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Author: HeadDoc56 One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35400  
Subject: Individual bonds vs funds Date: 3/26/2007 9:22 AM
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First, I'm fairly new to this board and apologize if I'm being redundant. I know there have been many a discussion about bonds vs funds but I have a rather specific question.

My spouse and I have been working on our asset allocation and have decided to put a third in bonds. We met with the bank guy who, of course steered us to a bond fund, since the bank gets a referral fee, or whatever you call it. However, in spite of this the fund did seem like a reasonably good choice. It's tax free, reinvests dividends and is more liquid that regular bonds. The expense ratio seemed kind of high though, at 0.71% (which includes a 12b1 fee of .10%) for a fund that has 8% annual turn-over. Over the past 10 years it averaged 4.68% annually. Now, I realize you cannot judge the future return based on it's past performance but can we come reasonably close? Am I missing something obvious?

Any thoughts are much appreciated.

Best,
HD56
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Author: ResNullius Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20144 of 35400
Subject: Re: Individual bonds vs funds Date: 3/26/2007 9:40 AM
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It's tax free, reinvests dividends and is more liquid that regular bonds. The expense ratio seemed kind of high though, at 0.71% (which includes a 12b1 fee of .10%) for a fund that has 8% annual turn-over. Over the past 10 years it averaged 4.68% annually.

I guess you're talking about a tax exempt muni fund, given that you said the income is tax free. If you want to invest in a muni bond fund, take a look at Vanguard. You just might save yourself a bundle in fees. Keep in mind that the .71% comes out each year. You didn't mention it, but I wouldn't be surprised if there's a front end load, given that the bank is peddling it. Whether tax exempt is better for you than taxable depends on your tax situation, so I would be sure to look at that very closely. Anyway, good luck and let us know what you end up doing.

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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: 20146 of 35400
Subject: Re: Individual bonds vs funds Date: 3/26/2007 10:26 AM
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Since you seem to be a beginner, I suggest you start by reading our complete FAQs, or at least the first part (general and conceptural issues) and the final part on bond funds.

Suffice to say, you need to decide whether you really are a candidate for tax-exempt (municipal) bonds, given your tax situation, and if so whether you can do better buying the bonds for yourself, instead of a fund. You also need to understand the risks of funds, which I'm sure whoever was peddling this fund to you failed to explain. And past returns on bond funds are probably even less relevant for making decisions than past returns on stock funds—you can legitimately look at different funds tracking the same bond index, but the differences in returns will mostly boil down to expenses and whether a fund is using leveraging strategies, which increase risk. If you still think a muni fund is a good idea, start with Vanguard.

Also, with munis, all munis are federally tax exempt (with some issues abouut AMT), but ones for your state are also exempt from state taxes, so if you are in a high tax state, that is an important consideration. In general, if you are in the 28% tax bracket or under, you should be able to beat muni bonds with other fixed-income options, except for high tax states with state specific munis.

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Author: TwoCybers Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20153 of 35400
Subject: Re: Individual bonds vs funds Date: 3/26/2007 1:23 PM
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HD56 I am just beginning in fixed income myself - but I would like to point you at a couple of things:

See http://boards.fool.com/Message.asp?mid=25173438
One of the points in this from the FAQ can be simply stated - in times of rising interest rates (example is 2005) you will loose money in a bond fund - where as actual bonds many decrease in market value, but if you hold to maturity you will not loose money.

Until recently the yield curve has been flat (or inverted). In any event this means one could put money into a tax free short term bond fund (example SWTXX)and avoid taxes.

Gordon
Atlanta

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Author: HeadDoc56 One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20159 of 35400
Subject: Re: Individual bonds vs funds Date: 3/26/2007 2:29 PM
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RN, Loki and Gordon, thanks for your responses and the link to the FAQs. I'll spend some time trying to digest the post. In the meantime:

I guess you're talking about a tax exempt muni fund, given that you said the income is tax free. If you want to invest in a muni bond fund, take a look at Vanguard.

Yes. It's a Franklin Templeton CT Municipal bond fund. And yes, it does have a front end charge depending on the amount invested.

I looked at the Vanguard site and though they do have tax exempt bond funds, they don't have one for CT. My layman look at state tax rates suggests CT is not particularly high or low.

In general, if you are in the 28% tax bracket or under, you should be able to beat muni bonds with other fixed-income options, except for high tax states with state specific munis

We are in the 28 % tax bracket. So I guess we should be looking at other fixed income options as well.

