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Author: matt8745 One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35400  
Subject: EBlakemore Date: 5/9/2000 7:39 PM
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Please read my original question. It's #621 on this board. I like some input to the issue I stated.
Thanks,Matt
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Author: EBlakemore Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 655 of 35400
Subject: Re: EBlakemore Date: 5/9/2000 9:56 PM
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Matt, Re: Why Bond funds?

I thought I had addressed your questions, but let me boil down my thinking to the exec. summary version.

First off, I hate funds.

I especially see little use for bond funds, for many of the reasons that others have discussed here, as well as my general distrust of the level of "expertise" of bond fund managers, and the tricks fund managers must play to deliver marketable returns, compared to what I could do at home. My strong feeling is that funds (and their intellectual ancestors, the 1920s investment trusts) embody far more risk than those marketing them will freely and in plain language admit.

So if you ask me "Why should I own bond funds?" my simple answer is "You shouldn't." But then I also feel that neither should people open themselves up to the uncharted (and, I feel, insufficiently disclosed) risks of equity funds.

I do feel that the risk/reward ratio is *probably* a little better for holders of equity funds as a class, and there are also exceptions I might make for a handful of fund managers who have gained my respect over the years in running specialty funds that invest in ways that I would find difficult to do at home.

Putting aside my dislike of funds, please refer to my previous message for the details on why I feel that owning bonds (not bond funds) provides a *different* and important form of portfolio insurance that MMs and equity funds (by and large) are unable to provide.

It is *possible* that investing in a small portfolio of established, dependably dividend-paying common or preferred issues *may* give you similar current income protection in retirement, but *nothing* guarantees that any common stock will pay dividends in perpetuity, and even those that do pay out earnings to shareholders may find themselves forced to cut dividends in a long-term downturn. If that decade (or generation or century) of tight earnings growth is preceded by a collapse in equity prices it will be too late to rebalance towards bonds without taking a major hit in the value of your remaining principal.

Of course, I also don't know the details of any pension, profit-sharing or other sources of retirement income you may be looking forward to relying on. If you already effectively *have* a good deal of stable, guaranteed income in the form of pension, annuities or other sources, there may be no real benefit to you personally in heaping up more bonds, when chances are good that you are holding a significant chunk of bonds by proxy in those other instruments.

My 2 cents, compounding at some unknown rate, possibly negative... {smile}


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Author: matt8745 One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 658 of 35400
Subject: Re: EBlakemore Date: 5/11/2000 5:15 PM
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Thankyou for your input. I have a pension and will supplement the pension with my mutual fund investments, all of which are taxed deferred. As I mentioned, I may or may not draw out any money at the age of 60. I am currently 55. My feeling is to keep about 25% in MMs for immediate liquidity, if needed and the rest in various types of equity portfolios. I don't believe in bond funds, but everyone seems to think I need these as part of my allocation. The response on this board has been primarily agreeing with me. All other boards I have posted this question never answered my question. They have just responded by giving me the standard answer about asset allocation that usually includes bonds as part of the allocation.

I do have a question for you. Since all of my investments are in tax deferred accounts with several mutual fund families , how do you purchase INDIVIDUAL BONDS with these monies?
Thanks, Matt

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Author: EBlakemore Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 660 of 35400
Subject: Re: EBlakemore Date: 5/12/2000 12:08 AM
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Matt,

I'm not trained as a financial planner, and in fact finding an advisor to double check my baseline assumptions on our investment, tax and estate planning (and whatever else comes up) is on my *things I should have done three years ago* list. <g>

I may be misreading your question so ask again if I miss the point, but I take it that these are 401ks or similar plans where you have a menu of choices, and those seem to be the only permissible choices? I guess my first step would be to grill the plan administrator and see if you can pressure them to give you the option of buying bonds directly within the plans. They may or may not have that flexibility. I know I've had trouble getting satisfying answers by way of my spouse, whose tax-deferred accounts are some of our major holdings outside of our home and various partnership interests.

One piece of advice I've heard from several planners I've auditioned so far, and seen over time in WSJ personal finance and other sources is to do much of your bond investing in taxable accounts, *especially* munis, if your present bracket makes them an attractive option. Some strategists seem to suggest that one should allocate nearly *all* of your tax deferred accounts to equities, to maximize the tax deferral benefits which are much stronger for stocks under most conditions than they are for bonds you buy and hold to maturity.

After all, with bonds you are only taxed on interest and, if you consistently buy your bonds above par, you can book an essentially meaningless loss at maturity. The effective yield to maturity tends to be the same, dollar for dollar, for an above par bond as it is for one sold below par. Unless I'm mistaken on the tax code, you should then be able to use such per "losses" to offset any capital gains you may be taxed on if you have a taxable stock portfolio in addition to your pension, 401ks and whatnot.

