I"ve decided that I want about 20% of my IRA invested in bonds - total retirement savings is about 50K and I have about 35 years until retirement. So about 10K would be in bonds (of course contributing more every year). Currently invested in BND (vanguard bond index fund) but I was wondering if it would ever make sense to invest in individual bonds instead. I"m thinking it is only worth it if I have a minimum invested so that I can diversify (probably need much more than 10K) and if I hold bonds until maturity. This way I have to worry less about interest rate changes. Any thoughts on this?Second and related question: are there any recommended brokers for bond trading? I currently have my IRA with TD Ameritrade, I'm not sure if their fees are competitive.
At the suggestion of a number of people at this board, I started an account with E*trade last year. They have a good corporate and municipal bond selection and the cost of a trade is $10 for up to 10 bonds and $1 per additional bond if you buy more than 10 at a time.Many sellers will allow you to buy one bond at a time while others require you to buy lots or 5, 10, or more. Look up some posts by junkman (now salispedes?). He details his bond portfolio in a number of posts and he frequently buys just one bond at a time. Junkman also recommends ZionsDirect as another good bond brokerage.Look through past posts to get a variety of opinions on bond investing. Junkman stands out as a more aggressive bond investor (in his portfolio posts, he shows the bond ratings of his purchases) while others are far more conservative.I hope this helps!
I was wondering if it would ever make sense to invest in individual bonds instead.You certainly can invest in individual bonds with the amount you are suggesting. The advantage of individual bonds is that you lock in your income stream and your return at purchase if you hold to maturity. This provides total portfolio stability when the stock market is on a roller coaster ride. The flip side of the coin is that individual bonds aren't as liquid as a bond fund and if prices suddenly become more favorable after you have spent your allotment it isn't as easy to switch and capture those better prices. This way I have to worry less about interest rate changes.Interest rate changes do need to be part of your consideration when you layout the guidelines for your bond port. You may decide, with as many years as you have to go, that you are going to consider interest rate changes lightly and worry about other issues. With about 10 bonds to work with you need to consider what quality paper you want to buy. How much you are going to worry about industry weighting. What maturities to hold. How are you going to make your selections. Are there any conditions where you won't hold to maturity. Examples:You could buy 3 1yr, 3 2yr, 3 3yr - at the end of every year roll over what matures into the next three yearYou could buy 2 1yr, 2 2yr, 2 3yr, 2 4yr and 2 5yr; rolling 2 bonds out 5 years as they mature. You could buy 3 28yr, 3 29yr and 3 30yr and add a 30 year or two when you get the money. You could also scatter plot the maturities if you liked the prices you are getting. Generally if we believe prices are going to fall(rising yields), we want to be weighted toward the short end of the maturity range. So we can buy into a rising market. At some point down the road when you/we believe that the market is about to turn the other way and prices start to rise(falling yields) you might want to reach out further on the maturity range so you/we can hang on to those higher yields longer. There a dozens upon dozens of good smart ways to build a bond portfolio. In the end you need to experiment some and find what works for you. You will make mistakes. You will buy at the wrong time. You will buy the wrong thing. You will miss out on some yield. You might even have a note or two crater on you. The good news is you have 35 years to retirement; a few lumps and bumps along the way will prepare you to manage your money better during those retirement years when far more of your portfolio might be weighted toward bonds. Bond funds both puts principal at risk and can capture principal appreciation, it is the nature of the beast. Buying bonds and holding to maturity locks that money up until maturity; for good or bad you will miss the interest rate move. thoughts? Questions?jack
The major problem with owning bonds themselves is that usually you must buy them from a bond dealer and sell them to a bond dealer. The bond dealer has a bid ask spread in each direction. Most bonds are traded over the counter. Those that are listed are not available to small investors at those prices. Hence, you never know what the market price really is (except by comparison with similar bonds offered by other dealers).For these reasons, most individuals must hold their bonds to maturity. So you buy quality bonds and sell them only in case of some emergency. You usually must own at least $5k of those bonds to get any kind of offer for them. And often bid ask means selling will cost you a year's interest or more.The large holding requirement also makes it difficult to diversify.You can avoid most of these problems by buying Trust Preferred stocks. These are essentially long bonds which are listed and traded on major exchanges as preferred stocks. That means market prices are quoted and you can track them once you learn the stock ticker. They are traded at discount broker commissions. You can buy as little as one share, often at $25 or less. They are available in a full array of bond ratings from AA down to junk ratings. So you can construct a portfolio, buy and sell at will, and move in and out of risky position as the market warrrants.The best source of information on these is QuantumOnLine.com. But I post a list of many of them occassionally. The most recent one is in message 28791 on this board. See them here--http://boards.fool.com/Message.asp?mid=28037457
I'll second that.My first thought was: With that long until retirement, any significant bond allocation is just wrong. An unwarranted fear of stock-market declines that drive some people toward the "safety" of bonds will cost them dearly in after-inflation dollars.My next suggestion is: Unless you have a much larger amount to invest, 35% of 50K is way too small to get a safe diversity in bonds. If you really really want to do it, preferred stocks is probably the way to go. In addition to quantumonline.com take a look at http://www.preferredstockinvesting.com I've bought a lot of preferreds in the last year, with a overall very generous average yield, and a pretty large capital gain. The prices have drifted up and current yields are lower now, but there's still a lot of good ones to be found.
