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Old 09-13-2013, 11:05 AM   #21
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But there are some products that are still good as part of an income portfolio; I'm thinking of TIAA-Traditional which is currently paying me 4.4% in the accumulation phase (way better than most of my fixed income) and has a vintage system for payout interest rates that will give me 5.5%. There is also a graduated payout system which helps account for inflation.
TIAA-CREF is an outstanding organization. If I had to do it over again and had the power to do so, I would say 'Give me the money you were going to use for my pension." And then I would put a lot of it in TIAA and index funds. No worries for me that politicains will foul up my pension, no unhappy taxpayers if they do, and one happy camper retired guy.
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Old 09-13-2013, 11:09 AM   #22
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Sure, but has anyone actually compared the performance of a bond ladder held to maturity to that of an index bond fund, of course risk would me more difficult to compare and as we are at historic lows you'd always want to model for a recovery and increase in interest rates. But I hear everyone saying go to individual bonds so you can hold to maturity, but are there any numbers? You are certainly getting back principal if you hold a bond to maturity, but if interest rates rise you'll be getting a below market coupon rate while the bond fund investor will be getting the higher market rate.
+1

The goal is to maximize TOTAL return. Not how much interest income one gets, or whether a security went up or down. These are plays in the game. What counts is the final score - total return.

That said, I tend to agree with Suzy. Sheesh!! Is there a blue moon this month?
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Old 09-13-2013, 11:11 AM   #23
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William Bernstein is wrong.
I suggest that you actually sit down with a financial text book and price bonds in a rising interest rate environment. I am certain that you won't be so quick to dismiss William Bernstein's expertise next time, if you do so.
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Old 09-13-2013, 11:18 AM   #24
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she "looked into his background" and crowed that she's able to do that. She sniffed that he (gasp!) had a $100K home and drove a junker.
I don't care where the adviser lives lives or what she drives. What I want to know is "Where are the customer's yachts?"


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This quote (and the book) refer to an ancient story (which the author finds is probably at least 100 years old by now) about a visitor to New York who admired the yachts that the bankers and brokers had in the harbor. Naively, he then asked where the customers' yachts were. Naturally, there were no customers' yachts.
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Old 09-13-2013, 11:25 AM   #25
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Suze is, um, less than a great source for advice.

As for bond funds, I have a modest amount in the interest of diversification. However, much of my fixed income is in CDs, I bonds, cash and the like. Since it is again at a decent discount to NAV, I have recently started buying GIM as a fixed income diversifier (foreign bonds).
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Old 09-13-2013, 11:45 AM   #26
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Karluk and Nun are correct. What counts is the yield and the duration when the initial investment is committed. Same for individual bond or bond fund. However, I think there is one advantage for the bond fund- it is seamless to re-invest dividends, if you do not need all of them for living expenses.

Ha
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Old 09-13-2013, 12:35 PM   #27
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Karluk and Nun are correct. What counts is the yield and the duration when the initial investment is committed. Same for individual bond or bond fund. However, I think there is one advantage for the bond fund- it is seamless to re-invest dividends, if you do not need all of them for living expenses.

Ha
The "seamless reinvesting of bonds" is the reason I have mine in a bond fund fund. Though I am sitting on the sideline with some cash and have considered buying treasuries if they rise a bit more, but what to do with the dribs and drabs of my interest is the main hold back. I will not use the money to live on and don't want to piss it away when it drops into my checking account. Bogleheads had a great chart a few weeks ago on this bond vs. bond fund discussion. One poster showed in two scenarios of an impact of a 1% and 2% rise in rates compared to holding bond to maturity vs. the bond fund. After a few years it showed that the loss of initial value of bond eventually several years later was more than over come by increased interest rate it returned over time. Now I know different scenarios are in play including holding them for 10 yrs. and when the spike occurs etc., but that did put my mind at ease concerning them.
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Old 09-13-2013, 01:33 PM   #28
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I suggest that you actually sit down with a financial text book and price bonds in a rising interest rate environment. I am certain that you won't be so quick to dismiss William Bernstein's expertise next time, if you do so.
I am well aware of how bond prices move in a rising interest rate environment. Amazingly, the price of a bond with a 10 yr maturity will be impacted effectively the same as a bond fund with a 10 yr average maturity. Assuming that the interest is either spent or reinvested at the higher interest rate, the only difference is that in 10 years the bond matures and the original face value is paid. This is then available for reinvestment at the higher interest rate. With a bond fund, the original investment is still devalued where it will remain until interest rates fall. At no time does the interest paid on the original investment change during those 10 years (barring defaults).

