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More Praise for Bonds, second edition

“There’s no such thing as risk-free investing, but Bonds, second edi-tion, gives investors practical advice on ways to minimize risk while growing their assets.”

—Bill D’Alonzo, Chief Executive Offi cer of Friess Associates, manager of the Brandywine

Funds family of growth-stock mutual funds

“Over the past decade, the “truth” that investment in equities is a sound, and perhaps the surest path, to long term portfolio success has been severely tested. The Richelsons make a persuasive case for taking a path less travelled—that of investing in individual bonds. With historical examples comparing the stock and bond markets, risk-reward analyses, and exploring of the “magic” of compound-ing, the book is, at a minimum, a fascinating read that for many will be a blue-print for a revolutionary new portfolio design.”

—Victor Keen, Of Counsel, Duane Morris LLP

“Hildy and Stan have written the ‘Everything You Always Wanted to Know About Bonds But Were Afraid to Ask’ book. This book pro-vides clear and concise insights into bond investing.”

—Alan Schapire, CFP®, CPA/PFS, Principal, Libra Financial Planning

“Stocks are always risky, no matter the long-run. Bonds should always have a place in investment portfolios. Stan and Hildy have been saying this correctly for years. Bonds: The Unbeaten Path to Secure Investment Growth, now in its second edition, is one of the best in-depth reviews of wisely navigating the bond markets and how to practically implement thoughtful strategies for fi nancial advisors and advisor-clients alike. Fellow colleagues, this is a must read.”

—Michael Dubis, CFP®, President, Michael A. Dubis Financial Planning; Adjunct Lecturer, University of Wisconsin Graaskamp Center for Real Estate; past

NAPFA National Conference Chair

“Bonds still aren’t part of the nation’s fi nancial culture, years after this book’s fi rst edition and through the stock market’s ups and downs. Don’t blame the Richelsons. Better yet, leaf through their book for a detailed examination of the only investment where income is king.”

—Joe Mysak, editor of Bloomberg Brief’s daily Municipal Market

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“Bonds, Second Edition explains the reality of today’s complex world of investing. It shows how bonds can be more predictable and more profi table for somebody’s fi nancial future. The Richelsons take the facts of investing and they explain how to make it safe. What could be better than that?”

—Paul H. Frankel, Partner, Morrison & Foerster

“The Richelsons have advocated the virtue of bonds long before they became in vogue when the stock market tsunami hit every American in 2008/2009. The second edition of their book about bonds is a must read for anyone who hasn’t invested in bonds because they don’t understand them, or, who wants to understand what they already own. Stan and Hildy’s passion for bond investing is contagious.”

—Kent R. Addis, Jr., President, Addis & Hill, Inc.

“With every conceivable bond topic discussed in plain English, this book is the most useful and practical guide to bond investing. If you’re looking for the “how to” and “why” of prudent bond invest-ing, this book is for you. In thoughtful refl ection, the 2nd Edition will enhance your understanding of the 2009 credit crisis, and will help you steer clear of bond investing mistakes.”

—Jeffery B. Broadhurst, MBA, CFA, CFP, President of Broadhurst Financial Advisors, Inc.

“Finally an up-to-date practical book on fi xed income vehicles as well as strategy in using them. A must-have resource for all levels of investors as well as advisors interested in growing their assets as securely as possible. Readers will truly benefi t from Hildy and Stan Richelson’s independent thinking and experience on effectively using this major asset class.”

—Harry Scheyer, CPA/PFS, CFP, Pinnacle Financial Advisors

“A great insight on understanding bond portfolios. It is an area of investing that is often overlooked and not understood.”

—Fred Amrein, Founder & Principal, Amrein Financial

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BondsSecond Edit ion

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Since 1996, Bloomberg Press has published books for fi nancial professionals, as well as books of general interest in investing, economics, current affairs, and policy affecting investors and business people. Titles are written by well-known practitioners, BLOOMBERG NEWS® reporters and columnists, and other leading authorities and journalists. Bloomberg Press books have been translated into more than 20 languages.

For a list of available titles, please visit our web site at www.wiley.com/go/bloombergpress.

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BondsSecond Edit ion

THE UNBEATEN PATH TO SECURE INVESTMENT

GROWTH

Hildy Richelsonand

Stan Richelson

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Copyright © 2011 by Hildy Richelson and Stan Richelson. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

TreasuryDirect® and SmartExchange® are registered trademarks of the U.S. Department of the Treasury.

