UnThreaded | Threaded | Whole Thread (14) | Ignore Thread Prev Thread | Next Thread
Author: mrslonz Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35351  
Subject: Bonds vs Bond Funds Date: 1/31/2002 6:07 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
I'm trying to help my dad make the wisest decision he can about how to invest funds he just received on an individual Bond that was called early. He likes to buy highly rated (AAA)Muni Bonds but right now it looks like he'd be looking at only about 4%-4.2% return on bonds with maturities from 7-9 years from now and up to 5% if he was willing to hold maturities of 20-30 years.

I was starting to direct him towards Vanguards Intermediate Term Tax Exempt Bond Fund (VMITX)but after reading many of the posts here I'm concerned that I might be setting him up for a loss in principle if he was to move into this fund at this time.

Morningstar rates the fund as 4 stars--below average risk, above average return. It's average return has been 4.52% over the last 3 years (4.5% after taxes). I know he'll still have to pay state tax on this fund, though it will be federally tax free.

My dad uses the interest checks from his investments to pay monthly expenses, but doesn't intend to touch the principle for the foreseeable future.

Can anyone provide some advice so I can help him make the most informed decision?

Thanks!
Print the post Back To Top
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: 2914 of 35351
Subject: Re: Bonds vs Bond Funds Date: 1/31/2002 7:18 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
When bonds get called it is always because the issuer of the bond can get cheaper money elsewhere. Therefore, in a time of low interest rates there are a lot of bonds called. My sympathy.
For the reasons you mention, buying bond funds at an interest rate low isn't a good thing.
If you buy a bond, at least you will get your principal back at maturity.
I'd try to mark time with a CD for a year or two, with the hope of being able to buy a bond at a lower price when the CD comes due.
I'm assuming your dad doesn't have the option for what I'm doing now when bonds are called, which is pay down my mortgage. I want to retire in several months and it would be useful to not have that need for cash flow. Generally I don't approve of paying mortgage early (very difficult to refinance if one has a serious medical problem and tubes from every orifice) but under the circumstances it seems my best option.
Best wishes, Chris



Print the post Back To Top
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: 2915 of 35351
Subject: Re: Bonds vs Bond Funds Date: 1/31/2002 11:13 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
"I'm trying to help my dad make the wisest decision he can about how to invest funds he just received on an individual Bond that was called early. He likes to buy highly rated (AAA)Muni Bonds but right now it looks like he'd be looking at only about 4%-4.2% return on bonds with maturities from 7-9 years from now and up to 5% if he was willing to hold maturities of 20-30 years."

This is an awful time looking for fixed income investments. As far as I can see, there are no good options, so we need to look for least bad choices.

"I was starting to direct him towards Vanguards Intermediate Term Tax Exempt Bond Fund (VMITX)but after reading many of the posts here I'm concerned that I might be setting him up for a loss in principle if he was to move into this fund at this time."

Vanguard's Intermediate Tax Exempt is the one I've been eyeing. It's too risky for me at the moment, but I'm looking at a 5-year CD as the alternative. In your father's case, it may be worth running a different calculation. I'm not expecting interest rates to sky-rocket any time soon, just go back up to maybe where they were in Dec. 2000, before the Fed started cutting. EE bonds were 5.7%, which I think is a good high end benchmark, with the current 4% as the bottom end. So, the likely downside risk to the NAV would be somewhere in the 5-8% range (1.7 max. x 4.7 duration). Current yield on the fund is 4.4%, though I would guess that would go up as interest rates go up—let's guess 4.7% over the next 5 years. At that rate, $10,000 investment (not compounded) would yield $2350 over the 5 years. If the NAV dropped 8%, that would be a loss of $800 principle (with tax loss of, lets say, $200), for a total return of $1750. So, the question is, can you beat that? That's just about what I can get with a 5-year CD right now (after taxes). It sure beats a money market or a 1 year CD. If interest rates go up to 5% EE bond in a year, then a 1-year CD followed by the bond fund would work better than putting the money into the bond fund now. Probably not if it takes 2 years to reach 5% EE bond.

"Morningstar rates the fund as 4 stars--below average risk, above average return. It's average return has been 4.52% over the last 3 years (4.5% after taxes). I know he'll still have to pay state tax on this fund, though it will be federally tax free."

Those return figures are next to useless, since they combine NAV and interest paid. You really need to separate the NAV and the interest rate parts, which is what I tried to do above. For bond funds Vanguard has the lowest fees and no loads, according to Fortune or Forbes or somebody listed on the Vanguard site a couple of days ago.

"My dad uses the interest checks from his investments to pay monthly expenses, but doesn't intend to touch the principle for the foreseeable future."

It would help to know his overall situation. If he's going for tax free bonds, I'm assuming he has a reasonable nest egg, because if you're below the 30% tax bracket, unless you are getting state specific tax exempt bonds, munis make no sense. If so, it might be worth looking at an alternative for a year or two, with the idea of going for a tax exempt fund (preferably long term by that point) when interest rates go back up. You might want to consider one of Vanguard's balanced funds (mixed stocks and bonds). I know lots of retirees are scared of anything involving stocks right now, and who can blame them (I'm scared). But if you look at the STAR Fund, it was only down 4% for 1 year at the end of October, at which time the S&P was down over 20%. It might not be something you'd want to drip money from every month, but if he has other sources of income, STAR or one of the other blend funds might do as a placeholder until interest rates go up. Others to look at would be Wellington, Life Strategies Conservative Growth, Life Strategies Income, and Wellesley.


Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
Author: brucedoe Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2916 of 35351
Subject: Re: Bonds vs Bond Funds Date: 2/1/2002 7:57 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Because bond interest is low, the value of bonds is high and as interest rates increase the price of bonds will fall. Thus this is not a good time to buy a bond fund from the perspective of the NAV. But it sounds like your father doesn't need to touch the principal, at least for the forseeable futute, so maybe the principal isn't an issue.

You might look into "bump up" CDs. for example, on occasion I buy one of these "double bump up" three-year CDs from Independence Federal Savings in Washington, D.C. If rates go up significantly, I can "bump up" twice. I've done the bump up several times over the years. But you pay a small penalty for this right (I think lately they are paying $3.4%).

As to muni's, you have to pay attention to the call date as well as the maturity date. There is a good chance that a muni bought now will never be called because of the unusually low rates. But you can still get around 6% on revenue bonds, the last I looked. Some of these are highly rated.

brucedoe

Print the post Back To Top
Author: mdpeterso Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2917 of 35351
Subject: Re: Bonds vs Bond Funds Date: 2/1/2002 8:19 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Generall advice (sorry if this is stuff you already know):

You can protect yourself from interest rate risk by buying individual bonds and holding them to maturity. You are exposed to this risk with bond funds.

Your income stream is more predictable with individual bonds.

Reinvestment risk is more accute with individual bonds (esp ones that are callable) than bond funds. Your father is experiencing this first hand now.

Interest rates have bottomed out. This does not bode well for bond funds, whose NAV will fall as interest rates rise. It also does not bode well for reselling any existing individual bonds. (However, this doesnt enter the picture if holding until maturity).

A milquetoast suggestion: Some of both?

A short term bond fund to ride out the interest rate risk. (The shorter the average weighted maturity, the less volitile the bond fund is to interest rate risk.)

Some individual munis to provide a dependable stream of income.

I'd think twice about buying long term bonds, or bond funds, in the current interest rate environment.

Hope this helps,
Mark in MD

Print the post Back To Top
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: 2918 of 35351
Subject: Re: Bonds vs Bond Funds Date: 2/1/2002 8:56 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
A really good place to get a sense of both annual interest yields and fluctuations of NAV (i.e., capital gain or loss on your initial investment) is in the annual report, which you can download from Vanguard Web Site. For the Intermediate Tax Exempt (report from Oct. 2001), see the Performance Summary (the list underneath, not the chart) that shows the interest and capital gains/losses for each of the last 10 years, on p. 24 of the PDF (I didn't check what page that was of the report); p. 26 is for the Long Term Tax Exempt. You might also want to download the report for the Taxable Bond Funds (not bond index funds) and look for the analogous Performance Summary data for short, intermediate, and long. Helps show that interest rate risk is very real, but also puts it in perspective.

Print the post Back To Top
Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2921 of 35351
Subject: Re: Bonds vs Bond Funds Date: 2/1/2002 1:06 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Lokicous makes an excellent point when he says:

"Those return figures are next to useless, since they combine NAV and interest paid. You really need to separate the NAV and the interest rate parts . . . ."

Note that the bond fund total return figures from '01 include the full effects of all the interest rate cuts made by the Fed last year. Those cuts are not going to continue in '02 (according to current best thinking), so over the next few years NAVs will be stable or decline in most bond funds as interest rates start to rise again. Total return can be expected to be negatively effected by interest rates.



Print the post Back To Top
Author: mdpeterso Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2923 of 35351
Subject: Re: Bonds vs Bond Funds Date: 2/1/2002 1:30 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
"Lokicous makes an excellent point when he says: "

>Those return figures are next to useless, since they combine NAV and >interest paid. You really need to separate the NAV and the interest >rate parts . . . ."

"Note that the bond fund total return figures from '01 include the full effects of all the interest rate cuts made by the Fed last year. Those cuts are not going to continue in '02 (according to current best thinking), so over the next few years NAVs will be stable or decline in most bond funds as interest rates start to rise again."

"Total return can be expected to be negatively effected by interest rates."

I suppose then look for the yield thats quoted, especially by Morningstar. I know they have it on their premium reports. Or your fund choice may be featured in the "FundInvestor" newsletter. Luckily my public library subscribes.

If you cant find that, then look at the financial highlights of the fund in the prospectus and observe what the income distributions were throughout the year. Then figure out the yield based on the NAV at the time of the distribution.

For a *very rough* estimate, use the current NAV and whatever the distribution was.

Mark in MD

Print the post Back To Top
Author: wisenlucky One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2925 of 35351
Subject: Re: Bonds vs Bond Funds Date: 2/2/2002 2:06 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Crosenfield,

You seem to have a lot of experience in bond investing. This is a very simplistic question, but how does a small investor buy bonds as opposed to bond funds? Do you go through a regular discount broker? Or are there brokers who do only bonds?

