond and all of them have met our standard of excellence and have been a part of the Club for many years.

Bond investing can be the answer to almost all of the needs of the average person, it may take a little effort to get to the same level of comfort you feel with stocks, but it will be worth it.

Good Investing,

Steve McDonald

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