Buying Bonds in Your Value Investing Portfolio

Buying bonds is not a strategy Benjamin Graham is well known for, but he was definitely a proponent.

In his book, The Intelligent Investor, Graham advised investors to always hold bonds in their investment portfolios. His recommendation is clear: “We recommend that the investor divide his holdings between high-grade bonds and leading common stocks; that the proportion held in bonds be never less than 25% or more than 75% with the converse being necessarily true for the common-stock component.”

We believe Benjamin Graham’s bond/stock allocation is the best approach to follow, regardless of the type of market we face.

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(1) When the stock market is low and undervalued, hold 25% bonds and 75% stocks.

(2) When the stock market is high and overvalued, hold 75% bonds and 25% stocks. When the stock market begins to go from being undervalued to overvalued, gradually reduce your stock portion, and fill the void by buying bonds or bond ETFs.

How do we determine when the stock market is undervalued or overvalued? Benjamin Graham detailed methods to estimate the current value of stocks. We apply Mr. Graham’s methods to determine the current value of the 30 stocks that make up the Dow Jones Industrial Average. The value investing methodology is based upon the 10-year financial history of each company, including the P/BV and P/E ratios.

In 1987, I attended an investment conference and heard Andrew Tobias speak. Tobias is the author of The Only Investment Guide You’ll Ever Need and many other books. He advised investors to lighten common stock holdings when the stock market is making new highs (buying bonds instead), and invest more heavily when the stock market is making new lows. Sell when the market is high and buy when the market is low is certainly good advice. However, not all of us have as good a “feel” for the stock market as does Andrew Tobias.

Tobias’ simple advice for value investors is easier to follow than the Benjamin Graham current valuation approach, but may be too vague or simplistic to provide the best results. In Cabot Benjamin Graham Value Investor, we publish the current value estimate range for the Dow Jones Industrial Average every month for our readers. We do the calculations; our readers follow our numbers and advice. Whichever approach or method you choose, Graham or Tobias, stick with it, and you will prosper.

*This post originally ran on November 3, 2016 and is updated periodically.

Timothy Lutts

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