Thursday, March 26, 2009

Bonds for Everyone

I’ve checked this blog’s stats and people from 78 different countries have visited it. Obviously, most for the Stanford issue, but a number have been sticking around and reading the stuff and links I’m putting up here. And I put some ads on the site, which earned me a total of $0.01 yesterday, so this is a promising business for sure. LOL But other than the Stanford people and some of the media, I have absolutely no idea who is out there, what your degree of financial knowledge and what you want to read about. So I’ll take requests. And I’ll keep it simple, because I like simple.

First request is from a former Stanford Investor from Mexico, who was asking (aside from the Stanford stuff) for help with investing. I know a little about that, so here goes with the caveat of DYODDD (Do your own due diligence. dude), shamelessly stolen from a fellow blogger.
The lesson of the day is about BONDS, later we’ll get to JUNK bonds (my favorite kind).

Bonds are among my favorite investments. Junk bonds in particular. Here are seven reasons why I like them and why I like recommending them.

1. Bonds are simple.

It’s a loan. An IOU. This isn’t a bond primer, so here are few links if you are a total neophyte. LINK 1, LINK 2 and LINK 3. Things are defined and orderly. You know how much they should pay you and when they should ay it. They don’t call it “fixed income” for nothing. So you can plan around them and with them.
Like all loans, there are responsible payers, deadbeats and rip off artists. But the investor knows that these things exist (or should). The idea is to find an area or niche where you feel comfortable.

2. Bonds eliminate the middleman

I dislike middlemen between my investments and myself. So I COULD take my money to the bank, open a CD, get a low rate (or not), get a government guarantee (or not) and the bank would then turn around and lend the money to Dow Chemical, Procter & Gamble, the Republic of Kazakhstan, the US Treasury, or whatever. Or I could buy a bond and do the lending myself. I’m taking on a risk, no one will bail me out, but there is usually a reward associated with it (higher return).
It’s not the only way to eliminate the middleman. I could lend money to people also, with peer to peer systems like, but that is outside my personal comfort zone.

3. Bonds are more self-reliant

I hate relying on other people for things. That’s one of the issues I have with stocks. You can analyze them and find what looks like a great opportunity. But the way you make money is that someone else comes and buys that stock for a higher price than you paid for it. It’s frustrating for an analyst to see a great stock he bought cheap languish or decline, while “lesser” stocks flourish, particularly if all he predicted is coming true (company performance, etc.). But that happens…all the time. So you wonder “why doesn’t this stock go up?” and maybe it will and maybe it won’t and maybe in the end you were wrong. With the bond, the DD centers on one main issue: will these guys pay me back? If you think they will, or at least you like the odds (risk/return relationship), you can go ahead and buy. If you’re holding for maturity, you have your final buyer: the issuer itself (when they pay you back the principal).

4. Bonds don’t require much maintenance

People complain that investing is hard work and it is. You can work hard at your bond portfolio, if you want to…but if it’s hold to maturity you can let it go and let them work for you. Bonds pay YOU to wait patiently.

5. Bondholders get a little respect (not much…but a little)

CEO’s are always telling us that “they have a duty to shareholders, etc.”. To a point that’s true, I guess. But no one was asking Me about the CEO’s salary, bonuses and cutting the dividend, when I was holding stock (kind of, but not really). So, yeah, there is a duty to the stockholders, but the CEO and the board usually get to keep their jobs unless they really screw up (and sometimes even then).

With bonds, there is a “little” more respect because they’re a bit higher up in the pecking order, and you don’t care about the company’s performance that much, as long as they pay. The day they don’t pay or don’t want to pay, there can be consequences (Default), which more times than not involves these guys losing their jobs (unless you are the President of Ecuador, of course). Most of these guys really like their jobs. They’ll at least LOOK like they’re making an effort to pay.

6. My wife likes bonds

My wife is an extremely intelligent person (despite her marrying me). She knows a great deal about marine biology and in particular fish. But investing and finance is not her greatest interest (where I come in). However, being smart, she also realized I may not be around forever (women outlive men and her lifestyle is a whole lot healthier) and maybe leaving all the investing to me wasn’t the greatest idea either.

Long story short, we went a bond seminar at a local broker’s office. Two hours. She “got it”, of course, and I filled in the blanks. Not long thereafter, she set up a little low-maintenance bond portfolio with her sisters that is doing quite well. Not that she really looks at it. She doesn’t really have to. She knows when the bonds are due to pay interest and principal. Nothing too risky, but most of it is what is considered “junk” (which is an awful thing to call a bond, and I’ll get back to that later). I’ll describe the portfolio in another post, if anyone is interested. Expected return: about 8-10%, if things go reasonably well.
She’s happy with it and if she’s happy, I’m happy.

