When buying bonds, buy quality

You get what you pay for. This is no different in the bond market. The higher rates offered by junk bonds are attractive, but come at the cost of an increased chance of defaults. This can be devastating if an investor only holds one large bond and it fails. It is more common to see bond investment in the form of a mutual or index fund. The funds can be anywhere on the spectrum of high or junk grade bonds.

To assign risk to bonds, rating companies will assign credit classes to bonds. AAA is the highest and best rating. This rating is attached to bonds with virtually no chance of failing. Next comes AA,A,BBB,BB,B, and lastly CCC and below.

FPO’s bonds records indicate historic default rates for various bond ratings. This was for the period 2002-2004.

AAA faired the best with 0.5% defaulting in that period. Next was AA with 1.3%, A with 2.3%, BBB with 6.6%.

Speculative class bonds is where things fall apart with BB rated issues defaulting 19.5% of the time, B defaulting 35.8%, and the junk bonds (CCC rating) defaulting 54.4% during this period.

2002 was a particularily bad year for stocks, and that does affect bond performance. There is a clear division point between BBB and BB rated bonds. This shown in how a corporate bond fund might be put together. A good bond fund manager will select a bond portfolio that it well balanced to offer a great risk-reward combo.

Vanguard’s intermediate term investment grade bond fund (VFICX) offers a blend of quality corporate bonds. Here is the current breakdown expressed in the percent of assets held in each bond credit rating category:

Aaa 16.7%
Aa1 4.4%
Aa2 5.2%
Aa3 8.8%
A1 8.6%
A2 18.2%
A3 14.0%
Baa1 8.5%
Baa2 7.9%
Baa3 4.0%
Ba1 0.9%
Ba2 0.0%
Ba3 0.0%


This rating breakdown uses Moody’s rating system. It is quite similar to the S&P rating system introduced above.

Notice that the weighting forms what looks very close to a bell curve. Nothing is below Ba1. The A2 rating serves at the central weighting point. It is this point where the best value can be had. The slight increase in expected defaults is more than made up for by the current yield.

S&P 500 above 1400 in February 2013

Hello FPO readers,

FPO has been analyzing whether or not the S&P 500 will be above 1400 this upcoming February.  At this point, Financial Place Online has determined that it is best to keep with a long position in the S&P 500.  Despite some slowdown in big players like Apple, market sentiment appears to be high; at least higher than usual.  In addition, the anticipated settlement in the political front and the policy ease will keep the S&P 500 at above 1400 levels. The fools club stocks (worth looking up) and NASDAQ  are also expected to gain and perform well this upcoming year based on the 100 year old data and history.  A favorite resource for gaining a “chartist’s” perspective on this is http://www.forecast-chart.com/index-sp-500.html.  Keep in mind that chartology should not be the sole determinant of one’s investing theory.  It is recommended to apply it as a weighted factor along with many others, including at the time risk tolerance, and the volatility index.


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