Unless you have a much larger amount to invest, 35% of 50K is way too small to get a safe diversity in bonds.I strongly disagree with this advice. If 10 stocks is a reasonable diversity than 10 bonds is reasonable diversity; any way you look at it 1/10 of the assets allotted are exposed to the risks of a single holding. Its this logic that forces people to put the capital that they want to invest in bond like objects to protect principal and earn a bit of a return into asset classes that put principal at risk. No one argues it would be poor investing to buy 10 CDs and build a ladder while it apparently it would be poor diversification to attempt the same with 10 Federal Treasuries, heaven forbid we even consider buying A+ - AAA debt. A sharp switch in interest rates can carve 10% out of the NAV of a bond fund which would be no different than having 1 bond out of ten completely fail. The principal of the holder of the 10 CDs or the 10 Treasuries is safer than either the bond fund or the 10 corporate bond portfolio and usually priced (yielding) accordingly. This whole site was founded by the belief that individual small investors can learn how to properly perform Due Diligence on companies and make smart stock picks. Yet, the same apparently doesn't hold true for bonds, the safer of the two ways to buy into a firms business. This mentality keeps people out of bonds, if this myth is dismissed it opens up many opportunities.There are dozens of well run companies that are so well run that I, as a value investor, can rarely buy their common stock. I can usually buy their debt at a much more competitive price. There are hundreds of rebound companies where their stock price is also too pricey; I can buy their debt. And if I want the safety of of Federal backing and easy market access liquidity I can buy treasuries. If you want to buy 1 bond to add or start your "bond-like" portion of your portfolio than buy 1 bond. If you want to buy 10 than buy 10, if you want to buy 100 then buy 100. The only caveat is that the shopping and the managing needs to be done intelligently. If you don't know how to perform DD on firms then you will not be able to intelligently pick corporate bonds. If you don't know how to manage a bond portfolio then start small so you can make mistakes and learn without tearing up your "bond-like" assets. In order to start small you need to toss in the garbage heap the idea that 5k or 10k is not enough capital to buy smartly into bonds. A far worse approach would be to save 50k - 100k and use that capital to learn how to manage your own bond portfolio. The magnitude of the mistakes are amplified in the larger portfolio not diminished by diversification; ignorance is the enemy, the hurdle to over come, not quantity of capital. Preferred stock is a useful tool as long as you understand what it is.http://www.investopedia.com/terms/p/preferredstock.aspThis means that not only can you capture capital gains you can lose capital. They are traded shares with prices set throughout the day, the price goes up and down over time. They have more protection in foreclosure than common stock and less than bond holders. Each individual needs to decide for themselves what kind of asset a preferred is. Some, as noted above, place them with debt instruments. Others are going to treat them as more stock than bond and use them to boost yield. I believe they behave more like bond funds than stocks or bonds and use them that way. (they are easier to examine than funds which can be handy)With 30+ years to go now is a great time to learn how to manage both the stock and the bond portion of your portfolio. Keep in mind that you probably skinned your knees learning to ride a bike or a skateboard, you are going to skin your knees learning how to manage your own assets. We skin our knees by buying the wrong fund, or stock or bond at the wrong time and at the wrong price. The first hurdle to overcome is learning how to make your own investing decisions instead of turning that task over to some professional fund, bond or stock picker. jack
