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Best choice: Bond Fund or CD or...
Old 10-28-2006, 09:19 PM   #1
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Best choice: Bond Fund or CD or...

Well, after the nice market run up, it's time to rebalance. I'd like to take some of my Keogh account mutual fund gains off the table and put the proceeds into either a bond fund, a CD (still within the Keogh) or in a ETF dividend-based fund). Anyhow, it all will stay tax-free while it's within the Keogh account. Any suggestions about which of the three makes the most sense? Thanks. I find that as I'm getting closer to retirement, the more conservative I'm becoming.
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Re: Best choice: Bond Fund or CD or...
Old 10-28-2006, 09:27 PM   #2
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Re: Best choice: Bond Fund or CD or...

A dividend-paying fund is still a stock fund, so you'd be moving from one stock fund to another if you go that route. That might be a good idea, but has nothing to do with moving money from equities to fixed income. I prefer gov't bonds and CDs (and REITs, which I see as different from both stocks and fixed income--kind of another beast) to bond funds, but I'm out of step with most people on this forum in that regard :
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 07:28 AM   #3
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Re: Best choice: Bond Fund or CD or...

You get two non-bond fund responses. I prefer knowing what the amount of money I will get and when. That is true with individual bonds and CDs (barring credit failures) but with a bond fund the value may go up and down depending on the interest rate. The fixed income is intended to be "stable" which is why I like knowing that I'll get some much annual income and then all of my principal back. I also keep my maturity in the 5 year range.

There are others who will back bond funds. I suspect they didn't own a bond fund in the early 70% and watch the NAV drop like a rock while interest rates triples. Not only was I only getting about 5% on my original investment when rates skyrocketed I also lost over half my principal. Now if I had only hung in there until the 1990's I would have gotten my original investment back.
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 07:40 AM   #4
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Re: Best choice: Bond Fund or CD or...

2B ... and, isn't that the confusion with bond funds? Folks say their principal goes down in a bond fund, but not with an individual bond ... but for comparable duration, it's always a matter of simply holding on, isn't it?

I mean, an individual bond goes "down" or "up" technically with the movement of interest rates everyday as well ... it's just that the owners don't sell everyday, or typically value them everyday either.
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 08:29 AM   #5
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Re: Best choice: Bond Fund or CD or...

Quote:
Originally Posted by Charles
2B ... and, isn't that the confusion with bond funds? Folks say their principal goes down in a bond fund, but not with an individual bond ... but for comparable duration, it's always a matter of simply holding on, isn't it?
When you buy an "intermediate" bond fund, you are told that the average maturity is something in the area of 6 to 10 years. If you are faced with an unfortunate turn of interest rates, you may be in the "intermediate " fund for the rest of your life without being able to get all of your original principal returned. With an individual bond/CD, in X years the cash is back. There is a certain degree of interest rate speculation that I personally avoid in an asset class that I use to provide cash for known "milestones" such as living expenses in 2008, 2009, etc.

We are also at near historic low interest rates. They could go lower but not too much unless we get the Great Depression II. That colors my opinion of all assets married to interest rates. Interest rates may stay here for ever but right now they are relatively low and there is not a premium being paid for going long in maturity.

I'm not as opposed to bond funds as the immediate annuities (poor internal interest rate unless you outlive your mortality table by about 10 years plus they are based on the current inverted yield curve) but I like to have people understand the pitfalls if they use fixed income like I do.
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 08:34 AM   #6
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Re: Best choice: Bond Fund or CD or...

2B, I use fixed income like you do--for secure returns in the near-term--and agree with your method and explanation.
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 08:37 AM   #7
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Re: Best choice: Bond Fund or CD or...

Quote:
Originally Posted by astromeria
2B, I use fixed income like you do--for secure returns in the near-term--and agree with your method and explanation.
And we could never both be wrong at the same time.
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 10:43 AM   #8
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Re: Best choice: Bond Fund or CD or...

A few thoughts,

1) Most folks won't be able to assemble a diversified portfolio of fixed income securities by buying individual bonds.

2) If you are buying anything other than treasuries and CDs the retail prices for bonds are typically horrible. Your institutional fund manager will get much better value on his purchases.

3) Individual bonds have the same NAV volatility and interest rate sensitivity as similar duration bond funds. Although you will get a check for the face amount of your bonds on a specific date, so too will your fund manager. If you ignore the mark-to-market of your individual bond, why not ignore the mark on your bond fund too?