7. Brokers and advisors hate bonds

If they hate bonds, why should I like them? Well, they don’t really hate bonds as an asset class, but they’re not enthusiastic because there isn’t a lot of money to be made selling bonds retail. Especially, if the client is just going to sit on them. Don’t get me wrong: they WILL get their cut, particularly when you first buy. They’ll hit you with a commission and probably a “mark-up” (they go and “get” the bond in the market and sell it to YOU for more…crazy huh?). But that’s usually it. It’s a one-time thing and you can milk these bonds for YEARS. So they don’t like that. They will prefer to sell you a Bond “Fund”. That has its advantages. You get a quick diversification and “professional” management. It’s usually more liquid. You WILL pay these conveniences, as long as you hold the fund (management fee). You also won’t know necessarily what’s in the fund.

I, particularly, like knowing who owes me money and I buy my music, rather than renting it. So I BUY my bonds. But that’s me. And I don’t really like paying middlemen (especially when I’m doing the DD).

This post is running long…like a BOND. More on “JUNK” and the problems with bonds....later.


  1. Hey Alex,

    On your third point on self-reliance, stocks do give you the right to the company's earnings, yes? Shouldn't that drive the valuation, and not what other (perhaps laid-off) fellow investors, or deleveraging hedge fund managers, or broker-analysts with tons of conflicts of interest are willing (or pretending in the case of analysts) to pay for it?

    It's not unheard of some stocks actually giving some of it back as dividends, sometimes even increasing them (gasp!). The good stocks that don't pay dividends, either reinvest it in the business (which should be a good thing if they were really doing good within their industries) or piling up the cash. What's wrong with holding on to a year or two of losses, if the reward could be 10x, 15x, or even 20x (my case with AAPL at one point) the amount invested?

    Great post, always entertaining to read you. I'll click on a couple of ads every time I come to help with your $0.01 in ad revenue. Assume half of your readers do the same and there you have your triple-digit growth business plan. Look out for the DMDY IPO! ;)

  2. Thanks for your comments. And answering your question (if there is one there. LOL), yes you do have the right to the company's earnings if you are a stockholder, you point out also, to the discretion of the executives. (not necessarily a bad thing).

    With the bond...the choice is not really theirs to make.

    Earnings should drive valuations naturally, but "market considerations" can not be overlooked, especially in times of "multiple contraction"such as recently. Very frustrating...good company performance...lousy stock performance!

    Not everyone has your patience...I wish I had on to my AAPL...not to mention CSCO back in the day.

    Good luck!

  3. LOL yes I thought there was a question there, somewhere! I just needed a professional like you to confirm that I wasn't being completely crazy or dumb in my belief that current market conditions have somewhat upside-down valuations (reminds me of your upside-down house) which tend to discount the future earnings of healthy companies, in a time when positive cash flows should instead be dearly priced. In my opinion these market imbalances always get corrected eventually, which creates excellent opportunities for those who can identify such biases.

    "Very frustrating...good company performance...lousy stock performance!"

    Precisely those "very frustrating" cases are the 10 or 20x opportunities. Sure, you better guess right, but it's not that different from hoping your bond issuer does not default.

    Recent market conditions and "multiple contraction" is comparable to a bond that's selling for 50% of its face value (this now sounds similar to your post on LOSER bonds if I'm interpreting it correctly), where the 100% payout may or may not come in either case (stock or bond). You argue that you should be able to sell the bond for a nice profit before it comes up due, but this implies market conditions and perception and worthiness of the issuer would have to improve from the current silly valuations. How is that any different from the case for stocks in the current market conditions?

    The trick with winner stocks like AAPL (the true growth hasn't been there for CSCO in this century) is being able to tell when everyone and their grandmother is riding the same horse, and it's inevitable that the poor animal will stop for a bit of water and refuse to keep running. Getting off of it when it feels a little too crowded before it stops would be ideal, but if you missed that chance and are still on it during the water-drinking, and all the other horses are also drinking or running the other way or already dropped dead, no point in getting off yours just to see it sprint away when everyone else got off.

    I acknowledge the point on depending on the management team. Not many can afford the best trainers or jockeys, and many times those insiders are the only ones who know they're actually running a donkey.

    I'm not trying to make this a stocks vs. bonds contentious issue. I'm just making the point that there are also good opportunities in some stocks out there. And that even though the market can get it wrong for a while, sooner or later it will have to declare the winner of the race, and the winning bets do get paid.

    Wow, sorry for the longest comment ever! LOL (Maybe I should get my own blog for this, the thing is I don't have the academic credentials to back my opinions on these matters, like you do. Opinions are a dime a dozen, so my place, at least in these matters, is in comments. In my blog I just give my prediction and don't worry too much about explaining how or why it works or not. If the reader sees it does have predictive value, that should be enough. I don't claim to be an expert, just to being right, most of the time.)

    Good luck to you as well!

  4. I agree. It WAS the longest comment ever. LOL.