"IF YOU DON'T know where you are going, you will end up somewhere else," said yogi Berra, manager of the new york yankees. In this section, we'll help you get to where you would want to go, if you knew where that was. In chapter 17, we outline four steps you might take to design and execute your personal bond-investment strategy. Before making any investment, you should update your life objectives and financial needs. After you've considered your future, divide your investment funds into two pots: secure and risk taking. Having done that, consider what the after-tax consequences of your investment choices might be and how the results might modify the working model of your proposal. finally, purchase plain-vanilla bonds that meet your financial objectives.
We offer a variety of financial-planning stories in chapter 18. These stories will give you a sense of how you might use bonds to design your own bond portfolio. One of our examples is a socially conscious investor who takes the unusual step of using bonds as her investment vehicle. Other investors deal with life-planning issues of achieving financial security, saving for college, and preparing for life's transitions.
In chapter 19, we present the concept of the yield curve, a plotted snapshot of interest rates, and how to adjust your investment strategies to maximize your return. We show you how to construct a bond ladder tailored to your own personal needs within the context of market fluctuations, tax consequences, concerns for safety and yield, and a variety of other factors.
Throughout our many years as financial advisers, we have followed a basic set of rules that have stood the test of time and have served our clients well. We call them the "Richelson Investment Rules" and share them with you here. They are conservative in that they are designed both to protect and to enhance the value of your investments. The 100 percent bond portfolio fully complies with these rules.
- Rule 1. Precisely define all your objectives.
List your financial objectives, life objectives, and values as specifically as you can. These objectives should determine the type of investments you choose.
- Rule 2. If you can't afford the risk, don't play.
The potential return from an investment is generally proportional to its risk. Determine what percent of your investment portfolio you will put at risk and what percent you will keep safe in plain-vanilla bonds.
- Rule 3. Don't lose money.
We do not say this in jest. People talk only about their winners, whether at the racetrack or in the stock market. You rarely hear about the money they lost. Compared to investors who win some and lose some, you'll come out way ahead if you never lose money. In Part One, we explain how the 100 percent bond portfolio can keep your money safe.
- Rule 4. Evaluate the return on all investments on a risk-adjusted, after-tax basis.
Our investment philosophy is that an investment should generate the largest after-tax economic return with the least risk of losing capital, the smallest investment costs, and the least aggravation. To compare apples to apples, always look at each investment on a risk-adjusted, after-tax basis. Risk adjusted means that in comparing one investment to another, you evaluate the likelihood of losing money. No investment made solely for tax purposes is a good investment.
- Rule 5. Understand the investment.
Don't invest in anything unless you understand its function as an investment vehicle and its tax consequences. When you experience MEGO (my eyes glaze over), consider it a warning flag. Promoters of investment products love to tell you about the front-end tax benefits of an investment and the gains that will surely be yours. However, they often don't mention what the downside may look like, how difficult it might be to sell the investment product, who will buy it, what the spreads might be, and whether there are adverse tax consequences when the investment terminates.
- Rule 6. Understand the investment's liquidity.
Be in control of the investment. Liquidity and flexibility are as important as yield, particularly if you need or want to sell the investment product before its due date.
- Rule 7. Check for the seller's conflicts of interest before you buy.
Always look for the seller's potential conflicts of interest and try to determine whether they may affect the description you've been given of the investment. Brokers, for example, often get larger commissions for trading stocks and complex financial products than they do for bonds bought and held for many years.
With these rules in mind, let's review investment planning strategies for how to increase your returns with bonds.