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The Wild World of Bond Investing

By David Luhman on Mon, 05/11/2009 - 23:18

The Wild World of Bond Investing

The biggest risk facing bond investors

How to really make money in bonds

Is the dollar "as good as gold"?

The biggest risk facing bond investors

The biggest risk facing bond investors isn't the risk that the company will go bankrupt (credit risk)

The biggest risk is interest rate risk

If you only learn one thing about bonds, understand that

When interest rates go up, bond prices go down

When interest rates go down, bond prices go up

This has nothing to do with the creditworthiness of the issuer

A 30-year US Treasury bond purchased in 1971 had lost half of its value by 1981 when interest rates were very high

Largest factor affecting the interest rate for investment-grade bonds is the inflation rate

How to really make (or lose) money in bonds

Invest in long-term bonds

Long-term bond prices are much more sensitive to interest rate changes

The reason is because long-term bonds lock you into either a very good interest rate or a very bad interest rate for a long time

Long-term bond prices are almost as volatile as stock prices

Is the dollar "as good as gold"?

Dollar was convertible into gold from 1834 until 1971

  • Convertability strengthened in 1900
  • Convertability weakened in 1934
  • Covertibility eroded in 1960s as US gold reserves dropped
  • Convertibility finally ended in 1971 after France's de Gaulle demanded gold for his country's dollars

Fixed amount of gold reserves restricted central bank's ability to print money

Inflation in the US was 0.1 percent annually during the "classical gold standard" period from 1880 to 1914

Without the gold standard, the US suffered high inflation in the 1970s

Is the gold standard necessary?

The gold standard isn't necessary if you have a good central bank that controls monetary growth

Other nations such as Argentina tried to control inflation with a "US dollar standard"

Nation would only issue currency that was backed by US dollars

The gold standard is a fairly ruthless way to monetary stability

The gold standard exacerbated recessions

But the gold standard has an excellent track record when it comes to restraining inflation

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