Part 3 – Some Ins and Outs

Hi everybody, I’m Marc Lichtenfeld, the editor of Oxford Bond Advantage. Welcome to part three of my bond tutorial series.

Let’s talk about how to set up and manage the bond portion of your portfolio.

One traditional method is to use your age as a percentage for your lower-risk holdings. So if you’re 65, you would own 65% in bonds, cash, annuities, certificates of deposit, etc., and 35% in high-quality or dividend-paying stocks. Naturally, this means the percentage shifts as you age.

Because people are living longer, many financial planners now recommend holding a percentage of your portfolio in bonds that is equal to 20 less than your age. So if you’re 65, you would own 45% in bonds, etc., and 55% in high-quality dividend payers or other stocks.

If you need help with this area, the brokers listed on the alerts can assist you.

In Oxford Bond Advantage, I am focused on shorter-term maturities, typically five years or less. With interest rates near zero, the only direction they can go is up, and that’s bad for bond prices. So we want to keep our maturities short. That way, if rates do go higher as our bonds mature sooner rather than later, we can buy higher-coupon bonds.

If rates move back up to their long-term averages between 4% and 5% on the 10-year Treasury, we could extend our time horizon to capture higher returns for longer periods. But for now, because shorter maturities drop less in value when rates go up, we’ll hold short maturities.

Also keep in mind that corporate bonds don’t react to rate changes the way Treasurys and municipal bonds do. Our bonds will rise and fall much more on changes to the fundamentals of their issuing companies.

We want at least one bond maturing each year for around five years. I call this a staggered portfolio. It allows us to have fresh money coming in each year to buy into rising rates.

And as rates go up, bond prices go down. We can make this work to our advantage.

We’ll make money no matter what rates do or how much our prices fluctuate. So when they start moving, don’t panic.

Since rates have been so low for so long, I know we’ll see bond prices drop and rates increase at a faster-than-normal pace when we finally see some inflation.

So let’s take the safest route by having cash come out of our bonds every year in order to take advantage of inflation.

This brings me to one of the most important factors in making money with bonds: patience.

In so many ways, bonds differ from stocks. For one thing, they require less attention and provide less excitement, which is usually a good thing. There’s little price movement in most bond markets.

The biggest challenge we face is being patient with our holdings.

We usually hold our bonds unless there’s a significant change in the underlying fundamentals of the companies behind them. And even then, unless the change is so severe that bankruptcy is possible – which happens less than 2% of the time for the type of bonds we hold – we’re better off just waiting for maturity.

Never put money in a bond if you can’t leave it there until maturity. Otherwise, if the price dips, you’ll be stuck.

That being said, if a bond rises significantly in price and we can take a sizable profit, we will. Often, it makes more sense to take the quick profit and find a new bond to invest in.

In summary, let’s review…

• Maintain small positions.
• We want one bond per year maturing. That’s the minimum… More is better.
• Always assume we’ll hold to maturity.
• Never sell a bond just because it’s down in price.
• Get used to doing nothing with your holdings.
• If a bond runs up in price, we’ll sell it before maturity to take a bigger profit.
• Limit the size of our riskier holdings and never get overloaded in one bond. That way, you won’t suffer a devastating loss in case one of our bonds runs into trouble.

That’s it for today. I’ll see you in Part 4.