Archive | April, 2017

Bond Basics 2: Why Your ETF Isn’t Losing Money

In my latest podcast, I answer a series of frequently asked questions about bonds. The second of these came from a reader named Andrew: “I have been investing using your Couch Potato strategy for just over three years now,” he wrote. “However, does it still make sense to invest in bonds when they are continually losing money?”

As it happens, bond ETFs have not been “continually losing money” at all. Indeed, over the three years ending March 31, broad-based funds such as the BMO Aggregate Bond Index ETF (ZAG) and the Vanguard Canadian Aggregate Bond Index ETF (VAB) returned close to 4% annually, with positive returns in each calendar year. A $1,000 investment in either ETF would have grown to about $1,120 over that period. So why would an investor think he had lost money?

I don’t blame Andrew for being confused, as this one trips up a lot of investors. The problem lies in the way brokerages display the holdings in your account. Rather than calculating the total return on your investments—which would include both price changes and all interest payments and dividends—your list of holdings reflects only the change in market price.

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Podcast 7: Making Sense of Bonds

I’ve always felt that being a defenseman is the toughest job on a hockey team. Forwards score most of the goals, and goalies can steal the show with a few timely saves, but fans rarely notice a defenseman until he makes a mistake. Bonds get that same lack of respect from investors: everyone seems to forget the times they provided a safety net when stocks plummeted, but if they lose a few percentage points they get kicked to the curb.

Part of the problem is that bonds can be difficult to understand. So in my latest podcast, I devote the full episode to answering common questions about the asset class investors love to hate.

I previewed this episode in my last post about why bond prices fall when rates rise, and I’ll continue with a series of blog posts that expand on some of the other issues discussed in the podcast:

If you started investing in bond ETFs about three years ago, chances are good that your holding is showing a loss on your brokerage statement. So you might be surprised to learn that broad-based bond index funds returned close to 4% annually over the three years ending March 31.

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Bond Basics 1: Why Bond Prices Fall When Rates Rise

Bonds have a reputation for being conservative, even boring. But no one ever accused them of being easy to understand. I get a steady stream of emails and blog comments about bonds, and they reveal that many investors are very confused by how bond ETFs work, how they’re affected by changes in interest rates, whether investors can use alternatives to bonds, and even whether it’s OK to abandon them altogether. So my next podcast (which goes live on April 19) is devoted to answering common questions about bonds, with the hope of clearing up some of this confusion. As a companion to the podcast, I’ve also created a short series of blog posts addressing the same questions.

In this first installment, let’s dig into one of the most fundamental concepts for bond investors to understand: the inverse relationship between bond prices and interest rates: when one goes up, the other goes down. This is confusing for many people—after all, investors regularly complain that bond yields are low, so shouldn’t higher interest rates be a good thing? And why are we told to stay away from bonds because yields might rise? You never hear people say you should avoid stocks because their dividends might get higher.

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Can ETFs Make the Market Go Up in Smoke?

[Note: This was an April Fool’s joke!]

Does the growing popularity of indexing and ETFs pose a real danger to the markets? As I discussed on a recent podcast, some market experts are concerned that the swelling ranks of index investors is creating a bubble. I used to brush off these concerns as the paranoid ramblings of money managers who are losing billions in assets as investors discover they add no value. But I’m starting to wonder if it might be true. After all, there are lots of articles on the Internet that say so.

A recent piece in the Globe and Mail, for example, featured billionaire hedge fund manager Seth Klarman, who worries that the growth of indexing is making markets less efficient: “The inherent irony of the efficient market theory is that the more people believe in it and correspondingly shun active management, the more inefficient the market is likely to become.”

I appreciate that index investors want to get broad diversification at the lowest possible cost, and that they’re attracted to a strategy that has the weight of academic evidence behind it.

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