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Now that we’re well past the first anniversary of Black Monday, many investors are taking a fresh look at their portfolios. Many who had invested heavily in quality stocks saw their unrealized capital gains quickly erode in a single day. By January 1988 the Dow Jones Industrial Average (DJIA) had recovered about
bond at the time of sale.)
Long-term bonds, particularly zero- coupon bonds, would be even more appropriate for an Individual Retirement Account (IRA), since there would be no tax consequences for the capital gains. Zero-coupon bonds allow the investor to know the precise value of an initial inin a leveraged investment that will reahze a greater capital gain and total return than a comparable coupon bond. Using Tab e 2, for example, we can see that a 30-year zero-coupon bond with a yield-to-matu- rity of 9% would result in an approximate capital gain (and total return) of 105% 1 sold two years later when the termina
Terminal Yield | Table 1 Capital Gain (Loss) | Total Return |
11.50% | (16.8%) | (1.88%) |
11.00% | (13.1%) | 0.68% |
10.50% | (9.1%) | 4.59% |
10.00% | (4.7%) | 8.99% |
9.50% | — | 13.69% |
9.00% | 5.2% | 18.89% |
8.50% | 10.8% | 24.49% |
8.00% | 17.0% | 30.69% |
7.50% | 23.9% | 37.59% |
7.00% | 31.3% | 44.99% |
Answers to the quiz in December’s “Money Matters”
60% of its Black Monday loss. Some investors then sold a majority of their stock holdings and converted the proceeds to short-term (6- and 12-month) certificates of deposit (CDs). Still nervous about the stock market and the economy, they continue to opt for the short-term when reinvesting as their CDs mature.
In view of the projected drop in interest rates over the next year or two, longer- term investments, even long-term Treasury bonds, may be more appropriate. This investment strategy will allow you, the investor, to take advantage of the expected decline in interest rates, both to lock in yield levels that represent excellent long-term value and to capture capital gain. (See the January 1988 “Money Matters” column for more about interest rate risk.) Using Table 1, we can see the approximate capital gain (or loss) and total return one would realize (theoretically) over an 18-month period on a 30- year Treasury bond yielding 91/2%. (The terminal yield is the current yield of the vestment in a given number of years at maturity. Because zero-coupon bonds, which provide no current income, are bought at a substantial discount to their maturity value (generally, the longer the maturity, the greater the discount), the investor can purchase a large face amount of principal with a relatively small capital investment. This discount feature results
► The mutual fund manager was Gerald Tsai, a stock-picking wunderkind of the 1960s. When he left the Fidelity Group to start the Manhattan Fund in February 1966, the DJIA was nearly 1,000 and the Manhattan Fund was capitalized to nearly $250 million by eager investors who wanted to get on the Tsai bandwagon. Six months later, the DJIA was at 735 and over the next 15 years the Manhattan Fund was among the worst-performing large mutual funds. Tsai left the fund in 1973.
► Success stories for investor newsletters are prevalent during strong bull markets. When you see these and other suggestions that there is no way but up for the market, it usually is a sign that the top is near.
yield is 7%. By investing in long-term, high-quality bonds, there is a strong P0' tential for high total return in a declining interest rate environment.
In my next “Money Matters” column. I will begin a discussion of ways to mini' mize your tax bill and maximize your tax return.
► The boom in oil stocks in the late 1970s and early 1980s was largely due to the decision by the Organc zation of Petroleum Exporting Countries (OPEC) t° double the price of oil, along with some major oil finds. However, after consumers learned to cope with lower temperatures in winter and smaller, more-effi' cient automobiles, oil stock prices dropped and one year later the $12 million investment shrank by 75%-
► Mutual funds tend to increase rapidly in net asset value at the top of a bull market. Naturally, investors don’t want to be left out so they jump in at the top- This influx of additional money may force the fund manager to put the money to work, regardless of the near-term prospects.
140
Proceedings / January 1989