Dear Jason,
I have two questions.
I'm interested in diversifying my portfolio of stocks, stock funds and
money markets to include bonds. Thoughts on how to proceed? Bond funds,
government issues?
Thanks,
Chris
chaddox@attglobal.net
Dear Chris,
Bond funds don't get no respect. Investors have recently been yanking out
close to $2 billion more than they've been putting into bond funds each
month. And nearly everybody these days is mouthing the mantra that stocks outperform bonds in
the long run.
But these people ought to think twice. The "long run" can be almost
unbelievably long, and anyone who tells you that stocks "always" outperform
bonds is crazy.
Sure, with stocks you're an owner and with bonds you're a lender--but
there's no law of financial physics that guarantees that owners will earn
more than lenders. Over many long periods in the past, it's been more
lucrative to lend than to own, and there's no reason to believe that won't
happen again.
Over the 12 years from 1966 through 1977, for instance, intermediate-term
government bonds earned 5.9% annually, outperforming stocks by two full
percentage points per year (two points a year might sound like chicken
feed, but it makes a big difference over a dozen years: $10,000 in bonds
would have grown to just under $20,000, while $10,000 in stocks would have
grown to a bit less than $16,000).
And fuhgeddabout the Thirties and Forties, when bonds beat the stuffing
out of stocks over the twenty-year period from 1929 to 1948. None of this means no one
should own stocks; but it does mean most people should own some bonds.
How you buy bonds depends on your tax position and how much money you have
to invest. If you're in the 28% Federal tax bracket or higher--and
especially if you live in a tax hell like California, Massachusetts or New
York--consider tax- free municipals (probably through a fund). And if you
have $100,000 or less, you're often better off buying a bond fund than an
individual bond since most bond brokers take an invisible "spread", which
lowers your yield.
If you buy a fund, make sure its annual expenses are well under 0.75% of
assets; for most people, a
U.S. Treasury fund or a bond index fund is the best bet. However, if you're
100% certain that you can hold onto a bond until its final maturity date,
there's no better deal than buying a Treasury bond direct from Uncle Sam. For more general
info, check out this site run by the Bond Market Association.
I think people who scoff at bonds (or foreign stocks for that matter)
misunderstand the point of diversification. The reason to diversify is not
to increase your return, or even to lower your risk; it's to insure
yourself against the unforeseeable.
I've spent years studying financial history to
attempt to figure out what we can learn about the future from the past.
I've concluded that the only universal truth the past offers about the
markets is that they will always surprise us--always!
The corollary to that historical law is that the markets will most brutally
surprise those who are most certain in their views about what the future
holds. And the people who today are refusing to put any money in anything
but U.S. stocks are the exact people who will panic in astonishment when we
finally get a bear market; then they'll bail out at the bottom and spend
years wringing their hands while they sit on their hands.
Meanwhile, diversified investors like you and me will plod right on past,
leaving them in the dust. That's why diversification is so powerful, and so
necessary: It's insurance against the ultimate risk of being surprised by
what happens around us.
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