Conventional wisdom is a dangerous thing. For generations, investors have been told that bonds are always safer than stocks, which is WRONG, WRONG, WRONG! Today, the popular "retirement-date funds" just allocate a greater and greater portion of a person's portfolio into bonds as they get older, which should be WRONG, WRONG, WRONG! Investors think they are being prudent by investing in bonds -- but are being anything but . . .
Suppose you pay $10,000 for a bond paying 5%. That means you get paid interest of $500 annually. Now, let's suppose interest rates go up to 6%. But, your bond still only pays $500 or 5%. However, you can still sell your bond but not for the $10,000 you originally paid for it. How much would somebody else pay you for it? You can compute it this way: $500 divided by 6% equals $8,333. That is all your bond is worth after rates go up -- just one percent. In other words, your bond just lost almost 17%, which doesn't sound all that safe to me. If interest rates go up 2%, you lose almost 29%
(I'll spare you the arithmetic but long-term bonds are much more risky than short-term bonds. That's why extra cash should only be parked in short-term bonds, not long-term bonds, even though short-term bonds normally pay lower interest than long-term bonds.)
According to the conventional wisdom (AKA old wives' tales) investors primarily seeking income (as opposed to capital growth) should be invested in a portfolio of bonds with varying maturities. With so little safety of capital in bonds and with so many excellent stocks paying dividend rates much higher than interest rates, the conventional wisdom is WRONG, WRONG, WRONG!
This morning, I felt vindicated watching Warren Buffett, as he said that investors "could lose a lot of money on long-term bonds" even U.S. Treasuries. I've been saying this a long time. I may not agree with Warren on everything, but I am always delighted when he agrees with me.
Now, do you have any long-term bonds? If you don't know, why don't you know?
Suppose you pay $10,000 for a bond paying 5%. That means you get paid interest of $500 annually. Now, let's suppose interest rates go up to 6%. But, your bond still only pays $500 or 5%. However, you can still sell your bond but not for the $10,000 you originally paid for it. How much would somebody else pay you for it? You can compute it this way: $500 divided by 6% equals $8,333. That is all your bond is worth after rates go up -- just one percent. In other words, your bond just lost almost 17%, which doesn't sound all that safe to me. If interest rates go up 2%, you lose almost 29%
(I'll spare you the arithmetic but long-term bonds are much more risky than short-term bonds. That's why extra cash should only be parked in short-term bonds, not long-term bonds, even though short-term bonds normally pay lower interest than long-term bonds.)
According to the conventional wisdom (AKA old wives' tales) investors primarily seeking income (as opposed to capital growth) should be invested in a portfolio of bonds with varying maturities. With so little safety of capital in bonds and with so many excellent stocks paying dividend rates much higher than interest rates, the conventional wisdom is WRONG, WRONG, WRONG!
This morning, I felt vindicated watching Warren Buffett, as he said that investors "could lose a lot of money on long-term bonds" even U.S. Treasuries. I've been saying this a long time. I may not agree with Warren on everything, but I am always delighted when he agrees with me.
Now, do you have any long-term bonds? If you don't know, why don't you know?
