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I agree. One of the most cringe-worthy parts of this post is the author's multiple references to bond funds. Owning bond funds is not the same thing as owning b

I agree. One of the most cringe-worthy parts of this post is the author's multiple references to bond funds. Owning bond funds is not the same thing as owning bonds and every bond investor should know the difference. Bond prices have an inverse relationship with interest rates. Bond prices fall when interest rates rise. When you own individual bonds, you cannot lose your principal if you hold to maturity unless the issuer defaults. Most bond funds do not hold bonds to maturity, so investors in bond funds have significant exposure to interest rate risk. This is especially true today given the interest rate environment. There are other ways to address interest rate risk with bond funds, especially if you have a longer horizon. You can buy short-term bond funds, and there are even defined maturity funds. But you don't find any mention of those in the post. It's just bonds = bond funds. It all comes back to your comment, "put the time in and you'll be rewarded over the long term." Even seemingly simple financial advice ("buy a bond fund!") is insufficient because it requires more time and effort to execute correctly than most people are willing to put in.

Retric 12y ago
I don't think bonds are really a good investment for most people. They basically have the same edge case volatility as stocks(1) without the upside. If you have a diversified portfolio the worst stock market crashes where only an issue if you used leverage. (1)As in if the issuers fail you get nothing. PS: Granted if bonds where still paying 10+% that would be another story, but after taxes there only slightly ahead of inflation.
- tacos 12y ago
  Getting the same return on a bond investment as a stock investment is not the goal. Diversification into fixed income reduces risk (specifically volatility) which is important when you need the money at a predicted date. See this link, provided elsewhere in this thread: http://bucks.blogs.nytimes.com/2011/09/06/why-and-how-diversified-investors-win/ http://bucks.blogs.nytimes.com/2011/09/06/why-and-how-divers... Sorry to ding, but "I don't think bonds are a good investment for most people" is exactly the type of MattCuttsian financial generalization I'm trying to discourage in my little corner of this thread.
  - Retric 12y ago
    Bonds are paying way less than stocks. If you think there a good idea feel free to defend them but consider this: First off most methods of diversifying bonds (bond funds) add interest rate risks so there not predictable returns. Which means you can buy specific bonds. A 1 year T-Bill pays under 1% before taxes which is hardly worth the hassle for most people. To get better returns in the short term your stuck with increased risks. Sure, longer term bonds have higher returns but not all that high and your still stuck with inflation risks. As to the classic advice of sticking 50% of your portfolio into bonds your basically getting negative risk adjusted returns. If you want liquidity just hold cash it's safer and more flexible. As to being an inflation hedge I don't see how we can have less inflation in the future. PS: There are edge cases, but as long as interest rates are this low their fairly rare. Edit: I do agree it's a good idea to keep some liquidity, but nothing is wrong with just holding some cash.
    - tacos 12y ago
      Worldwide bond market is $82 trillion. Larger than the entire stock market. Meanwhile "Retric" on HN says bonds are pointless. Hmm.
      - Retric 12y ago
        Because clearly individual small time investors make the majority of all investments... Err, wait no. Sure, there is also a huge market for elemental fluorine that does not mean it's something you want in your house. Don't get me wrong there generally small risk adjusted net gain in any portfolio if you spend the effort picking the correct set of bonds. The problem is there a far more complex financial instrument than stocks which makes them really easy to mess up. Add to that the current returns and it's just a poor bet for most people. Also, I note you in no way actually defended them. In there defense a condo association saving up for known long term repairs are basically an ideal bond invester. PS: A 1/10 th percent gain on 50 billion is worth a lot of effort a 1% percent gain on 50k is not worth much.
        12y ago
gfodor 12y ago
This is oft-cited difference between bonds and bond funds is a red herring when it comes to determining the proper investment of the two. The reason a single bond keeps you from losing your principal is because it has a declining duration, whereas bond funds generally have a fixed duration (more or less) since maturing bonds in the portfolio are usually reinvested into bonds of the same time to maturity. You can simulate the behavior of a single bond by rolling your investments into shorter and shorter duration bond funds over time. The reason you would do this is if you have a known date for when you are going to need the principal. (This is the same justification you would use for buying an individual bond.) By controlling the duration via reinvestment into bond funds, you are diversifying away a majority of of the default risk (the major risk of owning bonds) while still being able to ensure your bonds are worth at least as much as your principal on a fixed date determined at the beginning of the investment. As an aside, concern about the market price of a bond is usually a good example of focusing on the wrong thing. If a bond's price has declined because of increased default risk, this is obviously bad. But if a bond's price has declined because of increased interest rates, this means you will be able to re-invest the coupon at a larger yield, so depending on your investment goals (such as having a robust inflation adjusted income stream for retirement) this may not be strictly a bad thing. http://www.bogleheads.org/wiki/Individual_bonds_vs_a_bond_fund http://www.bogleheads.org/wiki/Individual_bonds_vs_a_bond_fu...
- 7Figures2Commas 12y ago
  > You can simulate the behavior of a single bond by rolling your investments into shorter and shorter duration bond funds over time. As I noted, there are ways to address interest rate risk with bond funds, but you're ignoring the most important question in the context of this discussion: how many retail investors who put money into bond funds actually know about laddering strategies? > But if a bond's price has declined because of increased interest rates, this means you will be able to re-invest the coupon at a larger yield... This is true, but you have to wait until maturity unless you're willing to sell your bond at a loss. Despite the low interest rate environment, there are still a good number of retail investors buying exposure to long-dated bonds because they don't take the time to understand their investments. Many of these investors will either have to realize potentially painful losses or wait a long time before they have the opportunity to buy new bonds with higher yields.
Matt_Cutts 12y ago
7Figures2Commas, of course I know the difference between a single bond vs. a bond index fund. I clipped coupons off a bond my grandfather gave me as a kid. The interest rate environment at this moment is interesting with QE coming to an end, but I'm trying to give advice that will work well long-term.
- 7Figures2Commas 12y ago
  You might know the difference between a bond and a bond fund, but there's nothing in your post that highlights the distinction for the readers who don't. As an example, you state: > I’d also recommend investing in a bond index fund. Bonds tend to do well when stocks do poorly, and vice versa, so investing in both will tend to reduce your risk. Notwithstanding the fact that "bonds tend to do well when stocks do poorly" is a vast oversimplifcation[1], "I’d also recommend investing in a bond index fund" is far too general a statement to be considered actionable advice. This is not actionable advice either: > But there is a simple trick to minimize your taxes: buy municipal bonds for the state where you live. For example, Vanguard offers municipal bond funds for many states, including a bond fund for California. Vanguard offers multiple bond funds for California (there's an intermediate-term and long-term). Which one are you referring to, and why? If you followed the title of your post ("Nine hard-won lessons about money and investing") and didn't package your own lessons as "advice" (your words, not mine) for everyone else, I think folks would have responded less critically to it. Instead, you ironically dissed financial advisors while providing "advice" far less detailed and actionable than one could expect from even the most mediocre or inexperienced of financial advisors. [1] https://media.pimco.com/Documents/PIMCO_Quantitative_Research_Stock_Bond_Correlation_Oct2013.pdf https://media.pimco.com/Documents/PIMCO_Quantitative_Researc...

