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Anyone think this is a good time to be investing in Bond Funds?

I'm balancing my portfolio (for the first time) and I have a very low amount of money invested in bonds. I keep finding advice that says not to time the market... just diversify and stick with it.

With the interest rates low and the mounting deficit, seems to me like there's alot more downside than upside to Bond investments... does everyone agree? Are there any good managed balanced funds that have a good record of converting bonds to stock as interest rates rise. (I've been told that many Balanced funds just weather the storm and keep their allocations at 60/40 or whatever they're predisposed to do).

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I'm in a similar situation, being too heavy in stocks for the long term. However, I believe interest rates will rise in 2004 and 2005. At the same time I expect stock prices to rise also.

I'm going to hold my stocks for the most part but rebalance about 5% of the portfolio each quarter in 2004. This will include taking some profits on rising stocks but not liquidating the whole position so long as I feel the stock has further to run.

I've been dealing with the interest rate risk issue for the past year by buying individual bonds in the secondary market with 1 to 2 years to maturity. I've had some good yields in GMAC notes and bonds for example. You could also look at short term corporate bond mutual funds for now and move the money to intermediate term funds when you feel most of the interest rate rise is over.

Bill
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Anyone think this is a good time to be investing in Bond Funds?

I believe there is never a good time to buy bond funds, but especially now. With the current low rates you can lose a bundle if rates go up. Buy a bond directly if you feel the need to rebalance. I find bond funds are more risky than stock funds.

cliff

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The risk is indeed that interest rates may start rising one of these days. (Fools have been saying that for almost 3 years now.) I think probably not until after the election next Fall. So for the next year bond funds will probably be OK, but you will want to keep a close eye on them and sell if it sounds like the Fed is thinking about raising rates.

The Asset Backed Securities are backed by long bonds and traded on the NYSE. Low commissions at a discount broker make it easier for individuals to trade in and out of these than traditional bonds. (See message 7693 on the Bond board.) The ability to trade cheaply and easily makes them potentially a better vehicle in uncertain times, but thin trading volumes can be a problem. It remains to be seen if they are liquid enough to get your money out when rates start to rise.

Owning the bonds themselves is the safest protection from big losses. Unfortunately short bonds are low yield and expensive. Intermediate bonds are a better deal, but you can be holding those paper losses if interest rates rise for quite a while.

Personally, I would do an estimate of how much interest rates have to rise before a prospective investment loses money compared to say a 3 to 5 yr CD. This keeps your choices in perspective.

Lastly, keep in mind that for the last year or so, gold has been a top performer. That will likely continue as long as the dollar continues to weaken and until interest rates start to rise. If your timing is right, gold or precious metal funds can do better than bonds.

I do not agree with the comment that equity funds are a better investment than bonds. Equities tend to amplify any interest rate effect. So if you think bonds are risky due to rising rates, stocks are more so (unless you select very carefully). Both depend on economic recovery and the business cycle. As the recovery gains strength, it becomes more likely the Feds will raise interest rates (and defend the dollar).

At the moment, we are not talking about deflation. The concern is that inflation could become a problem. That would cause rates to rise.
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I'm in the same boat as you are. Bond funds are under-represented in my portfolio due to my initial set-up (I follow a varient of the Coffeehouse Portfolio). However, I think now is not the time to beef it up for the reasons you mentioned.

Overall, I would say rebalancing has a net benefit: Remember, in 2000, the stocks were up and bonds were down. Re-allocation would've taken money out of stocks and put it into the bonds for the ride up these past couple years. However, we seem to be in a position now where we're 'instructed' to put more money in the 'peaking' asset - it doesn't jive. Fortunatlely, I'm fairly young so I can be more aggressive when deciding to sit this re-allocation out (at least leaving the bond fund out of the re-allocation mix) and waiting until bond funds become more favorable, interest rate-wise. Someone closer to retirement has a much more difficult choice.

Mark
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Anyone think this is a good time to be investing in Bond Funds?

If you're retired and need principal protection plus a steady income, I'd say now is a fine time to be investing in bond funds. If you're 25, and 40 years away from retirement, I'd wouldn't find them as interesting.

Disagree with Cliff- I think bond funds are excellent vehicles for low cost, diversified fixed income exposure.

Nick



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yobria writes,

Anyone think this is a good time to be investing in Bond Funds?

If you're retired and need principal protection plus a steady income, I'd say now is a fine time to be investing in bond funds. If you're 25, and 40 years away from retirement, I'd wouldn't find them as interesting.

Disagree with Cliff- I think bond funds are excellent vehicles for low cost, diversified fixed income exposure.

Nick


For corporate bonds, a mutual fund may be a necessary evil. But for Gov't bonds they make little sense. Here's an analysis of what you'll lose to fees in a low-cost Vanguard TIPS fund over 10 years versus just buying a 10-Year TIPS and holding to maturity.

Vanguard's TIPS bond fund has a 0.22% expense ratio.

Here's the 10-year expenses for a $100,000 investment in the 3 alternatives.

Buy one $100,000 10-Year TIPS at auction -- 10-Year expenses = $25 or less

Put $100,000 into the Vanguard TIPS fund -- 10-Year expenses = more than $2,200.

