Bonds 2e – The Unbeaten Path to Secure Investment Growth

Foreword xxiii
<p>Preface xxvii</p>
<p>Acknowledgments xxxvii</p>
<p>Introduction xxxix</p>
<p>PART I Clearing the Cobwebs 1</p>
<p>Chapter 1 Bonds: The Better Investment 3</p>
<p>Examining the Myths 5</p>
<p>Historical Annual Return 5</p>
<p>Unhappy Returns: Uncovering the True Returns on Stock Investments 6</p>
<p>Taxes, Costs, and Risks of Investing in Bonds 9</p>
<p>Past Performance 10</p>
<p>Risk 14</p>
<p>Growth and Income 18</p>
<p>A Second Look at Risks and Returns 19</p>
<p>Stock Market Volatility: The Impact on Retirement Planning 21</p>
<p>Why Bonds Are a Better Investment than Stocks 23</p>
<p>Individual and Institutional Investors: How They Differ 24</p>
<p>Institutional Bond Investors 25</p>
<p>Key Questions to Ask about Whether You Should Invest in Stocks rather than Bonds 27</p>
<p>Notes 27</p>
<p>Chapter 2 The All–Bond Portfolio 29</p>
<p>Advantages of the All–Bond Portfolio 30</p>
<p>Financial Planning 31</p>
<p>Designing the All–Bond Portfolio 33</p>
<p>Plain Vanilla Bonds 33</p>
<p>Plain Vanilla Exclusions 34</p>
<p>A Word about Other Bonds 36</p>
<p>High–Yield Debt 36</p>
<p>The All–Bond Antidote to Greed and Fear 37</p>
<p>Notes 38</p>
<p>Chapter 3 Adopting the All–Bond Portfolio: A Case Study 39</p>
<p>A Poor–Fitting Portfolio 39</p>
<p>Peter s Financial Objectives 40</p>
<p>Peter s Concerns about His Portfolio 41</p>
<p>A Consultation with Stan Richelson 43</p>
<p>A Financial Plan Aligned with Objectives 44</p>
<p>Step 1: Peter s Objectives and Financial Needs 45</p>
<p>Step 2: Allocation Between Safe Bonds and All Other Assets 45</p>
<p>Step 3: Tax Review 45</p>
<p>Step 4: A Goal–Directed Portfolio 46</p>
<p>Reaching a Comfort Level 48</p>
<p>Note 48</p>
<p>PART II Bond Basics 49</p>
<p>Chapter 4 The Evolution of a Bond: From Verbal IOU to Electronic Entry 51</p>
<p>Learning the Language 51</p>
<p>The Early Years 52</p>
<p>A Colonial Debut 55</p>
<p>After the American Revolution 56</p>
<p>Entering the Twentieth Century 59</p>
<p>Changes in the Twentieth Century 62</p>
<p>A Modern Metamorphosis 64</p>
<p>Great Recession of 2007 2009 67</p>
<p>Basel III International Securities Standards 68</p>
<p>Derivative Regulation 70</p>
<p>The Internet s Impact on Bond Buying 70</p>
<p>Notes 71</p>
<p>Chapter 5 The Life of a Bond: How it s Created, Issued, Priced, and Traded 75</p>
<p>By Way of Background 76</p>
<p>Preparing a Bond Issue 78</p>
<p>Rating a Bond 81</p>
<p>Setting a Coupon Rate 84</p>
<p>Launching a Bond 85</p>
<p>Understanding Risk 86</p>
<p>A Bond s Cost and Yield 88</p>
<p>Determining a Bond s Yield 88</p>
<p>Current Yield 89</p>
<p>Simple and Compound Interest 90</p>
<p>Yield–to–Maturity 91</p>
<p>Yield–to–Call and Yield–to–Worst 92</p>
<p>Yield–to–Average Life 92</p>
<p>After–Tax Yield 93</p>
<p>The Call Option 93</p>
<p>Duration 94</p>
<p>Total Return 96</p>
<p>Cash Flow upon Death: The Estate Feature 97</p>
<p>Mind Mr. Market 98</p>
<p>Pricing a Secondary Market Bond 100</p>
<p>Key Questions to Ask When Purchasing a Bond 101</p>
<p>Notes 101</p>
<p>PART III Bond Categories 103</p>
<p>Chapter 6 U.S. Treasury Securities 105</p>
<p>The Big Picture 105</p>
<p>U.S. Treasury Notes and Bonds 108</p>
<p>Advantages 108</p>
<p>Risks 109</p>
<p>Tax Implications 109</p>
<p>Pricing Information 110</p>
<p>Special Features and Tips 110</p>
