Investing: For Once, Tap Your Principal

[Dover]

Investing: For once, tap your principal

by Chuck Jaffe, Boston Globe

For many income-oriented investors, the options have come down to this: Increase yield by investing in higher-risk securities or eat into principal while sticking with surer money-market funds and ultrashort bonds.

..snip..

"People tend to think of bonds in yield terms, and not price terms," said Jim Griffin, editor of the ING Aeltus Weekly newsletter. "When you see the kind of price volatility we've had in the past few weeks and believe it will get worse, you have a decision to make.
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"By avoiding touching principal, you could actually wind up touching the third rail of volatility, locked into a long-term, low-yielding contract or facing a capital loss as rates turn and move in the wrong direction. There's a lot of risks to be balanced, but you could see how nibbling at the principal now so that you are better positioned for what happens next might be the smart decision."..>> MORE

http://www.iht.com/articles/104987.html

[Code_Name_D]

1. Okayyy

I read this artical five times in a row, and still have no idea what he is saying. I think he is trying to say "don't sell your bonds becase of low yealds, the recovery is just around the corner," or something. But it looks more like giberish about third rails and "eating your young."

Any one else want to take a stab at translation?

[Boom_cha]

2. He's saying

that rather than buying bonds now, with yields so low and rising recently, you're better off staying in cash (money market fund, etc.) to await better opportunities (i.e., higher yields) later, even if it means that you have to draw down your principal to some extent. By doing this, you'll come out better in the long run.

[twilight]

3. its a bit late now though

If you were going to sell all of your bonds, the time was in mid-June for the top yield.

Since then, it has been a big loss - as much as 10% in some cases.

Now I noticed that TODAY they were all going up again. I don't know what to think.

All I do know is that I sold all of the bond funds I had several weeks ago and bought a CD at 4% interest.

At least that is safe.

Better safe than sorry at this point.

I seriously doubt I will ever enter the stock market again and I am fortunate that I did not lose any money with this investment which I bought into at the end of August 2002.

Thanks for nothing *. :grr: :grr: :grr:

:dem:

[SuperZippy]

4. wouldn't it be better...

to use a common laddering strategy?

the knowledge of "when" interest rates are going to rise isn't available.

so buy bonds with varying maturities, from 1 to 5 years, then as a portion of your dollars are available for re-investment you will be investing at new rates.

not necessarily higher.

[rapier]

5. Bond basics

The article contained the key point. To wit, "When bond yields rise, bond prices fall, which is why long-term bond funds have been crushed in recent weeks."

If you have a bond fund in your IRA or 401 plan you will discover next statement that you have lost money recently due to the spike in bond interest rates. Why is that you say? If interest rates rise don't I get more return. Well you do on any new bonds the funds purchase at the higher rates and the quoted yeild on your fund will be higher. But look at the price of the fund. It has fallen over the same period. The price decline of the fund means that you have lost on your principal.

OK, don't get it? I'll try again.

Even more basic. Bonds are sold with a stated interest rate. Let's say 5%. If the market rate for similiar bonds is 5% on the day of issue then when you or your fund buys say $100,000 in said bonds you pay $100,000. Now lets say the day after you buy the 5% bonds, interest rates spike to 6%. How do you sell a bond paying 5% when a buyer can go out and get a 6% bond issued today. Simple, you have to discount the price so the buyer is in effect getting todays 6% yeild. I don't have the actual numbers but let's guess and say to sell your 5% bond to equal 6% you might have to sell the $100K bond for $90K. The actual number might be worse.

I think now you might get it. When bond interest rates rise the prices fall. The obverse applies as well. When interest rates fall bond prices rise. TO take our example. If rates fall to 4% that next day if you were to sell your bond paying 5% you can get a premium. After all, why should the buyer get 5% when the market rate is 4%. So let's say you can sell for $110K. A big gain.

Now for most here they probably bought their bond fund with rates around where they are now or higher since the plunge lasted just a few months and rates are still low by historical standards. Still, the price quote of your fund is now lower than it was a month ago.

Whew. Hope that helps. It has nothing to do with 'ehtical'investing. Well I don't believe in such a thing really. The purchase of financial assets, ie. stocks and bonds is speculation, not investing. Always was, always will be.

Now go back and read the article. If you bought the bond fund at $50 dollars it might be $40 now. In other words if you switched out of the fund you would be losing money, ie. losing principal. Just like losing on a stock or stock fund. If interest rates continue to rise you will lose even more. The question is do you sell now. I might wait for a rally. Next time rates fall, if they do, consider selling the bond fund.

I am loath to make predictions on any market. If these were real markets now I would say sell or get ready to. 25 years is a long trend, old in the tooth, ready to reverse. But the markets are no longer honest. The are managed to an amazing degree. Above all else, even the stock market, it is absolutely imperetive for the financial world that rates do not change trend. I don't think the financial world can survive a trend to higher rates for several reasons. First is all the paper profits dependent upon falling rates. All bond holders have been holding their bonds at a profit on their books, in general, over the 25 year bull market. Many sets of books and assumptions of wealth and worth of banks, bussinesses and individuals depend upon the high and rising prices of already issued bonds.

Another reason is that much borrowing now is done for the purpose of paying off old debt. Like refinancing your mortgage and taking the equity to pay off your credit cards. Not just households are doing this. Corporations are as well. Nobody can afford to borrow at a higher interst rate to pay off lower interest debt. Instead a borrower must use their principal to pay off the debt.

I would say, and this might be esoteric to most, that the economy has now reached the stage, because of higher rates, that we are now as a nation being forced into liqudating our assets to pay off debt. This is actually as it should be because of our proligage borrowing. It is also one way to define recession or depression.