Retric 12y ago

I don't think bonds are really a good investment for most people. They basically have the same edge case volatility as stocks(1) without the upside. If you have a diversified portfolio the worst stock market crashes where only an issue if you used leverage. (1)As in if the issuers fail you get nothing. PS: Granted if bonds where still paying 10+% that would be another story, but after taxes there only slightly ahead of inflation.

tacos 12y ago
Getting the same return on a bond investment as a stock investment is not the goal. Diversification into fixed income reduces risk (specifically volatility) which is important when you need the money at a predicted date. See this link, provided elsewhere in this thread: http://bucks.blogs.nytimes.com/2011/09/06/why-and-how-diversified-investors-win/ http://bucks.blogs.nytimes.com/2011/09/06/why-and-how-divers... Sorry to ding, but "I don't think bonds are a good investment for most people" is exactly the type of MattCuttsian financial generalization I'm trying to discourage in my little corner of this thread.
- Retric 12y ago
  Bonds are paying way less than stocks. If you think there a good idea feel free to defend them but consider this: First off most methods of diversifying bonds (bond funds) add interest rate risks so there not predictable returns. Which means you can buy specific bonds. A 1 year T-Bill pays under 1% before taxes which is hardly worth the hassle for most people. To get better returns in the short term your stuck with increased risks. Sure, longer term bonds have higher returns but not all that high and your still stuck with inflation risks. As to the classic advice of sticking 50% of your portfolio into bonds your basically getting negative risk adjusted returns. If you want liquidity just hold cash it's safer and more flexible. As to being an inflation hedge I don't see how we can have less inflation in the future. PS: There are edge cases, but as long as interest rates are this low their fairly rare. Edit: I do agree it's a good idea to keep some liquidity, but nothing is wrong with just holding some cash.
  - tacos 12y ago
    Worldwide bond market is $82 trillion. Larger than the entire stock market. Meanwhile "Retric" on HN says bonds are pointless. Hmm.
    - Retric 12y ago
      Because clearly individual small time investors make the majority of all investments... Err, wait no. Sure, there is also a huge market for elemental fluorine that does not mean it's something you want in your house. Don't get me wrong there generally small risk adjusted net gain in any portfolio if you spend the effort picking the correct set of bonds. The problem is there a far more complex financial instrument than stocks which makes them really easy to mess up. Add to that the current returns and it's just a poor bet for most people. Also, I note you in no way actually defended them. In there defense a condo association saving up for known long term repairs are basically an ideal bond invester. PS: A 1/10 th percent gain on 50 billion is worth a lot of effort a 1% percent gain on 50k is not worth much.
      - 12y ago