<p>U.S. Treasury Bills 111</p>
<p>Advantages 111</p>
<p>Risks 111</p>
<p>Tax Implications 112</p>
<p>Pricing Information 112</p>
<p>STRIPS 112</p>
<p>Advantages 113</p>
<p>Risks 114</p>
<p>Tax Implications 114</p>
<p>Pricing Information 114</p>
<p>TIPS 114</p>
<p>Advantages 117</p>
<p>Risks 117</p>
<p>Tax Implications 118</p>
<p>Special Features and Tips 118</p>
<p>Key Questions to Ask about All Treasury Securities 120</p>
<p>Notes 120</p>
<p>Chapter 7 U.S. Savings Bonds 121</p>
<p>Simple Investments with a Few Complexities 121</p>
<p>Purchasing a Savings Bond 122</p>
<p>Series EE Savings Bonds 123</p>
<p>EE Bond Purchases on or after May 1, 2005 123</p>
<p>Special Rules for Old EE Bonds 124</p>
<p>Advantages 125</p>
<p>Risks 125</p>
<p>Tax Implications 125</p>
<p>Special Features 127</p>
<p>Recommendations and Tips 129</p>
<p>Series HH Savings Bonds 130</p>
<p>Advantages 130</p>
<p>Risks 131</p>
<p>Tax Implications 131</p>
<p>Series I Savings Bonds 131</p>
<p>Advantages 133</p>
<p>Risks 134</p>
<p>Tax Implications 134</p>
<p>Recommendations and Tips 134</p>
<p>Key Questions to Ask about Savings Bonds 135</p>
<p>Chapter 8 U.S. Agency Debt 137</p>
<p>Major Debt–Issuing Agencies 138</p>
<p>Fannie Mae and Freddie Mac 139</p>
<p>Federal Agricultural Mortgage Corporation 142</p>
<p>Federal Farm Credit Bank System 142</p>
<p>Federal Home Loan Bank System 142</p>
<p>Financing Corporation 143</p>
<p>Resolution Funding Corporation 143</p>
<p>Student Loan Marketing Association 144</p>
<p>Tennessee Valley Authority 144</p>
<p>Advantages 145</p>
<p>Risks 145</p>
<p>Tax Implications 147</p>
<p>Special Features and Tips 147</p>
<p>Key Questions to Ask about Agency Bonds 148</p>
<p>Notes 149</p>
<p>Chapter 9 U.S. Agency Mortgage–Backed Securities and Collateralized Mortgage Obligations 151</p>
<p>Mortgage Securities Guaranteed by the Agencies (Agency MBSs) 152</p>
<p>MBSs: A Complex Structure 153</p>
<p>The Agencies 155</p>
<p>Agency Mortgage–Backed Securities 157</p>
<p>Advantages 158</p>
<p>Risks 159</p>
<p>Tax Implications 160</p>
<p>Special Features and Tips 160</p>
<p>Key Questions to Ask about Mortgage–Backed Securities 161</p>
<p>Collateralized Mortgage Obligations 161</p>
<p>CMOs: A Closer Look 162</p>
<p>Advantages 164</p>
<p>Risks 165</p>
<p>Tax Implications 165</p>
<p>Pricing Information 166</p>
<p>Key Questions to Ask about CMOs 166</p>
<p>Chapter 10 Municipal Bonds: Overview 167</p>
<p>Why Buy Munis? 168</p>
<p>Munis: The Opaque Market 169</p>
<p>Default Risk Considered 172</p>
<p>Risks in Common Bring about Change 174</p>
<p>Ratings and Municipal Bond Insurance 177</p>
<p>Downfall of the Muni Bond Insurers 180</p>
<p>Phoenix Rising 182</p>
<p>Purchasing New Issue Municipal Bonds 182</p>
<p>Municipal Notes 183</p>
<p>Prerefunded and Escrowed Bonds 184</p>
<p>Advantages of Prerefunded Bonds 185</p>
<p>Advantages of Escrowed Bonds 185</p>
<p>Risks 185</p>
<p>Tax Implications 185</p>
<p>Protect Your Muni Bond Portfolio? 185</p>
<p>Taxes on Municipal Bonds 186</p>
<p>Key Questions to Ask about Muni Bonds 187</p>
<p>Notes 188</p>
<p>Chapter 11 Municipal Bonds: Types 191</p>
<p>Tax–Exempt or Taxable Bonds? How to Decide 191</p>
<p>Taxable Municipal Bonds 194</p>
<p>Advantages 195</p>
<p>Risks 195</p>
<p>Tax Implications 196</p>
<p>Special Features and Tips 196</p>
<p>Private Activity Bonds 196</p>
<p>Advantages 197</p>
<p>Risks 197</p>
