It seems impossible these days to open a financialnewspaper or magazine without comingacross some grim warnings about theimpending disaster in the bond market. All theseexperts may be right. However, proceed with caution.After these analysts led the public into thebiggest stock market bubble and disasterof our generation, they're now seeingbubbles and disasters at every turn in aneffort to establish themselves as thevoice of reason. Their expertise is suspect.Also, be careful when everyone,especially every expert, comes to aunanimous decision. They generally listento each other all day, and if peoplehear something enough times, it'shuman nature to start believing in it.
This isn't to say that the bond marketis not a dangerous place now. It'sprobably more dangerous than it hasbeen in a long time. But it doesn't callfor dumping your bonds and running tothe stock market as a safe haven, assome are suggesting. As always, youshould have a long-term investmentphilosophy and plan, and if you're followingthese, you can ignore the experts and enjoywhat's left of the summer. Slow andsteady wins the race. Let's see how this philosophyapplies to bond investing.
MAINTAIN STEADY PACE
Everyone needs to have a certain amount ofbond-holding for portfolio diversification—itmay be in the range of 20% to 30% for youngpeople and 50% or more for people nearingretirement or already retired. If you fall in theyoung category and are holding a large amountof bonds because the stock market scared youaway, you've now missed the sharp recovery thestock market has staged lately, and youmay have missed an opportunity tomake up some of your losses.
My suspicion is this rally won't lastlong, but that opinion is worth nothing.I don't know; nor does anyone else. Thepoint is, you need to maintain a steadyratio of bonds to stocks in your portfolio,and if you've gorged on bonds lately,it's time to make some changes. Anindividual investor should probablynever buy bonds of longer than 5-yearor, at most, 7-year maturity. The additionalrisk you take by going longer isgenerally not justified by the small additionalreturn you may earn.
So, if you're holding more bondsthan you should be at your stage inlife, it's time to cut back, starting withthe long maturities. Put the extramoney in a money market fund and slowly dollar-cost-average it back into the stock marketover a period of time.You'll be earning next tonothing in the money market fund, but the firstprinciple of making money is not losing a lot ofit. So be patient.
Even if you are holding the approximateamount of bonds you should be holding, switchyour longer-term bonds to maturities of 5 yearsor less. This is a 1-time adjustmentyou should be making. Don't try to play thegame of shortening the maturity of your bondportfolio when experts predict interest rates willgo up and then lengthening the maturity whenthey predict interest rates have peaked. EvenAlan Greenspan is wrong about where interestrates are going, and he's the one who sets theshort-term rates. Likely, you and your guruwon't know any better.
STAY SLOW AND ON TRACK
If you want to be a successful long-terminvestor, follow the reverse of the philosophythat may be good in other areas of life: Don'tjust do something; sit there.
With all the daily information thrown at you,it's difficult not to keep making changes to yourportfolio. If you're holding too many bonds, itprobably started with first putting too muchmoney in the stock market, then getting scaredand taking out whatever you had left, then rushinginto long-term bonds because money marketsand short-term bonds were providing paltryreturns, and so forth. This is too much activity—too many opportunities to make mistakes andpay too much in taxes along the way.
So, once you've adjusted your portfolio tothe right mix of stocks and bonds and cut backthe maturities of your bonds to reasonable levels,sit back and relax. The bond market disastermay come in 2 months, 2 years, or 10 years.But that too will pass.
author of The Only
Proven Road to Investment
Wiley; 2002), currently
teaches finance at the
Graduate School of
Business and consults
with individuals on
financial planning and
questions or comments