If you've assembled a "ladder" that corresponds to your expected cash needs, that may be a different story. If, however, you intend to reinvest the maturing principal in longer duration fixed income investments, I don't really see the difference between individual bonds and a similar duration bond fund (other than less diversification and higher priced securities).

4) With the current flat to inverted yield curve you pay no price for keeping a short-duration fixed income portfolio. But a more normal yield-curve could see 200bp or more difference between short and long maturities. That is an awful lot of yield to give up on 30-40% of your portfolio. While long-duration bonds got crushed in the late 70s they were rock stars when rates came back down. Obviously you don't want your grocery money stashed here, but it seems reasonable to have some fixed income duration as part of a balanced portfolio.

For me, I'll keep a couple of year’s expenses in money market funds, CDs, short duration bonds, or whatever is offering the best juice at the moment. For someone with a typical ~4% withdrawal rate, that short-duration money will likely only amount to 10-15% of the total portfolio and only 1/3 of the total fixed income portion. The rest would go in bond funds of longer duration to take advantage of both better yields (presumably) and also volatility that is hopefully negatively correlated with my equity investments.


Edit
Heh, heh, heh. I just realized I didn't answer your question but responded to other posters instead . . . sorry about that.

But I guess you can gather from my last paragraph above a hint at the answer . . . which is "it depends". Whether CDS, or individual bonds, or ETFs, or bond funds depends on the rest of your portfolio and what you are looking to accomplish with this money. If you're just looking for a place to stick some fixed income cash, I'm kind of indifferent between CDs and short to intermediate term bond funds. With the current yield curve, there isn't much incentive to extend duration too much.
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 11:22 AM   #9
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Re: Best choice: Bond Fund or CD or...

Quote:
Originally Posted by 3 Yrs to Go
A few thoughts,

1) Most folks won't be able to assemble a diversified portfolio of fixed income securities by buying individual bonds.

2) If you are buying anything other than treasuries and CDs the retail prices for bonds are typically horrible. Your institutional fund manager will get much better value on his purchases.
If you are putting only a $100,000 or less into fixed income you can usually beat high quality corporates by shopping carefully for FDIC insured CDs. If you can't it's usually not by much. The interest rate spread for different levels of credit worthiness varies so you have to watch it.


Quote:
Originally Posted by 3 Yrs to Go
3) Individual bonds have the same NAV volatility and interest rate sensitivity as similar duration bond funds. Although you will get a check for the face amount of your bonds on a specific date, so too will your fund manager. If you ignore the mark-to-market of your individual bond, why not ignore the mark on your bond fund too?
That's one of the problems with bond funds is that the bond never matures. An intermediate fund will sell bonds and whatever price exists for bonds with too short a maturity for their target range. They will then take this money and buy bonds on the upper end of their maturity range.

In a falling interest rate environment, you can get hit with capital gains. That's generally good tax treatment. In rising interest rates, a mutual fund can not pass the losses on to shareholders. You are forced to sell to realize the capital loss.

Bond funds also take an annual management fee which further weakens their overall return. A 0.5% fee can usually be forgiven for an actively managed fund that does well. That type of fee seriously lowers the ability of a fund to compete with an individual buying their own.

It's different strokes for different folks. I just see a lot of people that don't really understand how a bond fund works.
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 02:08 PM   #10
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Re: Best choice: Bond Fund or CD or...

Quote:
Originally Posted by redduck
Well, after the nice market run up, it's time to rebalance. I'd like to take some of my Keogh account mutual fund gains off the table and put the proceeds into either a bond fund, a CD (still within the Keogh) or in a ETF dividend-based fund). Anyhow, it all will stay tax-free while it's within the Keogh account. Any suggestions about which of the three makes the most sense? Thanks. I find that as I'm getting closer to retirement, the more conservative I'm becoming.
Presuming we aren't talking about a huge proportion of money, I would split the rebalanced gains into half TIP and half AGG or TLT. TIP will do well in a nasty inflationary environment, AGG and TLT will do well in a recession.
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 02:09 PM   #11
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Re: Best choice: Bond Fund or CD or...