Put $100,000 into the iShares TIPS ETF fund -- 10-Year expenses = more than $2,000.

As low as Vanguard's expenses are, you still get hosed to the tune of thousands of dollars over time.

intercst


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Here's my $0.02.

Intercst had a good point, and so did cliff666.

My take, never by bond funds. Why? Can lose principle. You can by individual bonds as long as you keep them to maturity there is less chance to lose principle and change in interest rates won't effect them. However, you have the risk of the issueing company defaulting (thus chance to lose principle).

My solution, by CDs. Typically small difference in a 3-5 year CD and a bond, at least to me when you consider chance of default. Therefore, for my cash/interest bearing portion of portfolio, it is CDs for me.

JLC
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Here's the 10-year expenses for a $100,000 investment in the 3 alternatives.

Buy one $100,000 10-Year TIPS at auction -- 10-Year expenses = $25 or less

Put $100,000 into the Vanguard TIPS fund -- 10-Year expenses = more than $2,200.

Put $100,000 into the iShares TIPS ETF fund -- 10-Year expenses = more than $2,000.

As low as Vanguard's expenses are, you still get hosed to the tune of thousands of dollars over time.


Very good point - it's nice to avoid the fees if you can. Along that route - you mention $100,000 as your purchase. Is this the lowest denominator to buy direct or can you buy in $50 (or whatever) increments like I-bonds? For some of us, $100,000 is a little more than we'd like to plunk into paper at the moment <grin>

Mark
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Crazylegs883 asks,

Very good point - it's nice to avoid the fees if you can. Along that route - you mention $100,000 as your purchase. Is this the lowest denominator to buy direct or can you buy in $50 (or whatever) increments like I-bonds? For some of us, $100,000 is a little more than we'd like to plunk into paper at the moment <grin>


You can buy TIPS at auction in $1,000 increments. Vanguard charges a $25 fee to buy any amount TIPS at auction -- $1,000 or $1 million.

If the total value of your accounts at Vanguard exceed $1 million, Vanguard waives the $25 fee. In effect, you can then buy TIPS at auction commission free.

Because of the way TIPS are taxed, you should only hold them in an IRA/401k. I-bonds are the appropriate investment for taxable accounts.

intercst
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All the advise I see says Buy short term (1 to 3 years - keep them to maturity also) and go to Corporates at the low end of just below investment grade.

This makes some sense if you expect the economy to get better (and interest rates to raise) - Most of the bad news for defaults should be gone now.

Personally I do not expect interest rates to get high until after November 2004, but with real interest rates today at a negative 1 or 1.5%, you could have mortage rates for example increase by 1% before the end of 2004.

Gordon
Atlanta
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For corporate bonds, a mutual fund may be a necessary evil. But for Gov't bonds they make little sense

Yes, in your example -the man who's never saved a penny, then discovers $100,000 in his basement, which we won't need for exaclty 10 years- buying individual bonds is the way to go.

But most people I know don't invest this way. Instead they manage to spend a little less than they earn each week and invest that savings regularly in either a 401k or taxable account. For them, a bond fund makes a lot of sense, especially since they can get exposure to Agencies, Treasuries, and corporates in one fell swoop.

Even in your $100,000 example, buying individual bonds is risky, since you're wealth is concentrated at a single interest rate. Bond funds offer diversification over time as well- an instant ladder. I think they're anything but a necessary evil.

Nick
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I read this thread with a great interest, and I will still need to come back to reread and ponder upon that has been said.
However, I have a question. Does this apply merely to bond funds? Or does this also apply to "balanced" funds e.g. DODBX, Vanguard Retirement funds and the like since a part of assets are invested in bonds beside stocks?

Thanks for your opinions, Aida
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Aida2003 asks,

I read this thread with a great interest, and I will still need to come back to reread and ponder upon that has been said.
However, I have a question. Does this apply merely to bond funds? Or does this also apply to "balanced" funds e.g. DODBX, Vanguard Retirement funds and the like since a part of assets are invested in bonds beside stocks?


I think it depends on the size of your portfolio.

As yobria points out, if you are a small investor, a mutual fund may be the only convenient way to invest. But as your portfolio grows, you may have enough money to devote to a single asset class to buy individual securities. It may also be possible for you to invest a large portfolio for less in fees and commissions than your mutual fund expense ratio.

Personally, I dumped all my mutual funds in 1989 once my portfolio reached $200k in value. I then started buying a diversified portfolio of individual stocks, Treasury securities, and CDs.

I retired in 1994 at age 38.

intercst
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Disagree with Cliff- I think bond funds are excellent vehicles for low cost, diversified fixed income exposure.

Nick

I am remembering the GNMA and High Yield funds (T. Rowe Price) I got back in the early 70's. Everything was hunky dory until the huge increasees in interest rates took a giant bite out of my net worth.

cliff
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Even in your $100,000 example, buying individual bonds is risky, since you're wealth is concentrated at a single interest rate. Bond funds offer diversification over time as well- an instant ladder. I think they're anything but a necessary evil.