Since most munis are entirely tax free, if you limit yourself to issues in your home state, there is virtually *no* real benefit to holding these in a tax deferred account. Obviously I don't know enough about your finances as a whole to know how much of this may apply in your case.

Best to get a detailed answer from a credentialled planner on the details there. So far I only hold one muni, though my plan is to increase and ladder my muni holdings over the next year or two. Somewhere in there I'll probably also be looking at other parts of the bond market, especially if we see a strong decline and signs of a short-term bottom in bond prices soon.

Since I see lots of reasons that we *may* see further declines over the next year or more, I'm not exactly in a rush right now to load up on bonds, but the macro picture is so hazy right now that I should really be paying close attention for indications that rates are possibly peaking, at least for a few months. I may well be missing some exceptional short-term lows right now, in advance of the next generally-anticipated Fed rate hike.


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Author: TMFSynchronicity Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 661 of 35400
Subject: Re: EBlakemore Date: 5/12/2000 12:48 AM
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[I]f you consistently buy your bonds above par, you can book an essentially meaningless loss at maturity. The effective yield to maturity tends to be the same, dollar for dollar, for an above par bond as it is for one sold below par. Unless I'm mistaken on the tax code, you should then be able to use such per "losses" to offset any capital gains

Actually, the tax advantages are minimal, and you are better off amortizing the premium instead of taking the capital loss.

Just to clarify a point here (I used to deal with this way too much at my old job), if you purchase a municipal bond at a premium, you have to amortize the amount of the premium until maturity. You would reduce your tax-exempt interest each year by the amount amortized. This shouldn't effect your taxable income in most situations, but it does mean that if you hold to maturity, you will have neither a gain nor a loss.

If you purchase a taxable bond at a premium, you have the choice of either A) amortizing your premium each year, and reducing your taxable income by that amount, or B) not amortizing, and taking the capital loss on maturity. You'd rather take an ordinary loss now, instead of taking a capital loss later.

If you purchase a bond at a discount (not an OID bond), and hold to maturity, that amount of discount will be considered to be additional income, NOT capital gain. IIRC, you can either recgonize that each year, or recognize it all upon maturity.

OID bonds must have that discount recognized each year until maturity, as I'm sure most of you know.

The Tax Strategies Board has more information on these issues, and they're covered in sections 1271 thru 1278 or so of the Internal Revenue Code, for all the tax geeks out there.

hope this is helpful,

-synchronicity



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Author: EBlakemore Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 663 of 35400
Subject: Re: EBlakemore Date: 5/12/2000 8:44 AM
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Thanks for the correction. I've only gotten rid of one muni so far, and did that in an asset swap with a family member. I'm working from memory here, but I thought my accountant handled it as, if memory served, a capital loss, since we got cash that was somewhat less than our cost basis for the bond, held onto our accrued interest, and booked the transaction as a loss against the best estimates we could present on market value at the time of the trade.

Then again, since I stopped doing my own taxes a few years ago, I haven't always examined every single line or questioned his way of doing things and I don't follow tax code changes very closely at all, except when changes come up due to new twists in our personal/professional finances and I'm asking him how to best keep the necessary records.

I'll definitely have to talk to him about this, as it appears I was working under a misconception, and did buy the lonely little muni in my port at a slight premium to par, though frankly I bought it *mainly* because the tax-equivalent yield was attractive (about 8.8% counting presumed Federal and NJ rates).

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Author: TMFSynchronicity Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 665 of 35400
Subject: Re: EBlakemore Date: 5/15/2000 1:51 PM
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I thought my accountant handled it as, if memory served, a capital loss, since we got cash that was somewhat less than our cost basis for the bond, held onto our accrued interest, and booked the transaction as a loss against the best estimates we could present on market value at the time of the trade.

It's possible to have a gain or loss on the sale of a bond (just not at maturity). For example, say you find a 1,000 face value muni paying..oh, 8% interest (real high rate), that matures in 5 years. You pay 1,100 for it. Basically, every year you'd amortize that 100 premium by about $20/year. (it's really a constant rate calc instead of a straight line calc), and reduce the tax-exempt income you report by $20 each year.

After two years, you decide to sell the bond. Your basis would now be 1,060. Say rates have gone up and you're only able to get 1,010 for it. You'd have a capital loss of 50 bucks.

Of course, if you held to maturity, you'd amortize the entire hundred bucks, so your basis would be 1,000, and the amount you'd receive on disposition would also be 1,000.

This is similar to the OID rules, where you have to report a certain amount of OID as "income" each year. Otherwise you could purchase OID bonds and sell them after holding for at least a year, effectively converting ordinary income into (lower-taxed) long term capital gain.

The concepts are simple, but the calculations can get pretty complicated.

hope this is helpful,

-synchronicity

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