Long-Term Bonds Do Wonders When Times Are Right

Reader Ron reminded me of this blunder I wrote back in May: TIPS Price Up: Buy, Hold, Or Sell? Back then I wrote about a 30-year TIPS bond maturing in Feb. 2041 having gained 13% in short three months between February and May 2011.

I suggested investors might consider selling the 30-year TIPS, and buying a 15-year TIPS instead, because 15 years was the "sweet spot" giving the best bang for the buck between risk and expected return.

The market has proven me wrong. Since May, the 30-year TIPS went up another 16%. A 15-year TIPS went up only 11%. If you bought the 15-year TIPS instead of the 30-year TIPS, you would’ve earned 5% less. If you had the 30-year TIPS and you switched to the 15-year TIPS following my suggestion, you would’ve missed out more than 5% when you add the cost of switching.

Altogether since mid-February when the 30-year TIPS was first issued:

Huge difference in just six months, isn’t it? $1,000 invested in a S&P 500 fund became $860. $1,000 invested in the 30-year TIPS became $1,310. That’s more than 50% more.

This shows that you shouldn’t take my advice. I do not give advice. I only write about what I would do. I had TIPS maturing in 2028 and 2029, closer to the 15-year data point. I did not switch to 30-year TIPS. As a result I earned quite a bit less than I could have. I take full responsibility for the consequence of that decision.

Was it the right decision though? That’s a tricky question. For any given period in the past, which strategy led to a better outcome is crystal clear. Either strategy A won or strategy B won. For any given period in the future, it’s not clear at all. There’s no way to tell whether strategy A will win or strategy B will win. But we still have to make decisions today about the given period in the future. This uncertainty over strategy and outcome makes investing hard.

Most people would say broadly diversifying your investments with mutual funds and/or ETFs is a better strategy than concentrating your investments in a handful of individual stocks. However, you would have earned much much more if you put money in Apple shares or gold in the last ten years instead of in broadly diversified mutual funds or ETFs.

Will investing in Apple shares or gold in the next ten years continue to beat investing in broadly diversified mutual funds or ETFs? I don’t know. Replace Apple shares or gold with any other investment alternatives, say a group of actively managed mutual funds, same answer: nobody knows. If someone says don’t do X but do Y, ask them if they will make up the difference if you follow their advice. If they are not willing to do that, talk is cheap.

I wonder why we don’t hold investment advisors to this standard. Agree upon a benchmark when the client signs up. Agree to a set milestone. Look back. If the advisor beat the benchmark, the advisor keeps the fee. If not, the advisor makes up the difference to the client. Make sure the advisor carries enough insurance or posts enough collateral to back up this obligation. If we don’t hold advisors to a performance standard, what’s the point of having an advisor if the client can just get the benchmark performance on their own?

I still think sticking with 2028 and 2029 TIPS and not extending to 30 years was the right decision, but that’s just me. If I have 30-year TIPS today, I would sell them. The interest rate risk isn’t worth it to me. If it can gain 30% in six months, it can easily lose 30% when the wind blows to a different direction. But when times are right, long-term bonds do wonders.

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Comments

  1. Brad says

    “I wonder why we don’t hold investment advisors to this standard. Agree upon a benchmark when the client signs up. Agree to a set milestone. Look back. If the advisor beat the benchmark, the advisor keeps the fee. If not, the advisor makes up the difference to the client. Make sure the advisor carries enough insurance or posts enough collateral to back up this obligation.”

    Generally speaking it’s because we’re lazy, but this is an excellent suggestion and approach. I think with the recent volatility and astounding poor decisions made by fund managers, I think you will see more demand for suggestions like yours. Nice article.

    Brad

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