Bond vs Bond Fund

[aja8888]

Thanks for the Forbes article. We have an assigned CFP at Vanguard, so I’ll ask him.

Just curious, what are you going to ask your CEP about the article? It's pretty straight forward unless I am missing something? Thanks.

 

[daylatedollarshort]

Thanks for the Forbes article. We have an assigned CFP at Vanguard, so I’ll ask him.

I'm curious, too, if you really think you are going to get an unbiased answer from a representative of a company that has a vested monetary interest in bond funds? The investment companies make money from the bond funds in annual expense fees whether you make or lose money. Freedom56 stated in his previous post, "The total return with treasuries is superior to BND and there is zero risk to capital." Do you not believe that is true?

 

[Freedom56]

I'm curious, too, if you really think you are going to get an unbiased answer from a representative of a company that has a vested monetary interest in bond funds? The investment companies make money from the bonds funds in annual expense fees whether you make or lose money. Freedom56 stated in his previous post, "The total return with treasuries is superior to BND and there is zero risk to capital." Do you not believe that is true?

You also have to consider that 67% of BND is US Government debt. So it begs the question, why not just invest in zero risk treasuries or agency notes for better yields and 100% return of capital?

 

[RunningBum]

The Forbes article only gives half the picture.

Take, for instance, a simple bond fund like IEF IEF +1.1%, the iShares U.S. Treasury 7-10 year ETF (-12.99% YTD). It contains 12 U.S. Treasury bonds maturing between 2029 and 2032. To maintain the 7-10 year range over time, the fund will periodically sell the bonds that fall short of the 7-year maturity and purchase bonds that are closer to 10 years. As interest rates rise and time passes, the fund will buy bonds at lower rates (higher prices) than when they sell them, sometime later, at higher rates (i.e at lower prices). That is, bond funds are forced to buy high and sell low.

Meanwhile, the individual bond holder is getting a sub-optimal rate with their bond bought when rates were lower. And if they need to sell the bond before maturity, they would take the same loss as the fund does. The bond fund has bought a new bond at the current (higher) rate so now the rate of return is higher, offsetting that loss the took to sell the old bond.

There's no magic here. Their can't be. If you believe the half story told in the article, what happens if rates fall? The bond fund is making money when it sells a bond that has a higher than current market rate. So that makes the bond fund better than an individual bond since you are only going to get your purchase money back, no more, right? Of course not! By keeping the bond, you are getting that higher interest rate than the bond fund gets with a new purchase.

Bonds and bond funds both take a hit when rates rise, and do better when rates drop. They just get the loss or gain in a different way, but it evens out in the end.

The advantage to buying individual bonds is that you aren't paying the mutual fund fee or the drag of the bid/ask spread. There's no other magic happening.

 

[daylatedollarshort]

The Forbes article only gives half the picture.
Meanwhile, the individual bond holder is getting a sub-optimal rate with their bond bought when rates were lower. And if they need to sell the bond before maturity, they would take the same loss as the fund does. The bond fund has bought a new bond at the current (higher) rate so now the rate of return is higher, offsetting that loss the took to sell the old bond.

There's no magic here. Their can't be. If you believe the half story told in the article, what happens if rates fall? The bond fund is making money when it sells a bond that has a higher than current market rate. So that makes the bond fund better than an individual bond since you are only going to get your purchase money back, no more, right? Of course not! By keeping the bond, you are getting that higher interest rate than the bond fund gets with a new purchase.

Bonds and bond funds both take a hit when rates rise, and do better when rates drop. They just get the loss or gain in a different way, but it evens out in the end.

The advantage to buying individual bonds is that you aren't paying the mutual fund fee or the drag of the bid/ask spread. There's no other magic happening.

Good points, and Kiplinger's has the answer on how to profit from those points, "When the Federal Reserve cut interest rates to near 0% overnight two years ago to offset the impact of the COVID-19 crisis, we advocated investing in bond funds and decreased our investment in individual bonds where it made sense. We did this because the bonds in those funds were already providing higher yields than if we had purchased individual bonds.

Now, as rates have started to rise, the reverse could make sense. Investors may look to replace these bond funds with individual bonds, which have a better yield since the funds now hold bonds with lower yields."