All of the arguments that say how it all works out in the end for bond funds are based on many years of reinvested dividends at the higher rates. "Soon" you can't see a significant difference. That may be fine for someone in the accumulation phase but it makes no sense for someone nearing retirement.

In the future, please feel free to show me where I have made a mistake. If you can't, I do not appreciate a flippant comment effectively calling me stupid.
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Old 09-13-2013, 03:30 PM   #29
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I'm not an expert on bonds but I'll try to recap this thread to see if there is consensus.

As rates rise...

Individual Bonds lose principal value but is fully regained by maturity. Interest income steady the whole time. Investor does not lose money if held to maturity. Risk of credit default.

Bond Funds lose principal value and sales by bond manager cause this to be permanent. However, this loss is fully recouped by higher interest payments. Bonds not sold by bond manager work same as individual bonds above. Overall, investors do not lose money if they hold to the original average maturity. Risk of credit default is minimized by diversification.

In both funds and individual bonds, it looks like investors only lose money if THEY sell before maturity.
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Old 09-13-2013, 03:47 PM   #30
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I'm not an expert on bonds but I'll try to recap this thread to see if there is consensus.

As rates rise...


Bond funds ...investors do not lose money if they hold to the original average maturity. .
I don't think this is necessarily true. The fund does not hold bonds to maturity. It is continually maintaining a maturity to match the objective. If rates move substantially higher, like in the 1970's, the fund may experience constant principal erosion.
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Old 09-13-2013, 03:56 PM   #31
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It is amazing to me how something as simple as bonds can confuse so many people.
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Old 09-13-2013, 04:17 PM   #32
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In theory the only difference between holding individual bonds vs those same bonds in a fund should be the management vs brokerage expenses. Reality, however, makes this comparison impossible because no such fund exists. Like all thing investing, we can only know with certainty what would have worked best in the past.

For most investors, including mot of us, the more important questions are how much fixed income do each of us need, and how it be acquired & held. There is no answer that fits everyone, but I imagine most people are better off keeping a big part of their fixed income allocation in a way that can be easily converted (without losing value) to another asset class should the opportunity arise. A decade or two long bond ladder may win all the math contests yet prove to be the big loser in real life due to inflation.
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Old 09-13-2013, 04:24 PM   #33
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The convenience, simplicity, ease of investing small amounts, rebalancing and the variety of bond funds available are important considerations for me. CD's are just the opposite and I wouldn't take the risk of buying an individual bond.
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Old 09-13-2013, 05:13 PM   #34
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As a general rule, investors should hold their bond funds in tax advantaged accounts, in which case there would be no difference in before-tax and after-tax returns. As as second general rule, if it's possible to sell losers in a taxable accounts and establish a capital loss for tax purposes, investors should do so in order to get the deduction from current income.

That said, tax law is very complicated and future tax rates are unpredictable, so I wouldn't be so bold as to say selling is always better on an after-tax basis. But I would have to see a convincing argument in favor of holding losers, since the tax benefits of selling are obvious and immediate. YMMV
The reason I ask is because it seems to me that you are trading a capital loss on the original bond, which is used first to offset lower taxed capital gains, against increased regular income from the higher yielding new bond, which will be taxed at a higher rate.
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Old 09-13-2013, 05:18 PM   #35
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First off, I agree with 2B, so I won't reiterate his analysis. Bernstein is wrong in that funds don't hold everything to maturity.

