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If You're Investing in Bonds, Bill Gross Has a Message For You

By Guest Editorial, Money Morning - February 7, 2013

If you're investing in bonds, Bill Gross just delivered you a serious warning.

Gross wrote in his February newsletter that the factors that contributed to last month's 1% loss for U.S. Treasuries - the biggest since March 2012 - aren't going away any time soon.

Total debt, which includes corporate, government and household, has expanded from $3 trillion in the 1970s to about $56 trillion today, explained Gross. He said that's left bond yields in the 1% - 2% range, instead of the historic level of 3% - 4%.

Gross said the staggering amount of debt in the United States has created a "credit supernova" that could crush the bond market as the global credit bubble "is running out of energy and time."

"Our credit-based financial markets and the economy it supports are levered, fragile and increasingly entropic," Gross wrote.

Gross warned that anyone investing in U.S. government bonds should evaluate their exposure.

And he isn't alone. Jim Rogers and Goldman Sachs have both been bearish on bonds.

"I'm short long-term government bonds," Rogers said Feb. 6 on Bloomberg Radio. "I plan to short more. That bull market, that's a bubble."

So what should bond investors who want yield do with their money?

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Investing in Bonds: How to Build a Bond Ladder

By Martin Hutchinson, Global Investing Specialist, Money Morning - April 24, 2012

With interest rates at near-record low levels it appears that the only way for rates to go is up.

As the U.S. economy moderately strengthens, that means the bond bubble will begin to leak. Even darker, the bubble might just burst altogether.

The prospect of yet another bursting bubble makes investing in bonds difficult. The same is true for stocks.

After all, stocks tend to underperform when rates head north, while gold will certainly drop back once interest rates begin to rise ahead of inflation (which may take a considerable time.)

However, there is one strategy that enables you to prosper even in this tough environment.

It is called the bond ladder. It works like this...

Bond investing in a rising rate environment can be a terrific way to lose money.

If you buy short-term bonds, the yields may well be less than inflation, causing you to lose money in real terms.

And if you invest in long-term bonds, your immediate yield will generally be higher, but you run a large risk of losing part of your principal as rates rise and bond prices decline.

These losses can be a large multiple of your interest payments.

For example, if 30-year bond yields rise from their current 3.11% to 5.11% over the next year, your principal loss on a 30-year T-bond will be $30 on every $100, far more than the $3.11 you will have received in interest.

Of course, if you hold the bond for the next 29 years you will get your principal back at maturity.

But meanwhile you will have spent 30 years locked into an investment at interest rates below the market, and probably below the level of inflation. Not a wise choice.

Investing in Bonds: Building a Bond Ladder

The problem of investing in bonds then is one of reinvestment. You really don't know at what rate you will be able to reinvest your money when the time comes.

This problem is solved by buying bonds in a range of maturities, from short to long, and reinvesting the proceeds of each investment as it comes due.

For example, you could invest 10% of your money in each Treasury bond maturity from 1 to 10 years.

Then when the first bond came due in year 1, you would reinvest the proceeds in a 10-year bond, so you would again have 10 equal bond investments coming due in years 2 through 11.

Here's a concrete example.