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A year ago my wife and I were talked into investing $10,000 in a bond fund through our bank. Wrong. I didn't do my usual homework and as soon as I got home THEN did my homework and discovered a number of analysts saying that was a BAD time to get into the bond market. Sure enough, it began falling, and though it has earned about $30 interest every month, the share price has fallen such that the total value is now around $9850. The agreement with the bank included a $100 penaly for withdrawing the fund in the first year, so we left it in. The year is up and now I am wondering what the bond fund prognosis is going forward. I would like to at least break even at $10,000, but don't want to take another Foolish chance :).

Advice anyone ? What would you do ?

Thanks,
Scott W
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""Advice anyone ? What would you do ?"".........My 2 cents would be to take the money and run. I base this on the (?)fact that the economy appears to be very strong, that inflation seems to be rearing its head, and the fact that when the FED starts to raise rates it usually involves more than just one hike, but rather a series of hikes. If it is an intermediate or long term bond fund its price will drop.

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"My 2 cents would be to take the money and run...If it is an intermediate or long term bond fund its price will drop"

It is indeed an intermediate fund:

OIMCX
ONE GROUP INTERMED BOND FUND CL C

OK, this will show just how Foolish I am, but if interest rates go up, then won't that eventually reflect in higher interest paid on bonds ? Which will increase the yield ? And that's a good thing, I think (?).

Is it true that IN GENERAL when stocks are doing well, and the stock buying public thinks they will continue to do well, money is moved out of bonds (and other instruments I am sure) and into stocks? Which would drive the price of bonds down ?

Thanks, Scott
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I suggest looking at my recent link to Vanguard talk about bond funds.

We don't know where interest rates are going or by how much or when: no one does, though the advice givers always claim to then conveniently forget to tell us when they've been wrong. It does sound like you got into an intermediate fund when rates were historically very low and when you could have bought 5-year CDs for as good a yield with less risk, usually a good indication to stay away.

The Fed is certainly makin noises about increasing the only rate they directly control in the hope of staving off inflation. How much this will affect longer rates is hard to judge, since an increase was anticipated and probably was reflected in the recent surge in longer bond yields. I, and a lot of others on this board, think the happy-economy is a myth—you pump enough borrowed money into an economy, both government and personal debt, you'd better get some stimulus from it, but a lot of the new jobs are temporary, low paying, or directly connected to the construction boom, which could be crushed if interest rates do go up. In other words, Greenspan's "soft-landing" could be as soft as his last one, requiring him to reverse course quickly.

I still think, with the national debt and starting from historically low interest rates, chances are rates will go up considerably, but it is not a given, any more than further lowering of interest rates and deflation was a given a few months back.

As to what to do: I'd certainly get out of your fund, but not necessarily move to money out of bonds. You are almost certainly paying too high an expense ratio, and with a greater likelihood of rates going up substantially than down substantially, you'd be better off with Vanguard's Total Bond Market Index fund. I've been comparing Vanguard's Total Bond Fund and its Intermediate Bond Index fund for the last few years, and what you can see is over time the yields on the two funds are similar, but the NAV on the Intermediate fund fluctuates a lot more. This means, when interest rates are high, you're likely to get a bigger capital gain from falling interest rates with the Intermediate Fund, while you'll take a bigger loss when rates go up. In any case, you're expenses will be lower with Vanguard than what you have now.

If you use a bond fund in a balanced portfolio and rebalance periodically and reinvest dividends, you can take advantage of lower NAV on the bond fund to even things out. The alternative, which is what I would do, would be to eat your loss, put the money into a ladder of 1-5 year CDs, and put it back into the Vanguard Total Bond Fund as each of the CDs come due.
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Loki,

You're one of the posters I always read, because your posts are on point and your advice seems so reasonable. You advised: "The alternative, which is what I would do, would be to . . . put the money into a ladder of 1-5 year CDs, and put it back into the Vanguard Total Bond Fund as each of the CDs come due."

We've been sitting in Vanguard's Short-Term Bond Index, reinvesting dividends. With the idea of keeping 5 years of future income in cash, I've been planning to build a 5-year CD ladder at Vanguard, starting with 2 and 3 year CDs, and rolling into longer term CDs each year. I've been reluctant to tie money up in 4 and 5 year CDs in the current low interest rate environment, and that's the same reason I've avoided the Total Bond Market Fund. I thought to keep a year of cash at ING Direct, whose rate seems to be the same as a 1-year CD. Advise sought.
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Scott if this is an open ended fund, and it looks that way to me, you are in for a long downward ride if the people who predict interest rates are correct. If it is a closed end fund, sooner or later you will get the face value of the bonds out.

Bonds will not go up until interest rate start going down and it is hard for interest rates to get below zero.

Gordon
Atlanta
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I would like to at least break even at $10,000

Over the years I have read messages like that but it is an emotional response, not a financially sound one.

Your fund is costing you 1.48%/yr (annual expense ratio, 1.00% of that is just the 12b-1 fee), so with a fund yielding only 3.93% (trailing twelve months), a lot more could be realized by reducing the expenses.

Contrast that against, say, the Vanguard Total Bond Market Fund, which costs only 0.22%/yr (annual expense ratio) and has a yield of 4.43% (trailing twelve months).

So, if the funds continue this coming year like they did the past year, you would break even faster in VBMFX than you would by staying in OIMCX. Also, by getting out of OIMCX now, you would have a small capital loss that you might be able to use to reduce your income taxes.

