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Bonds vs. MM
Old 01-17-2008, 12:59 PM   #1
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Bonds vs. MM

It seems that most discussions on the FI portion of an AA always use bonds or bond funds. It appears that the Vanguard MM fund (for example) is paying better than most bond funds and doesn't have the same problems when rates start to rise.

Under the current situation -what is the advantage of bond funds over MM funds?
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Old 01-17-2008, 01:02 PM   #2
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Bonds produce income and preserve capital. Money market is really a cash equivalent and has more liquidity. Their purposes are different.
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Old 01-17-2008, 01:08 PM   #3
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There's no "advantage",per se,it's a matter of what you are trying to accomplish..............
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Old 01-17-2008, 01:08 PM   #4
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Cash is fine for what it is. Historically, the long-term real return has been about 1% vs 2.5% for longer-term treasuries.

And when the fed lowers rates, the real return on cash often goes negative. Which it might do by the time of the next fed meeting at the end of this month.
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Old 01-17-2008, 01:25 PM   #5
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Bond funds (or bond ladders) diversify you over different parts of the yield curve. By holding a range of bonds from say 1 yr to 5 yr, you lower your exposure to interest rate changes. When you are in cash you are only holding one term: zero years.

The original post is kind of like asking "why would I want to hold an index fund when my favorite stock pick is beating the index right now?". The answer is that over time the index will likely beat the one stock, and with less volatility.
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Old 01-17-2008, 01:52 PM   #6
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here's an interesting graph that shows what the previous replies already said.
Drag the blue diamond at the bottom of the graph (on the time scale) to pick
the time period you are interested in seeing. I think around 2003 or so it shows
a steep yield curve with money market funds at 1% or so and longer term bonds
at 3%----both pretty low but imagine if you were depending on that money market fund
to produce income that you depended on . I don't think I ever thought that yields
could ever get that low when before the bubble/bust they were more like 5% or so?

Historical Yield Curve
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Old 01-17-2008, 02:07 PM   #7
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Here here... the best education I ever had in interest rates was going to one of those web pages that lets you see the yield curve historical data. It really helps to get a feel for what how much interest rates can vary (and how often they stay in the same ranges).
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Old 01-17-2008, 02:35 PM   #8
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Our AA includes 20 percent in MM and 10 percent in bond funds (plus whatever percentage of those is within the 20 percent allocated in the Target retirement 2010 fund). The amount in the MM was purely as a safety net.
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Old 01-17-2008, 03:43 PM   #9
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MM have interest rate risk- the returns are directly proportional to what the fed funds rate is.

Bonds have interest rate risk and principal risk. The return of bonds has a principal and interest rate component (if you only compare yields of MM to yields of bonds, you are missing a return component for the bonds). If we talk bond mutual funds, the bond fund will have the cost of principal moving the inverse of interest rate. As rates drop the value of the bonds in the bond fund goes up, so you can make money that way too (in addition to the interest the bond fund is paying you).

Because bonds have more risk, their overall return should be higher (to compensate you for taking that risk).
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Old 01-17-2008, 05:55 PM   #10
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long bonds can move 1 to 2% in a day cushioning alot of the losses in equities lately. money markets dont provide that offset. i have been trading in and out of TIPS AND TLT for the last 2 months adding nice capital gains of a few per cent each time stocks tank. ive been re-buying them again each time they roll back 2%. sold tlt again today
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Old 01-17-2008, 09:12 PM   #11
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Quote:
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MM have interest rate risk- the returns are directly proportional to what the fed funds rate is.

Bonds have interest rate risk and principal risk. The return of bonds has a principal and interest rate component (if you only compare yields of MM to yields of bonds, you are missing a return component for the bonds). If we talk bond mutual funds, the bond fund will have the cost of principal moving the inverse of interest rate. As rates drop the value of the bonds in the bond fund goes up, so you can make money that way too (in addition to the interest the bond fund is paying you).

