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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35365  
Subject: CD Ladders vs Bonds vs Bond Funds Date: 4/24/2003 1:23 PM
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Just posting my recent thoughts on these competing investments.

CD Ladder:
Total return=the interest rate. Cap gains/loss is irrelevant.


Bond Ladder (or Tradable CD Ladder):
If interest rates rise, you hold til maturity. Identical to a CD Ladder. If interest rates fall, you may choose to sell, realizing a cap gain. However when you reinvest your new rate will be proportionally lower, offsetting your cap gain. Thus, unless you plan on spending the money or investing in another asset class, there is no benefit to realizing the cap gain, except that you can take advantage of the lower cap gains tax rate or to realize a cap loss.


Bond Fund:
Once you've owned the fund until the bonds that were in the fund when you bought it mature, it's identical to the Bond Ladder (except you can't selectively realize cap gains). However, when you buy into the fund, you're getting a bond basket that isn't trading at par. With the ladders above, all of your investments were trading at par initially, so you're never in a situation when you paid $15,000 for the bond, but only got $10,000 when it matured.

Take for example Vanguard's Intermediate Treasury fund, VFITX. The average coupon is 5.3%, and the Yield To Maturity is only 2.9%. You are therefore paying a significant premium for the bonds in the fund. This is offset, of course, by the higher coupon these bonds pay. The question is: Does this matter? When all the high yielding bonds are flushed out (assuming interest rates stay low), how will total return be affected?

Nick
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