Unless you have a much larger amount to invest, 35% of 50K is way too small to get a safe diversity in bonds.I strongly disagree with this advice. I don't understand why you do.My thoughts went: 35% of 50K is $17K.Looking at Etrade's bond screener and plugged in A-rated corporates, 5yr, sorted by yield. The minimum quantity of the first few were: 25, 10, 100, 40, 10, 5, 5, 10, 1, 1, 2, 20. The first's yield was 5.2%, the last's was 3.7%. Prices ranged from 105.25 to 99.03.How many issues do you need to be adequately diversified? 5? 10? 20?If it's 5 (which IMHO is not enough) then you need 3-4 bonds of each issue. But that doesn't meet the minimum quantity requirement for most of the issues. Eyeballing it, most of the issues have a minimum order size of 5 or 10 bonds.I don't know much about selecting bonds, but a 3.7% yield with a built-in 3%-5% capital loss doesn't sound like an attractive investment.If 10 stocks is a reasonable diversity than 10 bonds is reasonable diversity; any way you look at it 1/10 of the assets allotted are exposed to the risks of a single holding.Bonds are not stocks.Even so, 10 stocks is not enough. Rule-of-thumb says no more than 3%-5% of your portfolio should be in any one stock. That means you need 20-30 stocks.I have no idea if this is the right number for bonds. If so, then you need 20-30 bonds----and you aren't going to be able to do that with only $17K to invest.
$17k can buy you 17 bonds, even if you restrict yourself to A min rated bonds. (Not that that pool is where I like to go swimming).I did a screen on E*Trade of A (&A-) to All with a minimum yield of 3% without restricting maturity date and got a list of 2253 options. Scrolling through the first page of 500 - there are 20 in the first quarter of a page or so... Would take some work to "properly" diversify between companies, sectors, maturity, and credit rating, but 17 will get you pretty close on a portfolio of this size IMHO.Scott
$17k can buy you 17 bonds, even if you restrict yourself to A min rated bonds. (Not that that pool is where I like to go swimming).I did a screen on E*Trade of A (&A-) to All with a minimum yield of 3% without restricting maturity date and got a list of 2253 options. Scrolling through the first page of 500 - there are 20 in the first quarter of a page or so... Would take some work to "properly" diversify between companies, sectors, maturity, and credit rating, but 17 will get you pretty close on a portfolio of this size IMHO.OKay, tat's better than I came up with. I guess you'd really do proper DD here, to avoid unnecessary risk.The thing I mainly looked at was the prevalence of issues where you could buy just 1 bond. I only looked at 5 years maturity. If you go out much further you could be taking a larger risk of lower price when interest rates start to rise. That could be a real nasty shock to somebody who bought a large bond allocation expecting it to be safer than stocks.But.......PenFed has 3 year CDs at 3% and 5 year at 3.5%. Unless you are making a 6-digit investment, these would seem to be superior to bonds. Guaranteed principal, low transaction costs, virtually identical interest rate.Or am I missing something?
