The investor should be aware that even though safety of its principal and interest may be unquestioned, a long-term bond could vary widely in market price in response to changes in interest rates.
If it is virtually impossible to make worthwhile predictions about the price movement of stocks, it is completely impossible to do so for bonds.
In the old days, at least, one could often find a useful clue to the coming end of a bull or bear market by studying the prior actions of bonds, but no similar clues were given to a coming change in interest rates and bond prices.
Hence the investor must choose between long-term and short-term bond investments on the basic chiefly of his personal preferences. If the investor wants the 7.5% now available on good long-term corporate bonds, or the 5.3% on tax-free municipals, he must be prepared to see them fluctuate in price.
Banks and insurance companies have the privilege of valuing high-rated bonds of this type on the mathematical basis of "amortized cost", which disregards market prices; it would not be a bad idea for the individual investor to do something similar.
A good many of the convertible issues have been sold by companies that have credit ratings well below the best. Some of these were badly affected by the financial squeeze in 1970.
As a result, convertible issues as a whole have been subjected to triply unsettling influences in recent years, and price variations have been unusually wide.
In the typical case, therefore, the investor would delude himself if he expected to find in convertible issues that ideal combination of the safety of a high-grade bond and price protection plus a chance to benefit from an advance in the price of the common.
Over the past decade the bond investor has been confronted by an increasingly serious dilemma: Shall he choose complete stability of principal value, but varying and usually low (short-term) interest rate? Or shall he choose a fixed-interest income, with considerable variations (usually downward, it seems) in his principal value?
It would be good for most investors if they could compromise between these extremes, and be assured that neither their interest return nor their principal value will fall below a stated minimum over, say, a 20-year period. This could be arranged, without great difficulty, in an appropriate bond contract of a new form.
Important note: In effect the U.S. government has done a similar thing in its combination of the original savings-bonds contracts with their extensions at higher interest rates.
It is hardly worthwhile to talk about nonconvertible preferred stocks, since their special tax status makes the safe ones much more desirable holdings by corporations-e.g., insurance companies than by individuals. The poorer-quality ones almost always fluctuate over a wide range, percentagewise, not too differently from common stock. We can offer no other useful remark about them.
- The Intelligent Investor, Benjamin Graham
