The Cost Of Waiting: 1st Anniversary

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

Trying to time the market?

A year ago, some investors told us that they’d like to invest in municipal bonds, but felt that rates were too low and would prefer to wait until they rose. We, however, have always strongly believed that the most successful investors do not attempt to time the market. Instead, they buy bonds when their funds are available.

As a result of this discussion last year, we began monitoring two hypothetical investors. At that time, AAA insured bonds were yielding 5.60%.

Investor A, not trying to outguess the market, bought $100,000 of these insured bonds.

Investor B, convinced that rates would be rising, decided to wait for bonds to yield 6.00%. In the meantime, he parked his $100,000 in a tax-free money market paying 2.25% and waited for the higher rates he was certain were just around the corner.

Now, one year later, Investor A’s 5.60% bonds have returned $5,600. Investor B, meanwhile, has watched his money market rate drop to .65%, resulting in an average return of 1.3%, or $1,300 in the prior 12 months.

The Cost of Waiting

Over the past year, Investor B has earned $4,300 less than Investor A. He probably doesn’t realize that even if he could buy a 6% bond today, it would take 10.75 years to match Investor A’s return on his capital. Unfortunately, there are no AAA bonds yielding close to 6%.

Even worse, Investor B is starting to fear that interest rates may not be going higher. In fact, contrary to what the financial media has been predicting, rates may be heading even lower. Tired of waiting for rates to rise and questioning whether he was even beating the rate of inflation with the meager returns from his money market account, Investor B decided to bite the bullet and purchase $100,000 5%, AAA-insured tax-free bonds.

For purposes of our illustration, let’s say Investor B has a brother, Investor C. Investor C also had investment funds earmarked for the bond market, but wasn’t convinced by his brother’s experience. He said he couldn’t recall a time when interest rates were lower, so they must be heading higher soon. He decided to delay his investment until then.

Can Investor C outguess his brother and successfully time the market? Stay tuned. We’ll check back with these investors in a few months to monitor their progress.

James A. Klotz

President

James A. Klotz is the President of FMSbonds, Inc.
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Jun 1, 2002

Please note that all investing entails risk. Fixed income securities are subject to risks that will affect their value prior to maturity. Some of these risks can be related to changes in market conditions, issuer creditworthiness, and interest rates. This commentary is not a recommendation to buy or sell a specific security. All references to tax-free income refer to U.S. federal income tax. Income earned by certain investors may be subject to the Alternative Minimum Tax (AMT), and or taxation by state and local authorities. Please consult with your tax professional prior to investing. For more information on these topics please click on the “Bond Basics” link below or search by keyword at the top of this page.