Bonds vs Bond Funds?

[Gearhead Jim]

It seems that bond funds (except Treasuries) have done a poor job of reducing portfolio volitility this year. Bond funds are cheap and easy to buy or sell; but seem to have the potential for capital losses even when interest rates are steady or declining.
If one can buy a diversified (companies AND industries) selection of bonds and hold them to maturity, that seems to reduce much of the capital loss risk. If one does not mind doing the homework, and can diversify broadly without undue expense, this seems like the better plan.
But you folks often have more information...

 

[FinanceDude]

This year, even bonds don't seem to work....... That being said, laddering corporate bonds is something I have done for quite a few years. However, it does take due diligence.

I have had better overall success with muni bonds than corporates. I do own a bond fund in my 401K but it's PIMCO Total Return managed by Bill Gross so I just leave it alone.........

 

[Gearhead Jim]

This year, even bonds don't seem to work....... That being said, laddering corporate bonds is something I have done for quite a few years. However, it does take due diligence.

I have had better overall success with muni bonds than corporates. I do own a bond fund in my 401K but it's PIMCO Total Return managed by Bill Gross so I just leave it alone.........

Are you saying that bond FUNDS are not working this year, but laddering individual bonds is working? That's what I would expect to be true, but I've been wrong before...

 

[youbet]

Are you saying that bond FUNDS are not working this year, but laddering individual bonds is working? That's what I would expect to be true, but I've been wrong before...

Actually, most bonds are not working this year. If you hold to maturity, and they don't default, you redeem at par. But until maturity, they are still down and contributing to the downward movement of your portfolio when valued at market.

When comparing bonds to a bond fund, you can't look at today's NAV of the fund and compare it to the future mature value of your bonds. You have to either:

1. Compare the bond fund today to the market value of your bonds today.

2. Compare the value of your bond ladder at maturity to some hypothetical value of the bond fund if sold in increments over the same time frame that your bond ladder matures.

Otherwise.... not apples to apples.

I do some of both funds and individual bonds. Pros and cons for both.

 

[Gearhead Jim]

Good comments, thanks. For me, a bond will be worth a certain value at the fixed maturity date, and it also pays a certain income until then. Bond funds and stocks will probably be worth more, some day. But we don't know when that day will be or what the value will be.
Different tools for different jobs.

 

[kcowan]

Laddered bonds offer 100% capital preservation by holding until maturity. Bond funds do not. So the funds are more volatile if you need to do rebalancing.

 

[FinanceDude]

Laddered bonds offer 100% capital preservation by holding until maturity. Bond funds do not. So the funds are more volatile if you need to do rebalancing.

Not quite correct, if the company issuing the bonds goes through bankruptcy, many times it doesn't matter that the bondholders are ahead of the equity folks, NOONE is getting paid. The secondary market dries up and you'll be lucky to sell the bonds at a loss. Remember, GM WAS a AAA rated bond at one time.........

If interest rates are moving in either direction quickly, duration becomes quite important. For instance, when the tech bubble burst, and Greenspan madly cut interest rates, my bond fund holdings blew away my laddered portfolios. However, I might have caught lightning in a bottle.

I am finding good quality muni issues as discounts to par in the 5-5.5% area, which is pretty sweet.......

 

[summer2007]

I bought into vanguards intermediate term investment grade bond fund in I think July. My original $3000 is now worth about $2700 so if I would have bought a cd I would have been better off so far.

Is there any way to get corporate bonds insured?

I always wondered that.

Jim

 

[SteveL]

A friend of mine was put into Lehman bonds by his advisor. These were highly rated by the rating agencies. Now the bonds are worthless.
Because the rating agencies are paid by the bond issuers, you can't trust these ratings. Over time, if you buy corporate issues, you have to expect a certain amount of bonds going bad.

Because of this, most bond funds start with a $10 share value at inception. Since they pay out the interest, bond defaults push the value down. Some bond funds never make it back to this level. At Vanguard, you can find the inception price, and for any year, look at the price per share on a daily basis. Over several years, you can see the effect of increases and decreases in market interest rates. For funds that buy more risky issues, you can see the effect of defaults.....

 

[kcowan]

The funds have the added variable of a fund manager.

 

[mathjak107]

what you have to remember about bond funds is that putting credit risk aside so lets talk about treasuries.... bond fund interest isnt fixed while a traditional bond is,... with a bond fund your nav drops when rates rise but your interest rises too. if a bond fund has a average weighted maturity of 5years than for every point rates rise your principal drops by 5% but for every year you hang in their your interest increased by 1% over the rate you started with so at the end of 5 years if rates are still up about 1% your principal is down 5% but you made an extra 1% for 5years . you have just about the same return as a fixed 5 year bond,..

the key to making bond funds work is you must stay in for the average weighted maturity time

 

[Gone4Good]

If one can buy a diversified (companies AND industries) selection of bonds and hold them to maturity, that seems to reduce much of the capital loss risk.

Not true. You'd be impacted by the same mark-to-market capital losses that the bond funds are suffering. The problem is that credit spreads have widened dramatically over the past couple of months. So an existing high quality corporate bond that had a 5.5% coupon and was issued at a spread of 100bp over 10 year treasuries is now trading at a 400bp spread for an 8.5% yield. Assuming a duration of ~6, the 5.5% bond you bought at par is now trading at $82 and yielding 8.5%. Even if you hold to maturity, your portfolio value will still reflect today's value of that bond, which is down 18% from where you bought it.

 

[jazz4cash]

I used to avoid bond funds for many of the reasons stated, but last year I set up a bond allocation in PTTAX which has met my expectations so far...it's been fairly stable in a down market. Reading these posts, I am beginning to think I should worry about this too?

 

[freebird5825]

This year, even bonds don't seem to work....... That being said, laddering corporate bonds is something I have done for quite a few years. However, it does take due diligence.
I have had better overall success with muni bonds than corporates. I do own a bond fund in my 401K but it's PIMCO Total Return managed by Bill Gross so I just leave it alone.........

corporates scare the stuffing out of me. i frighten easily...NOT!
i have never seen any conservative or traditional investing author say these are a good idea for the average Joe Investor. but for the financial guru or well educated in bonds, by all means, go get 'em.
ah, good ol' TE munis...they are backed up by the municipality's abilty to tax. call me crazy, but they are generating some nice monthly income for me right now. it won't last forever at these yields, but i will take 7% NAV loss over 42% loss for some of my stock MFs any day.
i am not tapping my dividends yet, but i could if i needed to.