If you go out much further you could be taking a larger risk of lower price when interest rates start to rise. That could be a real nasty shock to somebody who bought a large bond allocation expecting it to be safer than stocks.Bonds held to maturity need not be marked to market, their face value is 100 whether they were bought at premium or discount. The "safety" of the bond lies in its steady coupon dividend performance and its greater protection for payout not in its market price; market price is noise. The "price" risk is known at purchase it does not change through the life of the bond. Going "long" needs to be an educated move no matter the prevailing rate there is always a risk of rising rates. There is no "nasty shock" the face value = 100 and the coupon gets paid. When talking about holding bond directly we need to shift our thoughts away from how stocks, stock funds and bond funds operate. Stocks lose value when repriced lower. Mutual funds lose value when repriced lower. Bonds in the market are repriced daily, those that are held have a face value of 100 they do not lose that value unless some default occurs. Bonds are not safer because they diversify, they are safer by the mechanics of the instrument and the legal claims they have. Shorter maturities are not safer because of price stability, they are safer because, in a rising rate environment, we don't fall as far behind reinvesting into the higher rates. The face value of a 2yr, 5yr and 10yr are the same at maturity. The difference is how long our principal is going to be locked in earning a specific rate. The risk that needs to be considered is reinvestment risk, not price risk.PenFed has 3 year CDs at 3% and 5 year at 3.5%. . . .Or am I missing something? Held to maturity, you aren't missing much. PenFed currently has some of the highest insured assets on the market which sets the bar for risk free. jack
Thanks for the ideas. I hadn't thought too much about a strategy of which individual bonds to buy (ratings/maturity date/bond ladder, etc) but you gave me some things to think about. Really my main question is: considering the amount of my portfolio and my time horizon, should I even consider individual bonds instead of (or in addition to) a bond index fund. I already decided that I want 20% of my IRA in bonds (someone mentioned 35%, you misread my original post).I did a quick search on the bonds picker in my TD Ameritrade account, I got much less options than what someone else posted. It sounds like you don't get the same selection (or price) depending on your broker. I guess my first step would be to open a new account at Etrade or Zions.Thanks
I already decided that I want 20% of my IRA in bonds (someone mentioned 35%, you misread my original post).If that is your well considered plan then act on it, it is as good an approach as anyone else' if you know why you want to build your investment portfolio this way. considering the amount of my portfolio and my time horizon,You don't need to be in a rush to position yourself 80/20. During the in between time you need to consider what to do with that 20% while you consider how to deploy it within bonds/fixed income. Do you let it work in stocks with all those pros and cons or do you find a cash alternative. should I even consider individual bonds instead of (or in addition to) a bond index fundYes you can consider individual bonds, after your due consideration you may or may not want to buy individual bonds early in the process. What is important to understand is how the different vehicles work.A bond is bought at par, premium or discount at maturity it is worth its face value. During the life of the bond it pays out its coupon dividend. There are basically two monetary components to consider. The price related to par you are paying if you buy at premium you will lose money relative to face over the life of the holding, if you buy at a discount you gain principal over the life of the holding. The second part is the coupon stream of income which is fixed. Using bond math we can figure YTM which combines these two components to give us an estimate, a metric, that allows us to compare bonds to each other. Because the coupon yield on the bond is fixed the mechanics the market uses to make an older bond YTM equal or near new issues is to adjust the price. Similar credit quality with diverse coupons and diverse issue times but with similar maturity dates can have YTM within a few basis points of each other by adjusting price. On any given day a bond has two values, its market value + income stream and its face value + income stream. Bond funds operate differently because they have no maturity date. Because they lose maturity date they do not have two values the same way an individual bond does. Occasionally with manged funds and Closed End Funds it may be possible to buy their assets at a discount. With Open End Fund and Index funds this is nearly impossible. Bond funds have two moving parts market price and yield. These two components move in opposition; if rates are rising prices(NAV) is falling and vice-versa. The homework done on this board strongly suggests the rising yield, reinvested or not, does not compensate for the loss of NAV when rates rise. One of the reason bond funds can be shown to have done extremely well is that we had steadily falling rates from the early 1980's to the early 2000s. It is a case where the past is not set up to repeat in the future. We simply are not starting in mid to high double digits interest rates when we buy into a bond fund today. This doesn't mean that bond funds shouldn't be used, it means we need to have reasonable expectations about our returns from funds. The pro and con of funds is that they are repriced every day. Where ever the market moves, for good or bad, if you own a bond fund you move with