19,99 €
Updated edition of the established classic on investing in bonds In Bonds: The Unbeaten Path to Secure Investment Growth, Second Edition, the fully revised and updated edition of the classic guide to demystifying the bonds market, veteran investor husband and wife team Hildy and Stan Richelson expose the myth of stocks' superior investment returns and propose an all-bond portfolio as a sure-footed strategy that will ensure positive returns. Designed to educate novice and sophisticated investors alike, as well as to serve as a tool for financial advisers, the book explains why and when bonds can be the right choice. Case studies, detailed bond strategies, and a financial planning overview bring home the value of bonds in achieving financial goals. Presenting a broad spectrum of bond-investment options, and describing how to purchase bonds at the best prices, the book shows how to make real money by investing in bonds. The strategies presented here are designed to help the reader determine how to use bonds to take control of their own financial destiny. * New edition includes information on corporate bonds, emerging market bonds, municipal bonds, the new global ratings, and how to protect against municipal defaults * Looks at how bond portfolios protected against market volatility in the 2007-2008 crash and how they can do the same in the future * Includes information on how the bond market has changed * The wealthiest investors and financial advisers use the bond strategies outlined in this book to maximize the return on their portfolios while providing security of principal With more bond options available than ever before, Bonds continues to be a must-have for anyone looking to understand the investment opportunities available to them.
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Contents
Foreword
Preface
Acknowledgments
Introduction
Part I: Clearing the Cobwebs
Chapter 1: Bonds
Examining the Myths
A Second Look at Risks and Returns
Stock Market Volatility: The Impact on Retirement Planning
Why Bonds Are a Better Investment than Stocks
Individual and Institutional Investors: How They Differ
Key Questions to Ask about Whether You Should Invest in Stocks rather than Bonds
Notes
Chapter 2: The All-Bond Portfolio
Advantages of the All-Bond Portfolio
Designing the All-Bond Portfolio
A Word about Other Bonds
The All-Bond Antidote to Greed and Fear
Notes
Chapter 3: Adopting the All-Bond Portfolio
A Poor-Fitting Portfolio
A Consultation with Stan Richelson
A Financial Plan Aligned with Objectives
Note
Part II: Bond Basics
Chapter 4: The Evolution of a Bond
Learning the Language
The Early Years
A Colonial Debut
After the American Revolution
Entering the Twentieth Century
Changes in the Twentieth Century
A Modern Metamorphosis
Great Recession of 2007–2009
The Internet’s Impact on Bond Buying
Notes
Chapter 5: The Life of a Bond
By Way of Background
Preparing a Bond Issue
Understanding Risk
A Bond’s Cost and Yield
Total Return
Cash Flow upon Death: The Estate Feature
Mind Mr. Market
Key Questions to Ask When Purchasing a Bond
Notes
Part III: Bond Categories
Chapter 6: U.S. Treasury Securities
The Big Picture
U.S. Treasury Notes and Bonds
U.S. Treasury Bills
STRIPS
TIPS
Key Questions to Ask about All Treasury Securities
Notes
Chapter 7: U.S. Savings Bonds
Simple Investments with a Few Complexities
Series EE Savings Bonds
Series HH Savings Bonds
Series I Savings Bonds
Key Questions to Ask about Savings Bonds
Chapter 8: U.S. Agency Debt
Major Debt-Issuing Agencies
Key Questions to Ask about Agency Bonds
Notes
Chapter 9: U.S. Agency Mortgage-Backed Securities and Collateralized Mortgage Obligations
Mortgage Securities Guaranteed by the Agencies (Agency MBSs)
MBSs: A Complex Structure
The Agencies
Agency Mortgage-Backed Securities
Key Questions to Ask about Mortgage-Backed Securities
Collateralized Mortgage Obligations
Key Questions to Ask about CMOs
Chapter 10: Municipal Bonds
Why Buy Munis?
Munis: The Opaque Market
Default Risk Considered
Risks in Common Bring about Change
Ratings and Municipal Bond Insurance
Purchasing New Issue Municipal Bonds
Prerefunded and Escrowed Bonds
Protect Your Muni Bond Portfolio?
Taxes on Municipal Bonds
Key Questions to Ask about Muni Bonds
Notes
Chapter 11: Municipal Bonds
Tax-Exempt or Taxable Bonds? How to Decide
Taxable Municipal Bonds
Private Activity Bonds
Tax-Exempt Municipal Bonds
Checking Prices on Municipal Bonds
Key Questions to Ask about Types of Municipal Bonds
Notes
Chapter 12: U.S. Corporate Bonds
The Big Picture
Key Categories of Corporate Bonds
Corporate Medium-Term Notes
Corporate Retail Notes
Step-Up Bonds, Notes, and Debentures
Corporate High-Yield Junk Bonds
Corporate Convertible Bonds
Price-Checking Corporate Bonds
Key Questions to Ask about Corporate Bonds
Notes
Chapter 13: International Bond Markets
Definition of Terms
Trading Blocs
Foreign Bonds
Key Questions to Ask about International Bonds
Notes
Chapter 14: Bond Look-Alikes
Certificates of Deposit
Key Questions to Ask about Certificates of Deposit
Single-Premium Immediate Fixed Annuities
Key Questions to Ask about an Immediate Fixed Annuity
Deferred Fixed Annuities
Key Questions to Ask about a Fixed Deferred Annuity
Nonconvertible Fixed Rate Preferred Stock
Key Questions to Ask about Preferred Stock
Dividend-Paying Common Stock
Key Questions to Ask about Common Stock
Notes
Part IV: Options for Purchasing Bonds
Chapter 15: How to Buy Individual Bonds
Buying Online
Pricing Information
Key Questions to Ask about Buying Bonds Online
Choosing a Broker
Evaluating Bond Prices
Key Questions at the Point of Purchase
Notes
Chapter 16: Bond Funds
Common Ground
Checking the Costs: Hidden and Unhidden
Fund Categories
Key Questions to Ask about Types of Bond Funds
Notes
Chapter 17: Bond Funds
Money Market Mutual Funds: Taxable and Tax-Exempt
Municipal Bond Funds: Tax-Exempt
Taxable Funds
Municipal Bonds Funds: Taxable
Corporate Bond Funds
Government Bond Funds
Strategic or Multisector Bond Funds
Key Questions to Ask About Choosing a Bond Mutual Fund or ETF
Notes
Chapter 18: Choosing a Bond Mutual Fund or ETF
Bond Fund Fees
Understanding Yield
The Search Begins
Key Questions to Ask When Exploring Bond Fund and ETF Search Engines
Notes
Part V: Bond Investment Strategies and Richelson Investment Rules
Chapter 19: Financial Planning Framework for Bond Investing
Create Cash Flow with Bonds
The Basics of Creating Your Financial Plan: The Four-Step Financial Planning Process
Reevaluating Your Portfolio
Key Questions to Ask about Financial Planning with Bonds
Chapter 20: Financial Planning with Bonds
Baby Boomers Design a New Financial Plan
You Are Rich! Why Are You Worried?