Bonds Are Having a Rough Year. Here Are 3 Actions That Can Help
https://www.kiplinger.com/investing...a-rough-year-here-are-3-actions-that-can-help

It doesn't really even out in the end, because one can switch in and out of the funds as market conditions change. I sold my funds early in the year, and dodged a 10% loss. How does that even out in 6 -7 year with a fund owner? I can always start switching back the the bond funds when / if their rates look better than Treasuries.

 

[Freedom56]

The Forbes article only gives half the picture.
Meanwhile, the individual bond holder is getting a sub-optimal rate with their bond bought when rates were lower. And if they need to sell the bond before maturity, they would take the same loss as the fund does. The bond fund has bought a new bond at the current (higher) rate so now the rate of return is higher, offsetting that loss the took to sell the old bond.

An individual bond investor would not likely get themselves into a situation where they buy low coupon long duration notes. Would any sane individual bond investor lock of they money in a five year note from Apple with a coupon of 0.55% or just stay in cash/money markets at .45%? The answer is no, they would stay in cash. However bond funds are investing/losing "other peoples money" and really don't care. So your argument makes no sense. Bond funds don't automatically sell their low coupon debt and exchange it for higher coupon debt. That's not how passive ETFs operate.

 

[Markola]

Just curious, what are you going to ask your CEP about the article? It's pretty straight forward unless I am missing something? Thanks.

We use Vanguard’s Personal Advisor Services for many, many good reasons that work well for us and that I’ve listed on other threads. I don’t expect to change any minds, nor will my mind be changed, so I don’t feel like explaining all that again. I’ve never owned individual bonds, only bond funds, so I will ask our advisor his thoughts about the upsides and downsides of owning individual bonds for us and our goals. I don’t question the article. However, asset allocations only tend to work if one doesn’t fiddle with them; and these kinds of questions tend to look differently and sort themselves out over the very long time horizon we hope to have.

 

[RunningBum]

An individual bond investor would not likely get themselves into a situation where they buy low coupon long duration notes. Would any sane individual bond investor lock of they money in a five year note from Apple with a coupon of 0.55% or just stay in cash/money markets at .45%? The answer is no, they would stay in cash.

I can and have just as easily gotten out and stayed out of a bond fund when interest rates are that low.

 

[aja8888]

We use Vanguard’s Personal Advisor Services for many, many good reasons that work well for us and that I’ve listed on other threads. I don’t expect to change any minds, nor will my mind be changed, so I don’t feel like explaining all that again. I’ve never owned individual bonds, only bond funds, so I will ask our advisor his thoughts about the upsides and downsides of owning individual bonds for us and our goals. I don’t question the article. However, asset allocations only tend to work if one doesn’t fiddle with them; and these kinds of questions tend to look differently and sort themselves out over the very long time horizon we hope to have.

Thanks, makes good sense.

 

[sengsational]

I can and have just as easily gotten out and stayed out of a bond fund when interest rates are that low.

And just left it in a money market account?

 

[RetMD21]

Actually Vanguard does NOT do what gayl requested. No broker does. It's not possible.

As far as the things you mention Vanguard doing, Schwab does those too. I think it's pretty universal among the various brokerage houses.

MIL is signed up for Vanguard's service. The idea is that they look at the previous year end balance and sell/transfer tIRA sufficient to cover RMD every year in early December. I'll check their math for the initial year but then it should be set and forget if all goes well

 

[RunningBum]

And just left it in a money market account?

That question applies equally to those who decided against investing in a bond fund or individual bonds in times of poor bond rates vs. other savings rates so I'm not sure why I'm singled out. But to answer your question, most of it went into TIPS funds, which did a lot better than bond funds in 2021. Not so good in 2022, but still a little better than most bond funds. Leaving it in a money market would have been a reasonable thing to do as well, rather than locking into a very low rate with an individual bond or facing losses in a bond fund.

 

[pb4uski]

MIL is signed up for Vanguard's service. The idea is that they look at the previous year end balance and sell/transfer tIRA sufficient to cover RMD every year in early December. I'll check their math for the initial year but then it should be set and forget if all goes well

I think you can do this for a mutual fund account but not for a brokerage account. When DM had a mutual fund account tIRA her RMD was automatically processed on her birthday (I set it up that way), taxes withheld and the net withdrawals deposited into her taxable mutual fund account.

