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Don't Follow Bill Gross Off the Cliff

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One of the hardest things for investors to do is to admit that they've made a mistake. PIMCO bond maven Bill Gross seems to have done exactly that.

Earlier this year, Gross let loose with one of the most outspoken criticisms of Treasury debt made during this unprecedented period of low interest rates. Yet as Treasuries soared ever higher, Gross and his PIMCO Total Return mutual fund started falling behind its competitors. Now, PIMCO has announced that the fund has increased its Treasury holdings back to a more reasonable level. What's behind the move, and what does it mean for you and your own bond holdings?

The ultimate about-face to save face
Gross made a point of saying earlier this year how his fund, the largest mutual fund in existence, sold Treasuries short. He alluded to a number of colorful metaphors, suggesting that "your pocket will basically be picked if you stay" in Treasuries and that those who "stay in the pot" would "get cooked."

At the time, the move made plenty of sense. Effective real yields on inflation-protected Treasuries were negative for maturities as long as six years, while traditional Treasuries had rock-bottom rates pretty much across the yield curve. Yet longer-term bond ETFs such as the iShares Barclays 20 Year Treasury (NYSE: TLT  ) had already come off their highs, emboldening those using short-Treasury plays like ProShares UltraShort 20 Year Treasury (NYSE: TBT  ) to try to profit from a potential drop in Treasuries.

Yet across the board, bonds have held up a lot better than stocks. Vanguard Total Bond ETF (NYSE: BND  ) and iShares Aggregate Bond ETF (NYSE: AGG  ) are both up for the year, which is more than you can say for the S&P 500 and the Dow Jones Industrials (INDEX: ^DJI). Interest rates have continued to fall to record levels, with mortgage rates at multidecade lows. Even municipal bonds have recovered from their late-2010 swoon.

What should you do?
With Gross caving under pressure after his fund fell to the bottom 20% of bond funds in terms of one-year performance, should you follow suit and buy Treasuries? For most investors, the answer is "no."

When you buy a 10-year Treasury right now, you're committing to receive less than 2% on your money through the year 2021. In exchange for that interest, you get full exposure to all the risks that the U.S. economy faces right now, be it rampant inflation, dollar devaluation, government default, or a host of other less catastrophic events.

Now compare that risk with the pros and cons of holding shares of multinational giants Coca-Cola (NYSE: KO  ) or McDonald's (NYSE: MCD  ) . With sales around the world, neither of these companies is beholden to any one country. If prospects in the U.S. worsen, then they can shift their focus abroad and capture growth opportunities there. And all the while, shareholders will reap yields that at the moment far exceed the paltry 2% that Treasuries offer.

Of course, if you're absolutely convinced that stocks will suffer another Lost Decade in the 2010s and not provide even 2% returns between now and when your 10-year Treasury matures, then buying Treasuries may not seem silly at all. The key, though, is to understand that when you take dividends into account, stocks have to perform really badly to fall short of what Treasuries pay. Bill Gross may need to make that trade-off, but you don't have to follow him.

Stay safe
For good or ill, most investors need to have at least some of their money in safe, income-paying investments like Treasury bonds or their equally safe yet higher yielding alternatives, bank certificates of deposit. But you shouldn't take Gross' move back into Treasuries as a sign that they're likely to perform any better than Gross originally thought earlier this year. While he has the pressure of running the biggest mutual fund in the industry, you can sit back and make better moves with your own money.

Some stocks yield a lot more than just 2%. To find out about them, click here to get The Motley Fool's special free report: "13 High-Yielding Stocks to Buy Today."

Fool contributor Dan Caplinger thinks lemmings are cute but doesn't want to be one. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Coca-Cola. Motley Fool newsletter services have recommended buying shares of McDonald's and Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy will help you climb out of any hole.

Read/Post Comments (4) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 13, 2011, at 2:54 PM, ilovesumm wrote:

    Gross was early but his advice was good. For the short term the treasury returns did beat the market but 10 years from now is a lot different than a 6 month window.

    I agree with the author these dividend payers will outperform a 2% treasury .

  • Report this Comment On September 14, 2011, at 1:01 AM, BDF958 wrote:

    Gross was not wrong. His timing was off. Now rear view mirror types jump back in on basis that he was wrong. He was correct. He misscalculated the impact the government's manipulation would have. All things revert to the basics, at some point. We are pretty close to that point, have to be because we are simply running out of BS. Look at the action on TBT over past couple days. If you short bonds today, doubt you will be wrong again.

    The basics do not work with a heavily manipulated systemic system ( Yea, I know, but could not think of a better way to put it). Short term anyways.

    So instead of focussing on "Gross off a cliff" and performance of peers, please try to teach people the why's of the story. After all that was was of your founding principals right?

  • Report this Comment On September 14, 2011, at 11:13 AM, lctycoon wrote:

    Gross is correct. His timing met with some bad luck to make his bet wrong in the short-term. For example, the European debt crisis caused a lot of people to panic and flee to Treasuries. A good or rational decision? No, but for some reason, the USA - the largest debtor in the world with massive deficits as far as the eye can see - is considered a better risk than many countries (or companies) with no debt.

    I agree with the author. Dividend paying stocks are going to slaughter treasuries over a ten year period, even if stock prices stay flat.

  • Report this Comment On September 15, 2011, at 12:32 AM, Robnati wrote:

    Mr. Gross was dead wrong and missed one of the biggest treasury rallies in recent memory. Being early is the same as being wrong and losing money, unless -- like Mr. Gross -- you are working other people's money in which case you invent an excuse, such as, "I was early." The surprising thing was the lack of insight demonstrated by Mr. Gross in making his prediction.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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