THE PLAN!

Now, about that spreadsheet!


https://docs.google.com/spreadsheet/pub?key=0AmMlf3bsV3rFdFQ3eDBDeXRCTEU4a2FtOHlpUFMtM0E&output=html

The spreadsheet demonstrates the results of following a bond investing plan.  I believe it yields consistent results over time, and avoids most of the huge losses that periodically plague the world of stocks.  I think it is fairly simple, yet produces eye-popping results.

The spreadsheet has four inputs: a starting year, investment amount, lump sum indicator (is this a one-time investment, or a regular investment adjusted yearly for inflation?), and a tax rate.  All the scenarios depicted here assume a regular investment amount, with no allowance for taxes.  I'll discuss a lump-sum scenario in a later post.

You might be amazed to learn that the plan is simplicity itself: start with a base investment amount, and use it to buy BAA 30-year bonds every year.  Each year, increase that base amount by the prior year's inflation rate, to ensure that the same purchasing amount is invested each year.  Also, reinvest the prior year's interest.  Ignore the ups and downs of the stock market, and ignore periodic panics about inflation, war and pestilence.  Repeat every year for MANY years (a minimum of 20, preferably 30 or more).  You'll love the results!

Don't take this too literally.  "BAA 30-year bond" is a guideline.  You might buy bonds with a lower or higher rating (as long as they're investment-grade).  You might buy bonds with shorter or longer maturities, depending on what looks favorable when you're ready to buy.  Over time, you want a mix of maturities and industries, but buying every year will tend to smooth things out

The spreadsheet demonstrates results for every initial year from 1947 to the present.  For each such year, 10, 20, 30 and max (whatever the end year is) results are shown.  The benchmark is inflation.  To determine how well a time series has done, an inflation "toll" is subtracted from the portfolio's end value.  The difference is an after-inflation return.  What is striking about the results is that very few years show a negative return relative to inflation.  The worst is the earliest start year, 1947.  It starts out with nine straight years in which inflation is higher than the bond returns.  This is largely due to the fact that inflation 1947 was over 14%, and over 8% in 1948, while BAA yields were slightly over 3%.  This anomaly was due to the end of rationing in World War II.  However, this same series shows a final portfolio figure of nearly $4.75 million, even after adjusting for inflation!  All this from a total investment of $302,000 over 65 years (1000 inflation adjusted dollars every year).

While 1947 shows huge returns, so do more recent time series.  1980 was a terrific time to start (a little over 30 years).  A total of $65,000 becomes $463,000 by 2011.  But 1990 wasn't bad either.  It turns $30,000 into $100,000.  And 2000?  $14,000 becomes $27,000.  In fact, EVERY time series beats inflation by the 10-year mark!  By 20 years, every time series outperforms inflation by a large amount.

How could this be?  The magic lies in two factors: the power of compounded interest (an amazing thing) and the fact that the BAA yield was higher than inflation in all but 5 of the 65 years covered by the spreadsheet.  That excess yield compounds to produce stunning results.  Now, is this potential growth unique to bonds?  Not at all.  Most stock-return charts will show similar, or even better results.  The difference is that bonds are far less volatile, far more predictable, and ultimately, far safer than stocks.  Given the choice, in my opinion, you should always opt for the safer investment that still meets your investment needs.  That is, hands down, the bond option.

Here, again, are a few cautions.  The spreadsheet is a back-tested artifact.  It takes advantage of hind-sight.  The assumptions it makes are not guaranteed to work going forward.  Most of its spectacular returns are due to that huge spike in interest rates in the late 1970's and early 1980's.  Critically, it presumes that you don't have to pay taxes along the way (or that you pay them from outside the portfolio).  Most of the excess return comes from the regular reinvestment of income.  Remove some of that for taxes, and the results drop drastically.

