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Most bond-fund managers do well when interest rates rise, but that’s no reason to invest with them

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Rising interest rates are not a good reason to invest in an actively managed bond fund. That’s important to know, since the performance data appear to show just the opposite. As you can see from the chart below, a far greater percentage of bond-market timing newsletters beat a buy-and-hold strategy during bond bear-markets.

This would suggest that if interest rates rise from current levels — causing bond prices to decline — then active management would be the way to go.

In fact, the data do not support this conclusion. In order to exploit this pattern, you would first need to know that interest rates are indeed headed up — that bonds are in a bear market, in other words. But if you already knew that, then you wouldn’t need to utilize the services of an active manager; your best course of action would then simply be to get out of bonds and go to cash.

Perhaps you think that interest rates will rise. I’m skeptical. I’ve been hearing such predictions for many years now, and at least so far they’ve not come to pass. If you were to unexpectedly get an interest rate prediction right, it would be more a matter of luck than skill.

This is the implicit message of the data in the accompanying chart. That’s because it takes no skill to outperform the market when it’s declining. Even a monkey flipping a coin to determine when to get in and out of the bond market would come out ahead.

If beating a buy-and-hold strategy in a bear market were a matter of skill, then you’d expect to see just as many market timers beating bull markets. But that is most definitely not the case: In bond bull markets, as the chart shows, the percentage of market timing newsletters beating the market is barely above zero.

To construct this chart, I examined bull and bear markets in the U.S. bond arena back to 1993. While there is no hard-and-fast rule about when bond bull markets begin and end, I defined them according to multi-month up- and down trends in the 10-year Treasury’s yield. By my count there have been five complete market cycles since then.

In the bull and bear phases of each cycle, I calculated the percentage of bond timing newsletters monitored by the Hulbert Financial Digest that had beaten a buy-and-hold. The accompanying chart reports the averages across all five cycles.

Why is beating a buy-and-hold strategy so much easier in bear markets?

The reason a monkey’s market timing would most likely beat a buy-and-hold during a bond bear market: When bonds are falling in price, odds are high that going to cash will gain an advantage over the falling market — even if the timing of going to cash is picked at random. So beating a buy-and-hold during a bear market is not a sign of any special ability.

During bull markets, in contrast, just the opposite will be true: Any time spent in cash will most likely cause a market timer to fall behind a buy-and-hold, which will be continuing to gain as the market rises. That’s why the majority of bond market timers look like geniuses when the market is falling and yet appear to have no ability when the market is rising.

This is simply a matter of probabilities, of course, and not unique to the bond market. Four decades of performance tracking by the Hulbert Financial Digest has shown the same phenomenon to be true among stock and gold timers as well.

Hardly any bond timers beat a buy-and-hold over an entire cycle

Another way to illustrate the very low probability of successfully timing the bond market is to measure how timers do over an entire market cycle. The picture that emerges from Hulbert Financial Digest data isn’t pretty. For each complete (bull-plus-bear) market cycle since 1993, I calculated the percentage of monitored bond market timers who made more money than buying and holding. On average for all market cycles since 1993, the market-beating percentage is just 8%.

This is slightly lower than the comparable percentages for monitored stock and gold timers, and I think that makes sense. Market timers thrive on market volatility, and the bond market is far less volatile than either equities or gold. Over the last several decades, for example, the monthly volatility of the U.S. Treasury market has been 65% less volatile than the stock market’s. Gold’s monthly returns have been 8% more volatile.

The bottom line: Be on your guard against arguments that bond market timing is about to be more important than ever. Though the data appear to support those arguments, in fact they do not.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

More: There will be a ‘huge boom’ in the second quarter of 2021 if vaccines are effective, says investment strategist David Rosenberg

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‘I could live on my Social Security and still save money’: This 66-year-old left Chicago for ‘calming’ Costa Rica — where he now plans to live indefinitely

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Editor’s note: This article was first published in September 2019.

A school break changed 66-year-old Martin Farber’s life forever.

In 2007, his daughter — who at the time was attending Illinois State University — decided she wanted to spend a college holiday volunteering in Costa Rica and staying with a local family, he explains. She came home raving about the experience, so, in 2008, Farber — who at the time was living in Evanston, Ill., just outside Chicago, and selling cars — took his first trip there.

“It was a big surprise to me — bumpy roads, dogs barking in the streets,” he says. “I wasn’t enamored at first.”

But as his daughter began traveling there more and eventually moved there for a year, he took additional trips to Costa Rica. It quickly grew on him — in particular, the people. “The Costa Rican people are warm, open and friendly. I felt less invisible in a strange country in a strange town where I didn’t speak the language than I did in Evanston.”