For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.

Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com.

Library of Congress Cataloging-in-Publication Data:

Richelson, Hildy. Bonds : the unbeaten path to secure investment growth / Hildy Richelson and Stan Richelson. —- 2nd ed. p. cm. Includes index. ISBN 978-1-118-00446-3 (hardback); 978-1-118-10654-9 (ebk.); 978-1-118-10655-6 (ebk.); 978-1-118-10656-3 (ebk.) 1. Bonds. I. Richelson, Stan. II. Title. HG4651.R528 2011 332.63'23—dc22

2011010980

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To the youngest members of our family, Maya and Emily Carpenter, and to our newest family member, Kate Williams, who have expanded the possibilities

for our future.

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ix

Contents

Foreword xxiii

Preface xxvii

Acknowledgments xxxvii

Introduction xxxix

PART I Clearing the Cobwebs 1

Chapter 1 Bonds: The Better Investment 3 Examining the Myths 5

Historical Annual Return 5

Unhappy Returns: Uncovering the True Returns

on Stock Investments 6

Taxes, Costs, and Risks of Investing in Bonds 9

Past Performance 10

Risk 14

Growth and Income 18

A Second Look at Risks and Returns 19

Stock Market Volatility: The Impact on Retirement Planning 21

Why Bonds Are a Better Investment than Stocks 23

Individual and Institutional Investors: How They Differ 24

Institutional Bond Investors 25

Key Questions to Ask about Whether You Should

Invest in Stocks rather than Bonds 27

Notes 27

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x Contents

Chapter 2 The All-Bond Portfolio 29 Advantages of the All-Bond Portfolio 30

Financial Planning 31

Designing the All-Bond Portfolio 33

Plain Vanilla Bonds 33

Plain Vanilla Exclusions 34

A Word about Other Bonds 36

High-Yield Debt 36

The All-Bond Antidote to Greed and Fear 37

Notes 38

Chapter 3 Adopting the All-Bond Portfolio: A Case Study 39 A Poor-Fitting Portfolio 39

