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Though the stock market is rallying, bond buying also remains healthy. “Some $2.1 billion rolled into U.S. investment-grade corporate-bond mutual and exchange-traded funds in the week ending Feb. 8, the third most since 2010,” reports The Wall Street Journal. Though spreads are narrow, the buying boom continues as future opportunities look scant. For those looking to diversify their portfolio with bonds, there are a few critical mistakes to avoid. Let’s look at the key five.

1. Avoid short-term thinking.

A long-term game plan is critical for bond investors. To capitalize on the full value of a bond, you must hold it until maturity. The reason for this strategy is simple. Bond yields and prices have an inverse relationship. Bond prices fall as interest rates rise. Therefore, if interest rates increase after you buy a bond, then its value may drop. The best way to avoid a loss like this is to hold the issue until it reaches maturity.

2. Avoid hasty purchases.

Bonds are considered a less risky investment than stocks. While it’s true that the volatility of bonds is less than stocks, there are risks to consider. When you buy a bond, you’re extending a loan. You want to ensure that the borrower, the company issuing the bond, has a strong history of repayments. Bonds have less volatility than stocks. However, you can still lose your investment. Check the rating of the bond to become comfortable with the underlying company.

3. Avoid illiquidity.

Liquidity risk is the danger that an asset cannot be sold at, or near its value. In short, you want to know there will be a market ready to buy your bond when you sell. This concept ties into the above paragraph. If the company issuing the bond has a solid credit rating and a good history of debt management, then you likely won’t have a problem selling the bond. However, smaller companies seeking to attract investors with high yields may falter in the future. In such a case you might be stuck with an illiquid holding that you cannot sell.

4. Avoid risk.

Risk, even with bonds, cannot be eliminated entirely. However, diversification goes a long way towards mitigating the loss of capital. Bonds come in all shapes and sizes. Municipal bonds, for example, offer excellent tax benefits. High-yield bonds (“junk bonds”) provide high yields at high risk. Zero-coupon bonds make no coupon payments but come at a discounted par value. Do your homework to ensure that you aren’t too centralized in just one style of bonds. Moreover, ensure that you hold bonds issued by a variety of companies from different sectors.

5. Avoid tax pitfalls.

Investors rarely account for the tax implications of their decisions. For example, an investor may choose a municipal bond for its tax-friendly characteristics. However, this choice comes at a cost. A municipal bond is likely to pay a lower yield relative to a corporate bond. Consider the tax bracket you’re in and do the math to determine the after-tax income. The ultimate value of a municipal bond may be less than that of a corporate issue.

Bonds are sophisticated instruments that serve to do more than simply offset equity risk. They can be reliable sources of income if researched properly. However, long-term conditions will impact these steady cash flows. For this reason, also consider the future burden of inflation and how it may erode the purchasing power of your earned coupon payments.

For more check out 15 Money Mistakes You Shouldn’t Make!

The post Investing In Bonds: 5 Rookie Mistakes To Avoid appeared first on Wall Street Insanity.

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With the Syria crises hanging over the markets like the Sword of Damocles, the Federal Reserve is expected to announce that it will begin tapering its $85 billion monthly bond buying spree this week. Chairman Ben Bernanke and company have scheduled a two day meeting (which will end on Wednesday) to discuss their options. Economists reckon that initially there may be a $10 to $15 billion dollar cut, but that is more than enough to send the message that the Fed is moving towards a more normal economy with normalization of rates across the board.

The Fed initiated the latest bout of quantitative easing in answer to concerns about the dreaded fiscal cliff, which was expected to kick in at the end of 2012 along with Europe’s sovereign debt crisis. Those crises have long passed, but now traders are scrutinizing talks in Congress on a budget solution and the debt ceiling as new sources of potential crisis that could crop up sooner rather than later.

While the Fed meeting tops the list of what will certainly affect the economy this week, Congressional budget wrangling and developments on Syria will also combine to put major pressure on the markets. Stocks could feel some pain if the Fed’s rhetoric is not successful in assuaging the well founded fears of a jittery Wall Street. As a result, Chairman Bernanke is expected to choose his words wisely in conveying the Fed’s message on Wednesday. On the off chance that the Fed does not make the decision to begin tapering at this meeting, it is expected to do so soon. Few experts see it holding back from beginning the process this fall.