gfodor 12y ago

This is oft-cited difference between bonds and bond funds is a red herring when it comes to determining the proper investment of the two. The reason a single bond keeps you from losing your principal is because it has a declining duration, whereas bond funds generally have a fixed duration (more or less) since maturing bonds in the portfolio are usually reinvested into bonds of the same time to maturity. You can simulate the behavior of a single bond by rolling your investments into shorter and shorter duration bond funds over time. The reason you would do this is if you have a known date for when you are going to need the principal. (This is the same justification you would use for buying an individual bond.) By controlling the duration via reinvestment into bond funds, you are diversifying away a majority of of the default risk (the major risk of owning bonds) while still being able to ensure your bonds are worth at least as much as your principal on a fixed date determined at the beginning of the investment. As an aside, concern about the market price of a bond is usually a good example of focusing on the wrong thing. If a bond's price has declined because of increased default risk, this is obviously bad. But if a bond's price has declined because of increased interest rates, this means you will be able to re-invest the coupon at a larger yield, so depending on your investment goals (such as having a robust inflation adjusted income stream for retirement) this may not be strictly a bad thing. http://www.bogleheads.org/wiki/Individual_bonds_vs_a_bond_fund http://www.bogleheads.org/wiki/Individual_bonds_vs_a_bond_fu...

7Figures2Commas 12y ago
> You can simulate the behavior of a single bond by rolling your investments into shorter and shorter duration bond funds over time. As I noted, there are ways to address interest rate risk with bond funds, but you're ignoring the most important question in the context of this discussion: how many retail investors who put money into bond funds actually know about laddering strategies? > But if a bond's price has declined because of increased interest rates, this means you will be able to re-invest the coupon at a larger yield... This is true, but you have to wait until maturity unless you're willing to sell your bond at a loss. Despite the low interest rate environment, there are still a good number of retail investors buying exposure to long-dated bonds because they don't take the time to understand their investments. Many of these investors will either have to realize potentially painful losses or wait a long time before they have the opportunity to buy new bonds with higher yields.

Matt_Cutts 12y ago

7Figures2Commas, of course I know the difference between a single bond vs. a bond index fund. I clipped coupons off a bond my grandfather gave me as a kid. The interest rate environment at this moment is interesting with QE coming to an end, but I'm trying to give advice that will work well long-term.

7Figures2Commas 12y ago
You might know the difference between a bond and a bond fund, but there's nothing in your post that highlights the distinction for the readers who don't. As an example, you state: > I’d also recommend investing in a bond index fund. Bonds tend to do well when stocks do poorly, and vice versa, so investing in both will tend to reduce your risk. Notwithstanding the fact that "bonds tend to do well when stocks do poorly" is a vast oversimplifcation[1], "I’d also recommend investing in a bond index fund" is far too general a statement to be considered actionable advice. This is not actionable advice either: > But there is a simple trick to minimize your taxes: buy municipal bonds for the state where you live. For example, Vanguard offers municipal bond funds for many states, including a bond fund for California. Vanguard offers multiple bond funds for California (there's an intermediate-term and long-term). Which one are you referring to, and why? If you followed the title of your post ("Nine hard-won lessons about money and investing") and didn't package your own lessons as "advice" (your words, not mine) for everyone else, I think folks would have responded less critically to it. Instead, you ironically dissed financial advisors while providing "advice" far less detailed and actionable than one could expect from even the most mediocre or inexperienced of financial advisors. [1] https://media.pimco.com/Documents/PIMCO_Quantitative_Research_Stock_Bond_Correlation_Oct2013.pdf https://media.pimco.com/Documents/PIMCO_Quantitative_Researc...