Just a big picture observation: I assumed the whole point of bonds was to avoid the risk of losing principle and to give you a fairly certain idea of the yield. I guess bond funds do not really provide this level of certainty.

Best,
HD56


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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: 20160 of 35400
Subject: Re: Individual bonds vs funds Date: 3/26/2007 5:16 PM
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We are in the 28 % tax bracket. So I guess we should be looking at other fixed income options as well.

28% bracket is usually a wash. Of course, the exact premiums between other options and munis vary, but if you use other options (CDs, TIPS, maybe corporates, Treasuries), you have more flexibility to figure out what is best at any given moment (and take advantage of Pen Fed fire sales—i.e., when someone, usually Pen Fed Credit Union, is offering much higher than market rates for yields).

If Vanguard doesn't have a state specific muni fund, then state taxes aren't high enough to warrant it. It's hard to believe a fund with a load and high expense ratio can compete over the long run with Vanguard's generic muni funds (short, intermediate, long) should you still want to go that route.

Also, be aware of the AMT issue: some munis are exempt from AMT, others not, and finding out isn't always easy. Plus, if you get into a lower bracket down the road (retirement, increased 401k deductions), munis may be less attractive.

Currently Vanguard's Intermediate Corporate and Intermediate Tax Exempt funds are dead even at 28% bracket (3.71% yield after federal taxes). But with a 5 year Pen Fed CD at 5.74%, you'd have to be in a 35% tax bracket for the Tax Exempt fund to break even.

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Author: jrr7 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: 20161 of 35400
Subject: Re: Individual bonds vs funds Date: 3/26/2007 5:25 PM
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Most likely, CT taxes are low enough that Vanguard's regular muni fund (federal tax free but mostly taxable by CT) would be better than someone else's CT-specific fund.

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Author: Foolferlove Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20162 of 35400
Subject: Re: Individual bonds vs funds Date: 3/26/2007 6:48 PM
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Most likely, CT taxes are low enough that Vanguard's regular muni fund (federal tax free but mostly taxable by CT) would be better than someone else's CT-specific fund

Yes. I'd be willing to bet that after the loads and increased expense ratio and 12b-1 fee, the broker, bank and mutual fund company will make MUCH more in the long run than you'll ever save in taxes.

NEVER buy a load fund if you have a similar fund that Vanguard sells.

Follow previous advice and skip the CT-tax free fund, and go with a Vanguard state-taxable (but federally tax exempt) fund.

FFL

P.S. How much is the load, percentage wise?

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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: 20163 of 35400
Subject: Re: Individual bonds vs funds Date: 3/26/2007 7:00 PM
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Yes. I'd be willing to bet that after the loads and increased expense ratio and 12b-1 fee, the broker, bank and mutual fund company will make MUCH more in the long run than you'll ever save in taxes.

I don't feel like looking up CT tax rates, but at a 4% state income tax and 4% yield on a fund, that's 16 basis points. Ignoring loads, and assuming a steady yield (and ignoring compounding) on a fund, $1000 at 4% state taxable would cost you $1.60 a year in taxes. $1000 with an extra .5% expense ratio would cost you $5 a year. Throw in a 4% load (or the equivalent in extra expense ratio with a back end load) plus .5% expense ratio and you're talking $25 in added expenses, so to get the equivalent of a 4% state taxable Vanguard fund, the load fund would have to have a 6.5% yield, which can't be done without taking on a whole lot of extra risk. Even with a 2% load it can't be done.

Ask the guy selling you the fund to figure out how the fund can beat a no load low cost fund.

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Author: HeadDoc56 One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20174 of 35400
Subject: Re: Individual bonds vs funds Date: 3/27/2007 10:25 AM
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Currently Vanguard's Intermediate Corporate and Intermediate Tax Exempt funds are dead even at 28% bracket (3.71% yield after federal taxes). But with a 5 year Pen Fed CD at 5.74%, you'd have to be in a 35% tax bracket for the Tax Exempt fund to break even.

Sounds like we should be looking into some Pen Fed CDs even though we missed the sale around the first of the year.

P.S. How much is the load, percentage wise?

4.25%

Ask the guy selling you the fund to figure out how the fund can beat a no load low cost fund.

I did ask him that question. He said that big institutions get better rates on the bonds than the average low-life such as yourself. (Not his exact words but that's what he meant.) Therefore, you have to align with the institutions to have any hope of getting a decent return. …Funny thing, he called while I was writing this post asking if we'd be interested in speaking directly to the portfolio manager. Hmm, makes me suspicious.

