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Bonds: The Unbeaten Path to Secure Investment Growth, 2nd Edition


Praise For Bonds

"In the last financial crisis, Stan and Hildy Richelson's lessons about the dangers of having risky investments were learned by millions of people the hard way—by losing their money. In this book, the Richelsons educate investors about how to build safe portfolios with secure income that will enable them to enjoy the fruits of their labors."
—Kevin Adler, MBA, Editor, National Association of Personal Financial Advisors

"In their timely second edition of Bonds: The Unbeaten Path to Secure Investment Growth, Hildy and Stan Richelson provide the antidote for investors beset by erratic and volatile stock performance. Their compelling case for a high-quality bond strategy is well laid out for the prudent investor, along with extensive, practical information to help assess the opportunities and pitfalls in the fixed-income markets."
—Andrew B. Williams, CFA, Chief Investment Officer, Philadelphia International Advisors

"In the first edition of this wonderful book, the Richelsons argued that stocks and diversified portfolios would not outperform a carefully constructed bond portfolio. And that was before the 2008 Great Recession! Those who did not listen to them would be wise to grab and use the newly revised edition of this masterpiece."
—Sam Kirschner, PhD, Managing Director, MayerCap, LLC, coauthor, The Investor's Guide to Hedge Funds

The advice of Hildy Richelson, PhD, and Stan Richelson, JD, LLM, on bond investing is sought across the United States by individuals, financial advisors, and the media. As nationally recognized bond advisors and financial authors of five bond books, they have translated the complex world of bond investing into diagrams and layman's language, enabling motivated investors to take control of their financial lives.

Scarsdale Investment Group, Ltd. restricts its practice to the design and implementation of bond portfolios for high-net-worth individuals. Visit their website at and sign up for a free newsletter to receive updates on bond market trends.

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

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

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

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


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

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

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

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

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

Definition 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

Certificates 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

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

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 Confirmation 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

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

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 Diversification 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

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

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