Managed Bond Funds rather than Index Bond Funds?

[Spanky]

No, it’s not diversified. It’s just muni bonds which is just one segment of the bond market. It’s not a substitute. But you could always hold some in muni bond fund because I don’t think the total bond index fund holds munis.

It seems that Total Bond Market is a better choice even for our taxable account based on the following data:
Marginal Tax rate: 24%
SEC yield Total Market: 3.15%
SEC Yield Int-Med-Tax-Ex: 2.24%

Effective yield of Total Market after tax: 2.39%, which is greater than 2.24%.

 

[ER Eddie]

Looking at past history, index funds have usually behaved better than managed core bond funds when stocks are hit hard for the very reason they are often criticized - holding “too much” in government bonds. In 2008 some well respected managed core bond funds were creamed. Many folks concluded that bond funds in general don’t protect you during a credit crisis/nasty bear, but if you look for which bond funds did do well, the highest credit quality bond funds did much better and many of these were index funds.

So if your goal is to hold a low correlation asset to equities, I think bond index funds based on a high quality index like AGG are a better choice.

Thanks for the advice. That's a significant downside of managed funds, if they don't protect you much during a crash.

Let me ask, is there any reason to think that the 2008 debacle was uniquely damaging to bonds, because it struck the banks and credit market directly? Would there be reason to think bonds might be more resilient in other types of "crash" scenarios (ones that didn't involve banks/credit so directly)?

 

[meleana]

A writer in MONEY magazine just wrote an article that he does not like Bond Index Funds and recommends managed bond funds. Suze Orman does not like bond funds at all and says people should only own individual bonds, especially municipal bonds, but you need a lot of money for a diversified portfolio of individual bonds and probably would need a broker to purchase them for you.


I have index and managed bond mutual finds only, plus some I Bonds purchased through Treasury Direct, and some old Series EE savings bonds that are finally maturing now. I use them to buy the I Bonds.

 

[Qs Laptop]

How about someone pick out some bonds from 3, 5, and 10 years ago, calculate the return and compare it to the backtesting results of some popular bond funds?

 

[audreyh1]

Thanks for the advice. That's a significant downside of managed funds, if they don't protect you much during a crash.

Let me ask, is there any reason to think that the 2008 debacle was uniquely damaging to bonds, because it struck the banks and credit market directly? Would there be reason to think bonds might be more resilient in other types of "crash" scenarios (ones that didn't involve banks/credit so directly)?

When a market crash or financial crisis/credit squeeze happens, there is a “flight to quality” and it can be very sudden. We had one in 2002 at the end of that bear market. So they are often associated with equity bear markets. Credit spreads widen and corporate bonds are more vulnerable and can be hurt. High yield bonds are usually toast.

Yes, 2008 was particularly bad and very dramatic, but you still see it during other periods of financial turmoil.

 

[audreyh1]

A writer in MONEY magazine just wrote an article that he does not like Bond Index Funds and recommends managed bond funds. Suze Orman does not like bond funds at all and says people should only own individual bonds, especially municipal bonds, but you need a lot of money for a diversified portfolio of individual bonds and probably would need a broker to purchase them for you.


I have index and managed bond mutual finds only, plus some I Bonds purchased through Treasury Direct, and some old Series EE savings bonds that are finally maturing now. I use them to buy the I Bonds.

This is a popular opinion, because during the good times managed bond funds tend to outperform bond index funds as they take on more credit risk to get a slightly higher yield. However, I prefer bond funds that perform better when the sh!t hits the fan. Many people were extremely disappointed and felt totally let down in their managed bond fund performance during 2008.

 

[Spanky]

A writer in MONEY magazine just wrote an article that he does not like Bond Index Funds and recommends managed bond funds. Suze Orman does not like bond funds at all and says people should only own individual bonds, especially municipal bonds, but you need a lot of money for a diversified portfolio of individual bonds and probably would need a broker to purchase them for you.


I have index and managed bond mutual finds only, plus some I Bonds purchased through Treasury Direct, and some old Series EE savings bonds that are finally maturing now. I use them to buy the I Bonds.

Check out the link below about what others think about Suze Orman's view on individual bonds vs total bond market fund.

https://www.bogleheads.org/forum/viewtopic.php?t=171226

 

[gwraigty]

A writer in MONEY magazine just wrote an article that he does not like Bond Index Funds and recommends managed bond funds. Suze Orman does not like bond funds at all and says people should only own individual bonds, especially municipal bonds, but you need a lot of money for a diversified portfolio of individual bonds and probably would need a broker to purchase them for you.

I've purchased individual bonds, both corporate and muni, for the last 15 years or so. You do not need a broker to purchase them for you. Research bonds through your brokerage account and click "Buy".