A related story about these so called financial “advisors”. At work, our 403b is managed by Prudential. Of course the guy directed us to the mutual funds for which Prudential gets a finders fee and an annual “servicing” fee. He never even mentioned the Vanguard options. We have four: Vanguard 500 (0.18%), Life Strategy Income (0%), Strategic Equity (0.35%), Inflation protected Secs (0.2%). I'll probably split between the V 500 and the Life Strategy Inc.

Thanks again for all the feedback. It has been very educational.

Best,
HD56


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Author: DeltaOne81 Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20175 of 35400
Subject: Re: Individual bonds vs funds Date: 3/27/2007 11:02 AM
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I did ask him that question. He said that big institutions get better rates on the bonds than the average low-life such as yourself.

Only problem is, that wasn't the question. It wasn't how a fund can beat an individual investor. Its how a load fund can beat a no load fund. Especially since the no load fund likely has lower yearly expenses too. Answer: it can't.


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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: 20176 of 35400
Subject: Re: Individual bonds vs funds Date: 3/27/2007 11:07 AM
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I did ask him that question. He said that big institutions get better rates on the bonds than the average low-life such as yourself. (Not his exact words but that's what he meant.) Therefore, you have to align with the institutions to have any hope of getting a decent return. …Funny thing, he called while I was writing this post asking if we'd be interested in speaking directly to the portfolio manager. Hmm, makes me suspicious.

Vanguard tax-exempt (intermediate) has an expense ratio of .17%.

The Tax-exempt (muni) bond market is a scam, one of the last holdouts in the broker/brokerage monopoly. A few years ago, some local communities tried to offer bonds directly to consumers, but it got squashed by the big players. The day of reckoning will come sooner or later: we've got a local school bond issue coming up, and there is no reason, other than lack of experience and precedent, why on-line purchases for small investors on the issue date coouldn't be set up along the lines of Treasury Direct auction bids. Until then, though, state specific munis will end up in the hands of big players, and you have to buy it from them for a price that is rarely worth it, especially if you state taxes are moderate.

Even with all that, you could probably buy state specific muni bonds and get better yields after commissions and mark ups than the costs with a load fund. But, of course, if you want the advantages of a fund (diversification, the fund being able to buy in bulk or directly from issuers), you can get that with a low cost, no-load fund. The only claim your salesman can legitimately make is that he has a state specific fund to offer, to which the reply is that will only save pennies on taxes compared to dollars in added costs.

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Author: ResNullius Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 20178 of 35400
Subject: Re: Individual bonds vs funds Date: 3/27/2007 11:25 AM
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Vanguard tax-exempt (intermediate) has an expense ratio of .17%.

Check the Vanguard Admiral intermediate tax-exempt. I think the expense ratio is .09% or something along those lines. I'm not sure what the investment minimum is, but it's probably around $100K, but that's just a guess. It's the same as the regular fund, only it has a lower expense ratio due to the high balance.



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Author: jrr7 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: 20179 of 35400
Subject: Re: Individual bonds vs funds Date: 3/27/2007 11:28 AM
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He said that big institutions get better rates on the bonds than the average low-life such as yourself. (Not his exact words but that's what he meant.)

That's often true, but it's not an answer to the question you asked. Vanguard is a big institution and doesn't have to overpay to buy bonds.

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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: 20183 of 35400
Subject: Re: Individual bonds vs funds Date: 3/27/2007 2:14 PM
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Check the Vanguard Admiral intermediate tax-exempt. I think the expense ratio is .09% or something along those lines. I'm not sure what the investment minimum is, but it's probably around $100K, but that's just a guess. It's the same as the regular fund, only it has a lower expense ratio due to the high balance.

Here's information of Vanguard Admiral shares. $100,000 in a fund is the basic amount, although you get Admiral shares at $50,000 after 10 years. Usually it reduces the expense ratio by .1% point, although I haven't seen any fund that gets below a .09% expense ratio.

https://flagship.vanguard.com/VGApp/hnw/content/Funds/FundsAdmiralSharesOverviewJSP.jsp?Entry=VGFundsOV

In terms of the load fund the OP is being "offered," even if the load is amoratized over 10 years and took state taxes into, to be competitive with a generic Vanguard muni fund, the load fund would have to be able to find state specific munis with average yields abot 1.25% above the average yields Vanguard is getting for munis, controlling for risk (same average duration, same average quality, same call and AMT risk). Ain't gonna happen.

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