
Subject: Re: individual bonds in IRA Date: 2/18/2010 11:37 AM
Recommendations: 22
Unless you have a much larger amount to invest, 35% of 50K is way too small to get a safe diversity in bonds.

I strongly disagree with this advice. If 10 stocks is a reasonable diversity than 10 bonds is reasonable diversity; any way you look at it 1/10 of the assets allotted are exposed to the risks of a single holding. Its this logic that forces people to put the capital that they want to invest in bond like objects to protect principal and earn a bit of a return into asset classes that put principal at risk.

No one argues it would be poor investing to buy 10 CDs and build a ladder while it apparently it would be poor diversification to attempt the same with 10 Federal Treasuries, heaven forbid we even consider buying A+ - AAA debt. A sharp switch in interest rates can carve 10% out of the NAV of a bond fund which would be no different than having 1 bond out of ten completely fail. The principal of the holder of the 10 CDs or the 10 Treasuries is safer than either the bond fund or the 10 corporate bond portfolio and usually priced (yielding) accordingly.

This whole site was founded by the belief that individual small investors can learn how to properly perform Due Diligence on companies and make smart stock picks. Yet, the same apparently doesn't hold true for bonds, the safer of the two ways to buy into a firms business. This mentality keeps people out of bonds, if this myth is dismissed it opens up many opportunities.

There are dozens of well run companies that are so well run that I, as a value investor, can rarely buy their common stock. I can usually buy their debt at a much more competitive price. There are hundreds of rebound companies where their stock price is also too pricey; I can buy their debt.

And if I want the safety of of Federal backing and easy market access liquidity I can buy treasuries.

If you want to buy 1 bond to add or start your "bond-like" portion of your portfolio than buy 1 bond. If you want to buy 10 than buy 10, if you want to buy 100 then buy 100. The only caveat is that the shopping and the managing needs to be done intelligently. If you don't know how to perform DD on firms then you will not be able to intelligently pick corporate bonds. If you don't know how to manage a bond portfolio then start small so you can make mistakes and learn without tearing up your "bond-like" assets.

In order to start small you need to toss in the garbage heap the idea that 5k or 10k is not enough capital to buy smartly into bonds. A far worse approach would be to save 50k - 100k and use that capital to learn how to manage your own bond portfolio. The magnitude of the mistakes are amplified in the larger portfolio not diminished by diversification; ignorance is the enemy, the hurdle to over come, not quantity of capital.

Preferred stock is a useful tool as long as you understand what it is.
This means that not only can you capture capital gains you can lose capital. They are traded shares with prices set throughout the day, the price goes up and down over time. They have more protection in foreclosure than common stock and less than bond holders.

Each individual needs to decide for themselves what kind of asset a preferred is. Some, as noted above, place them with debt instruments. Others are going to treat them as more stock than bond and use them to boost yield. I believe they behave more like bond funds than stocks or bonds and use them that way. (they are easier to examine than funds which can be handy)

With 30+ years to go now is a great time to learn how to manage both the stock and the bond portion of your portfolio. Keep in mind that you probably skinned your knees learning to ride a bike or a skateboard, you are going to skin your knees learning how to manage your own assets. We skin our knees by buying the wrong fund, or stock or bond at the wrong time and at the wrong price. The first hurdle to overcome is learning how to make your own investing decisions instead of turning that task over to some professional fund, bond or stock picker.

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