And the more time he spent there, the more it impacted him: “On one of my trips there, I thought: My daughter’s life makes more sense than mine,” he says. “There was nothing wrong with my life, but I felt that my life was out of context with who I’d become. … I would have bills and make money to pay them, but that had ceased to be satisfying,” he recalls. “I knew I needed to change my life — there was no more joy in what I was doing.”

What’s more, when he’d return from his Costa Rica trips, people noticed. “I would come back, and my friends and therapist would say: You seem better after you go,” he says with a laugh.

A view from the hot springs near Martin Farber’s home in Costa Rica.


Martin Farber

So in 2014, he packed up and moved to Orosi — a picturesque, lush small town with waterfalls and hot springs a little over an hour’s drive from San Jose — promising himself he’d stay for two years. It’s been five, and he now plans to stay in Costa Rica indefinitely. (Though Farber notes that, to him, “it’s not a retirement; it’s a chance to lead a new and different life.”)

Here’s what his life is like, from costs to health care to residency to everyday life:

The cost: While many expats spend way more living in Costa Rica, Farber says: “I could live on my Social Security and still save money.” He says “a person can live on $1,200 per month, two people on $2,000.” The key, he says, is to live more like he does and as the Costa Ricans do — in a modest home, eating local food and purchasing local goods.

Indeed, Farber himself spends just $300 a month for rent (he rents a home from a friend who moved recently and gave him a good deal), roughly $225 a month on groceries and just $50 a month total on water and electricity (the temperate climate in Orosi means you rarely need heat or air conditioning). The veteran Volkswagen
VOW,
+0.96%

 
VLKAF,
+0.98%

salesman saves money by not owning a car (those over 65 ride municipal buses for free), which can be a significant expense in Costa Rica; for his cellphone, “I pay as I go … roughly $10 may last me a couple weeks or more,” he says, adding that “many people handle there their cellphones this way. You can get them recharged anywhere.”

His major expense is travel: He goes back to the U.S. to visit his mother in Florida several times a year and lately has spent part of the summer in Chicago helping out a friend with a dealership there. He also spends a good amount of money on health care. He says that while flights can be had for as little as $350 roundtrip during offseasons, the cost can be much higher the rest of the year.

In the saddle.


Martin Farber

Health care: Farber, who has permanent resident status in Costa Rica, says he pays about $90 per month to participate in the country’s health-care system — adding that the health care he’s received has been very good. (A 2018 study of health-care quality and access in more than 190 nations ranked Costa Rica No. 62.)

When he developed a detached retina, though, he paid for the procedure out of pocket so that he didn’t have to wait for the required surgery, he says — adding that the entire procedure cost him about $5,000. “I would have had to have waited four days,” he says, if he had not paid to expedite matters. “That might have been fine, but it might not.” And he adds that the quality of care depends on where you get it in the country.

Lifestyle: Though Farber says that he “moved here with no goals and no agenda,” he’s found plenty to do. “I take Spanish lessons two days a week for two hours a day. It’s been great. I never thought I would acquire a usable language in my 60s,” he says. He also rides his bike all around the area, does some writing and belongs to a community group that undertakes projects to improve the area.

And he often simply takes in nature, which he says has been an essential part of why he feels calmer and more relaxed in Costa Rica than in the U.S. “I live at 3,000 feet but in a valley surrounded by coffee fields and lime trees and water. At night, if I open the windows, I can hear the river rushing by,” he says. “It is very calming … hundreds of trees everywhere … you know the Earth is alive.”

The historic Iglesia de San José de Orosi.


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Cons: “I don’t want to overglorify. It’s not without its problems,” Farber says of Costa Rica. “There are social problems and downsides.” He notes that crime and petty theft can be a problem (“I am cautious,” he says of his approach) and seem to have increased since he moved there, and adds that he misses out on some cultural things because of where he lives. And, he says with a laugh, “I can’t order Thai food at 9 at night.” But, he adds: “These are trade-offs — in the afternoon, I get to walk in the coffee fields and see flocks of parrots.”

Residency: To qualify for Costa Rica’s pensionado visa, expats must prove that they have a pension of at least $1,000 coming in each month. (Here are the details of that program.) Once you have lived in Costa Rica for three years, you can apply for permanent residency. Farber used a lawyer to help him figure out the ins and outs of residency options; his entire path to permanent residency took about a year, he says.

The bottom line: “After five years I am still amazed and surprised that I made the decision to lead a life I never thought I would,” he says. And while he may not stay in Orosi forever — “the town doesn’t have an ambulance, [and] I don’t know what it will be like to be 80 there,” he says — he does plan to stay in Costa Rica in no small part because of the people and sense of community. “I have the feeling that life is good here,” he says. “It’s hard sometimes, but we are all in it together.”



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Mutual Funds Weekly: These money and investing tips can help you read the market’s signs and stay on your path

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