<p>Tax Implications 198</p>
<p>Tax–Exempt Municipal Bonds 198</p>
<p>General Obligation Bonds 199</p>
<p>Revenue Bonds 202</p>
<p>Types of Revenue Bonds 205</p>
<p>Checking Prices on Municipal Bonds 220</p>
<p>Key Questions to Ask about Types of Municipal Bonds 222</p>
<p>Notes 223</p>
<p>Chapter 12 U.S. Corporate Bonds 225</p>
<p>The Big Picture 225</p>
<p>Ratings 225</p>
<p>Types of Corporate Bond Coupons 227</p>
<p>Taxation 228</p>
<p>Key Categories of Corporate Bonds 229</p>
<p>Advantages 230</p>
<p>Risks 230</p>
<p>Pricing Information 232</p>
<p>Special Features and Tips 232</p>
<p>Corporate Medium–Term Notes 234</p>
<p>Advantages 235</p>
<p>Risks 235</p>
<p>Pricing Information 236</p>
<p>Special Features and Tips 236</p>
<p>Corporate Retail Notes 236</p>
<p>Advantages 237</p>
<p>Risks 238</p>
<p>Pricing Information 238</p>
<p>Information Sources 238</p>
<p>Special Features and Tips 239</p>
<p>Step–Up Bonds, Notes, and Debentures 239</p>
<p>Advantages 240</p>
<p>Risks 240</p>
<p>Tax Implications 241</p>
<p>Special Features and Tips 241</p>
<p>Corporate High–Yield Junk Bonds 241</p>
<p>A Rose by Any Other Name 241</p>
<p>The Track Record 242</p>
<p>Brave Buyers 244</p>
<p>Advantages 245</p>
<p>Risks 246</p>
<p>Pricing Information 246</p>
<p>Special Features and Tips 247</p>
<p>Corporate Convertible Bonds 247</p>
<p>Advantages 248</p>
<p>Risks 248</p>
<p>Pricing Information 249</p>
<p>Special Features and Tips 249</p>
<p>Price–Checking Corporate Bonds 250</p>
<p>Key Questions to Ask about Corporate Bonds 251</p>
<p>Notes 252</p>
<p>Chapter 13 International Bond Markets: Foreign and Offshore 255</p>
<p>Definition of Terms 256</p>
<p>Types of International Bonds 257</p>
<p>Trading Blocs 260</p>
<p>European Bloc in the European Union 260</p>
<p>Emerging Market Bloc 261</p>
<p>Dollar–Denominated Foreign Debt 263</p>
<p>Foreign Bonds 265</p>
<p>Currency Considerations 265</p>
<p>Tax Implications 266</p>
<p>Advantages 266</p>
<p>Risks 267</p>
<p>Special Features and Tips 268</p>
<p>Key Questions to Ask about International Bonds 269</p>
<p>Notes 270</p>
<p>Chapter 14 Bond Look–Alikes 273</p>
<p>Certificates of Deposit 274</p>
<p>Ratings 274</p>
<p>Yields 274</p>
<p>Bank Certifi cates of Deposit 275</p>
<p>Broker–Sold Bank Certifi cates of Deposit 277</p>
<p>Key Questions to Ask about Certifi cates of Deposit 281</p>
<p>Single–Premium Immediate Fixed Annuities 281</p>
<p>Advantages 283</p>
<p>Risks 284</p>
<p>Tax Implications 284</p>
<p>Pricing Information 285</p>
<p>Information Sources 285</p>
<p>Special Features and Tips 285</p>
<p>Key Questions to Ask about an Immediate Fixed Annuity 287</p>
<p>Deferred Fixed Annuities 287</p>
<p>Investment Phase 287</p>
<p>Accumulation Phase 287</p>
<p>Nonfi xed Distribution Phase 288</p>
<p>Fixed Distribution Phase 289</p>
<p>Advantages 289</p>
<p>Risks 289</p>
<p>Tax Implications 290</p>
<p>Pricing Information 291</p>
<p>Special Features and Tips 291</p>
<p>Key Questions to Ask about a Fixed Deferred Annuity 292</p>
<p>Nonconvertible Fixed Rate Preferred Stock 292</p>
<p>Advantages 295</p>
<p>Risks 295</p>
<p>Pricing 296</p>
<p>Tax Implications 296</p>
<p>Information Sources 297</p>
<p>Special Features and Tips 297</p>
<p>Key Questions to Ask about Preferred Stock 298</p>
<p>Dividend–Paying Common Stock 298</p>
<p>Advantages 299</p>
<p>Risks 299</p>
<p>Special Features and Tips 299</p>