I'm woefully ignorant of bonds, as any frequent reader here can plainly
see (it is just me, or are they really quite a bit more complicated than
stocks ?), but given the current yields on bond funds I don't really quite
understand why one shouldn't put the bulk of one's fixed-income
into short-term Treasuries and CDs, where a reliable 5+% return is
obtainable at virtually zero risk. The only problem with that is that
it'll suck if interest rates go much lower, but as a previous poster said,
how much lower can they go ?

On a related note, can anyone explain how TIPS coupon rates are tied
into interest rates ? I believe generally interest rates rise with inflation,
but the inflation factor is built into the principal adjustment of TIPS, so ...

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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 02:13 PM   #12
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Re: Best choice: Bond Fund or CD or...

Quote:
Originally Posted by brewer12345
Presuming we aren't talking about a huge proportion of money, I would split the rebalanced gains into half TIP and half AGG ...
Hey, you told me to allocate my ENTIRE bond portfolio this way

But I'm putting some into munis (VWITX, VWAHX) and more adventurous stuff
like PPT and LSGLX too.
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 02:24 PM   #13
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Re: Best choice: Bond Fund or CD or...

Quote:
Originally Posted by JohnEyles
I'm woefully ignorant of bonds, as any frequent reader here can plainly
see (it is just me, or are they really quite a bit more complicated than
stocks ?), but given the current yields on bond funds I don't really quite
understand why one shouldn't put the bulk of one's fixed-income
into short-term Treasuries and CDs, where a reliable 5+% return is
obtainable at virtually zero risk. The only problem with that is that
it'll suck if interest rates go much lower, but as a previous poster said,
how much lower can they go ?

On a related note, can anyone explain how TIPS coupon rates are tied
into interest rates ? I believe generally interest rates rise with inflation,
but the inflation factor is built into the principal adjustment of TIPS, so ...
JE, bonds are actually a LOT simpler than stocks. You usually know what the cash flows will be and when you will get them, none of which you know with any certainty with stocks. The reason bonds seem more confusing is because they have been more fully described with understandable math, yet most people aren't all that familiar with math.

You are missing a very fundamental proposition with bonds. With CDs, savings accounts, etc., returns only come from one place: the yield. With bonds, return comes from two places: yield and market value gain or loss. Since traditional treasury bonds tend to do well as the economy goes into recession, the combination of long dated treasuries with equities is a good one, since one tends to offset the other. So if you bought a 5 year CD in April, you could have gotten a 5.5% or so yield (maybe more if you shopped around). Instead, if you had bought a 5 year treasury yielding just a hair below 5%, you got the yield (5%) plus the appreciation in value (an additional 1.5 to 2%).

How low can short term yields go? 1% in recent memory. :P

TIPS are simple once you understand how they work. Say you buy a 5 year TIPS at 2.5% coupon. Every 6 months, the principal of the bond gets an increase (ignoring the possibility of deflation) for inflation over the last 6 months. So if inflation was 2% over 6 months, your $10,000 bond now has face value of $10,200. But the coupon is still 2.5%, so instead of getting 2.5% X $10,000, you now get 2.5% X $10,200.
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 02:49 PM   #14
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Re: Best choice: Bond Fund or CD or...

[quote=2B ]
You get two non-bond fund responses. I prefer knowing what the amount of money I will get and when. That is true with individual bonds and CDs (barring credit failures) but with a bond fund the value may go up and down depending on the interest rate. The fixed income is intended to be "stable" which is why I like knowing that I'll get some much annual income and then all of my principal back. I also keep my maturity in the 5 year range.

There are others who will back bond funds. I suspect they didn't own a bond fund in the early 70% and watch the NAV drop like a rock while interest rates triples. Not only was I only getting about 5% on my original investment when rates skyrocketed I also lost over half my principal. Now if I had only hung in there until the 1990's I would have gotten my original investment back.

(mathjak107)
i faired not so bad in my bond fund in the 70,s. after reinvesting all the dividends at the higher rates and the fund replacing their lower paying bonds as they came due with higher yielding bonds i can't complain about that time frame.
my principal dropped for a few years while i was getting those nice juicy yields buying more shares every month. by the end of the 80's i was doing fine
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 03:05 PM   #15
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Re: Best choice: Bond Fund or CD or...

