Dear Clients and Friends,
As summer draws to a close, one area of concern among friends and clients has been the issue of whether investing in bonds makes sense considering the level of interest rates at this time. Another concern often heard: How does the flash crash affect those who like to invest some of their money on their own in the stock market? Here are my thoughts on both those subjects.
Recent
headline from Barron’s magazine: “Beware of Bond Funds”.
Then on August 10, 2010, the Federal Open Market Committee announced it will reinvest maturing agency and agency mortgage-backed securities into "long-term" Treasury securities which will in effect drive down yields.
The total bond market index is up almost 7 percent year to date.
So is it safe to still invest in bond funds?
In my opinion, yes, but you need to navigate the bond market carefully. Short term rates are almost at zero percent and long-term rates are going lower. When investing in bonds, be mindful of the idea that as rates go down, the value of your bond or bond fund should go up. However, even the anticipation of a decrease in rates will drive a bond value up which happened on Wednesday with long-term Treasuries rising by 1 ½ percent. So if you think rates can’t get any lower then what should you do?
I wouldn’t eliminate bonds right now because bonds are one of several good alternatives to lowering the risk of your portfolio. However, I would be very careful as to where and how you invest in bonds.
Barron’s recommends buying individual government bonds and holding them to maturity. That way you are assured you’ll get your money back plus interest income, assuming the bond doesn’t run into credit issues. This is a good strategy, especially if the economy runs into a deflationary period.
If the economy becomes inflationary, then interest rates will rise and you’ll miss the opportunity to invest in higher-yielding bonds. However, if you have laddered your bonds, so that you have some maturating over a period of time, as the bonds mature you can take that money and invest in higher-yielding bonds.
In order to have a well-diversified portfolio, I would limit this strategy to investable assets of $500,000 or more. And the biggest problem you will run into is to how to buy these bonds without paying commissions (and or spread). Your broker or even discount broker such as Fidelity or Schwab may tell you that there is no commission but when you see what you have paid for the bond and then see the market value, you will realize that someone took 1 to 2 percent in a spread. A good, reputable advisor will be able to help you build that portfolio with a minimal spread and or commission.
“Avoid Bond Funds”…says Barron’s
Barron’s recommends that you stay away from bond funds because the value of the holdings in the portfolio declines in a rising-rate market. That is true generally but I have to disagree. There are bond fund managers who have weathered the storm of increasing rates in the past. You want to seek out experienced global bond fund managers with few constraints on where and what they can invest in so that they be nimble and take advantage of TIPS (Treasury Inflation-Protected Securities), high yield bonds, high quality mortgage-backed securities and bank loans to name a few. Two of my favorites are Franklin Templeton Global Bond Fund and Pimco Total Return Fund.
Flash
crash: Steps an individual investor needs to take when investing on
their own.
On several occasions, friends remarked to me that the markets have been taken over by institutional investors and that there is no longer a place for the individual investor to buy and sell stocks for his or her portfolio.
Many people believe that when investing in the market, the volatility and inefficiency of prices will be sure to have a negative effect on their purchases; the individual investor will overpay and the institutional investor will reap the rewards. Common belief of many is that this volatility in prices will affect the overall return of one’s stocks.
Investors got hurt in the flash crash on May 6 because the market showed inefficiencies in the pricing of stocks and ETFs. For example; Apple traded for an instant for $100,000 a share. Can you imagine putting in a market order for 100 shares (expecting a lower price) and then finding out you owe ten million dollars on settlement!? Rightly so--investors began to think that the stock market is now only for the institutional investors, hedge funds and high frequency traders.
Individuals can still invest but you now have to
look at investing differently:
• First, you have to be careful when to invest in the market and how
you place your trade.
• Second, remember the old adage of investing for the long-term.
Tips for investing on your own:
• Avoid buying during times when there is strong news that would cause the market to panic. Volatility in the market is a sign that there may be a significant difference in the bid and ask price (the price the seller is willing to sell the stock for and the price that a buyer is willing to pay)
• Avoid buying right when the market opens. There is often less activity at that time so there can be a big difference in the price that is quoted and the price that you pay, especially low-volume traded stocks.
• Buy stock over time rather than all at once (assuming transaction fees are low). With the volatility that is in the market, you will even out the price swings and your average cost should be more reflective of the true value of the stock.
• When buying a stock, put a limit price on your order. A limit price is the price you are willing to pay for a stock. When the stock’s value reaches that limit price, it will trigger a buy order. That way you will avoid paying an outlandish price for a stock.
• Invest in a company because you believe it will perform well over the long term. Although you want to monitor its progress and earnings, ignore the volatility in its daily stock price and focus on its long term potential.
• When selling, you may not want to put in a limit order. A limit order is when you put in an order to sell a stock or ETF when it falls to a certain price. The problem on May 6 was the orders could not be filled at that price so many stop loss orders were filled at prices well below the limit the sellers set.
As always, if you have questions on this newsletter or other questions about your portfolio, I am available to consult with you.
Regards,
Susan Templeton
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