The huge advantage of a plan oriented to bonds is that losses can be pretty much ignored.  Repeat: your "losses" don't matter!  Those terrible drops of 1979-81 were on paper only.  They had NO effect on income, which continued unbroken, and increased very nicely in subsequent years due to the giant yields locked in along the way.  You don't need to worry because there is a "correct", predictable end price for a bond.  It is par.  What happens in the meantime is irrelevant, as the price will end, upon maturity, at 100 cents on the dollar.  The only thing that can hurt you along the way is a default (very very bad), or a margin call (so don't overuse margin).

The advantage of a "system" is that you have far fewer tough choices to make.  Each year, you're going to buy BAA bonds, 30 years out.  Yes, you have to decide which bonds, and when to buy during the year.  I'll have some more suggestions about these lesser issues in a later blog.

So take a look at the spreadsheet.  Then, you can kick the tires and mock the assumptions.

The Plan: Introduction

I have referred several times to a spreadsheet I built over the last couple of years.  It begins with  bond yield and inflation data from 1946 to 2010.  Bond yield data is taken from the Moody's Seasoned BAA yield series.  It represents "average" yields, by year, for corporate bonds of good, but not prime quality.  These bonds have a very low default rate, yet yield considerably more than the very top investment groups (AAA, AA and A).  Their rates have varied a great deal over the years, going from lows of 3.21% to 16%.  A key factor is that these rates are usually higher than the prime rate (the rate charged "prime" customers for short-term borrowing) for any given year, and usually beat inflation.  Why are the seasoned BAA rates higher than other bonds?  It's very simple: they are long-term rates.  As the website says: "Moody's tries to include bonds with remaining maturities as close as possible to 30 years."  

Why are long-term rates so much higher?  They reflect a perception of risk.  The farther out a maturity is, the more things can go wrong.  Rates can rise, eroding the value of the bonds.  Inflation will also do its erosion.  Finally, there is credit risk: the possibility that the financial health of the issuing company will deteriorate to the point that the bond defaults.  All of these possibilities lead investors to expect, and demand, higher rates of return for long-term bonds.  There is also a perceptual problem most investors have with these bonds: thirty years is "too long".  Older folks think they'll die first; younger ones dislike thinking about how they'll look in the mirror in thirty years.  Either way, that endless prospect discourages investors.

I believe, though, that BAA type bonds represent the absolute sweet spot in the investing world.  Sure, if you're old, you may be dead before these bonds mature.  But in the meantime, you'll be collecting those fat interest payments.  And will your spouse, children, or grandchildren, refuse the money?  Furthermore, if you need cash in the meantime, there is a ready resale market for most large-cap bond issues.  The price you get on a resale may vary greatly, depending on present interest rates (either up or down), supply and demand, and the ever-present fear factor.  All these make it a very good idea to make your initial bond purchases at a discount to par.  That shields you on the downside, and builds a predictable upside into the transaction (if you hold the bond to maturity).  It will, after all, return the exact same amount as the original buyer paid upon issuance (par).

My ideal scenario, reflected in my spreadsheet, is to build a long-term bond portfolio steadily, year after year.  A predictable amount should be added to the portfolio regularly, and interest income should be reinvested steadily.  This latter requirement means that the bonds should be held in a tax-deferred vehicle like a traditional IRA, Roth IRA or 401 K plan.  Since taxes are paid on the latter two only upon withdrawal, and the Roth is funded with post-tax money, everything compounds tax-free.  That's huge, as you will see.

Why not wait for those magic moments when bonds have reached a cyclical peak, and then pounce?  Well, there are two problems with that. First, those moments of peak yields are also moments of extreme terror.  In 1982, and 2009, people were running AWAY from bonds, not towards them.  In 1982 they were panicked about rates (16% and higher) exploding upward.  In 2009 they feared the entire financial universe was about to crash. Second, it's hard to recognize a peak until it's past.  Once it's past, you regret missing it, and stew instead of acting.   The brave souls who grabbed for peak and near-peak yields were richly rewarded, but they spent many sleepless nights until things went their way.  I was one of them, because I was following a plan (albeit a newly conceived one).

Psychologically speaking, brave investing is a non-starter for the huge majority of investors. Fear overwhelms greed at the precise wrong moment.  It's easy to be intrepid when you've just reached new highs in your portfolio; it's exceptionally difficult to jump in when you've just taken ferocious losses.  So, how can you overcome your own inner demons?  The only way I know is to have that plan, and stick with it through thick and thin.  Put it on autopilot as much as possible.

My next blog will demonstrate the results of following a plan.

I'm Back

Well, nobody's watching.  Too bad, because I know how to make EVERYBODY rich!  Yeah, I know, delusions of grandeur.  Still, I need to drum up some readers, because my message is actually important.  We live in a world where investment advisers almost universally tout the importance of stocks for building wealth and bonds for protecting it.  So, when you're young, they tell you to load up on stocks, ride out the ups and downs, and then move into bonds when arthritis claims your joints.

I have another message: bonds can, and should, be a primary vehicle for wealth creation too.  You might even consider ditching stocks altogether.  Yes, I mean it.  What justifies this obsession with boring old bonds?  Quite simply, they offer the prospect of stock-like returns over time, along with the demonstrated safety for which they are primarily known.  Here is a simple real-life example of explosive potential.  In 2009 a Goldman Sachs bond with a coupon of 6.75% maturing in 2036 was offered for sale at a price of 66.5.  So, a bond originally issued at $1000, and yielding $67.50 per year, could be bought for $665.  It was/is rated at A2/A- by Moody's and Standard & Poors (a solid investment grade rating).  The yield on that bond was therefore over 10%, locked in for 25 years!  AND the US government had just declared Goldman Sachs to be one of 10 "vital" banks that would not be permitted to fail.  AND, that bond, within two years, moved back to par.  So, the two-year return on this investment was (on paper) 71%.  If you can't get excited about that kind of nearly risk-free return, then you're reading the wrong blog.

Actually, the story is better than that.  Because I believed that the opportunity was of the kind that come only once or twice in a lifetime, I bought my bonds on margin.  No, not Corzine-type margin (leveraging 5-30 times equity).  My use of margin was fairly modest.  Here's how.

My broker (Interactive Brokers) will lend you money at rock-bottom rates, presently 1.25%.  This is, by the way, the lowest in the business, although professionals can usually borrow for even less.  So, let's run that Goldman Sachs bond through the margin machine.  On a purchase of 10 bonds at 66.5, I borrowed half of the purchase price, $3325, from IB and paid an equal amount in cash.  The 10 bonds yielded $675 per year over that two year span, a total of $1350.  The yearly margin expense on the $3325 borrowed from IB was $41.56, or a total of $83.12.  So, I netted $1267.  Since my cash investment was $3325, the return over two years was 38%.  Add in the paper gain to par of $3350, the total gain was $4617, or a two year return of 139%.

Now the warnings.  Margin can be frantically dangerous.  The greater the leverage, the greater the risk.  IB will lend you up to $5 for every 1$ of equity.  DON'T EVER  DO THAT!  The reason is the dreaded margin call.  If the value of your bonds (or stocks) declines even a bit, your broker will demand more cash.  If you don't supply it immediately (i.e., same day), they'll sell your positions to raise the cash.  And, that will, almost surely, lock in a loss.  That's why my rule of thumb is 1/1 or less. At that level, even a substantial downward fluctuation in values will not trigger a margin call.  But, you'd better hope that the price will recover, as margin will magnify your losses in exactly the same way as it enhances your gains.

What amazes me is how often folks, even brilliant folks, yield to the margin siren.  If 1/1 margin can give you a yield of 10 or 12%, they'll leap for the 20-40% you can achieve if you pile on the margin.  This is a stupid pet trick and rarely ends well.  It is, in fact, the core strategy of those famous hedge funds whose brilliance contributed mightily to the 2008-2009 crash.  These guys bought tons of high-yielding long-term stuff with low-cost short-term money.  Came the crisis, and the cost of money sky-rocketed.  Worse yet, the guys who had lent the money suddenly demanded it back.  So, the masters of the universe who had bought my Goldman Sachs bonds at par had to dump them to raise cash.  Supply overwhelmed demand, and they sat out there at 66.5.  Ironically, the hedgies sold their very best stuff at a loss, because their junk was nearly worthless.  You'd think they would have learned by now, but MFS just went belly-up doing the same crazy leverage game.

Note that my investing example above combined two factors to achieve high returns.  The first was simply exploiting the cycle.  Buy bonds when they're cheap, and ride them back to par.  The second was the careful use of borrowed money to enhance returns.  Occasionally, you can combine the approaches.  That's like riding a big wave off the north shore of Oahu.  Sometimes one or the other will work.  Ocasionally, neither works.  Right now, for example, the approach of buyings bonds cheaply (at a discount to par) is pretty much used up.  However, margin rates are still so low that you can achieve very nice yields following the 1/1 rule.

By the way, my Goldman Sachs example describes a theoretical gain of 139%.  To get that, though, I would have had to sell the bonds.  No way.  I have a solid 10% locked in for many years to come.  The capital gain (which is taxable) will come in due time (yes, 2036).  I may not see the money, but my kids will.  And that is a key part of my long-term bond investment strategy.  More detail in my next post.

Investing and Cycles

What I'm going to say here is simple, yet utterly essential to bond investing.  Bond yields are cyclical.  These cycles are different from than stock investing cycles, and easier to identify.   Technical analysts in particular love to chart stock movements over various period of time, and from those movements, to deduce grand trends.  They give them fancy terms, like "Elliott Wave".  They'll argue that a sharp upward movement in stock prices is really a head-fake in a larger "secular" bear market.  Some will see deeper meaning in the hourly fluctuations of a specific stock; thus unleashing a storm of day trades.

Bond cycles are much simpler.  Bond yields go up for a relatively long time, and then they go down.  I have a spreadsheet (mentioned before) which begins with bond yields over a very long time (from 1946 to the present).  The key yield for my purposes is the Moody's seasoned Baa yield.  This is a benchmark bond yield for a "typical" corporate bond of mid-level investment quality and long-term duration.  It's not a blue-blood bond, but it's a good way from junk.  These bonds have some investment risk, particularly over time, but that risk is quite small.  Diversification in the bonds you buy will largely take care of this risk.

In 1946, the first post-war year and the year of my birth, the Moody's seasoned Baa yield was 3.4%.  Not great, considering that inflation that year ran at 14%.  Still, the BAA yield stayed in that general range for the next ten years.  It then moved into the 4% range, then 5% by 1966.  By 1968, the rate had jumped to 8.5%, and finally topped out at 16.1% in 1982.  Rates then began a long, slow decline: back to 8% by 1996, and 6.5% by 2007.  There was then a tsunami between 2008 and early 2009, which almost disappears in the official statistics for those years (7.44% and 7.29%).  In fact, in late 2008 and early 2009, corporate yields of all kind skyrocketed!  Many issues topped 20%.  Since then, however, the long-term cycle has reasserted itself, with the seasoned yield somewhere under 6% right now.

Notice, over nearly 65 years, a grand swoop up, and a grand swoop down.  Lots of business in between, but that's the bottom line.  So, being astute cycle experts, what's next?  Will the grand down-trend continue back to those 3% levels of the 1940's?  Damned if I know.  While hindsight is 20/20, the future is almost always murky.

Still, there are a couple of really important things you can learn from this long cycle.  3% is a fairly rotten long-term bond yield, and 16.1% is a really high one.  So, it's simple, right?  Don't buy bonds with a 3% yield, and load up when they're 16%.  Yeah, true enough.  But when those bonds were yielding 16%, inflation was running over 20%.  Guess what?  People deserted bonds in droves in 1982!  They were terrified of hyperinflation (Zimbabwe style), and feared bonds like the plague.  You couldn't give the darn things away. Back in the fifties, lots of folks were pleased as punch to lock in a 3.5% yield:  they were being responsible and avoiding risk.

Clearly, those few brave souls who dove in in 1982 were rewarded extravagantly.  The long bonds they bought went up and up and up in price.  They were geniuses.  So, what happened to the idiots who bought in 1950?  Well, THAT DEPENDS.  If they made a lump sum investment, and did nothing afterwards, they got slaughtered.  Even if they held bonds to maturity, inflation devastated their results.  If, however, they kept investing, and particularly, if they reinvested their income as it came in, well, amazingly enough, they did very well too!  Why?  Because a regular investment program let them buy some high yield bonds too.   Almost every scenario I have run confirms the same thing; stay in the bond market long enough to catch the full up and down, and you'll prosper.

Of course, in the long run, we're all dead, and few folks have a sixty-five year investment horizon.  Can good things come with a shorter time line?  Possibly.  I'll have more to say about that in awhile.

So what's wrong with bonds?

My first three blogs have focused on the things I like about bonds: predictability and durability.  Believe me, I'm not alone in liking these qualities.  The last couple of years has seen a stampede into bonds.  People horrified by the losses they experienced in stocks have sought safety in bonds.  In the process, though, they have triggered a wave of sell-side advice.  Bonds, particularly bond funds, say many folks, have overreached.  Prices have risen so drastically that there is no further upside.  Since rising bond prices means lower yields (this is a constant of bonds, and you should run through the logic until you GET it), bond buyers are taking on very large risks for very small gains.

What do I think?  Well, I pretty much agree.  If you do what most folks are doing, which is to buy into bond funds, you are asking for trouble.  I'll talk much more about bond funds in a future blog.  For the time being, just know that I don't like them, and would strongly advise against them, now or pretty much ever.  Any time that buying a bond fund would be a good idea is a time when buying individual bonds is a far better one.  Period.  Just an opinion, of course.

So, what's the knock on bonds?  It relates to yield.  Bonds often don't yield much, particularly in comparison to stocks (remember that squishy 9-10% figure the pundits cite?).  Short term Treasuries  (3, 6 and 12 month maturities) have ZERO yield, three years out is still only 1/2%.  Even ten year maturities are a measly 2.65%.  Only the thirty year treasury (3.875%) offers a shred of hope of meeting inflation and taxes.  That's pretty bleak.  You won't lose your principal, but its buying power will decline over time.

Corporate bonds are better, but still pretty chintzy over shorter time spans.  A Goldman Sachs bond (A rated) will yield under 4% over four years.  Not great, but it makes the government bond look sick.  Take it out to 2037, and the GS yield is 7.2%.  This yield increment over the treasury is the difference between making REAL money and breaking even.  So, why not buy a long bond?

Well, the first risk relates to rising interest rates.  As demonstrated in my last blog, an increase in rates will trigger a decline in the bond's market price.  That's a problem if you need to sell, and a very good reason not to buy a bond if you have a short investment horizon.  The second risk is worse: inflation.  Right now, we have very low inflation, perhaps even a whiff of deflation.  So, the 7.2% you can get by going long is pretty good. You can pay your taxes and still have a nice, real return.  Should inflation flare up, though, that real return will decline by the amount of inflation.  AND, the bond's price will fall as rates rise.  You'll feel bad, and consider selling.

What to do, what to do?  If you know the future, it's easy.  That foreknowledge in 1980-82 or 2007-2008 would have led you to raise cash,  and wait until rates rose to the stratosphere.  Then you would have locked them in.  In real life, though, nobody knows what's going to happen next.  So, I would suggest a method.  If you have money to invest, and a long-term bond rate looks attractive in comparison to present inflation, then buy some bonds to snag that yield.  Don't bet the farm.  If rates rise, don't panic.  Buy some more, locking in that higher yield.  Keep buying until rates have clearly peaked, then buy a lot, thus locking in near-peak yields. How do you know when rates have peaked?  Well, they'll start going down.  You'll miss the top, but will probably get in well before the bottom.