Changing Course
Meeting a Need for Safety
An Unanticipated Transition
Ownership of Stock in a Private Company
Stock Options Pay Off Big
Planning for College Expenses
Invest a Large Amount of Cash at One Time
Socially Responsible Investing
Summary of Key Takeaway Points
Notes
Chapter 21: How to Make the Most Money from Bonds
Knowing When to Buy and Sell
Strategies for Deciding When to Sell
Strategies for Finding Bargain Bonds
Strategies for Avoiding Overvalued Bonds
Strategies for When Interest Rates Are High or Rising
Strategies for When Interest Rates Are Low or Falling
Investing for the Highest After-Tax Yield
Investing and Risk Tolerance
Strategies for Safe Investing
Investing for Income Needs and Financial Goals
If You Are Starting out with Less than $25,000 to Invest
Obstacles to Committing to an All-Bond Portfolio
Notes
Appendix: Useful Web Sites
About the Authors
Index
More Praise for Bonds, second edition
“There’s no such thing as risk-free investing, but Bonds, second edition, gives investors practical advice on ways to minimize risk while growing their assets.”
—Bill D’Alonzo, Chief Executive Officer of Friess, Associates, manager of the Brandywine, Funds family of growth-stock mutual funds
“Over the past decade, the “truth” that investment in equities is a sound, and perhaps the surest path, to long term portfolio success has been severely tested. The Richelsons make a persuasive case for taking a path less travelled—that of investing in individual bonds. With historical examples comparing the stock and bond markets, risk-reward analyses, and exploring of the “magic” of compounding, the book is, at a minimum, a fascinating read that for many will be a blue-print for a revolutionary new portfolio design.”
—Victor Keen, Of Counsel, Duane Morris LLP
“Hildy and Stan have written the ‘Everything You Always Wanted to Know About Bonds But Were Afraid to Ask’ book. This book provides clear and concise insights into bond investing.”
—Alan Schapire, CFP®, CPA/PFS, Principal, Libra Financial Planning
“Stocks are always risky, no matter the long-run. Bonds should always have a place in investment portfolios. Stan and Hildy have been saying this correctly for years. Bonds: The Unbeaten Path to Secure Investment Growth, now in its second edition, is one of the best in-depth reviews of wisely navigating the bond markets and how to practically implement thoughtful strategies for financial advisors and advisor-clients alike. Fellow colleagues, this is a must read.”
—Michael Dubis, CFP®, President, Michael A. Dubis, Financial Planning; Adjunct Lecturer, University of Wisconsin Graaskamp Center for Real Estate; past NAPFA National Conference Chair
“Bonds still aren’t part of the nation’s financial culture, years after this book’s first edition and through the stock market’s ups and downs. Don’t blame the Richelsons. Better yet, leaf through their book for a detailed examination of the only investment where income is king.”
—Joe Mysak, editor of Bloomberg Brief’s daily Municipal Market
“Bonds, Second Edition explains the reality of today’s complex world of investing. It shows how bonds can be more predictable and more profitable for somebody’s financial future. The Richelsons take the facts of investing and they explain how to make it safe. What could be better than that?”
—Paul H. Frankel, Partner, Morrison & Foerster
“The Richelsons have advocated the virtue of bonds long before they became in vogue when the stock market tsunami hit every American in 2008/2009. The second edition of their book about bonds is a must read for anyone who hasn’t invested in bonds because they don’t understand them, or, who wants to understand what they already own. Stan and Hildy’s passion for bond investing is contagious.”
—Kent R. Addis, Jr., President, Addis & Hill, Inc.
“With every conceivable bond topic discussed in plain English, this book is the most useful and practical guide to bond investing. If you’re looking for the “how to” and “why” of prudent bond investing, this book is for you. In thoughtful reflection, the 2nd Edition will enhance your understanding of the 2009 credit crisis, and will help you steer clear of bond investing mistakes.”
—Jeffery B. Broadhurst, MBA, CFA, CFP, President of Broadhurst Financial Advisors, Inc.
“Finally an up-to-date practical book on fixed income vehicles as well as strategy in using them. A must-have resource for all levels of investors as well as advisors interested in growing their assets as securely as possible. Readers will truly benefit from Hildy and Stan Richelson’s independent thinking and experience on effectively using this major asset class.”
—Harry Scheyer, CPA/PFS, CFP, Pinnacle, Financial Advisors
“A great insight on understanding bond portfolios. It is an area of investing that is often overlooked and not understood.”
—Fred Amrein, Founder & Principal, Amrein Financial
Since 1996, Bloomberg Press has published books for financial professionals, as well as books of general interest in investing, economics, current affairs, and policy affecting investors and business people. Titles are written by well-known practitioners, BLOOMBERG NEWS® reporters and columnists, and other leading authorities and journalists. Bloomberg Press books have been translated into more than 20 languages.
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Copyright © 2011 by Hildy Richelson and Stan Richelson. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
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Library of Congress Cataloging-in-Publication Data:
Richelson, Hildy.
Bonds : the unbeaten path to secure investment growth / Hildy Richelson and Stan Richelson. —- 2nd ed.
p. cm.
Includes index.
ISBN 978-1-118-00446-3 (hardback); 978-1-118-10654-9 (ebk.); 978-1-118-10655-6 (ebk.); 978-1-118-10656-3 (ebk.)