Because bonds have more risk, their overall return should be higher (to compensate you for taking that risk).
I think the risk of bond share prices falling is overblown by many people. The amount that a bond fund share price changes is exactly the opposite of the changes in future income. The returns and share prices are two sides of the same coin; the share price only looks volatile when you divorce it from the income generated.

As an analogy, cash funds are to bond funds as renting is to buying a home. When you buy a home you take on the market risk of the home value changing, and when you rent you don't take any of that risk on. A naive analysis says that renting is therefore safer. And it is safer if you are going in and out in a short period of time. Yet over the long term most people agree that buying a home reduces the volatility of their housing cashflow. Similarly, bond funds reward people who stay for the long term... less than stocks but more than cash.
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Old 01-18-2008, 03:56 AM   #12
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traditionally after taxes and inflation money markets are probley at a guaranteed loss in purchaseing power 90% of the time.

the risk with bonds is you stand a chance of maybe coming out ahead long term if you buy them when rates are higher but looking at some charts that were posted in other threads that show 10 year time frames for bond total returns adjusted for inflation for the last 60 years showed more negative return years than positive.

that makes it tough to hold bonds long term as unlike stocks which for 100 years have higher highes and higher lows as time goes on interest rates are random and so are the returns.

i find tips and long bonds great trading vehicles at these low levels but with their rates almost at floor level they are more inclined to go up from here than down.


i think the long shot here is we are going lower from here in the future. 5-1/4 is the historical average and we are way below
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Old 01-18-2008, 05:59 AM   #13
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Thanks for the replies. I realize I should have given more information. I have a large sum in MM funds that I am DCA into my AA currently. I'm just thinking that with the current environment, I might be better to wait a bit before buying all of my bond allocation.
I know (dirty market timer) but I find it is pretty easy to determine most short term interest rate changes - the market and government usually tell you in advance.

Anyone want to bet against an interest rate cut the end of this month?

I do agree with many of the posters, that over the long haul, the bonds funds are the way to go for my FI component.
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My situation...
Old 01-18-2008, 06:47 AM   #14
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My situation...

Before I was retired, I kept very little cash in the bond/cash portion of my AA.

Now that I'm retired, I've adjusted my MM holding to the current years gross expenses (includes 15% taxes) along with another three years in MM accounts. That means the beginning of this month, I had 4 years of gross income in MM accounts.

By December (when I do my "harvesting" for 2009), I'll determine if I had any "profit" (e.g. holding gains) during the year. If I don't (possible), I won't replenish my current year's MM account, and I'll tap my 3-year holdings for next years income. Assuming the market returns to "normal" (whatever that is) by the end of 2009, I'll replenish my MM accounts (up to the max of 4 years holdings a/o Jan 1). If not, I'll continue to tap the MM accounts.

I'm counting on this market to turn around within 4 years with my "method", before I would have to sell any of my fund holdings.

Again, my view is a bit different being retired. Most, especially those still wor*ing would have more in bonds rather than cash in their AA. That's understandable under the conditions. Since I'm looking for retirement income stability, I'm more comfortable with the cash.

BTW, I've split cash holdings between Vanguard/ Fidelity. Fidelity MM (FDRXX) is a bit ahead of Vanguard, but I'm sure they go back/forth on an ongoing basis.

- Ron
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Old 01-18-2008, 07:21 AM   #15
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Originally Posted by rs0460a View Post
Before I was retired, I kept very little cash in the bond/cash portion of my AA.

Now that I'm retired, I've adjusted my MM holding to the current years gross expenses (includes 15% taxes) along with another three years in MM accounts. That means the beginning of this month, I had 4 years of gross income in MM accounts.

By December (when I do my "harvesting" for 2009), I'll determine if I had any "profit" (e.g. holding gains) during the year. If I don't (possible), I won't replenish my current year's MM account, and I'll tap my 3-year holdings for next years income. Assuming the market returns to "normal" (whatever that is) by the end of 2009, I'll replenish my MM accounts (up to the max of 4 years holdings a/o Jan 1). If not, I'll continue to tap the MM accounts.

