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Junk bond fund as an annuity?
Old 11-16-2011, 09:52 PM   #1
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Junk bond fund as an annuity?

Scott Burns had an interesting question on his blog
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Q. I plan to retire sooner rather than later. I would like a consistent income stream without annuities. I've owned junk bond funds over the years, (mainly in retirement plans). It seems that while fund values change, their payout is "relatively" stable in 7 to 10 percent range. (price goes down, effective yield goes up). That yield is on par with annuities, even through changing interest rates, economic health, etc.
What are the relative options of high yield (junk) bond funds compared to annuities? I know there are risks and variability, but if in annuities, you surrender your money in exchange for the income stream, then changes in fund value to get a similar level of income seems the lesser of evils. —N.S., Dallas, TX
Junk Bond Fund Could Be Used as a Life Annuity - Registered Investment Advisor


The answer focuses on risk as you would expect, but it is an interesting idea.
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Old 11-16-2011, 10:40 PM   #2
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I think I'd pass on both plans.
The Vanguard High Yield (VWEHX) is often touted as the premier fund for "safety."
Check out a chart for the last 20 years or so and you will see why I'd pass. The line is moving the wrong way for my money.
I hold several high yielders and treat them like stocks because they act like stocks.
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Old 11-16-2011, 11:13 PM   #3
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I wouldn't use junk as an alternative to an annuity, but I would use Wellesley or some combo of a Total Bond Fund and a Total Stock Market fund.
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Old 11-17-2011, 09:13 AM   #4
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Quote:
Originally Posted by walkinwood View Post
Scott Burns had an interesting question on his blog
Junk Bond Fund Could Be Used as a Life Annuity - Registered Investment Advisor


The answer focuses on risk as you would expect, but it is an interesting idea.
Very interesting, thanks for posting walkinwood!

I downloaded some data, and I think he understates the chance of losing income in the future. It looks like the div yield is reasonably stable as a % of NAV, but since NAV has dropped over the years, that means the actual payment has dropped - while the annuity would stay stable.

You can offset it with any excess income as he says, but that seems like a small offset. But of course, you still have most of your principal, so that is huge.


It would be interesting to consider - hold the junk until you get older, at that point the annuity would pay a higher rate, offset by any loss you may have had in the junk NAV.


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Originally Posted by JPatrick View Post
The Vanguard High Yield (VWEHX) is often touted as the premier fund for "safety."Check out a chart for the last 20 years or so and you will see why I'd pass. The line is moving the wrong way for my money. ...

But the comparison here is to an annuity. A line 'going the wrong way over 20 years' would need to be compared to a line that drops to ZERO (you don't get your principal back from an annuity). Seems like an invalid reason to rule out the junk bond.


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I wouldn't use junk as an alternative to an annuity, but I would use Wellesley or some combo of a Total Bond Fund and a Total Stock Market fund.
How would that work? How would you get 7%?

Junk funds move at about half the swing that a stock index does. So how is that materially different from a 50/50 bond/stock fund?

-ERD50
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Old 11-18-2011, 01:41 PM   #5
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How would that work? How would you get 7%?

Junk funds move at about half the swing that a stock index does. So how is that materially different from a 50/50 bond/stock fund?

-ERD50
It doesn't, I'm making the argument that Wellesley with a 10% lifetime average annual return and averaging 6.5% for the last 10 years is a good alternative to a junk bond fund or annuity. It invests in high quality stuff, puts off nice returns, and you can get at principal. I imagine the risks are similar.....with the annuity you may have guaranteed income, but there is risk in giving up principal too.
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Old 11-18-2011, 02:16 PM   #6
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I wouldn't use junk as an alternative to an annuity, but I would use Wellesley or some combo of a Total Bond Fund and a Total Stock Market fund.
Funny that you say this.

I/we have an annuity (SPIA) along (with DW) substantial assets in Wellesley.

I guess you can say that I (we) are "belts and suspenders" kind of guy/girl ...

