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Author: couzensj Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35387  
Subject: Bonds-General Information Date: 1/17/2002 2:14 PM
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I have never purchased any a Treasury, Corporate or Municipal Bonds and am looking for some information.

Currently, my stock portfolio consists of 8 stocks but over the next 10 years I want to begin moving more funds into bonds before I retire. Since I do not expect a repeat of FY01 performance in bonds, due to stable to rising interest rates, I only expect to be putting new money into bonds this year. Although, I would like to build a individual portfolio of bonds I have always heard that you needed to have large blocks of bonds otherwise the bid/ask spreads may eat you alive so I guess I have to get into a no-load Intermediate Bond Fund - any suggestions?

Its my understanding that most bid/ask prices for Treasuries are based upon 1M blocks (ie 1000*1000)while most block for Municipals are in 25K range (ie 1000*25) and Corporate in the 100K range (1000*100).

What kind of bid/ask spreads should I expect if I am only trading in say 50K blocks of Treasuries or 25K in Corporates? I would hope that it would be in the 25-50 basis points range or less. Does anybody do enough trading to provide some guidance in this area?

It's also my understanding that only a few Corporate Bonds are traded on the exchanges and that most are traded over-the-counter. Does that mean that the only way to find out the bid/ask price for an over-the-counter bond is by calling a broker?

If I decided to build a bond portfolio then my plan is to begin looking for Company's whose Balance Sheet might be improving so significantly that a change in its credit rating might be made by somebody like S&P or Moody's in the near future.

I am generally not an advocate of Mutual Funds but maybe it makes sense with Bonds. Comments/suggestions.


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Author: foobar73 Big red star, 1000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2792 of 35387
Subject: Re: Bonds-General Information Date: 1/17/2002 2:33 PM
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I think treasuries don't make a lot of sense for the small individual investor, unless you have a specific long-term maturity target, as you can pick up an excellent alternative in US Savings bonds instead. Corporates are probably best dealt with through low-expense bond funds, since you will likely have trouble getting the diversification you need to obtain a reasonable amount of safety.

Most bonds are indeed not traded on an exchange, and you will have to call a broker to get pricing. Spreads depend on the specific issue and the broker you deal with, but I think a 2%-3% difference between bid/ask would be typical for popular issues in small quantities.

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Author: Crosenfield Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2793 of 35387
Subject: Re: Bonds-General Information Date: 1/17/2002 2:33 PM
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Particularly in an environment of rising interest rates, I would not like to own a bond fund. Bonds mature. Bond funds don't. If rates go up the prices of the bonds the fund already owns go down and so does the price per share.
Individual bonds are fine. The spreads would eat you if you were planning to be trading in and out, but if you hold to maturity and the company does not go bankrupt, you know at the outset what your return will be. Avoid buying bonds at a premium.
If you are buying treasuries, get them at auction from Treasury Direct. There is no commission. You can get a note, or bill for $1000 or any multiple thereof that you choose.
February will be the next auction of 5 and 10 year notes.
You would need to buy in large blocks if you were planning on trading, but to hold to maturity, no problem. The pitfalls are 1)you buy a bond and the company goes belly up. So watch the credit of the issuer. or 2) you pay more than 100c on the dollar for the bond, and the issuer calls it before maturity, at par or a slight premium. You don't get back the premium you paid for the bond.
Best wishes, Chris

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Author: couzensj Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2794 of 35387
Subject: Re: Bonds-General Information Date: 1/17/2002 2:41 PM
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Particularly in an environment of rising interest rates, I would not like to own a bond fund. Bonds mature. Bond funds don't. If rates go up the prices of the bonds the fund already owns go down and so does the price per share.
Individual bonds are fine. The spreads would eat you if you were planning to be trading in and out, but if you hold to maturity and the company does not go bankrupt, you know at the outset what your return will be. Avoid buying bonds at a premium.
If you are buying treasuries, get them at auction from Treasury Direct. There is no commission. You can get a note, or bill for $1000 or any multiple thereof that you choose.
February will be the next auction of 5 and 10 year notes.
You would need to buy in large blocks if you were planning on trading, but to hold to maturity, no problem. The pitfalls are 1)you buy a bond and the company goes belly up. So watch the credit of the issuer. or 2) you pay more than 100c on the dollar for the bond, and the issuer calls it before maturity, at par or a slight premium. You don't get back the premium you paid for the bond.
Best wishes, Chris


Good comments - hadn't really thought about the fact that I would be holding until maturity - understand your comment about bond premiums - thanks.

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Author: aesirai Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2795 of 35387
Subject: Re: Bonds-General Information Date: 1/17/2002 2:48 PM
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If you're in a bond fund, and rates go up, the fund will be purchasing higher interest bonds, so it should more or less balance out, right?


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Author: couzensj Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2796 of 35387
Subject: Re: Bonds-General Information Date: 1/17/2002 2:50 PM
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I think treasuries don't make a lot of sense for the small individual investor, unless you have a specific long-term maturity target, as you can pick up an excellent alternative in US Savings bonds instead. Corporates are probably best dealt with through low-expense bond funds, since you will likely have trouble getting the diversification you need to obtain a reasonable amount of safety.