 

[ER Eddie]

OP here. I am in the early chapters of John Bogle's "Little Book of Common Sense Investing," (which is great, btw). I flipped to his chapter on bond funds. It will probably not surprise many of you to hear that he's in favor of index funds for bonds, too.

Here are a few quotes:

"As a group, managers of bond funds will almost inevitably deliver a gross return that parallels the baseline... Yes, a few managers might do better ... by being extra smart, or extra lucky, or taking extra risk. Alas ... reversion to the mean often strikes. What's more, even if bond managers add a few fractions of a percent to the fund's gross returns, they rarely overcome the funds expenses, fees, and sales loads."

"Managers also may be tempted to increase returns by reducing the investment quality of their portfolio .... [which] subjects your bond investment to higher risk."

"Like stock funds, actively managed bond funds lag their benchmarks. Why? The arithmetic of costs."

"After their expense ratios, operating costs, and sales loads (if any) are deducted, their net returns will fall short [of the comparable indexes]."

[Citing a study] "During the 15 year period from 2001 to 2016, performance of the bond indexes is impressive, outpacing an average of 85% of all actively managed bond funds in the six categories -- short-term, intermediate-term, and long term grouped by US government and investment grade corporate sectors. The indexes also outperformed the managers of municipal bond funds (84%) and high-yield bond funds (96%). ... The average shortfall was about 0.55 percent per year."

"Once again, it is clear that low costs account for a dominant portion of the index advantage."

He quotes some others as well:

"Comparison of expenses, transaction costs, and where applicable, sales loads identify the cost advantage for bond index funds. For the actively managed load funds, the index fund advantage amounts to 1.2 percentage points per year ... [This] suggests how much additional return active management may have to add -- on average over an extended period -- just to break even!"

"You should not overlook the efficacy of index investing for bonds... The evidence is compelling and comes down firmly in favor of investing in index funds. ... This differential is largely due to fees."

---

So, that settles the question for me. I trust Bogle's advice, along with what Audrey and others have shared. I'm going to forget about managed bond funds and stick with index funds. [There is the third option of trying to figure out how to invest in bonds myself, but I don't want to go that route -- too much trouble, and I'm not confident that I'll outperform an index.]


Thanks for the input, folks. You've been helpful as always.

 

[COcheesehead]

I buy my own muni’s for taxable, corporates for deferred and bond funds for things I would have a hard time accessing individually. Fidelity has the tools to help you build and manage your own ladders. Commissions are $1/bond so it’s pretty cheap too.

 

[cooch96]

I've purchased individual bonds, both corporate and muni, for the last 15 years or so. You do not need a broker to purchase them for you. Research bonds through your brokerage account and click "Buy".

So I like the idea of buying and holding individual bonds to maturity. The concept is more intuitive to me than acquiring bond index funds.

But here is a question for you bond DIY-ers: what is the minimum amount of money one should allocate to bonds to make it worth the effort of researching and buying them? Assume the investor has a neutral outlook on the process: the feeling of pride in successfully managing his monies is equal to the concern over making a mistake. And how many hours a year does it take to research bonds enough to hold a diversified set with appropriately staggered maturity dates? Also please assume the investor kinda likes the research, but would honestly rather be doing something different. There is a cost to her research time.

I doubt I’ll ever have a large enough non-equity position to justify buying individual bonds; I’ll likely just stick to stocks, RE, and a CD ladder. But I’d be happy if someone could convince me otherwise.

 

[audreyh1]

OP here. I am in the early chapters of John Bogle's "Little Book of Common Sense Investing," (which is great, btw). I flipped to his chapter on bond funds. It will probably not surprise many of you to hear that he's in favor of index funds for bonds, too.

Here are a few quotes:

"As a group, managers of bond funds will almost inevitably deliver a gross return that parallels the baseline... Yes, a few managers might do better ... by being extra smart, or extra lucky, or taking extra risk. Alas ... reversion to the mean often strikes. What's more, even if bond managers add a few fractions of a percent to the fund's gross returns, they rarely overcome the funds expenses, fees, and sales loads."

"Managers also may be tempted to increase returns by reducing the investment quality of their portfolio .... [which] subjects your bond investment to higher risk."

"Like stock funds, actively managed bond funds lag their benchmarks. Why? The arithmetic of costs."

"After their expense ratios, operating costs, and sales loads (if any) are deducted, their net returns will fall short [of the comparable indexes]."

[Citing a study] "During the 15 year period from 2001 to 2016, performance of the bond indexes is impressive, outpacing an average of 85% of all actively managed bond funds in the six categories -- short-term, intermediate-term, and long term grouped by US government and investment grade corporate sectors. The indexes also outperformed the managers of municipal bond funds (84%) and high-yield bond funds (96%). ... The average shortfall was about 0.55 percent per year."