it. The pro and con of an individual bond is what you buy is what you get for the duration to maturity. It doesn't matter if the market moves up or down. As long as you are making informed decisions about what tool you are using you are doing the best you can. I'm not sure its worth opening another account just to explore what other firms offer access too but I don't know anything about TD Ameritrade's bond access either. It is probably more important to have a set of skills that will help you perform your DD when investigating corporate bonds. If you are comfortable picking stocks then you will probably be comfortable picking corporate bonds. If you are not comfortable doing individual firm studies then it will limit what you can do when trying to buy individual bonds. If you decide to jump whole hog into individual bond buying then it would benefit you to open an account with greater access. Anybody can set up a Treasury Direct account and buy Treasuries and get their prevailing rates, they carry the same security as FDIC backed CDs. It has been pointed out recently that there are CDs that are yielding higher rates the equivalent maturity Treasuries. The question to consider isn't "do I have enough capital". The question to consider is "what tool(s) can I most effectively use to my benefit". jack
jackcrow,You wrote, Preferred stock is a useful tool as long as you understand what it is.http://www.investopedia.com/terms/p/preferredstock.aspThis means that not only can you capture capital gains you can lose capital. They are traded shares with prices set throughout the day, the price goes up and down over time. They have more protection in foreclosure than common stock and less than bond holders.Not all preferreds are created equal. While the Investopia definition is accurate as far as it goes, it doesn't cover all the different types of legal entities that issues preferred shares.In college accounting classes, the most common type of preferred stock discussed involves shares directly issued by a corporation who will use those proceeds for general operations. But over the past 10+ years this type of preferred has become ... less preferred. Probably half of the preferred offerings available today are directly issued by some kind of an investment trust designed for the sole purpose of selling a stake in the debt obligations of some corporation into the broader stock market. Capital Trusts are one specific type of preferred issue that has become common place. A Capital Trust is typically a trust fund (a legal third party) created by a corporation (the guarantor) for the purpose of selling it's debt obligations. Capital Trusts are generally funded with junior debentures issued by the guarantor. The guarantor then issues itself the common stock. The preferred stock is sold to one or more "subscribers" who are typically investment bankers that resell the issue on an open exchange. Capital Trust preferreds are the most senior obligation owed by the trust itself - if the trust liquidates, the preferred share holders have the first claim on the underlying assets. The junior debentures are the sole assets of the trust. The trust exists solely to hold in book name these larger denomination debentures and sell smaller denomination preferred shares. Liquidation might be an issue, but this is also true of any junior debenture - many of which are available directly from your local broker and sold to individual investors as if they were just regular bonds.Beyond capital trust preferreds, there are other hybrid trust preferreds available - Capital Trusts are just one type. Third Party Trusts are similar to Capital Trusts in structure, except that the corporation itself does not personally guarantee the operation of the trust, it's issuance of payments, nor does it control the common stock of the trust. Instead a third party (usually an investment bank) constructs the trust either for a fee or for some benefit such as the ability to garner some portion of the underlying debenture's dividend payments.In addition, some trusts can have non-bond-like features. For instance, Ford's F-S is a Capital Trust Preferred issue with a tightly coupled common stock warrant feature. (See my prior analysis of F-S on this board.) The warrant adds intrinsic value to the security, making it somewhat cheaper to for the issuer to sell the security from a future cash-flow perspective. Warrants add a feature that provides optional or selective participation in the common stock's performance; but some hybrids actually have mandatory conversion options which make them much scarier products.Indeed, some hybrid preferreds are equity stakes in entities with very complex asset structures. However, some of the exchange-traded offerings are fundamentally identical to a bond, except for their price. Most of these tend to be referred to as an exchange traded Note. Notes tend to be in relatively small denominations, but they are the direct debt obligations of the issuing corporation - no intervening trust is involved. If you read the prospectus for Ford's F-A, it's almost indistinguishable form any of Ford's senior debentures. And F-A is senior debt. It's not senior debt held by a trust - like so many third party trust preferreds - it's actually a direct obligation of Ford and has a first-priority liquidation preference, ahead of other issues like F-S.And as I said earlier, not all bonds are created the same either. I've seen bond issues that were junior debentures, not senior. Bonds themselves can have a number of common and not so common features that make it more difficult to evaluate them for fair price. Of course you never see bonds with some of the complex structures you see with preferreds; but maybe that's simply because it's not practical to sell such instruments through the current