By Daniel A. Barnes, CFA

Stocks

Stocks are speculations. The safest stocks are, however, very safe speculations. A stock is a speculation because when you own a stock you have no claim to income from that investment, nor a do you have a claim to a return of your principal. As a stockholder, you are a minority owner in a company. It is your hope that the company will prosper, becoming more valuable over time, which will ensure that someone else would be willing to pay as much or more for what you paid for this piece of ownership. This is quite unlike a bond, which is a financial obligation on the part of a company to pay back the amount of the loan (bond).

Yet no one would invest in companies if there wasn’t a prospect of the return of capital — a return on capital which exceed the risks being taken.

When I buy stocks for clients, I buy the least speculative stocks. Most of our portfolio companies have a record of paying a dividend for at least ten years. Furthermore, most of them have increased the size of their dividend every year. When a company increases the size of its dividend every year, it is demonstrating that its business is out of the ordinary. Additionally, the increase in the dividend payouts over time increase the value of the stock.

Bonds

At Barnes Capital, we prefer to purchase individual bonds, as opposed to bond funds, for most investors’ accounts. The two inherent qualities of fixedincome investments — a guaranteed coupon (interest rate), and the return of principal upon maturity — are absent when a client invests in a bond fund. A bond fund has neither a fixed yield, nor a contractual obligation to return their principal to. Furthermore, bond funds have no maturity date. The average maturity and, therefore, risk profile of a bond fund is constantly changing at the whim of fund managers, who frequently trade their positions.

Bond funds aren’t efficient either. Bond managers cannot avoid harvesting losses in periods of rising interest rates. They inevitably trade a certain portion of their portfolio for a variety of reasons, many of which are beyond their control, such as share redemptions from fund shareholders. As such, bond fund managers are forced to liquidate their bonds in frequently
unpleasant market conditions.

At Barnes Capital we prefer to invest client assets in individual bonds because we know exactly what we are buying on your behalf, and when you will be paid your interest and when you will receive your principal back.

The Bottom Line

Stocks are speculations, so in the wealth preservation game, it only pays to buy the “safest” speculations. Bonds are contractual obligations, and investors can sleep well at night, knowing that unless Armageddon occurs, they will get a return on their money — and the return of their money.

New Address

Barnes Capital’s new Address is 985 Moraga Road, Ste 205, above Mangia’s in La Fiesta Square. Call for an appointment for a complimentary assessment of your current investment portfolios.

Barnes Capital is a Registered Investment Advisor located at in downtown Lafayette. With RB Capital Management, Barnes Capital develops custom tailored portfolios for its clients. Specialized in retirement income portfolios, financial planning in an integral part of our process. Call 925-284-3503.

This entry was posted on Tuesday, September 1st, 2009 at 8:19 pm and is filed under Monthly Column. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.