BTW, we also hold TBF; as far as equity funds, we are more total market - globally.
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Old 11-18-2011, 03:04 PM   #7
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Not as an alternative to an annuity but our current portfolio is;
My Roth - Wellington/ Reit Index
DW Roth - Wellesley / High Yield Bond
401k & IRA's - Total Stock Mkt/ Total Int'l Stock/ Total Bond Market / Stable value fund
Breaks down to 45% stock/45% bond/10%cash

The junk amounts to about 10% of our bonds. I don't think I would invest more in the future in the place of a SPIA annuity. While having no future plans for an annuity I'm keeping an open mind.
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Old 11-18-2011, 06:16 PM   #8
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I would also consider a managed distribution fund like GABUX as an alternative to junk bond funds. It has paid a consistent 7 cent per share per month distribution for over 10 years. Distribution is virtually all a Return of Capital, but fund has managed a total return of about 7% per year over last 10 yrs.
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Old 11-18-2011, 07:00 PM   #9
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It doesn't, I'm making the argument that Wellesley with a 10% lifetime average annual return and averaging 6.5% for the last 10 years is a good alternative to a junk bond fund or annuity. It invests in high quality stuff, puts off nice returns, and you can get at principal. I imagine the risks are similar.....with the annuity you may have guaranteed income, but there is risk in giving up principal too.
I would think that most of Wellesley previous performance has been due to a prolonged bond bull market that if not over, its very close (how low can we go?). Going forward in what may be a prolonged bear market in bonds I find it hard to believe Wellesley performance will continue.
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Old 11-18-2011, 07:15 PM   #10
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I would think that most of Wellesley previous performance has been due to a prolonged bond bull market that if not over, its very close (how low can we go?). Going forward in what may be a prolonged bear market in bonds I find it hard to believe Wellesley performance will continue.
Perhaps.

Remember that Wellesley is a balanced fund comprised of 35% dividend equities and 65% bonds. My expectation is the equity portion will help support and offset a portion of any future disappointment in bond performance. I base that on the performance of the fund over the past four decades. Wellesley has a total of six down years out of the past 40, and only once ('73 and '74) were those negative years back to back.

Of course past performance doesn't guarantee anything when it comes to the future, but I've paid my money and I'm taking my chances - at least with the approximately 40% of our portfolio we have in Wellesley.
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Old 11-18-2011, 08:10 PM   #11
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I would think that most of Wellesley previous performance has been due to a prolonged bond bull market that if not over, its very close (how low can we go?). Going forward in what may be a prolonged bear market in bonds I find it hard to believe Wellesley performance will continue.
That goes for any portfolio that includes bonds. I'm not bullish on bonds or equities so to succeed in ER I am planning for average annual returns of 3%. The big problem with the OP is planning on between 7 and 10% returns and being drawn to the risky regions of junk bonds. A couple of band years early on and they are in deep sh*t.
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Old 11-18-2011, 09:11 PM   #12
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Perhaps.

Remember that Wellesley is a balanced fund comprised of 35% dividend equities and 65% bonds. My expectation is the equity portion will help support and offset a portion of any future disappointment in bond performance. I base that on the performance of the fund over the past four decades. Wellesley has a total of six down years out of the past 40, and only once ('73 and '74) were those negative years back to back.

Of course past performance doesn't guarantee anything when it comes to the future, but I've paid my money and I'm taking my chances - at least with the approximately 40% of our portfolio we have in Wellesley.
Well, I don't necessarily think Wellesley will lose money, just not perform as well going forward (7 to 10% avg. returns). The last 4 decades were mostly a bond bull. I know you remember 16% 30 yr bonds in the 70's now 3%. In addition, equities did very well from 82 to 2000. A perfect environment for a 35/65 fund. I just think Wellington would be a better bet for the next 20 or 30 yrs. Of course I could be wrong.... I was once before.
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Old 11-18-2011, 09:19 PM   #13
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Well, I don't necessarily think Wellesley will lose money, just not perform as well going forward (7 to 10% avg. returns).
I agree. I'm expecting 3 to 4% for the next few years and hope I'm not being too optimistic.
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I just think Wellington would be a better bet for the next 20 or 30 yrs.
Did I mention I have 20% of my portfolio in Wellington?
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Old 11-18-2011, 10:28 PM   #14
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Well, I don't necessarily think Wellesley will lose money, just not perform as well going forward (7 to 10% avg. returns). The last 4 decades were mostly a bond bull. I know you remember 16% 30 yr bonds in the 70's now 3%. In addition, equities did very well from 82 to 2000. A perfect environment for a 35/65 fund. I just think Wellington would be a better bet for the next 20 or 30 yrs. Of course I could be wrong.... I was once before.
Looks like we are coming down to a mix of equities and bonds to fund retirement rather than annuity or junk bonds. Hold the presses!
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