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Bonds and the
Long-Term Investor

Some time ago an article appeared in the Los Angeles Times, titled "Individual Investors Are Fleeing Bonds, but Should They?"   While it made no specific recommendations, it did highlight the year-to-date total returns on various bond types. Included were long term Treasury bonds which had a return (price appreciation plus interest) of +15.3%. 

Real Vs Paper Gains

Now 15.3% is obviously a great return on a bond, but what does it really mean?  Unless you are a bond trader who plays the market for capital gains, it merely means that you have a handsome paper gain so far this year.  For the income investor it means little or nothing.  If you cash out to realize the capital gain, you become a bond trader yourself, and that is not why you bought the bonds in the first place.   When bond prices are high, yields are low so the long term bond investor usually has no good reinvestment alternatives.

When to Buy Bonds

Unlike most equities whose value increases with time, the market value of a bond merely fluctuates about some average value that depends on the current interest rate and the time to maturity.  In the case of a bond fund, which maintains a relatively constant average maturity, the market value reflects only the current interest rate for that maturity. 

The buy-and-hold bond investor foregoes the potentially higher return on equities in favor of a predictable return.  If the objective is to hold to maturity, as is the case for many investors, handsome paper gains means nothing.  The yield-to-maturity is essentially the total return.  The decision to buy should be based only on whether the yield-to-maturity is attractive at the time of purchase.

Bond Funds vs Bonds

The bond fund investor faces a less predictable situation.  There is no date-certain market value for the investment as in the case of bonds.  That's because the fund continually replaces its bonds to maintain its advertised average maturity. 

If you plan to buy a bond fund you should look for a current yield somewhat higher than the long term average yield-to-maturity on equivalent maturity bonds.  In this way you gain some protection against a capital loss due to a change in market interest rates.   Favorable occasions to buy a bond fund don't happen very often, and part of the reason is that fund expenses often soak up too much of the interest earnings.

Prefer Equities to Long Bonds

While equity investments can sustain an attractive total return over an extended period, the total return on a bond fund can only fluctuate about some long term average that is approximated by the interest rate yield, less fund expenses.  Long maturity bonds or bond funds are seldom a good choice for the buy-and-hold investor.

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