Peter’s Financial Objectives 40

Peter’s Concerns about His Portfolio 41

A Consultation with Stan Richelson 43

A Financial Plan Aligned with Objectives 44

Step 1: Peter’s Objectives and Financial Needs 45

Step 2: Allocation Between Safe Bonds and All Other Assets 45

Step 3: Tax Review 45

Step 4: A Goal-Directed Portfolio 46

Reaching a Comfort Level 48

Note 48

PART II Bond Basics 49

Chapter 4 The Evolution of a Bond: From Verbal IOU to Electronic Entry 51

Learning the Language 51

The Early Years 52

A Colonial Debut 55

After the American Revolution 56

Entering the Twentieth Century 59

Changes in the Twentieth Century 62

A Modern Metamorphosis 64

Great Recession of 2007–2009 67

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Contents xi

Basel III—International Securities Standards 68

Derivative Regulation 70

The Internet’s Impact on Bond Buying 70

Notes 71

Chapter 5 The Life of a Bond: How it’s Created, Issued, Priced, and Traded 75

By Way of Background 76

Preparing a Bond Issue 78

Rating a Bond 81

Setting a Coupon Rate 84

Launching a Bond 85

Understanding Risk 86

A Bond’s Cost and Yield 88

Determining a Bond’s Yield 88

Current Yield 89

Simple and Compound Interest 90

Yield-to-Maturity 91

Yield-to-Call and Yield-to-Worst 92

Yield-to-Average Life 92

After-Tax Yield 93

The Call Option 93

Duration 94

Total Return 96

Cash Flow upon Death: The Estate Feature 97

Mind Mr. Market 98

Pricing a Secondary Market Bond 100

Key Questions to Ask When Purchasing a Bond 101

Notes 101

PART III Bond Categories 103

Chapter 6 U.S. Treasury Securities 105 The Big Picture 105

U.S. Treasury Notes and Bonds 108

Advantages 108

Risks 109

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xii Contents

Tax Implications 109

Pricing Information 110

Special Features and Tips 110

U.S. Treasury Bills 111

Advantages 111

Risks 111

Tax Implications 112

Pricing Information 112

STRIPS 112

Advantages 113

Risks 114

Tax Implications 114

Pricing Information 114

TIPS 114

Advantages 117

Risks 117

Tax Implications 118

Special Features and Tips 118

Key Questions to Ask about All Treasury Securities 120

Notes 120

Chapter 7 U.S. Savings Bonds 121 Simple Investments with a Few Complexities 121

Purchasing a Savings Bond 122

Series EE Savings Bonds 123

EE Bond Purchases on or after May 1, 2005 123

Special Rules for Old EE Bonds 124

Advantages 125

Risks 125

Tax Implications 125

Special Features 127

Recommendations and Tips 129

Series HH Savings Bonds 130

Advantages 130

Risks 131

Tax Implications 131

Series I Savings Bonds 131

Advantages 133

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Contents xiii

Risks 134

Tax Implications 134

Recommendations and Tips 134

Key Questions to Ask about Savings Bonds 135

Chapter 8 U.S. Agency Debt 137 Major Debt-Issuing Agencies 138

Fannie Mae and Freddie Mac 139

Federal Agricultural Mortgage Corporation 142

Federal Farm Credit Bank System 142

Federal Home Loan Bank System 142

Financing Corporation 143

Resolution Funding Corporation 143

Student Loan Marketing Association 144

Tennessee Valley Authority 144

Advantages 145

Risks 145

Tax Implications 147

Special Features and Tips 147

Key Questions to Ask about Agency Bonds 148

Notes 149

Chapter 9 U.S. Agency Mortgage-Backed Securities and Collateralized Mortgage Obligations 151

Mortgage Securities Guaranteed by the Agencies (Agency MBSs) 152

MBSs: A Complex Structure 153

The Agencies 155

Agency Mortgage-Backed Securities 157

Advantages 158

Risks 159

Tax Implications 160

Special Features and Tips 160

Key Questions to Ask about Mortgage-Backed Securities 161

Collateralized Mortgage Obligations 161

CMOs: A Closer Look 162

Advantages 164

Risks 165

Tax Implications 165

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xiv Contents

Pricing Information 166

Key Questions to Ask about CMOs 166

Chapter 10 Municipal Bonds: Overview 167 Why Buy Munis? 168

Munis: The Opaque Market 169

Default Risk Considered 172

Risks in Common Bring about Change 174

Ratings and Municipal Bond Insurance 177

Downfall of the Muni Bond Insurers 180

Phoenix Rising 182

Purchasing New Issue Municipal Bonds 182

Municipal Notes 183

Prerefunded and Escrowed Bonds 184

Advantages of Prerefunded Bonds 185

Advantages of Escrowed Bonds 185

Risks 185

Tax Implications 185

Protect Your Muni Bond Portfolio? 185

Taxes on Municipal Bonds 186

Key Questions to Ask about Muni Bonds 187

Notes 188

Chapter 11 Municipal Bonds: Types 191 Tax-Exempt or Taxable Bonds? How to Decide 191