<p>Key Questions to Ask about Common Stock 300</p>
<p>Notes 300</p>
<p>PART IV Options for Purchasing Bonds 301</p>
<p>Chapter 15 How to Buy Individual Bonds: A Tool Kit 303</p>
<p>Buying Online 304</p>
<p>Pricing Information 305</p>
<p>Pricing a New Issue 308</p>
<p>Real–Time Prices 308</p>
<p>Key Questions to Ask about Buying Bonds Online 310</p>
<p>Choosing a Broker 310</p>
<p>What s Wrong with This Ad? 310</p>
<p>Choosing the Right Brokerage Firm 314</p>
<p>Criteria to Consider 315</p>
<p>Establishing a Relationship 316</p>
<p>Using a Stockbroker 316</p>
<p>The Managed Account 317</p>
<p>Evaluating Bond Prices 319</p>
<p>Nature of the Marketplace 320</p>
<p>Wholesale versus Retail 320</p>
<p>New–Issue Order and Confirmation Details 321</p>
<p>Key Questions at the Point of Purchase 322</p>
<p>Notes 324</p>
<p>Chapter 16 Bond Funds: The Good, the Bad, and the Worst 325</p>
<p>Common Ground 326</p>
<p>Maturity 327</p>
<p>Yield 327</p>
<p>Duration 328</p>
<p>Derivatives 329</p>
<p>Advantages 330</p>
<p>Disadvantages 330</p>
<p>Checking the Costs: Hidden and Unhidden 331</p>
<p>Load 331</p>
<p>Other Changes 332</p>
<p>More about Fees 335</p>
<p>Buying for Total Return 336</p>
<p>Fund Categories 337</p>
<p>Unit Investment Trusts (UITs) 337</p>
<p>Closed–End Funds 338</p>
<p>Exchange–Traded Bond Funds 340</p>
<p>Open–End Mutual Funds 342</p>
<p>Key Questions to Ask about Types of Bond Funds 346</p>
<p>Notes 347</p>
<p>Chapter 17 Bond Funds: A Taxing Matter 349</p>
<p>Money Market Mutual Funds: Taxable and</p>
<p>Tax–Exempt 349</p>
<p>Breaking the Buck 350</p>
<p>Municipal Bond Funds: Tax–Exempt 352</p>
<p>Municipal Bond Funds: High Yield</p>
<p>(Junk Bonds) 352</p>
<p>Municipal Bond Funds: National 353</p>
<p>Municipal Bond Funds: State Specifi c 354</p>
<p>Taxable Funds 354</p>
<p>Municipal Bond Funds: Taxable 355</p>
<p>Build America Bond (BAB) Funds 355</p>
<p>Corporate Bond Funds 355</p>
<p>Convertible Bond Funds 356</p>
<p>Corporate Bond Funds: High Yield (Junk) 356</p>
<p>Corporate Bond Funds: Investment Grade 357</p>
<p>Floating Rate Loan Participation Funds (Bank Loan) 358</p>
<p>International Bond Funds 360</p>
<p>Index Funds 360</p>
<p>Inverse Bond Funds 361</p>
<p>Long–Short Bond Fund 361</p>
<p>Stable–Value Funds 361</p>
<p>Ultrashort Bond Funds 363</p>
<p>Government Bond Funds 363</p>
<p>GNMA Funds 364</p>
<p>Infl ation–Protected Securities Funds 364</p>
<p>Treasury Bond Funds 365</p>
<p>Strategic or MultiSector Bond Funds 365</p>
<p>Target–Date Funds: Zero–Coupon 365</p>
<p>Target Date Funds: Life Cycle/Asset–Allocation Funds 366</p>
<p>Key Questions to Ask about Choosing a Bond Mutual Fund or ETF 367</p>
<p>Notes 367</p>
<p>Chapter 18 Choosing a Bond Mutual Fund or ETF 369</p>
<p>Bond Fund Fees 370</p>
<p>Understanding Yield 370</p>
<p>The Search Begins 372</p>
<p>Morningstar 375</p>
<p>Long–Term Thinking 377</p>
<p>Strategies for Bond Fund Buyers 377</p>
<p>Key Questions to Ask When Exploring Bond Fund and ETF Search Engines 380</p>
<p>Notes 381</p>
<p>PART V Bond Investment Strategies and Richelson Investment Rules 383</p>
<p>Chapter 19 Financial Planning Framework for Bond Investing 387</p>
<p>Create Cash Flow with Bonds 388</p>
<p>Focus on Cash Flow Not Performance 388</p>
<p>Buy Cash Flow, Not Diversification 389</p>
<p>Get Cash Flow, Not Hoped for Returns 390</p>
<p>Infl ation and Cash Flow 390</p>
<p>Cash Flow in Retirement 391</p>
