Bond Investing For Dummies
Book image
Explore Book Buy On Amazon

Here are ten questions and answers about bond investing with Dan Fuss, who is vice chairman of Loomis, Sayles & Company. He’s been managing investments for more than half a century.

The Loomis Sayles Bond Fund has returned more than 10 percent a year over the past 20-plus years — about 3 full percentage points above the return for the entire bond world. At the helm of the fund since 1991 (joined by co-manager Kathleen Gaffney in 1997).

Q. Dan, to what do you attribute your incredible success as a bond investor?

A. As you head to work in the morning and look around you, you get a sense for what season it is. Just as the calendar has seasons, there are also seasons of the economy, what one can also refer to as “cycles.” These can greatly affect bond returns.

One advantage I have is being older than the hills . . . I’ve seen a good number of seasons, and I can perhaps recognize them a little quicker than most. While I’m looking out for changes in the seasons, I also look at individual bond issuers and how the change of seasons is likely to affect them. Breezy-Weezy Widget Company might do better in a hot season than cold.

Q. What would you say is the most common mistake that bond investors make?

A. If we’re talking about investors in individual bonds, the most common mistake is not diversifying enough. I don’t think it is even possible to diversify adequately unless you have a bond portfolio of considerable size . . . $100,000 for Treasury bonds, $200,000 for municipals, and if you’re investing in corporate bonds, you’d better have at least $1 million to invest.

You’ll also need lots of time to invest in research, and a broker you really know and trust. Otherwise, you’re bound to take too much risk on individual issues, and you’re going to get eaten alive with fees.

Q. And what about investors in bond funds? What do you see as their most common or most fatal mistake?

A. There, I’d say the greatest mistake is buying an undifferentiated, general market-correlated fund — almost a “closet” index fund — with high expense ratios. If you’re going to be paying a bond manager to manage your bond portfolio, you want that manager to really manage.

You don’t want that manager simply buying the market, because the market is full of terrible bonds that might make perfect sense for the companies issuing them and the brokerage houses selling them, but make no sense for investors.

Q. Many investors today are nervous about both stocks and bonds — stocks because of the great volatility we’ve been seeing, and bonds because interest rates are so low. Are these fears warranted? What is your prediction as to what the total return on bonds and stocks will be over the next ten years?

A. Prediction? Let’s not use that word! My guess is that both bonds and stocks will return about 7 percent a year over the next decade, but stock returns will bounce around a lot more than bonds.

Q. So you’re saying that bond returns are likely to be considerably higher than their historical average, and stock returns will be considerably lower. On what are you basing those predictions, er, guesses?

A. Mostly on the growing U.S. federal deficit. That will require greater borrowing by the Treasury, which will tend to force up interest rates. In the long term, such as ten years, rising interest rates will be a good thing for bond investors and not such a good thing for stock investors. But I’m looking at other factors, too, including the currently reasonable valuations of most U.S. companies.

Q. You’re talking nominal returns, right? How much of these investment gains do you see being eaten away by inflation over the next decade?

A. Yes, I’m talking nominal returns. My best guess for inflation would be about 4 to 5 percent a year. It will be slower at first and then we’ll see a crescendo toward the end. Hopefully, it won’t be like the second half of the 1970s . . . hopefully!

Q. So if you reckon that stocks and bonds are going to return about the same in future years, and bonds are going to be much less volatile, are you then advocating all-bond portfolios?

A. I like bonds, but a diversified portfolio with both bonds and stocks still makes sense! First, my guesses about returns could be totally wrong. Second, stock and bond returns will likely continue, as they have in the past, to move up and down in different cycles. Third, if you know what you’re doing, you can add a lot more return on the stock side by focusing on specific risks.

Q. What is the best place to invest right now for people who are most concerned with safety?

A. There are no completely safe places in the bond market. The risk of capital loss is minimal if you invest in short-term Treasuries, but you have maximum reinvestment risk. If you invest in 30-year Treasury zero-coupons, there is no reinvestment risk, but there is certainly a lot of risk to the value of your principal. With corporate bonds, of course, there are all kinds of additional risks.

The greatest safety, now and always, can be found in diversification.

Q. What tips do you have for someone shopping for a bond fund . . . other than choosing Loomis Sayles, of course!

A. The expense ratio needs to be reasonable: less than 0.5 percent for a Treasury fund . . . not much more than 1.0 percent for anything else. There should be limited turnover. Turnover costs you money — I’d be wary of any kind of flipping over 80 percent a year.

Look for a fund with a long-term positive track record, and make sure that the same manager or team that earned that track record is still the one running the show.

Perhaps most importantly, make sure you know what you’re buying. For most investors, multi-sector bond funds will make the most sense. Beware that there are many so-called “strategic income” funds out there that sound like multi-sector bond funds, but they may really be balanced funds with exposure to equity as well as fixed-income investments. Read the prospectus!

Q. You’ve talked of diversification and you’ve used the word “multi-sector.” How diversified should investors be? And how “multi” is “multi” where bonds are concerned?

A. A diversified portfolio will have both equity investments and bonds. If munis make sense from a tax vantage point, I like to see a good array of municipal issues. If taxable bonds make more sense, I like to see a mix of Treasuries, corporate bonds, agencies, mortgage-backed, and international. Each category will do better at different times.

As much as everyone likes to make predictions, you never know what’s coming around the corner.

About This Article

This article is from the book:

About the book author:

Russell Wild, MBA, an expert on index investing, is a fee-only financial planner and investment advisor and the principal of Global Portfolios. He is the author or coauthor of nearly two dozen nonfiction books.

This article can be found in the category: