The Little Book of Bull's Eye Investing: Finding Value, Generating Absolute Returns, and Controlling Risk in Turbulent Markets

Chapter Eight

The Sisyphus Syndrome

Investing in Bonds

IN GREEK LEGEND, SISYPHUS was doomed forever to push a rock up a hill only to watch it roll back down.

For two decades, the 1980s and 1990s, bond investors watched the Fed fight inflation. At first, they were dismayed as interest rates rose and bond prices plummeted. But then, after rates peaked in the early 1980s, the rock started rolling back down the mountain, and it kept rolling for 20 years. As interest rates dropped, prices of long-term bonds soared.

Now, in 2012, the rock has rolled about as far down the hill as it can. Short-term rates cannot go lower than zero. Long-term interest rates can go a bit lower if deflation sets in. But there will come a time when rates start up again, perhaps because economic growth resumes and brings with it a demand for credit, or perhaps because too much quantitative easing by the Fed reignites inflation. However it comes about, amidst this new climate for bonds, you’ll need a vastly different approach than the usual bond fund.

Sadly, 45 percent of bond investors in a recent survey conducted by Schwab did not realize their bond fund could lose money if interest rates rose. In a rising interest rate environment, boring old bonds are anything but safe.

I believe that bond investors should, for the most part, avoid bond mutual funds and buy the bonds directly for their own account. There are some exceptions, tactically managed bond funds with good longer-term records and managers who know ...