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Help please on Municipal Bonds
04-30-2014, 08:11 AM
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#1
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Full time employment: Posting here.
Join Date: Dec 2004
Posts: 699
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Help please on Municipal Bonds
Understand the concepts, but not the details, around bonds. I don't understand the wide swing in returns on below list of municipal bond funds:
Best Municipal Bond Mutual Funds | US News Best Funds
I had a call from advisor at Merrill saying below - obviously there's a lot more I need to learn - but the above list is around 1% and he's claiming 4% ?
Fair comparison ? What am I missing ? Thanks !
"The institutional municipal manager we use is currently posting a 4-4.1% tax-exempt yield on the individual bond portfolio, so for an investor in a 33% bracket, this results in a 5.6-5.9% comparable bank CD rate (i.e., a 5.9% CD in a 33% bracket = 3.9% after-tax, etc.)."
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04-30-2014, 08:18 AM
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#2
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Thinks s/he gets paid by the post
Join Date: Jul 2009
Location: North Scottsdale
Posts: 1,545
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I believe you are looking at 1 year returns or appreciation in the price of the bond fund in US News Best Funds list.
The Merrill guy is quoting yearly yield or interest % the bonds would pay.
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04-30-2014, 09:04 AM
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#3
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: Nov 2010
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The 4% or so is the interest the bonds pay. The lower number is the total return would would include interest and the change in the market value of the bond(s).
Is your advisor steering you to individual bonds or to bond funds?
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05-01-2014, 06:38 AM
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#4
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Full time employment: Posting here.
Join Date: Dec 2004
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Quote:
Originally Posted by pb4uski
Is your advisor steering you to individual bonds or to bond funds?
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Individual bonds (meeting on Monday). So what needs to be factored into the 4% is the interest rate risk (which you only incur if you sell before maturity ?) and the municipality risk.
What do folks here do ? Individual bonds or funds ?
I'd have to guess we are in an increasing interest rate environment - so that would make individual bond purchases extra risky, right ? (unless the interest rate they have to offer already has this "built in".
Thanks.
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05-01-2014, 07:19 AM
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#5
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Administrator
Join Date: Jan 2008
Location: Chicagoland
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If it were my children I would tell them it is too great a risk to invest in a product they don't know how to evaluate on the advice of an advisor who earns a sales commission selling that product. My advice would be to stick with low cost bond funds
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05-01-2014, 07:38 AM
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#6
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Full time employment: Posting here.
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So I guess conceptually no different than stocks - funds are the "way to go" unless a person is really skilled at evaluation of individual products (individual stocks or bonds).
I am not. That plus the "advisor commission concern" really does not compel me to get into individual bonds.
Anything I am missing ?
OK - I'll just buy that variable annuity the FA was also selling (joking....)
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05-01-2014, 07:40 AM
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#7
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: Nov 2010
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Quote:
Originally Posted by MichaelB
If it were my children I would tell them it is too great a risk to invest in a product they don't know how to evaluate on the advice of an advisor who earns a sales commission selling that product. My advice would be to stick with low cost bond funds
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+1
But so the OP understands - interest rate risk is where the fair value of a bond changes inversely when interest rates change. So if rates increase the value of outstanding bonds decrease and vise versa. For example, if a bond with a coupon of 4% is outstanding and rates increase to 5%, then the 4% bond will be worth less because it pays less than the market interest rate of 5%. As a result the bond will trade at a discount to par, such that the effective interest will be 5% (a combination of coupon interest and the discount).
For individual bonds, absent a credit event if you hod to maturity you would get back the par value at maturity, but if you were to sell after you buy but before maturity you might have to sell at a loss if rates rose or a gain is rates declined during the period you held the bond.
__________________
If something cannot endure laughter.... it cannot endure.
Patience is the art of concealing your impatience.
Slow and steady wins the race.
Retired Jan 2012 at age 56
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05-01-2014, 07:51 AM
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#8
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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All else being equal, if that portfolio of bonds is paying higher than market yields, then the bonds themselves will need to be purchased at a premium. There is no free lunch.
