Experts Flunk Bond Investment Lessons

Far too many financial “experts” flunk bond market basics. They constantly have an unwarranted fear of the adverse effects of higher interest rates on individual bond prices and values.

Fact: Very few investors buy outright, individual bonds of any maturity, They invest, instead, in convenient, low-cost, fully diversified, mutual funds or ETFs.Therefore, the bulk of so-called expert comments on individual bond purchases and holdings don’t apply.

Fact: For the most part, bond fund owners reinvest their periodic  dividends.This is impractical and usually impossible for individual bond buyers to accomplish.

Fact: While it’s true that bond prices fall when interest rates rise, and bond prices rise as interest rates fall, these effects can be modified by duration and reinvestment principles. Duration explains why shorter-term bonds are not affected as much by interest rate movements as are longer-term bonds.

Fact: More important: Bond mutual fund investors who are aware of duration principles need not be hurt over the long term by interest rate moves; they can actually prosper when interest rates go up, with duration rule usage. .

Fact:  A bond holder is a lender. The higher interest rates go, the better off that lender is, provided he or she uses duration and reinvestment principles. And sticks to a plan of how long the bond fund is to be kept.

Note: Bond funds usually list their duration numbers. Look for, or ask  if they’re available for funds you seek. If not, approximate the figure to an extent by assuming that the shorter-term the bond portfolio maturity, the smaller the fund’s average duration.

The reinvestment solution:  The bond investor who reinvests dividends then holds the key to better performance. He should hold the fund longer than the stated duration period of that fund. If his intended investment period is more than 4 years, for example, it will be profitable to hold a bond fund with duration of at least 4 years. Long-term bond fund investors are always ahead in this game.

Fact: Experts love to bring up the question of credit defaults when evaluating bonds. But here again, pundits generally generate  more bluster than thought; the defaults rate is always built into the market price of a well-diversified fund. So higher defaults are offset by commensurate higher rates.

All these facts ruin arguments pundits have concerning values of individually-bought, non-in-kind, non-reinvested earnings, that apply to rates or interest-effected changes and looming inflation. (See the Earl J. Weinreb NewsHole® comments and @BusinesNewshole at Twitter.)