Lynn O'Shaughnessy

During the dot-com fiasco, millions of chastened stock investors vowed that they'd never chase hot returns again after discovering they could vanish quicker than a box of Girl Scout Thin Mints.

Many bond investors, however, have never seen any need to flagellate themselves over their own investing habits. But their behavior can be just as irrational as the equity ambulance-chasers.

Too many conservative bondholders remain motivated by the same greed that compelled so many people to invest in tech startups with cutesy names and business plans held together with silly string.

Fixed-income enthusiasts are often attracted to bond funds that advertise suspiciously high returns, or they hunt for outsized bond yields that more levelheaded investors would understand are ephemeral. Investors, for instance, embrace high-yield corporate bonds, better known as junk, for fatter yields. More recently, investors have sunk cash into emerging market bonds because of their head-spinning performance.

Larry E. Swedroe and Joseph H. Hempen, the authors of the new book "The Only Guide to a Winning Bond Strategy You'll Ever Need," argue that embracing bond funds with larger-than-life returns can booby-trap portfolios because these fund managers typically invest in extremely risky bonds that don't provide commensurate rewards.

The potential for severe volatility isn't the only reason why Swedroe, a nationally known investment adviser, states unequivocally, "There is absolutely no reason to invest in junk bonds." The junk bond deserves to be ostracized, he argues, because it's a hybrid that behaves partly as a bond and partly as a stock.

The problem with this is that junk bonds slip into their equity role at the worst times. When stocks are getting creamed, junk bonds are often getting whacked, too. So instead of junk bonds providing some ballast when Wall Street is rocking, your portfolio will be reeling from a double whammy. For this reason, you should also keep away from another hybrid - convertible bonds.

You might be able to overlook the junk bond's irritating behavior if the asset class' historic returns equaled or surpassed stocks, but, Swedroe observes, they haven't.

Some readers may recall that this was one of the arguments that David F. Swensen, the chief investment officer at Yale University, also poses in his book, "Unconventional Success: A Fundamental Approach to Personal Investment." In his book, Swensen insists that "junk bond investors cannot win." Among junk's sundry crimes, he suggests, are that these speculative bonds are more expensive to buy and harder to dump.


Lynn O'Shaughnessy

Lynn O'Shaughnessy is the author of Retirement Bible.

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