1. Bonds. I. Richelson, Stan. II. Title.
HG4651.R528 2011
332.63’23—dc22
2011010980
To the youngest members of our family, Maya and Emily Carpenter, and to our newest family member, Kate Williams, who have expanded the possibilities for our future.
Foreword
When Rob Arnott revealed in 2009 that bonds had outperformed stocks over the preceding 40 years, most people were shocked. Arnott, founder and chairman of the California money manager Research Affiliates, showed that an investor buying a constant-maturity, 20-year bond in 1968 enjoyed a higher total return than he would from an S&P 500 portfolio.
Stan and Hildy Richelson, though, were not in the least surprised. For the last 25 years, they have steadfastly advocated the all-bond portfolio, arguing, among other things, that bonds offer better risk-adjusted returns than stocks.
History proved them right.
This second edition of their book contains substantial new material, including a history of bonds, a chapter devoted to financial planning with bonds, and numerous case studies that explain the powerful role bonds can play in your investment strategy. The Richelsons show how these concepts can be employed in their hallmark All-Bond Portfolio.
Today, many fear that the bull market in bonds has run its course, that interest rates will rise and the history of the last 40 years will reverse itself. Municipal bond mutual funds, for example, suffered record outflows at the end of 2010 and the first quarter of 2011. Inflation is inevitable, the herd contends, and bonds will be the victims.
There is no crystal ball through which we can see into the future. Our economy may face inflation down the road, but the timing is highly uncertain. More likely, we will experience a period of slow growth and high unemployment—what the global bond manager PIMCO has called the “new normal”—because of continued deleveraging in the private and public sectors. Inflation has historically correlated highly with wage growth, and without strong and consistent economic expansion that creates jobs, deflation will be more likely than inflation.
The capital markets concur with this forecast. The break-even inflation rate over the next 30 years (the yield on fixed-rate 30-year bonds minus that of 30-year Treasury Inflation Protected Bonds, known as TIPS) is 2.6 percent—below the average inflation rate of 3 percent during the last century.
Deflation, or even moderate inflation, will be a boon to bond investors.
As the Richelsons explain in the pages that follow, even if inflation were to unfold, it is not the all-powerful menace that many bond investors fear. By constructing a portfolio of laddered fixed-rate bonds and reinvesting coupons at progressively higher interest rates, investors can insulate themselves from adverse interest rate movements. If they have a bond ladder in place before inflation begins, higher interest rates will be the investors’ upside case. Moreover, the yield-to-maturity calculation assumes that you will reinvest the interest payments at the same rate. Insofar as you can reinvest them at a higher rate, you will have a higher overall return.
If you truly fear inflation, TIPS provide a near-perfect hedge. Individual TIPS bonds offer real (after-inflation) interest income that precisely matches the government’s reported consumer price index (CPI). Only to the extent that the reported CPI does not match one’s individual inflation profile are TIPS an imperfect hedge.
A laddered portfolio and individual TIPS are examples of an important theme the Richelsons present in this book: The advantage of individual bonds over bond funds. Retirement portfolios are constructed to match assets with liabilities. Those liabilities consist of living expenses, tuition payments, health care costs, planned bequests, and other items; some we can forecast, and some we can’t. Funding those liabilities with individual bonds assures investors of highly predictable cash flows timed to meet their obligations.
Bond funds, by contrast, typically have a constant maturity that does not adjust to an investor’s dynamic liability profile. Moreover, fund investors must pay management expenses, which for active portfolios may comprise a large percentage of bond fund yields. Add to that the tax inefficiencies arising from portfolio turnover, and the Richelsons argument for individual bonds is eminently compelling.
The central question facing all retirement investors is how much money they need to retire. I am honored that the Richelsons have chosen to present research that I have conducted in the field of safe withdrawal rates (SWRs), an area of study that offers important insight into this problem. Previously, virtually all research on SWRs used an equity-centric portfolio, relying on the hoped-for good fortunes of the stock market to provide sufficient returns to fund one’s retirement. The risks of this approach were made painfully clear in 2000 and 2008, as retirees with equity-centric portfolios were forced to make major lifestyle sacrifices in the wake of market collapses.
As the Richelsons illustrate, a safer approach is to construct a de-accumulation portfolio of high-quality bonds that include TIPS and municipal bonds, which, depending on market conditions, offers SWRs of 4 to 5 percent with far less downside risk than the equity-centric approach.
Zvi Bodie, a finance professor at Boston University, has encapsulated the essence of retirement investment in a succinct and profound statement: One’s goal should be not to burden one’s children. Spend your life giving your children the education and love they need to live independently, and don’t saddle them with the burden of taking care of you in your old age.
But that is the risk that many take in an equity-based approach to retirement investing, whether in the accumulation or de-accumulation phase. Investing is about positioning a portfolio for the appropriate risk-adjusted return. Too many retirement investors focus on return and ignore risk. Stan and Hildy’s important book will help the investment world understand that bonds should play a central role in retirement investing, and that bonds offer attractive returns with far less risk than stocks.
Here’s to the next 40 years proving as profitable for bond investors as the last 40. If they come anywhere close, this book will be your guide to a safe and comfortable retirement.
Robert Huebscher
Preface
The first edition of Bonds: The Unbeaten Path to Secure Investment Growth (2007) took the untraditional stand that high-quality bonds are a better investment than stocks for individual investors. We supported our thesis by concluding that stocks historically didn’t outperform bonds when an individual investor’s taxes, transaction fees, expenses, and bad timing are all taken into consideration.
Furthermore, we put forth the heresy that asset allocation to multiple asset classes is not required for investment success. Instead, we proposed the wisdom and logic of the All-Bond Portfolio as the safest and surest way to investment success. We concluded that allocating your assets in the traditional way to many asset classes would actually increase your investment risk rather than decrease it, when compared to the strategy of the All-Bond Portfolio.
