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Bonds
and the
Long-Term Investor
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Some time ago an article appeared in
the Los Angeles
Times, titled "Individual Investors Are Fleeing Bonds, but Should
They?"
While it made no specific recommendations, it did highlight the
year-to-date
total returns on various bond types. Included were long term Treasury
bonds
which had a return (price appreciation plus interest) of +15.3%.
Real Vs Paper
Gains
Now 15.3% is obviously a great return on
a bond,
but what does it
really mean? Unless you are a bond trader who plays the market
for
capital
gains, it merely means that you have a handsome paper gain so far this
year. For the income investor it means little or nothing.
If you
cash out to realize the capital gain, you become a bond trader
yourself,
and that is not why you bought the bonds in the first place.
When
bond prices are high, yields are low so the long term bond investor
usually
has no good reinvestment alternatives.
When to Buy
Bonds
Unlike most equities whose value
increases with time,
the market value of a bond merely fluctuates about some average value
that
depends on the current interest rate and the time to maturity. In
the case of a bond fund, which maintains a relatively constant average
maturity, the market value reflects only the current interest rate for
that maturity.
The buy-and-hold bond investor foregoes
the potentially
higher return on equities in favor of a predictable return. If
the
objective
is to hold to maturity, as is the case for many investors, handsome
paper
gains means nothing. The yield-to-maturity is essentially the
total
return.
The decision to buy should be based only on whether the
yield-to-maturity
is attractive at the time of purchase.
Bond Funds vs
Bonds
The bond fund investor faces a less
predictable situation.
There is no date-certain market value for the investment as in the case
of bonds. That's because the fund continually replaces its bonds
to
maintain
its advertised average maturity.
If you plan to buy a bond fund you
should look for a current
yield somewhat higher than the long term average yield-to-maturity on
equivalent
maturity bonds. In this way you gain some protection against a
capital
loss due to a change in market interest rates. Favorable
occasions to
buy
a bond fund don't happen very often, and part of the reason is
that
fund expenses often soak up too much of the interest earnings.
Prefer Equities
to Long Bonds
While equity investments can sustain an
attractive total
return over an extended period, the total return on a bond fund can
only
fluctuate about some long term average that is approximated by the
interest
rate yield, less fund expenses. Long maturity bonds or bond funds
are seldom a good choice for the buy-and-hold investor.
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