Quote:
Originally Posted by brewer12345
JE, bonds are actually a LOT simpler than stocks ... bonds seem more confusing is because they have been more fully described with understandable math, yet most people aren't all that familiar with math.
Ok, I'll try harder - theoretically I should be able to handle the math (BS in Math
and PhD in engineering).

Quote:
You are missing a very fundamental proposition with bonds. With CDs, savings accounts, etc., returns only come from one place: the yield. With bonds, return comes from two places: yield and market value gain or loss.
Right, but if market value stays static (or falls) I'm better off in the 5+% T'Bill than
the bond fund yielding 4.5%, no ? So buying bond funds is really just a coin flip on
the interest rates, right ?, but as you say, it should correlate negatively with stock
returns, which is the whole point of the diversification ... I guess since interest rates
seem pretty static recently, and the consensus seems to be that they will rise before
they fall, I'm reluctant to put a bunch of money into anything besides TIPS.

Quote:
TIPS are simple once you understand how they work.
I wasn't clear - I understand how they work. What I don't understand is what
factors influence the coupon rate (of newly issued TIPS); since inflation is ALREADY
built into the principal adjustment, it's not obvious that coupon rates would move
with inflation and rate indicators the way interest rates on regular Treasuries do.

Practically, if I'm trying to put a big chunk of money into the laddered 5-yr TIPS
(I described with a spreadsheet in another thread), should I wait til April of
2007-2010 to buy the other 4 entries (I already have 1/5th of the money in
the one laturing in 4/2011), keeping the money in T'Bills til needed and thus
effectively DCA'ing my movement into TIPS ... or, should I just go ahead and buy
the other/sooner maturities on the secondary market now ? (I'm inclining towards
the former).

Thanks for trying to help me understand this !

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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 03:58 PM   #16
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Re: Best choice: Bond Fund or CD or...

Quote:
Originally Posted by mathjak107
i faired not so bad in my bond fund in the 70,s. after reinvesting all the dividends at the higher rates and the fund replacing their lower paying bonds as they came due with higher yielding bonds i can't complain about that time frame.
my principal dropped for a few years while i was getting those nice juicy yields buying more shares every month. by the end of the 80's i was doing fine
Exactamundo! Bonds (and bond funds) are all about total return. And PIMCO says the longest it has taken a mixed bond fund to recover is 3.5 years.



Good discussion from PIMCO
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 04:03 PM   #17
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Re: Best choice: Bond Fund or CD or...

On when to buy TIPS, that is up to you. The coupon is set by the markets requirements for real (not nominal) interest rates. Where does that come from? It in part comes from the void and in part from the other alternatives available.

If would say go ahead and buy TIPS now, but the illiquid retail secondary market will rip you apart.
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 04:16 PM   #18
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Re: Best choice: Bond Fund or CD or...

Quote:
Originally Posted by brewer12345
If would say go ahead and buy TIPS now, but the illiquid retail secondary market will rip you apart.
If you refer to illiquidity in selling, doesn't matter, the plan is to hold to maturity.

If in buying, yes, as best I can tell Schwab is charging about a 1% commission
(in the form of a spread) for purchase in the $30K range.


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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 04:24 PM   #19
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Re: Best choice: Bond Fund or CD or...

Quote:
Originally Posted by JohnEyles

I wasn't clear - I understand how they work. What I don't understand is what
factors influence the coupon rate (of newly issued TIPS); since inflation is ALREADY
built into the principal adjustment, it's not obvious that coupon rates would move
with inflation and rate indicators the way interest rates on regular Treasuries do.
Since TIPS are hedged against inflation by their design, their price is sensitive to changes in expectations for real interest rates only. The price of an ordinary bond is sensitive to changes in expectation for nominal interest rates, which could be due to changes in expectations for either real rates or inflation. For new issues, the coupon of a TIPS is set by current market expectations for real interest rates, while that of ordinary bonds is set by current market expectations for nominal rates.
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Re: Best choice: Bond Fund or CD or...
Old 10-29-2006, 04:52 PM   #20
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Re: Best choice: Bond Fund or CD or...

Quote:
Originally Posted by JohnEyles
If in buying, yes, as best I can tell Schwab is charging about a 1% commission
(in the form of a spread) for purchase in the $30K range.
Yep, that's what I meant.

There are some treasuries listed on the NYSE that you can buy through Schwab for $2 a bond. Not sure if any TIPS are listed, but it might be worth a look at the NYSE website to see.
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