Posted by kdadmin on June 26th, 2014.
Let’s talk about speeding. You’re much more apt to speed on a deserted highway in the middle of nowhere than you are to speed through a school zone. Both are risky, one is just not worth the reward.
Choosing bond investments is the same. There is a balance between the risk of loss and the reward of gain. The trick is know when a school zone in approaching. Now, consider your natural tendency in this situation, and look at the following picture …
The shaded area represents TLT (a 20 year treasury bond fund), the green line represents JNK (a high yield bond fund). Generally speaking, high yield bonds have the tendency to outperform 20 year treasuries but carry an increased risk of default.
In January, JNK was doing far better than TLT and therefore worth the increased risk. Owning it was like speeding on a deserted highway.
However, as time when on, the trend line showed that the spread (difference between the performances of JNK and TLT) was dropping. The trend line is akin to a warning sign saying, “School Zone Up Ahead.”
Finally, in early June, when TLT finally outperformed JNK, we had actually entered the school zone and it was time to sell JNK.
Investing is like driving. You never know when a school zone is approaching unless you pay attention and can read the signs.