We converted her tIRA to a brokerage account so we could buy brokered CDs and from what I have looked at we can't do that anymore.

To add insult to injury, the bank account that was linked to her mutual fund tIRA for years needs to be reauthorized.... getting sick of Vanguard's red tape.

This bank account can't be used until it's authorized for redemptions. To authorize this bank, print our Bank Transfer Service Form and return it to Vanguard with signatures notarized by a notary public.

 

[RetMD21]

I think you can do this for a mutual fund account but not for a brokerage account. When DM had a mutual fund account tIRA her RMD was automatically processed on her birthday (I set it up that way), taxes withheld and the net withdrawals deposited into her taxable mutual fund account.

We converted her tIRA to a brokerage account so we could buy brokered CDs and from what I have looked at we can't do that anymore.

To add insult to injury, the bank account that was linked to her mutual fund tIRA for years needs to be reauthorized.... getting sick of Vanguard's red tape.

I don't get it but MIL can do this from her tIRA brokerage account. Her CCRC set up the notarization so that was easy. I have brokered CD's on my tIRA list of options although I haven't actually tried to buy any

 

[gayl]

An individual bond investor would not likely get themselves into a situation where they buy low coupon long duration notes. Would any sane individual bond investor lock of they money in a five year note from Apple with a coupon of 0.55% or just stay in cash/money markets at .45%? The answer is no, they would stay in cash. However bond funds are investing/losing "other peoples money" and really don't care. So your argument makes no sense. Bond funds don't automatically sell their low coupon debt and exchange it for higher coupon debt. That's not how passive ETFs operate.

Not being a bond investor, I decided to just stick in a 30 day CD @ 1.75% while I figure it out. Most of it sorted thru, still sorting thru individual bond VS bond fund to smooth out risk VS just more SCHB

 

[jazz4cash]

Not being a bond investor, I decided to just stick in a 30 day CD @ 1.75% while I figure it out. Most of it sorted thru, still sorting thru individual bond VS bond fund to smooth out risk VS just more SCHB

Seems like a great place to park while you figure it out.

 

[all4j]

These $$s are just until I need to take RMDs in 1-2 yrs depending on Secure 2.0

1st, I have only skimmed this thread, but this jumped out. I had been thinking the decision between individual bonds or funds to be a solution in search of a problem. But for this length of time? Throw CDs into the mix & the end result likely won't be more than 1-5 basis points different anyway (imho). Sounds like your debate is which will outperform over next 1-2 years -- bonds or equities? Keeping in mind the deep-pocketed fed has tipped their hand...

But I can't help but be curious as to your plan when RMDs start? Why will you be changing then & in what direction?

 

[Freedom56]

Not being a bond investor, I decided to just stick in a 30 day CD @ 1.75% while I figure it out. Most of it sorted thru, still sorting thru individual bond VS bond fund to smooth out risk VS just more SCHB

You have many options for fixed income - CDs, Treasuries, Individual bonds, Agency notes etc... It's up to you to decide what's suitable for you. They will all return your capital at maturity. Bond funds will not. What people don't get is that the low fees of passive bond funds are an illusion. Funds do not disclose the trading fees when they buy and sell bonds. That is where the real theft occurs. Take a look at daily trades of widely held bonds and you will see some wide disparities in prices paid. The disparities are not happening by accident.

 

[DawgMan]

Quick read thru the threads... smarter people than me here, but as a newbie retiree, my MO changed. I went from pure TR with stock/bond ETFs to more of a bucket guy. I retired at the beginning of 2022 with a low 2% WR and made a strategic decision to be safe with 10 yrs of $$ and let the rest run with equities (effectively choosing to "play the game" for legacy reasons). This had me taking initially 5 years of spend and laddering it with individual bonds. I left 6-10 yrs in short/intermediate ETFs (may deploy in individual bonds??). This approach seems to appease my conservative and greedy nature. IN retirement, I do believe there is a stronger argument for some level of laddered bonds... but perhaps that's just me.

 

[gayl]

1st, I have only skimmed this thread, but this jumped out. I had been thinking the decision between individual bonds or funds to be a solution in search of a problem. But for this length of time? Throw CDs into the mix & the end result likely won't be more than 1-5 basis points different anyway (imho). Sounds like your debate is which will outperform over next 1-2 years -- bonds or equities? Keeping in mind the deep-pocketed fed has tipped their hand...