WiseNLucky

Print the post Back To Top
Author: clout100 Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2928 of 35351
Subject: Re: Bonds vs Bond Funds Date: 2/2/2002 9:08 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Crosenfield,

You seem to have a lot of experience in bond investing. This is a very simplistic question, but how does a small investor buy bonds as opposed to bond funds? Do you go through a regular discount broker? Or are there brokers who do only bonds?

WiseNLucky
--------------------------------------------------------------------

I'm not Crosenfeld, but I might be able to answer your question. Several of your big-name discount brokers offer individual bonds for small investors. E-trade is one I'm most familiar with.

Another alternative to comsider is a "bond" unit trust. This kind of unit trust is simply a collection of 5 or 10 different bonds which are bundled together. It's somewhat like a mutual fund, except you know which bonds you're invested in and you have a fixed maturity date. Your investment value will fluctuate with interest rates during the period you're invested. But you'll get your principal at maturity. Unit trusts are typically offered at full-service brokers and do charge commission. Check out these sites for more information: nikesec.com & ranson.com.

Richard

Print the post Back To Top
Author: imcharliehm Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2931 of 35351
Subject: Re: Bonds vs Bond Funds Date: 2/2/2002 9:32 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
I'm not Crosenfield, who most definitely is a reliable source of bond info and judgment, but I'd suggest that WHERE to buy is the easy part, namely any broker you do business with, unless its strictly a DAT firm like IB.

WHAT to buy is the tough part, though here again, there are easy parts and hard parts to the problem. Treasuries are no-brainers. In fact you don't even need a broker and can buy them directly from the Treasury Dept in a little as $1,000 increments. Just pay attention to the yield curve and Fed policy and buy T-bills, notes, and bonds when they're on sale.

How do you know when they're onsale, you ask? Get a hold of any introductory book on bond investing, with my favorite being Sharon Saltsgiver Wright's "Getting started in Bonds", and well as hit the major investment sites like SmartMoney, which have tutorials and tools, like yield calculators and living yield-curve demos.

Corporates are a bit harder. At a minimum you should know how to do fundamental analysis to the same degree that you do for your stock research, unless you want to stick strictly with the upper-tier credit stuff and depend on the informed, reliable, and impartial judgments of the rating houses like S&P and Moody's.

For spec-grade bonds, your choices of where to buy narrows considerably, with most brokers reluctant to make the trade unless you know what you're doing and explicitly tell them that you're making an unsolicted trade. Also, the research requirements increase dramatically. For junk bonds, I think E*Trade does a good job.

Lastly, be aware that bonds are mainly an institutional game to which small retail investors are uninvited and unwelcome and that spreads are atrocious compared to stocks. But be persistent. Buying your own bonds is way better than bond funds, IMHO, because you can hold to maturity rather than suffer the market risk of bond funds. Also, be aware that right now things are as tough and uncertain in the bond market as in the stock market, compared with the easy money of two years ago.

Charlie


Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
Author: wisenlucky One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2934 of 35351
Subject: Re: Bonds vs Bond Funds Date: 2/3/2002 6:59 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
clout100 (Richard),

Thank you! I cut and pasted your response to my desktop as I soon won't have access to these boards.

Thanks so much to all of you for the help you've given me over the last few years where I've been almost exclusively a lurker on this board.

WiseNLucky

Print the post Back To Top
Author: wisenlucky One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2935 of 35351
Subject: Re: Bonds vs Bond Funds Date: 2/3/2002 7:02 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Charlie,

Thank you as well. I've archived your message to my desktop as well.

WiseNLucky

Print the post Back To Top
Author: hackshark Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 2940 of 35351
Subject: Re: Bonds vs Bond Funds Date: 2/3/2002 8:31 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Generally I don't approve of paying mortgage early (very difficult to refinance if one has a serious medical problem and tubes from every orifice) but under the circumstances it seems my best option.


Another lesson taught to us from depressions past is the fear of debt.

I'm willing to bet that anyone from previous depressions would find it prudent to carry any debt while trying to save. Why are country became so addicted to debt is a mystery to me, but I suspect it has a lot to do with marketing by the financial establishment and the housing industry porkbarrel known as "mortgage interest deduction".

It would be interesting to add up all of the interest paid by the average american over a lifetime. This interest remains a drain throughout the typical person's life, stealing resources. The benefit of such debt-riddent lifestyle is debatable. If it were a one-time occurence then one could make a reasonable argument that it allows a person the chance to get out of emergencies. however, debt is typically anything BUT a relief from emergency situations. Heck, who pays cash for ANYTHING these days? Cars, appliances, and homes, all on the big credit card.

The bottom line is: you can't spend more than you have. Debt only creates the illusion that you can. It catches up with you. It makes no sense to me to invest anything while one is in debt.

Once you stop looking in terms of portfolio value, and start looking in terms of net worth, the meaning of my words becomes obvious.

-hack

Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
UnThreaded | Threaded | Whole Thread (14) | Ignore Thread Prev Thread | Next Thread
Advertisement