How bonds - the right ones - fit into back-to-basics investing
People who are growing a bit tired of all the ``experts'' and their ``theories'' about the stock market may be looking for a way to get back to basics. For many of them, one of the most basic investments is the bond: the corporate bond, the government bond, or the municipal bond. Unfortunately, while the bond has to play by the same basic rules, the overall investment game has changed. Now, if you want to play in the bond market, you have to watch and try to forecast the direction of interest rates, the dollar, and maybe even the money supply.
But this year, more people are willing to give bonds a try, especially after what happened to the stock market last year. Despite the changes in the bond business, a carefully selected portfolio of bonds can help get investors through these uncertain times.
``Bonds do serve a good purpose,'' says Elwynn Miller, a financial planner in Boston. ``People need income and want something that's not as volatile so they can sleep at night.''
``A lot of my clients are investing in bonds,'' he says. ``But if people go into bonds expecting not to lose any principal, they'd better get educated.''
Many people got a rude education - twice - last year when bond prices tumbled on concerns about higher interest rates. The declines in prices more than wiped out any gain from higher yields.
Part of the problem was caused by heavy advertising and marketing by brokers and mutual funds selling bonds or shares in their funds. Many of their ads overemphasized yields without explaining the risks to principal if bond prices fell.
This year, then, may see a back-to-basics movement in bonds, where old verities become more important.
``I think we've all learned that the markets are a lot more volatile now,'' says Gerald Guild, manager of fixed-income investments at Advest Inc. ``But the same basics still apply.''
Despite volatile swings of recent years, bonds are still attractive for conservative investors, because their basic features haven't changed. They can be counted on for steady interest income and, if they are kept until maturity, they will pay back the full face value. In other words, you get your original investment back - as long as you invested in a sound company or government in the first place.
The tricky part comes in trying to match the maturities in your bond portfolio with your financial needs. You don't want to tie up money for 10, 20, or 30 years unless you know you won't be needing it during that time. If interest rates go up in the meantime and you need some of that money, you could be forced to sell at a loss. If you think rates are going to go up, you're better off parking your money in a short-term vehicle like a money market fund, a short-term bond fund, or 90-day Treasury bills. Then, when rates seem to have peaked, you can lock in the higher yields.
Here, of course, is where investors will find themselves trying to guess the direction of interest rates. You probably don't want to base your financial security on your own guesswork, especially if the experts can't agree which way rates are going.
In the financial marketplace, ``jolts are jolts by definition because the professional investors didn't see them coming,'' says James Grant, editor of Grant's Interest Rate Observer, a newsletter.
If you're not sure you can afford to lock up money for a long time, the best way to avoid guesswork at this point is to keep bond maturities fairly short. Whether you're buying government notes, corporate bonds, or municipal issues, remember that the longer the maturity, the greater the risk to your principal. Of course, longer maturities pay higher yields to partly compensate for the risk.
You might consider a portfolio of staggered maturities of perhaps 3, 7, and 12 years. If interest rates go up, you can convert the short-term issues into bonds with higher returns. If rates go down, you'll be covered, since the long-term bonds will be paying higher-than-market rates.
Yields on the best longer-term (10-year maturity or more) corporate and United States government bonds currently range from 7 to 9 percent. To Mr. Miller, the best in the corporate area means well-known, established companies like General Electric, American Telephone & Telegraph, Du Pont, and International Business Machines.