Taxable Municipal Bonds 194

Advantages 195

Risks 195

Tax Implications 196

Special Features and Tips 196

Private Activity Bonds 196

Advantages 197

Risks 197

Tax Implications 198

Tax-Exempt Municipal Bonds 198

General Obligation Bonds 199

Revenue Bonds 202

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Contents xv

Types of Revenue Bonds 205

Checking Prices on Municipal Bonds 220

Key Questions to Ask about Types of

Municipal Bonds 222

Notes 223

Chapter 12 U.S. Corporate Bonds 225 The Big Picture 225

Ratings 225

Types of Corporate Bond Coupons 227

Taxation 228

Key Categories of Corporate Bonds 229

Advantages 230

Risks 230

Pricing Information 232

Special Features and Tips 232

Corporate Medium-Term Notes 234

Advantages 235

Risks 235

Pricing Information 236

Special Features and Tips 236

Corporate Retail Notes 236

Advantages 237

Risks 238

Pricing Information 238

Information Sources 238

Special Features and Tips 239

Step-Up Bonds, Notes, and Debentures 239

Advantages 240

Risks 240

Tax Implications 241

Special Features and Tips 241

Corporate High-Yield Junk Bonds 241

A Rose by Any Other Name 241

The Track Record 242

Brave Buyers 244

Advantages 245

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xvi Contents

Risks 246

Pricing Information 246

Special Features and Tips 247

Corporate Convertible Bonds 247

Advantages 248

Risks 248

Pricing Information 249

Special Features and Tips 249

Price-Checking Corporate Bonds 250

Key Questions to Ask about Corporate Bonds 251

Notes 252

Chapter 13 International Bond Markets: Foreign and Offshore 255

Defi nition of Terms 256

Types of International Bonds 257

Trading Blocs 260

European Bloc in the European Union 260

Emerging Market Bloc 261

Dollar-Denominated Foreign Debt 263

Foreign Bonds 265

Currency Considerations 265

Tax Implications 266

Advantages 266

Risks 267

Special Features and Tips 268

Key Questions to Ask about International Bonds 269

Notes 270

Chapter 14 Bond Look-Alikes 273 Certifi cates of Deposit 274

Ratings 274

Yields 274

Bank Certifi cates of Deposit 275

Broker-Sold Bank Certifi cates of Deposit 277

Key Questions to Ask about Certifi cates of Deposit 281

Single-Premium Immediate Fixed Annuities 281

Advantages 283

Risks 284

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Contents xvii

Tax Implications 284

Pricing Information 285

Information Sources 285

Special Features and Tips 285

Key Questions to Ask about an Immediate Fixed Annuity 287

Deferred Fixed Annuities 287

Investment Phase 287

Accumulation Phase 287

Nonfi xed Distribution Phase 288

Fixed Distribution Phase 289

Advantages 289

Risks 289

Tax Implications 290

Pricing Information 291

Special Features and Tips 291

Key Questions to Ask about a Fixed Deferred Annuity 292

Nonconvertible Fixed Rate Preferred Stock 292

Advantages 295

Risks 295

Pricing 296

Tax Implications 296

Information Sources 297

Special Features and Tips 297

Key Questions to Ask about Preferred Stock 298

Dividend-Paying Common Stock 298

Advantages 299

Risks 299

Special Features and Tips 299

Key Questions to Ask about Common Stock 300

Notes 300

PART IV Options for Purchasing Bonds 301

Chapter 15 How to Buy Individual Bonds: A Tool Kit 303 Buying Online 304

Pricing Information 305

Pricing a New Issue 308

Real-Time Prices 308

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xviii Contents

Key Questions to Ask about Buying Bonds Online 310

Choosing a Broker 310

What’s Wrong with This Ad? 310

Choosing the Right Brokerage Firm 314

Criteria to Consider 315

Establishing a Relationship 316

Using a Stockbroker 316

The Managed Account 317

Evaluating Bond Prices 319

Nature of the Marketplace 320

Wholesale versus Retail 320

New-Issue Order and Confi rmation Details 321

Key Questions at the Point of Purchase 322

Notes 324

Chapter 16 Bond Funds: The Good, the Bad, and the Worst 325

Common Ground 326

Maturity 327

Yield 327

Duration 328

Derivatives 329

Advantages 330

Disadvantages 330

Checking the Costs: Hidden and Unhidden 331

Load 331

Other Changes 332

More about Fees 335

Buying for Total Return 336

Fund Categories 337

Unit Investment Trusts (UITs) 337

Closed-End Funds 338

Exchange-Traded Bond Funds 340

Open-End Mutual Funds 342

Key Questions to Ask about Types of Bond

Funds 346

Notes 347

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Contents xix

Chapter 17 Bond Funds: A Taxing Matter 349 Money Market Mutual Funds: Taxable and