over-the-counter bond system. Also, Each individual needs to decide for themselves what kind of asset a preferred is. Some, as noted above, place them with debt instruments. Others are going to treat them as more stock than bond and use them to boost yield. I believe they behave more like bond funds than stocks or bonds and use them that way. (they are easier to examine than funds which can be handy)I would disagree with this statement on principal. The decision as to the performance characteristics of both bonds and preferreds were defined by their prospectus. They are not open to individual interpretation. Many, if not most preferreds are definitely bond-like (and exchange traded notes are indistinguishable from bonds) and have almost all of the same characteristics. What those characteristics are and whether or not the security will behave like a bond or a stock or something else altogether depends on how it was defined and what asset(s) back the issue. In most cases, a trust preferred provides you a proportionate interest in a bond held by the trust. It does not at all behave like a bond fund.While there are certainly plenty of exceptions to the bond-like characterization of preferreds. Many if not most preferreds behave exactly like a bond - right down to the call-ability, the redemption price and maturity dates. If you buy those types of preferreds, your performance should be more or less identical to purchasing a similar bond from the underlying issuer ... except for the fact that you can do things like buy and sell in small (typically preferreds trade for around $25) increments and you can dividend reinvest at most brokerages.- Joel
Joel,Very nice explanation of the variations of preferreds available.The decision as to the performance characteristics of both bonds and preferreds were defined by their prospectus.TrueHow I chose to apply that asset to my investing needs can be varied in many ways. I know folks that are holding higher dividend yielding entities as cash equivalents, are they stocks and REITS? sure they are and with the right management you may get a better return then short term CD's or bonds. Charlie runs a bond portfolio with near stock like returns. I know several folks that use equity dividends instead of bond dividends for their income stream. I'll also stand firmly behind my claim that the individual investor is free to define what is an asset class and what are subsets of asset classes. To one person different sectors of stocks are different assets because not all sectors move together. To another a stock is a stock is a stock. To one investor a stock fund or an index fund is the same as an individual stock to others they see all three as different asset classes. Are small cap, mid cap and large cap different asset classes or are they all lumped under stocks. We have choices some we are free to make if we so choose and some we must make in order to create our working guidelines that help us manage our investments. jack
b-18When it comes to the question of Bonds vs. Bond Funds/ETF, my personal choice is typically on the side of Bonds. There are numerous things to consider including as mentioned by one of this boards astute contributors, there appears an unrecoverable loss of NAV as the yields fluctuate and in addition as a result of a little something we call - management fee. Vanguards bond funds typically have low expense structure, maybe around 15 basis points so think how that would effect/compare to your costs using bonds??? Proper diversification? Well Vanguards BND is in US Treasuries so what is the difference in "diversification" if you go out and buy - well - US Treasuries? Plain and simple, looking within a single asset class, debt doesn't "diversify" the same way equity does. So in your example if you bought a ladder of $1000 each year for 10 years your diversification would be pretty close to that of the fund. (Duration, Convexity, Reinvestment, Default, what ever your measure) And the difference in the overall diversification across your portfolio would be almost indistinguishable.Worry About Interest Rates? For this I am going to take a more "behavioral finance" stance. Look, if you are worried about interest rates, you are probably going to be just as worried in both bonds and funds. Why, because this is your retirement. Unless you have a crystal ball and know what rates are going to do over a 35 year period you can just accept the risk. Meaning - You understand it but don't let it bother you. OR, if you would like, when rates are low you can shorter your duration by sticking with bills. When rates are high in your opinion grab some notes. And when the stuff hits the fan for double digit - go with bonds. To do this in the funds would require more buying and selling, some times in gain situations - sometimes in LOSS.Brokers Heck I will always throw a pitch out for the local folks at Zions Direct. They seem pretty good in the small retail arena. If you are going to stay with Treasuries you may look into a Treasury Direct account.d(Bond)/dTWho says that DEBT is the asset class (class), Treasuries, Municipals, Corporates are sub classes (family). Preferreds (when structured as debt) are a subset of the Corporate sub class (genus). Ratings split such as Investment grade -vs.- junk, opps sorry, high yield is the group of the subset of the sub class of the asset class -- the (species).............or something like that.....
d(Bond)/dTDid you just introduce differential calculus into this discussion?Geez, I always knew that many of you were well beyond my abilities in investing acumen, but this is getting ridiculous!cicciano
"d(Bond)/dTDid you just introduce differential calculus into this discussion?"I didn't even know that bond yields were a function of temperature! ;)
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