How Bond Ratings Work

Bond RatingsBonds are not the easiest investments to figure out. A bond fund, apart from its description, doesn’t tell you much about all the risks involved either. In an environment where investors chase higher yields, the greater risk of loss can be quickly ignored. Bond ratings make it easy for you to understand the default risk of a bond, while still taking into account all the other risks.

What Are Bond Ratings?

Bond ratings are credit scores for governments and companies. It measures the issuer’s financial strength and ability to make interest and principle payments to bondholders. For investors, these grades are an easy way to do a credit check without digging into financial statements.

The ratings are easy enough to understand. The higher the bond rating, the lower the risk of default. For that, the company gets a lower cost to borrow. For you, it’s a lower interest rate on the bond, but a higher chance you’re paid in full. Continue Reading…

Expected Return: Avoid The Seduction of Big Numbers

When it comes to expected return, we love big numbers. We gravitate to it like paparazzi to a celebrity. We do it with performance and projections because it sells.

But there’s one tiny problem. Our expectations change with the market.

A while back I covered how asset allocation lowers volatility. In it, I showed how four different asset mixes performed against an all stock and an all bond portfolio. It looked like the graph below. It showed how volatility lowers as you decrease the amount of stocks in your portfolio. But did it?

Of course it did. It was a simple exercise to prove a point. But it also showed how much better an all stock portfolio performed over the same period. Continue Reading…

Easy Tax Equivalent Yield Formula and Chart

Tax Equivalent YieldThere are many investments that offer tax advantages to investors. Tax free bonds, like municipal bonds, are one popular choice for high income earners and retirees. That idea of not having to pay taxes on investment earnings will always get attention, but are you getting the best return on your money? To find out, you need the tax equivalent yield on a tax-free bond to know whether it offers a better return than a taxable bond.

Given the choice between a taxable and tax-free bond or bond fund with the same amount of risk, credit quality, and maturity, it’s easy to pick the one with the higher yield. In this case, there’s one problem. It is an apples to oranges comparison. Continue Reading…

What Type Of Investor Are You?

Investor BehaviorIn recent years, there has been a growing upheaval in investing as we throw out overused theories and reintroduce behavior, redefine risk, and question labels that have been used for decades.

Yet, none of this is new. It was simply ignored or written off for decades thanks to a faulty belief in efficient markets. Ben Graham offered up behavior’s role in 1949 with the story of Mr. Market. Almost 100 years before that, Charles Mackay outlined the dangers of herd mentality and bubbles in Extraordinary Popular Delusions and The Madness of Crowds (1841).

Let’s not write off the EMT dark ages completely. It brought index funds and low-cost investing to the masses. There’s the tiny issue that masses bring more emotion to the markets, but hey, academia isn’t perfect. Still, index funds have only add to the list of labels used at a time when it should be simplified. Continue Reading…

Market Corrections Are Hidden Opportunities

stock market correctionsThe headlines are full of market anomalies this time of year. In December it’s the Santa Claus Rally. January it’s the ever original January Effect. After this weekend you’ll see the Super Bowl Indicator. Then comes Sell in May. It’s a seasonal thing, offering a break from the back and forth between stock market corrections and bubble headlines we’ve seen more of these past five years.

As Goes January…

…So goes the year.

This is another anomaly. The theory goes that if the market is up in January, it’ll be higher at the end of the year. But a down January, could bring about a rough year. It makes for fun headlines, but I’m not making investment decisions based on who wins the Super Bowl or what happens in January. I’ll stick to valuation, thank you. Continue Reading…