The wisdom and logic of the All-Bond Portfolio was certified as correct by the dot-com Crash of 2000 to 2003 and, five years later, by the epic Crash of 2008 that shook the investing world. In the Crash of 2008, all asset classes went down together—all, that is, except high-quality individual bonds. Stocks declined by almost 57 percent peak to trough. Looking back on the decade of 2000 to 2009, during which U.S. large company stocks returned an average of −0.95 percent,1 it is clear that bonds have been a better investment no matter how you evaluate the facts or measure performance.
The stock market roller-coaster ride from 2000 to 2009 resulted in much sound and fury but no net gain (apologies to Shakespeare). Despite this decade producing no stock market gain, there were the added indignities of taxes and fees to be paid, which further reduced performance. In addition, many investors sustained substantial losses due to trading in and out of the stock market at inappropriate times. Our view that the asset classes of stocks and bonds must be risk adjusted as part of every investor’s analysis was demonstrated in spades.
In the Introduction to the first edition in 2007, we made the following predictions for the future:
High-quality bonds can free investors from the fear of investing.High-quality tax exempt bonds will protect your principal and generate substantial after-tax income.High-quality bonds will provide as good or better returns than stocks without substantial volatility.High-quality bonds will provide growth through the magic of compound interest if the interest income is reinvested.All these predictions proved to be true in the years following 2007, but to a greater extent than anyone anticipated. Those who invested in high-quality individual bonds were saved from the fear and destruction of volatile markets. High-quality individual bonds proved to be safe and continued to provide all the income they promised and growth if the interest income were reinvested in additional bonds. High-quality bonds substantially outperformed stocks without substantial volatility.
A typical portfolio of high-quality individual tax-free bonds returned about 5 percent per year from 2000 to 2009. Thus, a bond portfolio of $100,000, compounding at 5 percent tax-free over a 10-year period, would be worth over $162,000 (a 62 percent appreciation after tax). Moreover, this 5 percent tax-free return would be equivalent to a 7.7 percent taxable return for an individual investor in the 35 percent marginal federal income tax bracket.
A Short History of the Causes of the Crash of 2008
There has been much written about the Crash of 2008 and the effects of the Great Recession that is still with us at the beginning of 2011. The Great Recession is the most serious global financial crisis since the Great Depression of the 1930s. Financial bubbles and panics have been with us throughout history. The most recent history of these financial crises over the last 800 years has been brilliantly researched and recorded by Carmen M. Reinhart and Kenneth S. Rogoff in their book This Time Its Different, Eight Centuries of Financial Folly (Princeton University Press, 2009).
During the 20-year period that comprises the 1980s and ’90s, declining inflation and declining interest rates stoked a massive stock market bubble, with the Dow Jones Industrial Average increasing from 825 on January 3, 1980, to 11,497 on December 31, 1999. The technology-led stock market bubble burst in March 2000, whereupon the large cap stock market index lost about half its value by early 2003. Technology stocks, as represented by the Nasdaq index, declined by 77.9 percent when the market bubble collapsed.
Although there was a massive real estate boom from 1996 to 2006, at the beginning of 2007, our public officials and business leaders believed that all was well, despite Federal Reserve Board chairman Alan Greenspan’s rhetorically asked question, “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”2 His perception that “irrational exuberance” could be a problem then was obscured by the commodities boom and the housing bubble of the 2000s. Investors during this period believed that it would be different this time: The United States was not in a bubble and was not headed for a crash. However, it was not different for the United States in 2008. The real estate bubble popped and was quickly followed by a market crash and the Great Recession.
Our public officials and business leaders believed for a number of reasons that this time was different because the United States was not like other countries that foundered financially:
The United States had the most innovative financial system ever devised and was supported by the most liquid capital markets that were wide and deep.The United States had the most reliable system of financial regulation and the strongest political system, monetary policy institutions, and policy makers.The increased worldwide financial integration of developed and emerging nations enabled countries such as the United States to increase its debt load. Creditor nations such as China needed a secure place to invest their surplus funds.3The immediate cause of the 2008 Crash was the U.S. subprime real estate crisis. That crisis, which began in the summer of 2007, soon morphed into a global financial crisis. Reinhart and Rogoff conclude that as usual the major players, pundits, and investors in the United States didn’t see a bubble forming in 2007. They believed that the U.S. boom in real estate between 1996 and 2006 would continue. They believed that “this time it was different”—there was no bubble and the boom would go on forever. Unfortunately, this time was not different. In 2008, the real estate bubble popped and set off a crash in all asset classes except for high-quality individual bonds. U.S. Treasury bonds actually went up in value.
In retrospect, a major cause of the Great Recession is clear. The U.S. real estate market from 1996 to 2006 increased by about 92 percent, more than three times the 27 percent real (after inflation) cumulative increase from 1890 to 1996!4 In 2005, at the height of the bubble, real housing prices soared by more than 12 percent (that was about six times the rate of increase in real per capita GDP for that year).5 By 2007, it was clear that something was wrong. Defaults on low-income housing mortgage loans made to subprime, generally low-income borrowers began to rise sharply. Many of these mortgage loans had low initial “teaser” rates and variable interest rates. When these low initial interest rates were reset at substantially higher rates the borrowers were unable to meet their obligations. When they could not sell their houses for at least the amount of the mortgage, they defaulted, and the subprime debacle resulted.
By August 2007, the financial markets began to seize up. However, it was not until 2008 that the stock market and other markets collapsed.
There were other causes of the 2008 crash in addition to the real estate bubble. The massive imbalance of U.S. trade with China and other countries resulted in a huge influx of cheap foreign capital that fueled the bubble. The United States was soaking up more than two out of three dollars that countries with trade surpluses were generating.6
In addition, deregulation of the U.S. financial markets had been going on for many years, setting the United States up for the crisis. The deregulation of the financial markets enabled financial movers and shakers, such as Goldman Sachs, Merrill Lynch, Bear Stearns, Lehman Brothers, and Citibank, to stoke their greed and maximize their profits through the use of massive borrowings. As their profits increased dramatically, they believed that their high returns were the result of innovation and financial genius, while underestimating the risks they were taking. They believed that their financial innovation allowed them to borrow 30 to 50 times their capital without risking the loss of their business. As we all know, Lehman went bankrupt and Bear Stearns and Merrill Lynch were acquired at the last minute before they went bust. Goldman Sachs and Citibank were rescued by the U.S. government.