For example, if they are priced at 10% above their issue price, when they mature you get the issue price (losing 10%).
The other possibility is that they are far more risky than the lower yield bonds you are comparing to.
Rather than meet with this salesperson on Monday, I'd suggest to do some research. The salesperson is well prepared, you are less so (not a put-down, that's just the way it is). This usually ends predictably - that salesperson has a living to make.
-ERD50
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05-01-2014, 07:53 AM
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#9
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Full time employment: Posting here.
Join Date: Dec 2004
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Quote:
Originally Posted by pb4uski
But so the OP understands - interest rate risk is where the fair value of a bond changes inversely when interest rates change.
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Got it. So when buying a bond fund, you're counting on the fund manager to buy the right "mix" of bonds - looking at maturities, municipality risk, etc - and I guess they buy/sell/hold based on their decisions on interest rate environment and direction.
I don't understand where/why I would trust a full-service (read:fees) Merrill Lynch bond fund manager to buy individual bonds on my behalf -- versus a bond fund.
Majority of my equities are index, low cost funds from Fido and VG - no reason to go a different direction on fixed income side.
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05-01-2014, 03:34 PM
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#10
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I would agree and I think most members here tend toward funds but there are some who buy individual bonds.
__________________
If something cannot endure laughter.... it cannot endure.
Patience is the art of concealing your impatience.
Slow and steady wins the race.
Retired Jan 2012 at age 56
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05-03-2014, 05:24 PM
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#11
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Thinks s/he gets paid by the post
Join Date: Oct 2012
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You need a lot of money for individual bonds for diversification and a ladder. It does take away interest rate risk, however.
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05-03-2014, 05:49 PM
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#12
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Moderator Emeritus
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Quote:
Originally Posted by Delawaredave5
I don't understand where/why I would trust a full-service (read:fees) Merrill Lynch bond fund manager to buy individual bonds on my behalf -- versus a bond fund.
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Commissions...
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05-03-2014, 06:38 PM
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#13
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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Quote:
Originally Posted by RobLJ
You need a lot of money for individual bonds for diversification and a ladder. It does take away interest rate risk, however.
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I would not agree with either statement. I think you can get reasonable diversification with 30 or so positions but more is better.
Individual bonds have interest rate risk (if rate increase their value declines and vice versa). The difference from bond funds is that if you hold to maturity you will receive the par absent a default whereas a bond fund never matures.
__________________
If something cannot endure laughter.... it cannot endure.
Patience is the art of concealing your impatience.
Slow and steady wins the race.
Retired Jan 2012 at age 56
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05-03-2014, 08:06 PM
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#14
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Thinks s/he gets paid by the post
Join Date: Oct 2012
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Quote:
Originally Posted by pb4uski
I would not agree with either statement. I think you can get reasonable diversification with 30 or so positions but more is better."
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Some would think 300k at minimum is a lot of money, but that's debatable. The main attraction is in a bond ladder where interest rate risk is off the table if you hold to maturity. As you say, if you sell early, all bets are off the table on interest risk. But I'm not disagreeing with your response.
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05-04-2014, 06:19 AM
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#15
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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I guess I'm thinking if you have a 60/40 allocation and $1m retirement portfolio then you would have $400k in bonds. Also, if you bought $5k of each issue, 30 different issues would only be $150k.
An interesting middle ground between individual bonds and bond funds are the iShares and Guggenheim target maturity bond funds.
__________________
If something cannot endure laughter.... it cannot endure.
Patience is the art of concealing your impatience.
Slow and steady wins the race.
Retired Jan 2012 at age 56
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05-04-2014, 01:18 PM
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#16
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Thinks s/he gets paid by the post
Join Date: Apr 2011
Posts: 2,962
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Quote:
Originally Posted by pb4uski
If you bought $5k of each issue, 30 different issues would only be $150k.
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I shop the secondary bond market regularly through Schwab, and I think the $5K and $10K issues can also sell at a relatively low premium. They may be too small for the big fish to chase compared to the $25K and $50K bonds.
That's my theory, anyway.
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