I'm counting on this market to turn around within 4 years with my "method", before I would have to sell any of my fund holdings.

Again, my view is a bit different being retired. Most, especially those still wor*ing would have more in bonds rather than cash in their AA. That's understandable under the conditions. Since I'm looking for retirement income stability, I'm more comfortable with the cash.

BTW, I've split cash holdings between Vanguard/ Fidelity. Fidelity MM (FDRXX) is a bit ahead of Vanguard, but I'm sure they go back/forth on an ongoing basis.

- Ron
Ron, why do you use a mm account rather than a cd ladder?
I use mm and cds ladder and am wondering if I am missing something here.
...want to learn Thanks.
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Old 01-18-2008, 08:12 AM   #16
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Ron, why do you use a mm account rather than a cd ladder?
I use mm and cds ladder and am wondering if I am missing something here.
...want to learn Thanks.
Just for ease of management in case of my death. Since my wife is not as "attuned" to the management of retirement investments, I've directed her how to get "help" if/when I'm gone.

Part of that plan is to get professional investment advice (another thread). The 3-4 years of income will allow her to "breathe" before she has to make a firm decision.

The other reason why I don't use CD ladders is management of the retirement account. I/we use Fidelity's IMA account and related software to show us on a monthly basis our "burn rate" as related to our "plan" (won't go into that, here). However, it's eash for my wife to see actual expenses vs. what was planned in our intermediate IMA account (current year). It's more of an ease in tracking/paperwork that is inituative in nature.

While there are arguments on how we could "make more $$$" through other alternatives (e.g. bond ladders), we've been more fortunate than most. LBYM over the last 25+ years, along with the fact that we don't have an estate problem (it's going to charity) means we don't have to worry about the "next generation". Most folks don't have that "luxury". We live well, travel where/ when we want (example: to Europe every year, for the last 12+ years) and have a good life.

Are we "rich"? Most would say we are not. However, we're "financially independent", able to live life in the way we want. Our goal is to continue that lifestyle for whatever time we have left. Due to our financial resources, we don't have to worry about that "last penny" and can afford to be a bit "flexable" in our investments. Could we make more by having less in cash (and more in "other investments")? Sure. Do we need to (and loose sleep over it?) Nope.

Life is good......

- Ron
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Old 01-18-2008, 09:04 AM   #17
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Life is good......

- Ron
Sounds like it ... I'm right behind ya. thanks Ron.
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Old 01-18-2008, 10:48 AM   #18
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. I'm just thinking that with the current environment, I might be better to wait a bit before buying all of my bond allocation.
I know (dirty market timer) but I find it is pretty easy to determine most short term interest rate changes - the market and government usually tell you in advance.

Anyone want to bet against an interest rate cut the end of this month?
If you are a market timer who believes rates will go down, you should be buying bonds with cash now because they will increase in value when rates go down.
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Old 01-18-2008, 04:46 PM   #19
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we are almost at that point where the rate drops coming up are already factored in. with only 2-3 % left before the bonds hit zero theres not much more upside to them in my opinion. the thing with bonds is you had to get in them early.
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Old 01-19-2008, 09:48 PM   #20
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I think the risk of bond share prices falling is overblown by many people. The amount that a bond fund share price changes is exactly the opposite of the changes in future income. The returns and share prices are two sides of the same coin; the share price only looks volatile when you divorce it from the income generated.

As an analogy, cash funds are to bond funds as renting is to buying a home. When you buy a home you take on the market risk of the home value changing, and when you rent you don't take any of that risk on. A naive analysis says that renting is therefore safer. And it is safer if you are going in and out in a short period of time. Yet over the long term most people agree that buying a home reduces the volatility of their housing cashflow. Similarly, bond funds reward people who stay for the long term... less than stocks but more than cash.
This is by far the best analogy I've ever seen in regards to the reasoning behind the allocation of money market funds and bond funds in a portfolio.
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