Individuals were not without blame for the bubble and the crash as well. Financial engineering allowed individuals to leverage up by borrowing huge amounts on their homes and using them as ATM machines while also borrowing large amounts on their credit cards as well.
Almost every investor lost money in the Crash of 2008, when stock markets, real estate markets, and commodities markets around the world registered huge declines. All the so-called “smart money” participated in the declines including hedge funds, private equity, venture capital, pension funds, insurance companies, endowments, and sovereign wealth funds.
The Crash of 2008 reminded investors that high returns are always generated by taking on more risk, even if they could not see the risk for a period of time. From a peak on October 9, 2007, to the bottom in March 9, 2009, equities as measured by the S&P 500 declined by 56.78 percent, from 1,565.15 to 676.53.7 Additional causes of the stock market Crash of 2008 were the banking crisis of late 2008, excess leverage, counterparty risk, liquidity risk, prime, and broker risk.
The Crash of 2008 not only caused massive losses, but it also called into question much of the received knowledge concerning investment theory and practice:
The Crash of 2008 invalidated “the beliefs that markets are efficient, capitalism is naturally stable, and policymakers can control the economy . . . Many people were surprised to learn in 2008 that the world is not as safe as they had thought. They do not have someone looking after them to ensure that everything will be okay.”8The Endowment Model, used by Harvard, Yale, and many other institutions, of diversifying into illiquid equity and equity-like investments is being reexamined.The strategy of stocks for the long-run has been seriously called into question.The strategies represented by buy the dips, buy and hold, and dollar cost averaging are being reexamined as valid models for individual investors.9Steven Drobny, in his book The Invisible Hands, concludes that after the Crash of 2008:
[I]t is irresponsible to point to 2008 as a 100-year storm and carry on with business as usual. High equity allocations have bailed out long-biased investors for the past 30 years, an extraordinary period marked by a strong tail wind of declining interest rates and inflation (not to mention globalization, technological advances, and productivity growth). Arguably, with interest rates and inflation running close to zero, that trade [buying and holding mostly stocks] is over, pointing to a more challenging environment going forward.10
Many investment advisors are still quite bullish and fully invested in equities. However, many clients, whose money is at risk and who have lost a great deal of their capital from 2000 to 2010, are more circumspect today and are beginning to challenge the wisdom of such persistent long-term bullishness in the current environment.11 In other words, many investors won’t tolerate losing money any longer. In Bonds, Second Edition, we speak to these investors and provide the strategy of the All-Bond Portfolio as a way to preserve capital and receive positive returns year after year.
Enhancements to Bonds, Second Edition
In Bonds, Second Edition: The Unbeaten Path to Secure Investment Growth, we have added a great deal of new material and updated every chapter. The story of why we believe bonds are a better investment than stocks has been updated from the end of 2006 to the beginning of 2011. We summarize here some of the major enhancements of the second edition.
In Chapter 1, we have updated our discussion (from the end of 2006 to the end of 2010) of why we believe bonds are a better investment than stocks, reflecting the profound events that have transpired during this four-year period. We describe the historical shift beginning in 1950 from bonds to stocks and how investors are now reassessing the merits of stocks. We present additional data enhancing our argument that bonds have historically been a better investment than stocks. We present evidence that stocks have much higher volatility than bonds and argue that the strategy of buy-and-hold investing in stocks doesn’t work in our current volatile environment for individual investors. We conclude Chapter 1 with a description of how the Endowment Model of institutional investing in leveraged illiquid investments was called into question by the Crash of 2008 when university endowments lost between 20 and 40 percent of their portfolios.
Chapter 4, The Evolution of a Bond, describes how loans were standardized over time so that they could be easily bought and sold. Our current system is based on developments that occurred hundreds of years ago in Europe and brought to the United States by settlers. Technological and financial innovations have created a variety of types of bonds and derivatives, new methods of trading them, and regulations to control them. Basel III brings together the world’s nations to standardize international financial practices, including the trading of derivatives. In Chapter 5, The Life of a Bond, we provide the basics of bond buying. If you can digest this chapter, you are well on your way to understanding how bonds work. Like any sub-culture, the world of bonds has its own language that can enable you to feel comfortable in discussing a bond purchase. We describe the rating agencies and the impact of the financial meltdown on them, and how to use them. We show you how to think about the impact of taxes on your bond purchases.
Chapters 8 and 9, discussing government agency bonds and mortgaged backed securities, were substantially revised to take into account the insolvency and failure of Fannie Mae and Freddie Mac. These government sponsored entities were placed in conservatorship on September 6, 2008, and, as of the beginning of 2011, their fate is still uncertain.
The chapter on municipal bonds has been split into two chapters preceded by a brief introduction. Chapter 10, Municipal Bonds Overview, discusses the basic context of municipal bond investing. Chapter 11, Municipal Bonds: Types, contains information about how to invest in different kinds of municipal bonds.
The corporate bond chapter has also been divided into two chapters. Chapter 12 discusses U.S. corporate bonds and Chapter 13 discusses international bonds. Chapter 13 is a totally new chapter and explains the terminology, different ways to classify international bonds, and two kinds of bonds issued internationally but not in the United States, that is, covered bonds and sukuk. We also discuss different factors that can affect the profitability of such an investment in international bonds.
Chapter 15, How to Buy Individual Bonds: A Tool Kit, has been updated to reflect all the progress that regulatory bond organizations have made to enhance price and financial transparency. One addition to this chapter is an advertisement for a bond and an analysis of the thought process that an investor might go through in analyzing that offering.
Chapters 16, 17, and 18 all describe bond funds. Chapter 16, the first bond fund chapter, compares the different kind of investment vehicles you can use to purchase bonds. This chapter sports a new table at the end of Chapter 16 to help you compare and contrast individual bonds to an open-end bond mutual fund, a closed-end fund, a bond electronic-traded fund (ETF), and a unit investment trust. We then provide detailed notes to explain the table.
In Chapter 18, Choosing a Bond Fund, we added a section on buying strategies for bond funds and expanded the discussion of the concept of yield as it applies to funds.