Most bonds are indeed not traded on an exchange, and you will have to call a broker to get pricing. Spreads depend on the specific issue and the broker you deal with, but I think a 2%-3% difference between bid/ask would be typical for popular issues in small quantities.


Foobar73:
Interesting info on bonds and spreads - thanks

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Author: Crosenfield Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2797 of 35387
Subject: Re: Bonds-General Information Date: 1/17/2002 2:52 PM
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"If you're in a bond fund, and rates go up, the fund will be purchasing higher interest bonds, so it should more or less balance out, right?"

Eventually. But the bonds the fund already owns won't change their coupon rate, so the price goes down.
As I've watched bond funds, they never seem to get back the NAV that they lost. The funds buy bonds that are subject to calls, and when rates go down, the higher-yielding bonds are called away and the fund is left with, or must buy, lower-yielding bonds. When rates are rising, the issuers are happy with the lower rates they are paying, and the bonds will go to maturity.
I've had a lot better luck with individual bonds than funds, and will never again own a bond fund. 1993 was painful and I don't need the lesson repeated. Best wishes, Chris


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Author: couzensj Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2798 of 35387
Subject: Re: Bonds-General Information Date: 1/17/2002 2:57 PM
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If you're in a bond fund, and rates go up, the fund will be purchasing higher interest bonds, so it should more or less balance out, right?

Aesirai
I am not sure that's correct - I do not think the additional bond fund income would offset the decreased value of the bonds in the portfolio. The value of the bonds in the portfolio will go down and so will your net asset value (nav).

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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2801 of 35387
Subject: Re: Bonds-General Information Date: 1/17/2002 4:28 PM
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If lots of new money is flowing into the fund, the fund will be able to buy higher-interest bonds.

However, if money is moving out of the fund (more likely, since people tend to flee when the NAV drops), the fund will have to sell off its existing bonds at depressed prices (& incur the bid-ask spread), and if it wants to get new, higher-yielding bonds, it will have to sell off even MORE old bonds at depressed prices.

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Author: TonySCFA One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2802 of 35387
Subject: Re: Bonds-General Information Date: 1/17/2002 9:09 PM
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but I think a 2%-3% difference between bid/ask would be typical for popular issues in small quantities.

ROTFLMAO!!!!!!!!!!!!!!!!!

Try 5-10% in the real world of bond dealers.Quit smoking crack and realize that dealers commit capital and expect to get paid for that risk. You don't get paid @ 2-3%.

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Author: foobar73 Big red star, 1000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2803 of 35387
Subject: Re: Bonds-General Information Date: 1/17/2002 9:56 PM
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but I think a 2%-3% difference between bid/ask would be typical for popular issues in small quantities.

ROTFLMAO!!!!!!!!!!!!!!!!!

Try 5-10% in the real world of bond dealers.Quit smoking crack and realize that dealers commit capital and expect to get paid for that risk. You don't get paid @ 2-3%.


Thanks for the response to my post. I'm glad you took the time to write a polite, well-mannered reply. Not.

I'll admit right off I'm not a seasoned bond veteran. However, in another browser window, I currently have bond quotes from my broker for some corporate bonds. A July 2003 Coca-Cola issue is quoted at 104.5/105.581 bid/ask. June 2004 Daimler Chrysler at 103.050/104.194. June 2005 GM at 103.335/104.544. A five-year Treasury at 108.000/108.301. These are for $5000 trades, BTW. I'm not sure which broker you use, or what your idea of "popular issues" is, but I'm even having trouble finding bonds trading with greater than 2% spreads.

I don't smoke crack, but I can see I can afford to do so more easily than you can, given the kind of pricing your broker seems to hand you.

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Author: rpb Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2804 of 35387
Subject: Re: Bonds-General Information Date: 1/17/2002 10:03 PM
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I don't smoke crack, but I can see I can afford to do so more easily than you can, given the kind of pricing your broker seems to hand you.

Great stuff, I have never seen 5% spreads myself, if I did I would not pay, I think we have found the crack smoker.

rpb

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Author: trico8xll Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2808 of 35387
Subject: Re: Bonds-General Information Date: 1/18/2002 7:11 AM
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A recent AAII magazine has a good article on bond investing. The author makes the point that the less the spread, the more saleable the bond. The greater the spread, the more risk that the broker cannot sell the bond. I've noticed an almost negligible spread on very high quality bonds.

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Author: aesirai Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2843 of 35387
Subject: Re: Bonds-General Information Date: 1/20/2002 8:15 PM
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I'm not so sure about this whole bond fund losing value thing.

I was looking at Vanguard's Long Term Tax Free Muni Bonds (VWLTX), and graphed investment growth from 1988-2002, a 14 year period. You would have averaged about 7.2% per annum in this fund over that time period. [although only 6% p.a. over the last 5 years]

Moreover, the growth of the investment was a fairly straight line. Short term interest rates have gone up and down over this period, but have of course not really affected long term rates much.