The above is comparing somewhat different funds and their behavior may differ in the future as interest rates rise--different sectors of bonds may experience different rate increases and that could affect the funds differently because they have somewhat differing portfolios, but the message is the same: it is better to move your money where it best meets your investment plan than it is to "break even" in OIMCX first.

Depending on how fast bond rates rise (and thus the value of existing bonds decline), it is possible that other instruments might be better, e.g., one person suggested CDs. Another possibility is savings bonds, which aren't subject to capital losses.

I personally have a chunk of my money in savings bonds (mostly with the intent of using it as the less liquid part of my emergency fund) and a chunk in the Vanguard Total Bond Market Fund (as part of my long-term asset allocation plan, so short-term losses are considered possible and not a serious cause of concern for my investment plan).
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"We've been sitting in Vanguard's Short-Term Bond Index, reinvesting dividends. With the idea of keeping 5 years of future income in cash, I've been planning to build a 5-year CD ladder at Vanguard, starting with 2 and 3 year CDs, and rolling into longer term CDs each year. I've been reluctant to tie money up in 4 and 5 year CDs in the current low interest rate environment, and that's the same reason I've avoided the Total Bond Market Fund. I thought to keep a year of cash at ING Direct, whose rate seems to be the same as a 1-year CD. Advise sought."

db,

Thanks. No good advice available. All of us who refuse to plunge more money into the stock market or market time have been stuck between a rock and a hard place. It swallowed hard when 5-year CDs hit 5% but continued to ladder with spare change down to 4% (I let new money sit in the money market when rates were below 4% for about 6 months). I think this strategy will work better than having let it all sit waiting for rates to go up, because they didn't and would still have to go up pretty quickly to make up for lost interest while waiting.

If you've got a big sum, I'd get 1,2,3, 4, 5 year CDs and start a ladder. With new money, I'd just keep buying 5-year CDs and roll over into Total Bond Fund or something when they come due, if rates look less risky.

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>>I would like to at least break even at $10,000...<<

People have probably lost as much money "waiting to break even" as from any other cause in investing.

The market doesn't know your break-even point and it doesn't care how much you lose.

Look at each market position in terms of the future. You have x dollars as of today that could be invested in something else, including cash, versus leaving in an underwater position that may lose more. Never think in terms your cost basis when evaluating investment positions.

Just my 2 cents.

P.S.: I paid a lot to learn this lesson.
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You said

"Bonds will not go up until interest rate start going down and it is hard for interest rates to get below zero."

Can someone explain the mechanism behind that ?

Thanks, Scott
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"I would like to at least break even at $10,000...<<"

Lesson learned :).

"including cash"

That't the ticket in our case - I think we will just put it in a high yield (high not being what it used to) savings account.

Thanks, Scott
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"Bonds will not go up until interest rate start going down and it is hard for interest rates to get below zero."

Can someone explain the mechanism behind that ?


Scott,

I think you already understand this, but the comment was confusing. The price for which you can sell a bond depends on what it's coupon is (the interest rate it pays). If a new bond of similar risk and maturity (e.g., you own a 10-year Treasury and the government issues new ones) has a different interest rate, the bond you already own would sell for more or less than the face value you paid for it to compensate for the higher or lower interest rate on the new bond. So, if you (or a bond fund in which you own shares) bought a bond when interest rates were very low, interest rates would have to go even lower in order for the sales value of your bond to be more than you paid for it (i.e., "bonds going up"). More likely, you would have to sell for a loss, because interest rates would have gone up. Of course if you bought a bond with a zero interest rate as the extreme case, you would never be able to sell it for better than break even.

The terminology gets confusing, because the price on bonds goes up as yields go down and vice versa.
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Scott -- I made two statements

The easy one relates to bond rates can not go below zero. To go below zero, the lender would have to pay someone to borrow money. While it is possible, that event is very unlikely to happen. (This would be like a bank paying you interest to take a mortgage on your house.)

The relationship between interest rates and bond prices is also simple, but I at least do not know any short explanation -- so bear with me here.

A Bond is an agreement between two people. The Borrower promises two things #1 To return the money at some point in the future (when the bond matures) and to pay an interest payment periodically.

For simplicity, let's say the interest is paid once a year and the bond is for $10,000. Also let's say the interest rate on the bond is $10% and that the bond is a 30 year bond. That means you gave $10,000 to the Borrower and the Borrow will pay you $1,000 each year in interest.

OK something magic happens the day after you buy the bond and interest rates are now 6% a drop of 4% from when you bought the bond. If you want to buy a second $10,000 bond you will get annual interest checks of $600 on the new bond. But the old bond will still pay you that nice $1,000 every year. Which bond do you think is more valuable?

Now let's say for some reason you want to sell the old 10% bond. Naturally you want to sell it at the highest price you can. Well that bond pays $1,000 a year – so it will be worth more then $10,000. If I want to buy a bond paying me $1,000 when rates are 6%, I would need to buy a $16,666.67 bond. (such bonds don't exist, but we can pretend).

In the real world of buying and selling bonds, there are lots of things affect the value of the bonds. Things like who the lender is, where the bond is sold, and how many years the bond has left before the principle is returned.

Now what has happened to your bonds (actually the bonds owned by the mutual fund you bought) is just the opposite – interest rates have gone up.

If the day after you bought a $10,000 10% bond, the interest rates went up to 15% this is what would happen. If you had an additional $10,000 you could get a second bond that would pay you $1,500 every year. But if you wanted to sell your first bond, nobody would pay you $10,000 – That bond only pays $1,000 a year. With the 15% interest rate, one only needs to invest $6,666.67 to get $1,000 in annual interest.

Hope this helps.

Gordon
Atlanta
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