Chapter 19, Investment Planning with Bonds, has been enhanced with an emphasis on the key ingredient and importance of cash flow in financial planning. We also explore the impact of inflation on financial planning. We have included a new discussion of the five levels of financial needs and life objectives to inform your thinking about your financial planning goals.
In Chapter 20, Financial Planning with Bonds: Case Studies, we have added five new case studies to the five case studies which we offered in the first edition. One new case study deals with baby boomers designing a new financial plan. A second is entitled “You Are Rich, Why Are You Worried?” A third deals with investing a large amount of cash at one time. We have added to each case study a summary of key points.
The last chapter, Chapter 21, deals with bond strategies. It has a new section based on a new study that concludes that a bond portfolio consisting of municipal bonds and Treasury inflation-protected securities (TIPS) can sustain a higher withdrawal rate for a retired investor than a balanced portfolio of stocks and bonds.
We have also sprinkled new charts and figures through the book to help the reader.
As recounted briefly here, the financial world has changed substantially since Bonds was first published in 2007. We are pleased to have the opportunity to present Bonds, Second Edition: The Unbeaten Path to Secure Investment Growth, so that we may describe to you an updated view of bonds in the world of investments. We hope that this book will change the way you view the world of investments.
Notes
1. Ibbotson SBBI 2010 Classic Yearbook (Chicago: Morningstar, 2010), 19.
2. Alan Greenspan, “The Challenge of Central Banking in a Democratic Society,” remarks by Chairman Alan Greenspan at the annual dinner and Francis Boyer Lecture of The American Enterprise Institute for Public Policy Research, Washington, D.C. (December 5, 1996).
3. Carmen M. Reinhart and Kenneth S. Rogoff, This Time is Different (Princeton, NJ: Princeton University Press), 214.
4. Ibid., 207.
5. Ibid.
6. Ibid., 210.
7. Ibbotson SBBI 2010 Classic Yearbook,13.
8. Steven Drobny, The Invisible Hands (New York: John Wiley & Sons, 2008), 140.
9. Ibid., xvi.
10. Ibid., 412.
11. Ibid., 356.
Acknowledgments
Bonds, second edition, has enabled us to clearly articulate our philosophy and deeply held beliefs about the importance and uses of high-quality bonds for both income and growth in the portfolios of individual investors.
We wish to thank our editors at John Wiley & Sons, Laura Walsh and Judy Howarth, for their understanding of the value of bonds and their help and encouragement in shaping and organizing this second edition. We also want to express our appreciation to the staff at Wiley for their expert and very professional help in producing this book. We want to express our gratitude to Robert Huebscher for writing the Foreword.
We particularly wish to thank and acknowledge the expert help of our associate and friend, Dr. Peter Blake, for his encouragement and energy in the writing and review of this second edition.
Evan B. Carpenter provided invaluable help in multiple reviews of Part I of the book, which focuses on the relationship of stocks and bonds.
We would like to express our deep appreciation to our friends in the Delaware Valley NAPFA Study Group and other NAPFA members who provided invaluable assistance in reviewing chapters and sharing their wisdom. We thank Kent R. Addis Jr. (“Chip”) of Addis & Hill Financial Advisors, Fred Amrein of Amrein Financial, Jeffrey B. Broadhurst of Broadhurst Financial, Michael A. Dubis of Dubis Financial Planning, Jeff Metz of Pinnacle Financial Advisors, Alan M. Schapire of Libra Financial Planning, and Harry Scheyer of Pinnacle, Financial Advisors.
Other financial professionals and experts who reviewed chapters of our book and shared their expert knowledge and critical thoughts include Thomas P. Caffrey, Bradford Currie, Tom Dannenberg, Dr. Sam Kirschner, Phillip Millman, Cynthia L. Parker, and Mark Socol.
Thanks also goes to U.S. Treasury personnel for their review of the Treasury Bonds and Saving Bonds chapters.
We wish to acknowledge our friends in the investment community who teach us daily about bonds: Jeffrey DiFrancesco, Matthew Duckworth, Robert Huebscher, Richard Kidd, J.P. Scanlon, and Robert E. Schaffer.
Special thanks go to our dear friends and family who have encouraged us and supported us throughout this project: Carole and Emilio Gravagno, Drs. Sam and Diana Kirschner, George Robinson, and Dr. Abby Van Voorhees. Thanks also goes to Judy and Milton Moskowitz who love and cherish us most of the time and to our parents, without whom this book would not have been possible. We are grateful to our daughter Jolie Carpenter and our son Scott Richelson, Esq., for their warmth and generosity of spirit.
We learn about investments and the real world every day from our friends and fellow investors who provide the real-life context to our study and work. By asking questions and sharing aspects of their lives with us, they have enhanced and sharpened our skills. For this, we wish to acknowledge and thank Katharine Ayers, Dean Bress, Esq., John Clements, Jerry and Lois Cooper, Christopher Doyle, Esq., Michael Druckman, Mark Dresnick, Esq., Ron and Holly Flaherty, Colleen Gordon, Ellen and Lucien Greif, Anusia and John Hirsch, Richard Illes, David Lihn, Drs. Gary and Elaine Liversidge, Robert Mandel, Esq., Michael C. and Neeru Phillips, Dr. Linda Ripstein, Neil Seidman, Esq., Edmund Spelman, Juliet Spitzer, Phil Wachs, Kevin West, Dr. Stanley Wulf, and Ivan Zuckerman.
We were inspired by the love and encouragement offered us by our association with the Souls Network: Don Arnoudse, Dr. Peter Blake, Rich Constantine, Vince DiBianca, Jeffrey DiFrancesco, Tony Freedley, Dr. Sam Kirschner, Anton T. Lahnston, Dave Laveman, Jim Selman, and Gary Taylor.
We also thank Mary Alice Cullinan, Dr. Donna Funk, and Micah Josephson who keep us strong in body, mind, and spirit.
Introduction
Bonds are a misunderstood investment. In Bonds, The Unbeaten Path to Secure Investment Growth, second edition, we intend to rectify that by clearing up long-held misconceptions about bonds. We also explain an unexplored investment strategy for individual investors, the All-Bond Portfolio, which enables investors to attain financial security while achieving a good return on their investment.