Tax-Exempt 349

Breaking the Buck 350

Municipal Bond Funds: Tax-Exempt 352

Municipal Bond Funds: High Yield

(Junk Bonds) 352

Municipal Bond Funds: National 353

Municipal Bond Funds: State Specifi c 354

Taxable Funds 354

Municipal Bond Funds: Taxable 355

Build America Bond (BAB) Funds 355

Corporate Bond Funds 355

Convertible Bond Funds 356

Corporate Bond Funds: High Yield (Junk) 356

Corporate Bond Funds: Investment Grade 357

Floating Rate Loan Participation Funds

(Bank Loan) 358

International Bond Funds 360

Index Funds 360

Inverse Bond Funds 361

Long-Short Bond Fund 361

Stable-Value Funds 361

Ultrashort Bond Funds 363

Government Bond Funds 363

GNMA Funds 364

Infl ation-Protected Securities Funds 364

Treasury Bond Funds 365

Strategic or MultiSector Bond Funds 365

Target-Date Funds: Zero-Coupon 365

Target Date Funds: Life Cycle/Asset-Allocation

Funds 366

Key Questions to Ask about Choosing a Bond Mutual

Fund or ETF 367

Notes 367

Chapter 18 Choosing a Bond Mutual Fund or ETF 369 Bond Fund Fees 370

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xx Contents

Understanding Yield 370

The Search Begins 372

Morningstar 375

Long-Term Thinking 377

Strategies for Bond Fund Buyers 377

Key Questions to Ask When Exploring Bond Fund

and ETF Search Engines 380

Notes 381

PART V Bond Investment Strategies and Richelson Investment Rules 383

Chapter 19 Financial Planning Framework for Bond Investing 387

Create Cash Flow with Bonds 388

Focus on Cash Flow Not Performance 388

Buy Cash Flow, Not Diversifi cation 389

Get Cash Flow, Not Hoped for Returns 390

Infl ation and Cash Flow 390

Cash Flow in Retirement 391

The Basics of Creating Your Financial Plan:

The Four-Step Financial Planning Process 393

Step 1. Determine Your Life Objectives and Financial Needs 394

Step 2. Divide Your Investment Portfolio into Two Categories 396

Step 3. Plan for Taxes 398

Step 4. Select Bonds to Support Your Life Objectives and

Financial Needs 401

Should You Add Risk to Your Portfolio? 406

Reevaluating Your Portfolio 409

Key Questions to Ask about Financial Planning with Bonds 410

Chapter 20 Financial Planning with Bonds: Case Studies 411 Baby Boomers Design a New Financial Plan 411

Every Family Has a Different View of What Lifestyle

Is Appropriate for Them 412

Summary of Key Takeaway Points 415

You Are Rich! Why Are You Worried? 415

Summary of Key Takeaway Points 418

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Contents xxi

Changing Course 418

Summary of Key Takeaway Points 419

Meeting a Need for Safety 420

Summary of Key Takeaway Points 420

An Unanticipated Transition 421

Summary of Key Takeaway Points 422

Ownership of Stock in a Private Company 423

Postscript 424

Summary of Key Takeaway Points 424

Stock Options Pay Off Big 424

Postscript 426

Summary of Key Takeaway Points 426

Planning for College Expenses 427

Summary of Key Takeaway Points 428

Invest a Large Amount of Cash at One Time 428

Summary of Key Takeaway Points 431

Socially Responsible Investing 432

Ill-Advised Advisers 433

Mikala’s Bond Portfolio 435

Charitable Lending and Personal Growth 437

Church Bonds 438

Mikala’s Life Plan 439

Summary of Key Takeaway Points 439

Notes 440

Chapter 21 How to Make the Most Money from Bonds 441 Knowing When to Buy and Sell 441

The Yield Curve 443

Strategies for Deciding When to Sell 447

Strategies for Finding Bargain Bonds 448

Strategies for Avoiding Overvalued Bonds 450

Strategies for When Interest Rates Are

High or Rising 451

When Interest Rates Are Rising 451

Strategies for When Interest Rates Are Low or Falling 453

Investing for the Highest After-Tax Yield 455

A Reminder about Taxes on Investments 456

Strategy for Placing Bonds in Tax-Effective Accounts 457

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xxii Contents

Strategies for Individuals in High Tax Brackets 458

Strategies for Tax-Deferred Retirement Accounts

and Individuals in Low Tax Brackets 458

Investing and Risk Tolerance 460

Practical Considerations for Assessing Risk Tolerance:

Know Yourself 460

Strategies for Reducing the Risk of Default 462

Strategies for Safe Investing 463

Strategies for Reducing Market Risk 464

Strategies for Reducing Liquidity Risk 469

Strategies for Reducing Call Risk 469

Investing for Income Needs and Financial Goals 470

Strategies for Short-Term Goals 470

Strategies for Long-Term Goals 471

Strategies for Life Events 473

Strategies for Increasing Income 473

Strategies for the Socially Responsible Investor 475

If You Are Starting Out With Less Than $25,000 to Invest 475

Obstacles to Committing to an All-Bond Portfolio 475

Notes 477

Appendix: Useful Web Sites 479

About the Authors 483

Index 485

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xxiii

Foreword

When Rob Arnott revealed in 2009 that bonds had outperformed stocks over the preceding 40 years, most people were shocked. Arnott, founder and chairman of the California money manager Research Affi liates, showed that an investor buying a constant-maturity, 20-year bond in 1968 enjoyed a higher total return than he would from an S&P 500 portfolio.