This approach presumes that you have money to invest, and will have more in the future.  Part of that future money will, of course, come from the bonds you already own.  The rest should, one hopes, come from saving part of your income.

Does this work?  I'll talk about some analysis I've done of bond investing over various time periods.  I think it's extremely interesting, and might put stock investing to shame.

Continuing Bond Basics (Bodaciously)

OK, I have follower now.  I suspect somebody I love lobbied hard, but what the heck!

My last blog focused on bond basics: their initial pricing, end pricing, and what might happen in the meantime.

Now I want to talk a little about income streams.  You can (and should) think of a bond as an income stream.  Those bi-yearly payments will flow to you until the bond matures.  It's income, and very valuable, particularly as you grow older.  You may be surprised to know that traditional stock analysts also work from the perspective of an income stream.  They talk about the discounted (or present value) of a company's future income stream (the money the company will generate over time).  If you anticipate robust growth in a company's earnings, then you will pay more for the stock right now.  If it's going to decline over time, then you'll pay much less for that stock, even though it might be highly profitable right now.

What's the difference between the income streams from stocks vs. bonds?  Predictability.  Make a basic assumption about the company behind a bond, and you know precisely how much money that bond will generate over its life.  What assumption?  Well, will it go belly up?  In 2009, I asked that simple question about Goldman Sachs and JP Morgan.  Would they survive the tidal wave of mortgage failures, or not?  Since Uncle Sam had backed them to the hilt, I decided that they would, indeed, survive.  After that, everything was simple.

How about anticipating the future income stream of a stock?  Oops.  Get nineteen factors absolutely right, miss the twentieth, and a future Microsoft suddenly morphs into an also-ran.  In 2009, an almost endless string of stocks with unblemished histories of rising dividends suddenly cut those dividends to the bone, or eliminated them entirely.  JP Morgan went from $.38 a quarter to a nickel! Retirees trying to live on those dividends experienced an 87% cut in income.  And, the price of the stocked plummeted from $47 to $16, a 66% haircut.  Even though the stock has recovered robustly (to a recent $38, the dividend still lingers at a nickel.  Who know when it'll be back at $.38?  Now, what happened to Morgan's bondholders?  Nothing, absolutely nothing ... unless they sold in a panic.

A predictable income stream is golden.  It's why people go to work, it's why retirees love Social Security, and it's why people getting ready for retirement will often hand huge sums over to insurance companies in return for an annuity.  An annuity will promise a given return until the buyer's death.  A sixty-five year old might hand over $100,000 in exchange for a guaranteed $500 monthly check (6%) until she dies.  Most financial advisors will encourage her to do this.

Here's my question: why on earth is this gal not buying bonds in the same amount?  At age 65, she can reasonably expect to live perhaps 25 or 30 years more.  So, what if she bought bonds maturing in 2035 with that same 6% yield?  She would get her $6000 a year until 2035.  At that point, she (or her grateful heirs) gets her money back, all of it.  The boob with the annuity?  He's either dead, in which case the money's gone, or he's nearly dead, in which case the money will soon be gone.  So, what sounds like the better investment to you?

By the way, such bonds exist; I just checked.  One example: a Goldman Sachs issue has a maturity of 2036 and coupon of 6.45%. It trades under par (91.2), to yield 7.2%. You all know Goldman Sachs.  It's had a wild ride, but has weathered the recession.  It's high medium quality (A2 S&P, A- Moody's), and a bank that "too big to fail."   Now, I'm NOT saying to go out and buy that specific bond.  You would need to do due diligence; analyze the company and make up your own mind about whether it will still be around in 2036.  What I am saying is that there are plenty of similar issues out there, and most of them will be fine investments.

My next blog will focus bond critics, and why those guys may be missing the boat.