The bond market may at first seem complicated. However, its principles are straightforward and anyone can master them. This book provides you with the tools to understand and successfully invest in the bond market so that you can build and protect your capital and effectively realize your financial and life goals.
For individual investors, that understanding is vital. The world has changed drastically in the past 20 years. The financial markets crashed in 2008, and we are still recovering from the Great Recession. The economic safety net is now frayed. Unemployment peaked in 2010 and job security has sharply declined. Company-sponsored pension plans are becoming extinct, and many people rightfully worry about the health of the Social Security and Medicare systems. Given these concerns, we all must take responsibility for our own financial well-being.
If you want to take responsibility for your financial life, this book can be an indispensable guide to your decision making. Bonds, second edition, is designed to educate novice and sophisticated investors alike and serve as a tool for financial advisers as well. We explain why bonds can be the right choice for you and how to use bonds to achieve your financial goals. We also present a broad spectrum of bond investment options, describe how to purchase bonds at the best prices, and, most important, explain how to make money with bonds.
This book offers straightforward bond strategies that are used by the wealthiest investors and financial advisers to maximize the return on their bond portfolios while providing security of principal. These strategies can help you determine how to use bonds in your portfolio and investment program and take control of your own financial destiny. You’ll be playing it smart while playing it safe.
Investments in bonds have grown significantly since the beginning of the twenty-first century. Investors now understand that they can make money with bonds and that bonds are an essential part of every investment program. In fact, for the investor who is risk averse or who cannot afford to lose money, bonds are hugely important because basing a financial plan on stock appreciation has proved to be a very risky strategy.
A 2006 poll by the National Association of Variable Annuities found that many baby boomers were very concerned about retirement and the risks of stock investing:
A majority of Americans between the ages of 50 to 59 were concerned about having enough money to retire.64 percent said that they would not put more than 30 percent of their money into equities.32 percent would not put any money in stocks at all.Among younger boomers, ages 40 to 49, 53 percent would not put more than 30 percent of their money in stocks and 23 percent would put no money in stocks at all.1These numbers are probably a surprise to many investors because investors are told that investing the bulk of their money in stocks is the key to financial success. However, many stock investors may share the same feelings expressed by this middle-aged woman named Ruth: “I am frightened and panicked to the point of paralysis about making decisions about my money and about whether to stay in the stock market or get out because of the current volatility. My future depends on being right.”2
Investing in high-quality bonds can free investors from the fear of investing. They will protect your principal and generate substantial after-tax income without subjecting you to the substantial risk inherent in stocks. We believe that high-quality bonds will provide as good or better returns than stocks in the future after taxes, fees, and bad timing. Bonds will also provide growth through the magic of compound interest if you reinvest the income that bonds provide. Bonds, second edition, offers you a way to realize your financial goals and secure your financial future without taking substantial market risk.
Most bond books just describe all the different kinds of bonds and why you should buy this or that category. This book is much broader than any other bond book. Not only does it have a point of view and a philosophy, but it also describes:
Why you should buy bondsHow to construct the All-Bond PortfolioAll the major categories of bonds in the same formatA framework to understand bondsThe history of bondsHow to buy individual bondsAll the different types of bond fundsConsiderations in buying bond fundsFinancial planning with bonds, including many case studiesBond strategiesInvestors have different reasons for reading this book. To help you navigate through this long book, we divided the book into narrative chapters and descriptive chapters as shown in the reading guide presented in Figure I.1. As you can see, bond investing is a study unto itself.
Figure I.1 Reading Guide
Bonds, second edition, is divided into five parts. One way to navigate through the book is to first read Parts I, II, and V, the narrative chapters. These chapters are the easiest to read and describe the big picture around bonds. Start by reading Part I, Clearing the Cobwebs, which describes why we believe you should invest all your money in bonds. We explain in Chapter 1 how you may hope to get a better return by speculating, but after fees, taxes and bad timing you are better off with a high-quality bond portfolio. Chapter 1 explains why the All-Bond Portfolio is superior to diversifying into stocks and alternative investments. It explains why plain vanilla bonds are the best investment for individual investors to use to achieve their life and financial goals.
Chapter 2 explains how to structure and implement the All-Bond Portfolio composed of high-quality bonds. It further describes how the cash flow generated by the All-Bond Portfolio can be used to provide a stream of income to be spent or to be reinvested for growth. Chapter 3 presents a case study of a client who turned to the All-Bond Portfolio to solve his financial problems and the implications for his personal life.
Part II, “Bond Basics” provides key information you need to know about bonds. Bond language, which is often arcane, is easier to understand when placed in its historical context. Chapter 4 provides that context and explains how bond structures are rooted in history and some current updates. It is a fun walk through history that gives you a perspective on how ingrained bond investing is in our culture. In Chapter 5, The Life of a Bond, we trace how a bond is created, issued, priced, and traded. If you do not know anything about bonds, read this chapter to understand what it takes to issue a bond and the various moving parts. All bonds use the same structures. Once you grasp the basic concepts, you can read in detail about all of the different categories of bonds. This will put meat on the framework (sorry vegetarians) of what a bond is. Part II can also be used as a reference before you decide to buy a bond.
Part V, “Bond Investment Strategies” discusses financial planning with bonds, investment planning with bonds and bond strategies. Rich in detail, this section will enable you to determine how bonds can best fit into your portfolio. Chapter 19 tackles the vital subject of how to think about your financial and life needs and describes how to use bonds in your financial planning to achieve financial well-being.
Chapter 20 contains case studies describing how bonds might be used to meet a variety of financial-planning goals, including socially conscious investing. This chapter profiles how different people have employed bonds to create a safe haven for their financial lives.
Chapter 21 not only discusses techniques tailored to the individual investor but also offers a complete checklist of strategies useful as well to investment advisers and other professionals. Specific strategies address topics such as determining when to buy and sell bonds, constructing and implementing a bond ladder, finding bargain bonds, keeping away from overvalued bonds, what to do when interest rates are rising or are falling, investing for tax advantages, investing by risk tolerance, and investing for income needs.