Nick

I am of the opinion that if your time horizon is ten years or more, bonds have no place in your portfolio. Buy good quality stocks or stock funds. In today's marketplace, bonds or bond funds make sense as an anchor or stabilizer for someone in or nearing retirement.

cliff
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Do you remember how big a bite it was and about what time frame the slide in price started?
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Do you remember how big a bite it was and about what time frame the slide in price started?

It coincided with the double digit interest rates the banks were paying (and charging) during and after Viet Nam.

The High Yield fund was down about 50%, iirc. GNMA wasn't quite as bad.

cliff
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I am remembering the GNMA and High Yield funds (T. Rowe Price) I got back in the early 70's. Everything was hunky dory until the huge increasees in interest rates took a giant bite out of my net worth.

Yep, bond funds can go down...and the 70s was (let's hope) an extreme example of interest rate spikes that we won't see again. Funds will get their principal back when each bond in the fund matures, however, so you need to hold for the long term.

I am of the opinion that if your time horizon is ten years or more, bonds have no place in your portfolio

I'm still struggling with the place bonds should have in a portfolio. First, there's the time horizon angle. I'm 31, and am happily 100% invested in stocks. Easy decision there. But my mother is 53, and will be retiring in 10 years or so. How much of her portfolio (which I manage) should I invest in bonds? Vanguard tells me it's presently only 12.7%, though we're also holding 20% cash since she'll be buying a house in the next year.

One of the reasons she's so light on bonds is that interest rates are so low. That's the next point- should one allocate in and out of bonds depending on rates? Or keep a steady age based allocation and not assume rates will regress to some historic mean?

The third question is the type of bonds you should hold. Right now Mom's got about half of her bond allocation in the Total Bond Market fund, and about half Vanguard High Yield fund, so I guess she's over-weight corporates.

Nick


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That's the next point- should one allocate in and out of bonds depending on rates?

Any time I've ever tried any form of market timing, I've been unhappy with the results. I'm 45 year old and like you, 100% in stock. I'm struggling to understand why anyone would be in bonds if you have a long term investment horizon.

Gup
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MissouriGup asks,

That's the next point- should one allocate in and out of bonds depending on rates?

Any time I've ever tried any form of market timing, I've been unhappy with the results. I'm 45 year old and like you, 100% in stock. I'm struggling to understand why anyone would be in bonds if you have a long term investment horizon.


I've been retired for 9 years and have a long term investment horizon (hopefully 40 or 50 years.) I maintain a minimum of 5 years worth of living expenses in fixed income assets (TIPS and CDs.) If you use the often mentioned "4% withdrawal rate" for your retirement portfolio, that equates to a minimum of 20% bonds. If you have a huge portfolio and can survive off of a 1% withdrawal rate, maybe you feel comfortable with 5% in bonds and 95% in stock.

intercst
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I agree with cliff666. A bond fund never matures. A bond does. If you buy a long term bond fund and hold it 30 years, you still have a long term bond fund.
If you want 5% or 20% of your portfolio in bonds, buy BONDS, and ladder them. Don't go out too far, and don't pay a premium. When you ask your broker what interest rate you can get without paying a premium, it may sour you on the whole idea of buying bonds at all, which is probably a good thing, with interst rates at long-term lows.
If the long-term treasury ever goes to 10% again, buy with both hands!

For now, look for stocks with generous dividends and improving business conditions. My personal favorite is DPL, but there are those who would disagree and maybe they are right. Or look for companies with a long history of raising their dividend. JNJ is one. You might get more income in 20 years from such a stock than from the bond, although you won't get as much immediate (taxable) income. Remember, the company will NEVER increase its payments to bond holders no matter how well the company is doing!

Best wishes, Chris
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I'm still struggling with the place bonds should have in a portfolio. First, there's the time horizon angle. I'm 31, and am happily 100% invested in stocks. Easy decision there. But my mother is 53, and will be retiring in 10 years or so. How much of her portfolio (which I manage) should I invest in bonds? Vanguard tells me it's presently only 12.7%, though we're also holding 20% cash since she'll be buying a house in the next year.

I help my mother with her portfolio and here is what I tried to do until she upped the pace of her retirement.

Basically, at retirement, aim for 20-25% of portfolio in fixed income assets. For me the simplest is CDs, some might want to investigate INDIVIDUAL bonds or Tresuries. 5 years away from retirement, put 5% in fixed income, for example a 5 year CD. Then each succeeding year, another 5% at a 5 year maturity. At retirement time, you'll have 25% fixed income, laddered for maturity. That'll help with budgetting, you'll know what you're going to get and when, and will help with any potential market downturn and give the equities portion time to recoup.

I would not do bond funds because the rate of return would be unknown and not allow for more exact planning. Nor would principle be guranteed and at retirement, you're less likely to tolerate loses.

JLC
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This link has just the answers you are looking for! Vanguard (sometime in aug) and smith barney (in muni bonds section in november) had articles with the same message.

http://www.pimco.com/LeftNav/Latest+Publications/2003/roles_of_bonds.htm

If you are still uneasy about losing some money in the short term try stable value fund. The one in my 401(k) plan has a yeild of about 4.5% free of interest rate risk.
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