Why not stocks?

As I see it, an investor two main choices: stocks and bonds.  I know, pretty obvious.  And, lots of folks will complain that this is way too limited.  How about commodities (GOLD!), futures, currency plays, derivitives, real estate, collectibles, etc?  Well, to be succinct (and therefore deliberately exaggerating a bit - I'll have more to say about alternative investments in time), they are speculations, not investments.  What's the difference?  It's huge and fundamental.  Both stocks and bond have a yield.  Sometimes that yield is pretty small (a tiny dividend, a low interest rate), but it's real. 

Stocks are like the American dream, partial ownership of a corporation, its assets, and its earnings both present and future.  Even if the corporation has no dividend, its earnings tend (over time, over time) to be reflected in the stock price.  If they go up, the price will eventually reflect that.

Bonds are an IOU issued by a corporation, with a stated rate of return and a stated end date.  Until that end date, bonds are legally obligated to pay the stated rate on a regular basis (typically twice a year). 

Most other "investments" lack this yield feature.  They are a zero-sum game: one person wins, another loses.  There is no earnings engine behind copper, sugar, puts, or beanie babies.  They require a "greater fool"; someone to pay you more than the thing has cost you.  Maybe that person exists, maybe not.  At all times, you need to consider that the greater fool is you.  As they say in poker, if you look around the table and don't know who the sucker is, then it's you.

So, assuming you are interested in investing, why not buy stocks?  Great fortunes have been made in them, and stock proponents just love to tout their long-term superiority over bonds.  Just think of IBM, Microsoft and Google!  Peter Lynch raved about ten-baggers (stocks that went up ten times from purchase to sale), and most stock brokers and investment advisors cite long-term returns for stocks over the past century (or whatever time period is most advantageous to their case) of 9-10%.

 The problem is that this rosy figure is largely crap.  The farther back you go, the greater the inaccuracy, due to the simple fact that the return is calculated from companies that still exist!  All the ghosts (buggy whip makers, Grants, dozens of early computer makers, Enron, Bear Sterns, Lehman Brothers, Chrysler, and GM), and the huge fortunes they destroyed, are conveniently discarded from the computation.  Yet real people owned those stocks, and their long-term results were severely degraded in the process.  Don't forget, we've just completed an entire decade during which stocks went absolutely nowhere.  That's zero return, before inflation (so really, a loss of principal)!

Now don't get me wrong.  I actually think there is a case to be made for stocks, at least in theory.  Just buy them when they're cheap.  Spring of 2009 was a great time to do this.  In fact, the best tool for identifying such opportunities is hindsight.  To quote Mark Twain (loosely):  "Buy a nice little stock, wait till it goes way up, then sell it.  If it doesn't go up, then don't buy it."  That's a perfect way to describe the art of timing!

My point? Timing is very difficult.  Most professionals fail miserably; why do you think you'll do better?  I can't overstate this.  PROFESSIONALS FAIL MISERABLY at the very thing they claim to do: outperforming a monkey.  The monkey throws darts at a newspaper to pick stocks; a professional dredges through reams of statistics and charts to do it.  They both achieve, in the aggregate, the same result.  Of course, the monkey doesn't charge anything, and so is the better choice for picking a portfolio.  I'm serious!

Sure, I know you worship the mega-monkeys: Peter Lynch, Warren Buffett, the Barron's round table sages, etc.  But take 100 dart-throwers, and you will, after ten years, come up with one or two simian geniuses who have vastly outperformed the market.  Would you bet on these super-chimps being next year's champs?  Want a case in point?  Bill Gross, legendary stock-picker for 15 years, just quit after five straight years of  crappy results.  He's highly apologetic, specifying his "mistakes."  I disagree.  The odds just caught up with another King Kong.