I think long term bonds are in trouble if a) there is inflation, b) everyone starts selling bonds (e.g. US currency falls in value), c) municipalities get downgraded. Of course, I think all three of these things are going to happen to some degree, so I'm just thinking out loud.

7.2% per annum tax free is an excellent return, and I would take it if I thought I could get it. The short term muni bond fund (VWSTX) only averaged 4.5% from 1988-2002.


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Author: foobar73 Big red star, 1000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2844 of 35387
Subject: Re: Bonds-General Information Date: 1/20/2002 9:11 PM
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I'm not so sure about this whole bond fund losing value thing.

I was looking at Vanguard's Long Term Tax Free Muni Bonds (VWLTX), and graphed investment growth from 1988-2002, a 14 year period. You would have averaged about 7.2% per annum in this fund over that time period. [although only 6% p.a. over the last 5 years]

Moreover, the growth of the investment was a fairly straight line. Short term interest rates have gone up and down over this period, but have of course not really affected long term rates much.

I think long term bonds are in trouble if a) there is inflation, b) everyone starts selling bonds (e.g. US currency falls in value), c) municipalities get downgraded. Of course, I think all three of these things are going to happen to some degree, so I'm just thinking out loud.

7.2% per annum tax free is an excellent return, and I would take it if I thought I could get it. The short term muni bond fund (VWSTX) only averaged 4.5% from 1988-2002.


Unfortunately (or fortunately), there haven't been any really bad downturns in bonds for about two decades now. The bottom of the bond market was around 1982, and things have been improving rather steadily from there, with only a handful of exceptions. If you can find any performance statistics from around 1975 to 1982, these would be more interesting to look at.

Take a look at the performance of your fund in 1994 and 1999 for an indication of what a bond bear market looks like. Repeat that year after year for about 7 years and you'll see what bond owners had to face in the mid-seventies.

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Author: Lokicious Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2846 of 35387
Subject: Re: Bonds-General Information Date: 1/20/2002 10:24 PM
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"I'm not so sure about this whole bond fund losing value thing.
I was looking at Vanguard's Long Term Tax Free Muni Bonds (VWLTX), and graphed investment growth from 1988-2002, a 14 year period. You would have averaged about 7.2% per annum in this fund over that time period. [although only 6% p.a. over the last 5 years]
Moreover, the growth of the investment was a fairly straight line. Short term interest rates have gone up and down over this period, but have of course not really affected long term rates much."

I would suggest looking at the chart for Vanguard's long term muni fund's NAV. It has fluctuated from about 10.1 to 11.6 over the last 5-years, and we have not been in a period with truly high interest rates, which would drive the NAV down much further (although then you would get higher dividends). The fluctuations correspond quite well with long term interest rates: for example, look at EE bond rates, which have gone from 5.7 now down to 4.03 (I'm doing this from memory, so may not be exact). Using EE bond rates as a benchmark, the formula of multiplying average duration by %point change in interest rates is a pretty good approximation.

http://finance.yahoo.com/q?s=VWLTX&d=c&k=c1&a=v&p=s&t=my&l=on&z=m&q=l

For anyone looking to park money in a long term bond fund for just a year or two, the affect of a 1% point interest rate hike (in EE bonds, for example), would likely lead to about a 7.5% loss of principle with the long term tax exempt fund, 11% with the long term corporate fund. This at a time when yield is only 4.9%.

Over a longer term things may even themselves out, but then the question is whether there is any point in putting money into the fund now, or finding something else to do with the money and investing in the bond fund after interest rates go back up at least a point. My calculations tell me, with the long term fund, definetely wait. With the intermediate fund, it's less clear.


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Author: imcharliehm Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2860 of 35387
Subject: Re: Bonds-General Information Date: 1/23/2002 12:56 AM
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foobar,

Unfortunately, Tony knows what he's talking about, his laughing at you aside.

Spreads on junk are typically 5-6 points, which can work out to a spread of as much as 20% for issues offered in the low teens.

Listed issues are another story, with narrower spreads, and Treasuries are yet another market again, with very tight spreads.

That's the game. You pay or you don't play.

What I've found is that spreads, atrocious as they are, are the least of my concerns. The biggest hassle, and the biggest money maker, is getting the research right. A 5-6 point buy-in fee is small potatoes compared to the 20-70 points I'm trying to capture from cap gains.


Charlie





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Author: foobar73 Big red star, 1000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2867 of 35387
Subject: Re: Bonds-General Information Date: 1/23/2002 12:53 PM
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Unfortunately, Tony knows what he's talking about, his laughing at you aside.

Spreads on junk are typically 5-6 points, which can work out to a spread of as much as 20% for issues offered in the low teens.

Listed issues are another story, with narrower spreads, and Treasuries are yet another market again, with very tight spreads.

That's the game. You pay or you don't play.

What I've found is that spreads, atrocious as they are, are the least of my concerns. The biggest hassle, and the biggest money maker, is getting the research right. A 5-6 point buy-in fee is small potatoes compared to the 20-70 points I'm trying to capture from cap gains.


I don't believe junk was the original topic, though.

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