Editor's Note: Jeffrey R. Kosnett is the regular author of Cash in Hand. This special interview was conducted by guest columnist Andrew Tanzer.
Marilyn Cohen, a Los Angeles–based fixed-income expert, has published a new book called Bonds Now! (John Wiley & Sons, $30), which she coauthored with her husband, Chris Malburg. Written in plain English, Bonds Now! is a street-smart guide to picking through the minefield-infested landscape of bond investing. We asked Cohen, a battle-scarred veteran of these tricky markets, for some savvy advice for bond investors.
KIPLINGER: The subtitle of your book is Making Money in the New Fixed Income Landscape. What’s changed for bond investors?
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COHEN: The credit crisis taught us many lessons. One is that allocation and diversification in a bond portfolio are enormously important. Do-it-yourselfers never thought of this before the credit crisis. They would just accept any bond offer from their brokers. As a result, their portfolios typically fell 30% to 40%, which is unthinkable in a bond portfolio. Instead of doing the groundwork and hunting for what they should buy to balance their portfolios, they just took what their brokers sold them. As a result, people were over-allocated to bonds in the financial and auto sectors because that’s where the largest issuers were. The new landscape is all about planning, populating the portfolio the way a stamp collector buys individual stamps to balance a collection.
How do you suggest a do-it-yourselfer build a portfolio and conduct bond research? Construction is pretty easy. You create a model allocation, stay in different industry classes and allocate no more than 15% to an industry, such as financials. No one issuer should account for more than 3% to 5% of an entire bond portfolio, whether the name is Goldman Sachs (GS) or JPMorgan Chase (JPM). This is a very simple, common-sense approach, but people didn’t use it before the credit crisis. They just grabbed for yield.
As for research, investigating a bond is much like researching a stock. You make sure you understand what a company does for a living, you look at quarterly numbers and you see whether management is bond-friendly. CEOs who are busy increasing dividends, repurchasing shares and making acquisitions may be doing things that stroke their own egos and favor shareholders over bondholders.
Do you recommend that investors buy individual bonds or invest in professionally managed bond funds? You have to look at where we are in the economic cycle and where your investment will be the safest. Right now, I think we’re in a huge bond-fund bubble because of the enormous amount of money that has flowed out of the stock market, CDs and money-market funds into bond funds of all kinds since January 2009. More money went into bond funds in 2009 than in the ten prior years combined. It’s a bubble because a massive number of retail investors who have never participated in the bond market before have piled in en masse. The 30-year bull market we’ve seen in bonds will come to an end when interest rates start rising. That should be soon. If we have an event such as a large default or a spike in interest rates or in consumer prices, then investors will start selling their bond funds. That would beget more selling, and then you could have massive liquidation. By contrast, if you own individual bonds, the prices will come down, but you can just wait until they mature and return their face value.
How should investors deal with their brokers? You need to be in the driver’s seat, not in the back seat. You need a minimum of two brokers. Tell your broker what you’re looking for; don’t let him sell you a bond because he’s getting a big markup. Once he comes back with a price quotation, log on to www.investinginbonds.com or emma.msrb.org, which are free Web sites. Type in the bond CUSIP number and see at what price the bond last traded. The broker may be offering it at 101 [$1,010 for one bond], but you see that 30 minutes ago it traded at 99½ [$995]. Assuming the bond fits your investment parameters, you tell your broker that you’re interested in the bond but not at 101. Make it clear that you know how the market works. Make a counteroffer. Portfolio managers like me do that all day long.
If you are buying online, never ever point, click and buy a bond. You’ll be taken to the cleaners. You have to see where it last traded, be patient and put in the price you’re willing to buy the bond at. The only way you know the price is to look at the price at which it last traded. Brokers don’t own most of these bonds; they’re fed in from broker-dealers, and everyone’s taking a markup before they appear on the Fidelity, Schwab or Vanguard sites. Just because you’re buying from a discount broker does not mean you’re buying bonds at a discount. You’re paying full fare or more. So put in the price you want to pay and let the market come to you. If you don’t look at last trades, you’re pointing and clicking with a blindfold on.
What are some of the most common mistakes bond investors make? They don’t buy enough bonds on the new-issue market, where you know you’re getting the same price as everyone else. In fact, during the retail-priority period, you can buy municipal bonds before the institutions can. Also, too many investors are yield hogs: They look at yields first, and everything else is secondary. A lot of people buy things with characteristics they don’t understand, such as the nature of the underlying business or the capital structure of a corporation. With munis especially, people often don’t know what they own. You must understand what the sources are of coupon and principal payment -- for example, the source of revenue to pay off a revenue bond. Finally, too many investors simply accept the price from the broker or the online trading system as the only price at which they’ll be able to get the bonds.