<p>The Basics of Creating Your Financial Plan: The Four–Step Financial Planning Process 393</p>
<p>Step 1. Determine Your Life Objectives and Financial Needs 394</p>
<p>Step 2. Divide Your Investment Portfolio into Two Categories 396</p>
<p>Step 3. Plan for Taxes 398</p>
<p>Step 4. Select Bonds to Support Your Life Objectives and Financial Needs 401</p>
<p>Should You Add Risk to Your Portfolio? 406</p>
<p>Reevaluating Your Portfolio 409</p>
<p>Key Questions to Ask about Financial Planning with Bonds 410</p>
<p>Chapter 20 Financial Planning with Bonds: Case Studies 411</p>
<p>Baby Boomers Design a New Financial Plan 411</p>
<p>Every Family Has a Different View of What Lifestyle</p>
<p>Is Appropriate for Them 412</p>
<p>Summary of Key Takeaway Points 415</p>
<p>You Are Rich! Why Are You Worried? 415</p>
<p>Summary of Key Takeaway Points 418</p>
<p>Changing Course 418</p>
<p>Summary of Key Takeaway Points 419</p>
<p>Meeting a Need for Safety 420</p>
<p>Summary of Key Takeaway Points 420</p>
<p>An Unanticipated Transition 421</p>
<p>Summary of Key Takeaway Points 422</p>
<p>Ownership of Stock in a Private Company 423</p>
<p>Postscript 424</p>
<p>Summary of Key Takeaway Points 424</p>
<p>Stock Options Pay Off Big 424</p>
<p>Postscript 426</p>
<p>Summary of Key Takeaway Points 426</p>
<p>Planning for College Expenses 427</p>
<p>Summary of Key Takeaway Points 428</p>
<p>Invest a Large Amount of Cash at One Time 428</p>
<p>Summary of Key Takeaway Points 431</p>
<p>Socially Responsible Investing 432</p>
<p>Ill–Advised Advisers 433</p>
<p>Mikala s Bond Portfolio 435</p>
<p>Charitable Lending and Personal Growth 437</p>
<p>Church Bonds 438</p>
<p>Mikala s Life Plan 439</p>
<p>Summary of Key Takeaway Points 439</p>
<p>Notes 440</p>
<p>Chapter 21 How to Make the Most Money from Bonds 441</p>
<p>Knowing When to Buy and Sell 441</p>
<p>The Yield Curve 443</p>
<p>Strategies for Deciding When to Sell 447</p>
<p>Strategies for Finding Bargain Bonds 448</p>
<p>Strategies for Avoiding Overvalued Bonds 450</p>
<p>Strategies for When Interest Rates Are High or Rising 451</p>
<p>When Interest Rates Are Rising 451</p>
<p>Strategies for When Interest Rates Are Low or Falling 453</p>
<p>Investing for the Highest After–Tax Yield 455</p>
<p>A Reminder about Taxes on Investments 456</p>
<p>Strategy for Placing Bonds in Tax–Effective Accounts 457</p>
<p>Strategies for Individuals in High Tax Brackets 458</p>
<p>Strategies for Tax–Deferred Retirement Accounts and Individuals in Low Tax Brackets 458</p>
<p>Investing and Risk Tolerance 460</p>
<p>Practical Considerations for Assessing Risk Tolerance: Know Yourself 460</p>
<p>Strategies for Reducing the Risk of Default 462</p>
<p>Strategies for Safe Investing 463</p>
<p>Strategies for Reducing Market Risk 464</p>
<p>Strategies for Reducing Liquidity Risk 469</p>
<p>Strategies for Reducing Call Risk 469</p>
<p>Investing for Income Needs and Financial Goals 470</p>
<p>Strategies for Short–Term Goals 470</p>
<p>Strategies for Long–Term Goals 471</p>
<p>Strategies for Life Events 473</p>
<p>Strategies for Increasing Income 473</p>
<p>Strategies for the Socially Responsible Investor 475</p>
<p>If You Are Starting Out With Less Than $25,000 to Invest 475</p>
<p>Obstacles to Committing to an All–Bond Portfolio 475</p>
<p>Notes 477</p>
<p>Appendix: Useful Web Sites 479</p>
<p>About the Authors 483</p>
<p>Index 485</p>