After you have read the narrative chapters in Parts I, II, and V, read the descriptive chapters in Part III, “Bond Categories” as a way to understand what it means to invest in all the major types of bonds and compares them in detail in a uniform and useful format.
If you are interested in bonds providing state tax exemption, you might read Chapters 6 and 8 on Treasury and agency bonds. As we describe in a brief introduction to investing in municipal bonds, if you are seeking federal tax exemption as well, then you should read Chapter 10 on tax-free municipal bonds to understand if you can benefit, and then read its companion, Chapter 11, to understand what kinds of municipal bonds are issued.
If you want to understand and buy the safest bonds, read the chapters on Treasury bonds, U.S. government agency bonds, and U.S. savings bonds. They may not provide the highest yields, but they can give comfort by offering a relatively safe place to park your assets that can yield a steady stream of income or long-term growth.
If you are looking for a higher yield, then Chapters 12 and 13 on U.S. corporate and international bonds respectively are good places to start. Chapter 9, on mortgage-backed securities, sheds light on another high-yielding class of securities.
If you are trying to understand why you should buy bonds rather than invest in common or preferred stock for dividends, the difference between a bond and a certificate of deposit, or the difference between investing in individual bonds and purchasing a fixed immediate or deferred annuity, then read Chapter 14 on bond look-alikes. We have not written about all the other types of insurance policies because they are very complicated and beyond the scope of a book devoted to fixed income investing.
When you understand enough about bonds, we hope you are ready to buy them. At this point read Part IV, Options for Purchasing Bonds, which explains how to buy individual bonds either through a broker, online, or through mutual funds and similar vehicles. Included is thoroughly practical real-world advice on how to buy bonds without the help of an investment adviser, how to best use a broker, and how, through use of the Internet and other techniques, to evaluate the price of a bond. Drawing on our many years of experience representing clients in their purchase and sale of bonds, this chapter tells the secrets of the trade from the perspective of an experienced and expert bond investor. We outline resources that you can use if you wish to buy bonds yourself.
Four chapters in Part IV, Chapters 15, 16, 17, and 18, provide an in-depth discussion of how to buy individual bonds and the different kinds of bond funds, including individual bonds with more or less expensive wrappers. We explain the advantages and disadvantages of bond mutual funds, closed-end funds, exchange-traded funds, and unit investment trusts and then compare them all to investing in individual bonds. We then describe the considerations in buying bond funds and the strategies that you might employ.
Finally, an appendix of useful web sites, annotating those mentioned throughout the text, serves as an invaluable reference for finding bond information on the Internet. You will discover sites for bond calculators, yield curves, and other practical roman.
Whether you are a novice and want to read Bonds, second editions, from cover to cover, or a seasoned investor or adviser who wants to brush up on a long-neglected market, you’ll find what you need here—an abundance of practical information about bonds, bond funds, and how to make them part of your portfolio.
All in all, whether you are a beginning bond investor, or an investment advisor or professional bond investor, you should easily find topics of interest to entertain and enlighten you. We have enjoyed writing this book and we hope that you find some pleasure in reading it.
To keep up to date with developments in the bond market, sign up for our free bond newsletter by going to www.AllBondPortfolios.com.
Notes
1. Warren S. Hersch, “Boomers Fear for Their Nest Eggs, but Are Wary of Stocks,” National Underwriter 18, no. 25 (December 2006), 24.
2. Byron Katie, Loving What Is (New York: Three Rivers Press, 2002), 189.
PART I
CLEARING THE COBWEBS
The main purpose of this book is to debunk the many myths surrounding investing in stocks and bonds and to provide new thinking for you to consider when developing and carrying out your financial plan. In Part I, we take you on an unusual journey and encourage you to look at the financial world through our eyes and examine the proposition that, for individual investors, individual bonds are a better investment than stocks or any other asset class.
In Chapter 1, we compare stocks and bonds and describe the powerful case for investing in bonds. When we refer to “bonds,” we only mean individual bonds and not bond funds. Bond funds are quasi-equities because they do not have a due date. Our case for bonds has always existed. However, it has been made more persuasive by the dot-com crash of 2000 to 2002, the crash of 2008, and the Great Recession beginning in 2009. If you find that bonds make sense for you, we describe in Chapter 2 how to carry out the strategy of the All-Bond Portfolio, including the specific kinds of bonds to buy (we call them plain vanilla bonds). Plain vanilla bonds are high-quality individual bonds, easy to buy and sell at low or no cost, and easy to understand. In Chapter 3, we provide a case study illustrating why and how a family used the All-Bond Portfolio to support their life objectives and their financial goals using our four-step financial planning procedure.
Come with us as we look at the financial world in an unbiased way, challenge the traditional thinking found in articles and books on investing, and offer strong evidence to support our belief in bond investments. Financial plans based on the traditional thinking that emphasizes stock investing have not worked out well for many individual investors. They have taken substantial risks with their nest eggs and endured severe and upsetting market declines and financial uncertainty. Indeed, many individuals lost their retirement savings. We believe that the All-Bond Portfolio is a better way to plan and secure your financial future. This book will show you how to build one. We hope that this book will change the way you view the world of investing.
CHAPTER 1
Bonds
THE BETTER INVESTMENT
Watching your stocks all day long is amusing up to a point, but income is the thing if you’re shopping for anything from pajamas to pastrami sandwiches.
—Joe Mysak, Bloomberg columnist
For generations, stocks have gotten top billing over bonds. Stocks, many insist, have outperformed bonds in the past, will outperform bonds in the future, and are not risky if held for 10 years or more. We believe these assertions are myths. In fact, this thinking is now being called into question by sophisticated market players such as Citigroup. Citigroup Global Markets published an article dated September 1, 2010, entitled “The End of a Cult.” The article points out that from 1950 to 1999 global pension funds and individual investors substantially increased their asset allocation to stocks and substantially decreased their asset allocation to bonds. “Back in 1952, U.S. private sector pension funds held just 17 percent of their assets in equities compared to 67 percent in fixed interest. Over the next 50 years, these weightings reversed.” Japanese pension funds in 1998 held 55 percent of their portfolios in equities. By 2010, that percentage dropped to 36 percent.
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!
Lesen Sie weiter in der vollständigen Ausgabe!