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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: of 35357  
Subject: Re: Bonds going up or down ? Date: 6/10/2004 11:28 AM
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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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