2 Common Bond Buying Mistakes

12/08/2011 11:00 am EST

Focus: BONDS

Marilyn Cohen

President & CEO, Envision Capital Management, Inc.

Bond expert Marilyn Cohen, editor of Bond Smart Investor, sees bond buyers making two common mistakes.

Is this the new norm or have we seen this play before? Let’s ask Marilyn Cohen. Hi Marilyn.

Hi.

Is it the new norm?

Well, you know, it is all messed up. We have had situations like this before…it is always just a little different color and a little different tweak on it, but I think we will struggle through it. But it will be challenging.

It will be challenging, and because of this investors know that they make mistakes. What are some of the common investor mistakes that you have seen?

The common investment mistakes that I have seen by individuals in the bond market are concentration. They buy too many of the same type of bonds in the same industry.

Specifically, many, many do-it-yourselfers buy too many bank bonds, too many brokerage bonds…and those are financials. The financials are always the most volatile when things go awry.

The way this happens is not overt, it just happens. Most people have multiple brokerage accounts, maybe they have a Morgan Stanley (MS) account, maybe they have Fidelity or maybe they have a Schwab.

Then they go, "Oh, here is a Bank of America (BAC) bond, or here’s a JPMorgan (JPM) bond. Oh, look at this Sallie Mae bond…" And if they ever looked at all three accounts as one, they usually end up with 50% or 60% in financials. That is what tanked many of their portfolios during the credit crisis.

So I think keeping the allocation down to 10% to 15% in any one sector is the way to go. Overallocation has always been a very big problem for the do-it-yourselfers.

Oh gosh yes, no diversification will definitely hurt you. What is another mistake you have seen?

I think another mistake is sticking around when the story has changed, and hoping and praying that everything will be fine.

Specifically, a company starts to stumble in how they are managing their business. Or management decides to take a lot of the valued money off of their balance sheet to do some kind of acquisition that doesn’t make any sense to you.

People say, "Well, let’s give him a chance; let’s go ahead and go with the flow." But if it doesn’t make sense to you, you’ve got to get out of Dodge.

I think that people just stick around with their bonds; they say to themselves and they have said to me, "I will just wait to maturity, and I will be fine." Not necessarily.

Why? A lot of people think that they are going to get all their money back at maturity. What is wrong with that thinking?

Well, because if the company has gone outside of what they usually do—buy a business that they have never integrated into their business model before; if management changes and is no longer bond friendly—I just think that you can’t set it and forget it, Karen.

You have go to be proactive in your bond portfolio just like you are proactive in your equity portfolio. Hoping and praying belongs in churches and synagogues, not in your bond portfolio.

Especially in these volatile times, you can’t just sit, set it and forget it.

Exactly.

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