Am I saying the professionals are idiots?  Not at all; in fact, the opposite.  That's the problem.  There are THOUSANDS of brilliant folks out there trying to out-psych each other.  Chart-readers are divining mystical data trends; fundamentalists are analyzing cash flows, macro-guys are predicting the rise of China and fall of America, ad infinitum.  Each one of them is bright.  In the aggregate, though, they tend to cancel one another out.  Burton Malkiel and his folks have it right.  At any given point, the price of a stock or group of stocks represents pretty much everything that everybody knows.  Good news is baked in for high-performers; disaster for laggards.  You can make a guess, and be right, but don't assume it's because you were smart.  The course of a stock, or a group of stocks, over a short period of time, is a random walk.  In time, a stock, or a group of stocks, will move according to underlying value, but that movement is inherently unpredictable, as predictable value is always discounted in a stock's present price.

What to do with stocks?  Well, forget timing, forget analysis.  (Perhaps even forget stocks.)  If you do choose to own them (and diversification is probably the best reason), then buy an index fund or ETF, invest regularly, and close your eyes.  In twenty or thirty years, you'll probably be pleased.  DON'T time the market, DON'T sell when you're discouraged, and DON'T double down when you're just made a killing.  You'll do just as well as all the other patient monkeys, much better than most impatient monkeys, and much better than most professionals (who are, after all, a merely a subset of the second group).

Why does timing fail?  It should be possible, right?  Occasionally, there come times when things are OBVIOUSLY cheap (again, Spring 2009). They were cheap because people were scared, and so were you.  Your brain told you that you couldn't miss, but your gut said things might get a lot cheaper.  So, you did nothing.  We all act like this, and in reverse when things are obviously expensive. 

I do think there is an answer.  When it's painful, it's probably the right thing to do.  So, do something, but not so much that you can't sleep at night (perhaps with an Ambien, to be sure).  You need to buy something when your gut tells you it might go to zero and your brain tells you it's a screaming bargain.  You need to sell something when the id screams about losing out, while Mr. Brain is shrieking "nosebleed!".  BUT, this simple answer is very difficult!  Human nature being ... well, human, few people can time when timing is objectively feasible.

Is there an investment that can work better for real people?  We come back to bonds.  I like them a lot.  There is an admirable simplicity to a bond, despite its reputation as arcane and complex.  A bond has a beginning date, an end date, and a predictable income stream (the coupon) in between.  A bond has a beginning price and an end price, which are usually the same.  A typical bond will be issued at $1000, with a specific coupon rate (say 6.5%) and a maturity date (usually from one to thirty years).  In this example, you will receive two payments of $32.50 a year.  When the bond matures, you get that $1000 back.  That's pretty simple, right?  You know exactly how much money you're going to make, how long it will take to make it, and when you're going to get your entire investment back. 

Of course, interest rates go up and down.  Therefore, a bond must reflect those changes in the meantime.  That 6.5% coupon was the going rate at the time of issue (for that maturity and credit quality).  If the rate goes up to 7% for new bonds, then older ones will have their price adjusted so that they too yield about 7% to a buyer.  So, the quoted price of your 6.5% bond will go down (perhaps to $928). Now its $65 of income is 7% of  $928.  This might cause you distress, and is the reason most experts are screaming that you shouldn't buy bonds now.  You've "lost" $72, or 7.2% on a small upward movement (1/2%) in yield!  True enough, but what happens if you do nothing?  It's not a loss unless you take the loss.  Hold the bond to maturity, and you get that $72 back, for sure.  In fact, it really doesn't matter how low it goes, you WILL get the money back!  That's huge.  As opposed to stocks, there really is a "correct" price for a bond, at least eventually.

Are you interested now?

Update 11/2015.  Well, now I can report on stock returns with another five years of perspective.  In the commentary above, I mentioned that we had just completed a full decade of zero returns for stocks.  Well, using a standard Dow calculator, it now appears that the return for the last FIFTEEN years has been 2.61%!  Now fifteen years is a pretty long stretch for such crappy returns.   It makes my most plain vanilla scenarios look absolutely world-beating!