Stan and Hildy Richelson, though, were not in the least surprised. For the last 25 years, they have steadfastly advocated the all-bond portfolio, arguing, among other things, that bonds offer better risk-adjusted returns than stocks.

History proved them right.This second edition of their book contains substantial new

material, including a history of bonds, a chapter devoted to fi nan-cial planning with bonds, and numerous case studies that explain the powerful role bonds can play in your investment strategy. The Richelsons show how these concepts can be employed in their hallmark All-Bond Portfolio.

Today, many fear that the bull market in bonds has run its course, that interest rates will rise and the history of the last 40 years will reverse itself. Municipal bond mutual funds, for example, suffered record outfl ows at the end of 2010 and the fi rst quarter of 2011. Infl ation is inevitable, the herd contends, and bonds will be the victims.

There is no crystal ball through which we can see into the future. Our economy may face infl ation down the road, but the timing is highly uncertain. More likely, we will experience a period of slow growth and high unemployment—what the global bond manager PIMCO has called the “new normal”—because of continued deleveraging in the private and public sectors. Infl ation has historically correlated highly with wage growth, and without strong and consistent economic expansion that creates jobs, defl ation will be more likely than infl ation.

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xxiv Foreword

The capital markets concur with this forecast. The break-even infl ation rate over the next 30 years (the yield on fi xed-rate 30-year bonds minus that of 30-year Treasury Infl ation Protected Bonds, known as TIPS) is 2.6 percent—below the average infl ation rate of 3 percent during the last century.

Defl ation, or even moderate infl ation, will be a boon to bond investors.

As the Richelsons explain in the pages that follow, even if infl ation were to unfold, it is not the all-powerful menace that many bond investors fear. By constructing a portfolio of lad-dered fi xed-rate bonds and reinvesting coupons at progressively higher interest rates, investors can insulate themselves from adverse interest rate movements. If they have a bond ladder in place before infl ation begins, higher interest rates will be the investors’ upside case. Moreover, the yield-to-maturity calculation assumes that you will reinvest the interest payments at the same rate. Insofar as you can reinvest them at a higher rate, you will have a higher overall return.

If you truly fear infl ation, TIPS provide a near-perfect hedge. Individual TIPS bonds offer real (after-infl ation) interest income that precisely matches the government’s reported consumer price index (CPI). Only to the extent that the reported CPI does not match one’s individual infl ation profi le are TIPS an imperfect hedge.

A laddered portfolio and individual TIPS are examples of an important theme the Richelsons present in this book: The advantage of individual bonds over bond funds. Retirement portfolios are con-structed to match assets with liabilities. Those liabilities consist of living expenses, tuition payments, health care costs, planned bequests, and other items; some we can forecast, and some we can’t. Funding those liabilities with individual bonds assures investors of highly predictable cash fl ows timed to meet their obligations.

Bond funds, by contrast, typically have a constant maturity that does not adjust to an investor’s dynamic liability profi le. Moreover, fund investors must pay management expenses, which for active portfolios may comprise a large percentage of bond fund yields. Add to that the tax ineffi ciencies arising from portfolio turnover, and the Richelsons argument for individual bonds is eminently compelling.

The central question facing all retirement investors is how much money they need to retire. I am honored that the Richelsons have

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Foreword xxv

chosen to present research that I have conducted in the fi eld of safe withdrawal rates (SWRs), an area of study that offers important insight into this problem. Previously, virtually all research on SWRs used an equity-centric portfolio, relying on the hoped-for good for-tunes of the stock market to provide suffi cient returns to fund one’s retirement. The risks of this approach were made painfully clear in 2000 and 2008, as retirees with equity-centric portfolios were forced to make major lifestyle sacrifi ces in the wake of market collapses.

As the Richelsons illustrate, a safer approach is to construct a de-accumulation portfolio of high-quality bonds that include TIPS and municipal bonds, which, depending on market conditions, offers SWRs of 4 to 5 percent with far less downside risk than the equity-centric approach.