But I can't help but be curious as to your plan when RMDs start? Why will you be changing then & in what direction?

Yr 1 RMD: 60% SCHB to brokerage acct / 40% fixed income (75% of this to IRS / 25% to FTB). Adjust yr 2 as needed

 

[RetMD21]

Quick read thru the threads... smarter people than me here, but as a newbie retiree, my MO changed. I went from pure TR with stock/bond ETFs to more of a bucket guy. I retired at the beginning of 2022 with a low 2% WR and made a strategic decision to be safe with 10 yrs of $$ and let the rest run with equities (effectively choosing to "play the game" for legacy reasons). This had me taking initially 5 years of spend and laddering it with individual bonds. I left 6-10 yrs in short/intermediate ETFs (may deploy in individual bonds??). This approach seems to appease my conservative and greedy nature. IN retirement, I do believe there is a stronger argument for some level of laddered bonds... but perhaps that's just me.

Makes sense to me. A 2% WR with a 60/40 portfolio means you have 20 years of spending in fixed income, right? I am working toward a 10 year tips ladder for bonds.

 

[DawgMan]

Makes sense to me. A 2% WR with a 60/40 portfolio means you have 20 years of spending in fixed income, right?

Well, my revised strategy has me holding no more than 10 years in fixed so that skews my AA to a higher stock position. As mentioned, I could choose the more conservative approach of reducing my stock allocation and "stop playing", but I choose to "keep playing" as I feel 10 years worth of highly discretionary spend (along with levers to pull to reduce spending if needed) is enough to ride out most bear markets.

 

[BackcountryMe]

You have many options for fixed income - CDs, Treasuries, Individual bonds, Agency notes etc... It's up to you to decide what's suitable for you. They will all return your capital at maturity. Bond funds will not. What people don't get is that the low fees of passive bond funds are an illusion. Funds do not disclose the trading fees when they buy and sell bonds. That is where the real theft occurs. Take a look at daily trades of widely held bonds and you will see some wide disparities in prices paid. The disparities are not happening by accident.

Why would you invest in some of the corporate notes you've mentioned at a 3.5% yield (Credit Suisse, Wells Fargo, etc.), when a 6-month T-bill is trading around 3%? It's ~15% more yield, but more credit risk and twice the duration. I'm not disagreeing with you. I'm just curious how you think about this.

 

[Freedom56]

Why would you invest in some of the corporate notes you've mentioned at a 3.5% yield (Credit Suisse, Wells Fargo, etc.), when a 6-month T-bill is trading around 3%? It's ~15% more yield, but more credit risk and twice the duration. I'm not disagreeing with you. I'm just curious how you think about this.

I'm not aware of any 3.5% notes. There was a 3.75% one year note form Citigroup that pays monthly which was good alternative to a one year CD at the time. However before buying a high grade corporate note, I always compare yield with CDs, agency, and treasuries. The corporate notes mentioned and that I bought were high grade notes at the following yields:

CIBC 42 month - 4.47%
Bank of Montreal 36 month - 4.5%
TD Bank 5 year - 5%
Citigroup 5 Year - 5%
Wells Fargo 3 year - 4.5%

All the above notes are safe alternatives to CDs and treasuries. However the bulk of my corporate note buys this year were from the secondary market and were high yield and lower investment grade with YTMs in some cases over 9%. However, I won't put 100% of my capital into high yield. I don't invest in equities at all and high yield notes in my mind are a safer bet than the casino mentality of the stock market.

 

[all4j]

Yr 1 RMD: 60% SCHB to brokerage acct / 40% fixed income (75% of this to IRS / 25% to FTB). Adjust yr 2 as needed

Thanks. I think I must have misunderstood the post I cited earlier & perhaps muddied the water. I thought previous post was saying you were considering whether to use individual bonds or a bond fund until RMD time when you would change to something else. Usually when selecting "bonds" (or their alternative, I just don't care for the fixed income terminology), someone picks duration/maturity based on their need. That is complicated now due to anticipated frequent rate shifts. So, one has to balance which risk is more important to them.

I think in your case I'd try to not overthink it & build a ladder of some sorts; but not one that stops with year 1 rmd.

btw, I didn't pick up on what "FTB" is...

Good luck & whatever you decide, don't look back!