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Originally Posted by RetireAge50 View Post
I'm not an expert on bonds but I'll try to recap this thread to see if there is consensus.

As rates rise...

Individual Bonds lose principal value but is fully regained by maturity. Interest income steady the whole time. Investor does not lose money if held to maturity. Risk of credit default.

Bond Funds lose principal value and sales by bond manager cause this to be permanent. However, this loss is fully recouped by higher interest payments. Bonds not sold by bond manager work same as individual bonds above. Overall, investors do not lose money if they hold to the original average maturity. Risk of credit default is minimized by diversification.

In both funds and individual bonds, it looks like investors only lose money if THEY sell before maturity.
I do disagree that the loss is fully recouped with higher interest payments. In order to do so, you're receiving a lower return than what the fund is advertising. In time, you will recoup your principle, but it may be longer than if you held individual bonds.

A simple and probably incorrect example is say your bond fund has a duration of 5. If interest rates go up by 2%, the value of your fund drops by 10%. You're looking at a minimum of 5 years if your fund sold everything and re-invested at the higher rate. Seeing as they won't do this, it will take longer. In the mean time, my bond is increasing back to par and I can re-invest it at current rates.
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Old 09-13-2013, 09:50 PM   #36
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This is why I'll stick with bond funds over a ladder.

https://personal.vanguard.com/pdf/s354.pdf
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Old 09-14-2013, 08:55 AM   #37
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If one was to buy tips only, would you do it in a fund or as individual bonds? To me, buying a security for inflation protection and then wrapping it up in a fund that moves inversely with rising inflation and rates is silly.
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Old 09-14-2013, 02:01 PM   #38
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OK on WL and SPIAs (at present for sure) but what does she recommend instead of bond funds? All stock and/or cash?
She recommends bonds not bond funds. From what I have read unless you have at least $250k to invest in bonds you are not going to be able to properly diversify your bond holdings. Buying bonds can be expensive and in the secondary market you can really get taken.

I'd take advice from a bum pan handling before I put any stock in what that arrogant preachy PITA says!
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Old 09-14-2013, 06:43 PM   #39
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If one was to buy tips only, would you do it in a fund or as individual bonds? To me, buying a security for inflation protection and then wrapping it up in a fund that moves inversely with rising inflation and rates is silly.
It's not hard to set up a bond ladder using treasury direct. But the denominations are pretty high, so the nominal size of your bond allocation can't be too small. As to how to handle the cash throw-off, one could use the rocks (individual bonds) and sand (bond fund) approach. You tell TD what account you want the proceeds to go to, and you just make a bunch of small bond fund purchases from those direct deposits.
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Old 09-14-2013, 10:35 PM   #40
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A simple and probably incorrect example is say your bond fund has a duration of 5. If interest rates go up by 2%, the value of your fund drops by 10%. You're looking at a minimum of 5 years if your fund sold everything and re-invested at the higher rate. Seeing as they won't do this, it will take longer. In the mean time, my bond is increasing back to par and I can re-invest it at current rates.
If this analysis is correct, then you can make a fortune. Simply buy individual bonds and short a bond fund which has the same duration.

But, wait, if you buy a bunch of individual bonds, then what you have is your own little private bond fund. How could it be that *your* bond fund will make a much larger profit than the public bond fund?

The hungry sharks that swim on Wall Street and who can compute NPVs in their head would arbitrage that trade in an instant. Any time you think you see a risk-free profitable trade that nobody else has seen .... you are almost certainly wrong. It's time to closely examine your premisses.

By holding on to a bond to maturity vs. selling at a loss brfore maturity all you are doing is changing the shape of your time-valued total return -- you are not changing the NPV at all.
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