Zvi Bodie, a fi nance professor at Boston University, has encapsu-lated the essence of retirement investment in a succinct and profound statement: One’s goal should be not to burden one’s children. Spend your life giving your children the education and love they need to live independently, and don’t saddle them with the burden of taking care of you in your old age.

But that is the risk that many take in an equity-based approach to retirement investing, whether in the accumulation or de- accumulation phase. Investing is about positioning a portfolio for the appropriate risk-adjusted return. Too many retirement investors focus on return and ignore risk. Stan and Hildy’s important book will help the investment world understand that bonds should play a central role in retirement investing, and that bonds offer attractive returns with far less risk than stocks.

Here’s to the next 40 years proving as profi table for bond investors as the last 40. If they come anywhere close, this book will be your guide to a safe and comfortable retirement.

Robert Huebscher

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xxvii

Preface

The fi rst edition of Bonds: The Unbeaten Path to Secure Investment Growth (2007) took the untraditional stand that high-quality bonds are a better investment than stocks for individual investors. We supported our thesis by concluding that stocks historically didn’t outperform bonds when an individual investor’s taxes, transaction fees, expenses, and bad timing are all taken into consideration.

Furthermore, we put forth the heresy that asset allocation to multiple asset classes is not required for investment success. Instead, we proposed the wisdom and logic of the All-Bond Portfolio as the safest and surest way to investment success. We concluded that allocating your assets in the traditional way to many asset classes would actually increase your investment risk rather than decrease it, when compared to the strategy of the All-Bond Portfolio.

The wisdom and logic of the All-Bond Portfolio was certifi ed as correct by the dot-com Crash of 2000 to 2003 and, fi ve years later, by the epic Crash of 2008 that shook the investing world. In the Crash of 2008, all asset classes went down together—all, that is, except high-quality individual bonds. Stocks declined by almost 57 percent peak to trough. Looking back on the decade of 2000 to 2009, during which U.S. large company stocks returned an average of –0.95 percent,1 it is clear that bonds have been a better investment no matter how you evaluate the facts or measure performance.

The stock market roller-coaster ride from 2000 to 2009 resulted in much sound and fury but no net gain (apologies to Shakespeare). Despite this decade producing no stock market gain, there were the added indignities of taxes and fees to be paid, which further reduced performance. In addition, many investors sustained substantial losses due to trading in and out of the stock market at inappropri-ate times. Our view that the asset classes of stocks and bonds must be risk adjusted as part of every investor’s analysis was demonstrated in spades.

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xxviii Preface

In the Introduction to the fi rst edition in 2007, we made the following predictions for the future:

High-quality bonds can free investors from the fear of investing.High-quality tax exempt bonds will protect your principal and generate substantial after-tax income.High-quality bonds will provide as good or better returns than stocks without substantial volatility.High-quality bonds will provide growth through the magic of compound interest if the interest income is reinvested.

All these predictions proved to be true in the years following 2007, but to a greater extent than anyone anticipated. Those who invested in high-quality individual bonds were saved from the fear and destruction of volatile markets. High-quality individual bonds proved to be safe and continued to provide all the income they promised and growth if the interest income were reinvested in addi-tional bonds. High-quality bonds substantially outperformed stocks without substantial volatility.

A typical portfolio of high- quality individual tax-free bonds returned about 5 percent per year from 2000 to 2009. Thus, a bond portfolio of $100,000, compounding at 5 percent tax-free over a 10-year period, would be worth over $162,000 (a 62 percent appre-ciation after tax). Moreover, this 5 percent tax-free return would be equivalent to a 7.7 percent taxable return for an individual investor in the 35 percent marginal federal income tax bracket.

A Short History of the Causes of the Crash of 2008

There has been much written about the Crash of 2008 and the effects of the Great Recession that is still with us at the beginning of 2011. The Great Recession is the most serious global fi nancial crisis since the Great Depression of the 1930s. Financial bubbles and pan-ics have been with us throughout history. The most recent history of these fi nancial crises over the last 800 years has been brilliantly researched and recorded by Carmen M. Reinhart and Kenneth S. Rogoff in their book This Time Its Different, Eight Centuries of Financial Folly (Princeton University Press, 2009).

During the 20-year period that comprises the 1980s and ‘90s, declining infl ation and declining interest rates stoked a massive stock

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