Investing in Bonds For Dummies. Russell Wild

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СКАЧАТЬ fact, that’s just what happened in the real world.) Even though you aren’t rich, $11,730 doesn’t sound too shabby. But you need to look at the whole picture.

Beating inflation, but not by very much

      

Yes, you enjoyed a return of 5.5 percent a year, but while your bonds were making money, inflation was eating it away … at a rate of about 3.0 percent a year. What that means is that your $11,730 is really worth about $885 in 1926 dollars.

      To put that another way, your real (after-inflation) yearly rate of return for long-term government bonds was about 2.5 percent. In about half of the 89 years, your bond investment either didn’t grow at all in real dollar terms, or actually lost money.

      Compare that scenario to an investment in stocks. Had you invested the very same $100 in 1926 in the S&P 500 (500 of the largest U.S. company stocks), your investment would have grown to $567,756 in nominal (pre-inflation) dollars. In 1926 dollars, that would be about $42,800. The average nominal return was 10.2 percent, and the average real annual rate of return for the bundle of stocks was 7.0 percent. (Those rates ignore both income taxes and the fact that you can’t invest directly in an index, but they are still valid for comparison purposes.)

      So? Which would you rather have invested in: stocks or bonds? Obviously, stocks were the way to go. In comparison, bonds seem to have failed to provide adequate return.

Saving the day when the day needed saving

      But hold on! There’s another side to the story! Yes, stocks clobbered bonds over the course of the last eight or nine decades. But who makes an investment and leaves it untouched for that long? Rip Van Winkle, maybe? But outside of fairy tale characters, no one! Real people in the real world usually invest for much shorter periods. And there have been some shorter periods over the past eight or nine decades when stocks have taken some stomach-wrenching falls.

      The worst of all falls, of course, was during the Great Depression that began with the stock market crash of 1929. Any money that your grandparents may have had in the stock market in 1929 was worth not even half as much four years later. Over the next decade, stock prices would go up and down, but Grandma and Grandpa wouldn’t see their $100 back until about 1943. Had they planned to retire in that period, well … they may have had to sell a few apples on the street just to make ends meet.

      

A bond portfolio, however, would have helped enormously. Had Grandma and Grandpa had a diversified portfolio of, say, 70 percent stocks and 30 percent long-term government bonds, they would have been pinched by the Great Depression but not destroyed. While $70 of stock in 1929 was worth only $33 four years later, $30 in long-term government bonds would have been worth $47. All told, instead of having a $100 all-stock portfolio fall to $46, their 70/30 diversified portfolio would have fallen only to $80. Big difference.

      Closer to our present time, a $10,000 investment in the S&P 500 at the beginning of 2000 was worth only $5,800 after three years of a growly bear market. But during those same three years, long-term U.S. government bonds soared. A $10,000 70/30 (stock/bond) portfolio during those three years would have been worth $8,210 at the end. Another big difference.

      In 2008, as you’re well aware, stocks took a big nosedive. The S&P 500 tumbled 37 percent in that dismal calendar year. And long-term U.S. government bonds? Once again, our fixed-income friends came to the rescue, rising nearly 26 percent. In fact, nearly every investment imaginable, including all the traditional stock-market hedges, from real estate to commodities to foreign equities, fell hard that year. Treasury bonds, however, continued to stand tall.

      Clearly, long-term government bonds can, and often do, rise to the challenge during times of economic turmoil. Why are bad times often good for many bonds? Bonds have historically been a best friend to investors at those times when investors have most needed a friend. Given that bonds have saved numerous stock investors from impoverishment, bond investing in the past eight to nine decades may be seen not as a miserable failure but as a huge success.

Gleaning some important lessons

      Bonds have been a bulwark of portfolios throughout much of modern history, but that’s not to say that money – some serious money – hasn’t been lost. In this section, I offer examples of some bonds that haven’t fared well so you’re aware that even these relatively safe investment vehicles carry some risk.

       Corporate bonds

      Corporate bonds – generally considered the most risky kind of bonds – did not become popular in the United States until after the Civil War, when many railroads, experiencing a major building boom, had a sudden need for capital. During a depression in the early to mid 1890s, a good number of those railroads went bankrupt, taking many bondholders down with them. Estimates indicate that more than one out of every three dollars invested in the U.S. bond market was lost. Thank goodness we haven’t seen anything like that since (although during the Great Depression of the 1930s, plenty of companies of all sorts went under, and many corporate bondholders again took it on the chin).

      In more recent years, the global bond default rate has been less than 1 percent a year. Still, that equates to several dozen companies a year. In recent years, a number of airlines (Delta, Northwest), energy companies (Enron), and one auto parts company (Delphi) defaulted on their bonds. Both General Motors and Ford, as well as RadioShack experienced big downgrades (from investment-grade to speculative-grade, terms I explain in Chapter 2), costing bondholders (especially those who needed to cash out holdings) many millions.

      Lehman Brothers, the fourth largest investment bank in the United States, went belly up in the financial crisis of 2008. Billions were lost by those in possession of Lehman Brothers bonds. (Many more billions were also lost in mortgage-backed securities and collateralized debt obligations. These investments are debt instruments issued by financial corporations, but they are very different animals than typical corporate bonds and rarely spoken of in the same breath. I’ll get to those in Chapter 5.) Most recently, we’ve witnessed the collapse of once very healthy corporations, from Borders to Sharper Image to Kodak. Even Hostess became little more than crumbs. (It’s tough to imagine that with our insatiable appetite for sugary snacks, a company could lose money on Ding Dongs and Twinkies!) As we’ve seen time and time again, corporations sometimes go under. None are too big to fail.

       Municipal bonds

      Municipal bonds, although much safer overall than typical corporate bonds, have also seen a few defaults. In 1978, Cleveland became the first major U.S. city to default on its bonds since the Great Depression. Three years prior, New York City likely would have defaulted on its bonds had the federal government not come to the rescue.

      The largest default in the history of the municipal bond market occurred in 2013, when Detroit declared bankruptcy, leaving holders of more than $8 billion in bonds wondering (and, at the time of this writing, they are wondering still) if they will ever their money back.

      Largely due to the situation in Detroit, there has been lots of talk about municipal bankruptcies of late. Yet not many have occurred. In recent years, the number of municipalities defaulting on their bonds has been estimated to run about 6/10 of one percent.

      Several budget-challenged cities and counties have had to make the difficult choice between paying off bondholders or making good on pension obligations for retired police, firefighters, and teachers. Thus far, the retired workers have suffered more financial pain than the bondholders, perhaps because they have less political clout – and no one wants to alienate bondholders, who may provide much-needed cash in the future.

       Sovereign bonds

      Nations СКАЧАТЬ