The Little Book of Common Sense Investing, Updated and Revised

Chapter FourteenBond Funds

Where Those Relentless Rules of Humble Arithmetic Also Prevail.

SO FAR, MY APPLICATION of common sense has been applied largely to the stock market, to equity mutual funds, and to equity index funds. But the relentless rules of humble arithmetic with which I’ve regaled you also apply—arguably even more forcefully—to bond funds.

Perhaps it’s obvious why this is so. While a seemingly infinite number of factors influence the stock market and each individual stock that is traded there, a single factor dominates the returns earned by investors in the bond market: the prevailing level of interest rates.

Managers of fixed-income funds can’t do much, if anything, to influence rates. If they don’t like the rates established in the marketplace, neither calling the Treasury Department or the Federal Reserve, nor otherwise trying to change the supply/demand equation, is likely to bear fruit.

Why would an intelligent investor hold bonds?

Over the long term, history tells us that stocks have generally provided higher returns than bonds. That relationship is expected to continue during the coming decade, although rational expectations suggest that future returns both on stocks and on bonds are almost certain to fall well short of historical norms.

As noted in Chapter 9, I estimate that annual returns on bonds over the coming decade will average 3.1 percent. To summarize, since 1900, annual returns on bonds have averaged 5.3 percent; since 1974, 8.0 percent; ...