Perhaps of equal interest to the markets is that, for the first time, the Fed will forecast its rate guidance for 2016. Indications are that it expects to start raising the target rate for overnight lending between banks, in 2015. Officials have repetitively assured markets they do not intend to hasten to raise short-term rates, which affects a whole range of consumer loans from credit cards to mortgages.

The bottom line is that it is becoming clear that efforts to manage the economy with monetary policy are hitting a solid brick wall and these programs are at a point where they offer diminished returns. Focusing on fiscal policy is the key to a continuous U.S. recovery. The good news is that the Fed seems to understand and is hopefully acting this week to address the issue.

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Bonds prices, and consequently bond funds, have taken a hit over the past month, while bond yields have spiked upward. Some market commentators have called a bubble in the bond market that has finally popped. Investors have lost confidence to some extent, and withdrew a massive $23.3 billion from bond funds in the week ending June 26th. It appears that most of the downward movement in the bond market can be linked to statements that the Federal Reserve would begin tapering its quantitative easing measures by reducing the amount of treasuries it is buying. The Fed is currently making about $85 billion in monthly Treasury purchases. Still, famed bond investors such as Bill Gross and Jeff Gundlach have indicated that the bond sell-off is over, and bonds will rise once again.

https://twitter.com/PIMCO/status/350649368321327104

The market took an initial dim view of the news from the Fed, but now that expectation may be priced into the market. Bond prices have recovered some of its recent losses in the past few trading days. The question for investors is whether this is a temporary stabilization in the bond market, or whether there is a danger of a further downward pressure.

The current yield on the 10 Year Treasury Note is 2.49%, up around 88 basis points since early May, and even recently broke through the 2.5% “line in the sand” drawn by some bond experts. The I-shares Barclay’s 20+ Year Treasury Fund (NYSE: TLT) is down 10.45% year to date, but has recovered 1.67% in the last week. The PIMCO Total Return Bond ETF (NYSE: BOND) has also been hit, losing 2.21% in June, but up 2.9% on the year. June’s monthly loss is the largest since the inception of the ETF in February 2012.

Bill Gross is the head of PIMCO, with approximately $285 billion under management. Gross said in a recent note to investors that the recent bond decline was overdone, because the economy is currently too weak to sustain higher borrowing costs. He said the downturn was a result of the de-leveraging of risk by the market. Gross stated that the Fed’s economic forecast was too optimistic, and failed to consider the recent spike in mortgage rates which would increase borrowing costs for home buyers. He advised that bond investors not jump ship now, but rather stay the course. Still, he indicated that the previous performance in the run up in the bond and equities market over the past 20 years would likely not be replicated moving forward. Gross also predicted that the 10-year Treasury should be in the range of 2.10%, rather than the current level.

Jeff Gundlach, the CEO and founder of Doubline Capital, is another prominent bond investors who is renowned for having made some very accurate market predictions over the years. However, his crystal ball has not been so clear lately, as he had previously declared that the 2.5% yield on the 10-year Treasury would not be breached. He held a webcast last week to try and explain the current bond market uncertainty.

Gundlach blamed the recent downturn on a liquidation cycle. He hypothesized that the liquidation was initiated by a few key players taking leveraged risk off the table, which then led to other leveraged market participants getting margin calls. His presentation included a number of slides, highlighting the rapid decline in gold, the overall bearish trend in commodities, and the recent spike in the China Inter-bank Offering Rate, among others. Gundlach further predicted the 10 year yield would fall to 1.7% by the end of the year.

Despite the protestations of the bond kings, other prominent financial minds are still bearish on bonds. The Oracle of Omaha, Warren Buffett, recently called the current bond market a terrible investment, and stated that investors could lose a lot of money as interest rates rise. He further stated the treasury market was artificially inflated due to the Fed’s quantitative easing. Thus, there are differing views on the future of the bond market. It remains to be Gundlach and Gross have successfully called the bottom in the bond market remains to be seen, as yields have declined marginally in the past few days, or whether another downturn for bonds is in store.

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