"Once again, it is clear that low costs account for a dominant portion of the index advantage."

He quotes some others as well:

"Comparison of expenses, transaction costs, and where applicable, sales loads identify the cost advantage for bond index funds. For the actively managed load funds, the index fund advantage amounts to 1.2 percentage points per year ... [This] suggests how much additional return active management may have to add -- on average over an extended period -- just to break even!"

"You should not overlook the efficacy of index investing for bonds... The evidence is compelling and comes down firmly in favor of investing in index funds. ... This differential is largely due to fees."

---

So, that settles the question for me. I trust Bogle's advice, along with what Audrey and others have shared. I'm going to forget about managed bond funds and stick with index funds. [There is the third option of trying to figure out how to invest in bonds myself, but I don't want to go that route -- too much trouble, and I'm not confident that I'll outperform an index.]


Thanks for the input, folks. You've been helpful as always.

That’s a very useful summary from Bogle’s book.

One of the major criticisms of bond index funds is that they “own everything”. If more government debt is issued, they will own more government debt, for example. I don’t know exactly how a long-time bond index benchmark like AGG is structured, but I do know it holds only investment grade bonds, and that it is diversified across treasuries, other government-backed bonds, and investment-grade commercial bonds. So the credit quality is very high.

Another thing that comes up is people decide some segment of the bond market is “overvalued” and think the bond index holds “too much” of a given segment. Some folks like only owning commercial bonds, for example. To me this kind of smacks of market timing in terms of guessing future outperformance by avoiding some asset classes and going whole hog on others. That’s all well and good when those asset classes are outperforming, but they do sometimes underperform. It’s really hard to pick outperforming asset classes in advance. People are constantly predicting future market moves but usually their timing is way off, and/or the effects are quite different at different durations. Better to look at the big picture and look at diversification and correlation across the portfolio.

 

[COcheesehead]

So I like the idea of buying and holding individual bonds to maturity. The concept is more intuitive to me than acquiring bond index funds.

But here is a question for you bond DIY-ers: what is the minimum amount of money one should allocate to bonds to make it worth the effort of researching and buying them? Assume the investor has a neutral outlook on the process: the feeling of pride in successfully managing his monies is equal to the concern over making a mistake. And how many hours a year does it take to research bonds enough to hold a diversified set with appropriately staggered maturity dates? Also please assume the investor kinda likes the research, but would honestly rather be doing something different. There is a cost to her research time.

I doubt I’ll ever have a large enough non-equity position to justify buying individual bonds; I’ll likely just stick to stocks, RE, and a CD ladder. But I’d be happy if someone could convince me otherwise.

I am not going to try and convince you to do anything. The amount I have in bonds is equal to the amount I want in guaranteed funds. How long does it take to research? Well I have bonds maturing every 30-60 days. Finding a replacement takes me about 10 minutes.

 

[gerntz]

I buy my own bonds.

+1

 

[gwraigty]

So I like the idea of buying and holding individual bonds to maturity. The concept is more intuitive to me than acquiring bond index funds.

But here is a question for you bond DIY-ers: what is the minimum amount of money one should allocate to bonds to make it worth the effort of researching and buying them? Assume the investor has a neutral outlook on the process: the feeling of pride in successfully managing his monies is equal to the concern over making a mistake. And how many hours a year does it take to research bonds enough to hold a diversified set with appropriately staggered maturity dates? Also please assume the investor kinda likes the research, but would honestly rather be doing something different. There is a cost to her research time.

I doubt I’ll ever have a large enough non-equity position to justify buying individual bonds; I’ll likely just stick to stocks, RE, and a CD ladder. But I’d be happy if someone could convince me otherwise.

You have to do what's comfortable for you. Fidelity is $1 per bond, with no minimum. Schwab is $1 per bond with a $10 minimum. I started out with CDs, then branched out into individual bonds. With corporate bonds, you can buy as little as $1,000 face value. Munis require $5,000 minimum.

Time for research is greater in the beginning, then goes faster as you become more comfortable with it. EMMA is one good source for munis. Moody's gives some decent information without having a subscription. If the corporate bond is that of a publicly traded company, you can peek into their finances as if you were researching their stock.

It doesn't have to be an all or nothing deal. You can buy bond funds/ETFs and individual bonds, as your mood dictates and opportunities arise.

 

[audreyh1]

Before I retired I decided that I was not going to buy any individual stocks/securities except the occasional CD, Treasury or iBond which are super easy.

This was simply because I was not interested in doing and maintaining the research during retirement. I wanted my retirement portfolio to be very low maintenance, one that I could ignore for a whole year if I wanted to. Just occasionally rebalance, preferably no more than annually: run off and enjoy retirement and ignore investments for months at a time.

I certainly understand that many folks do like buying individual securities and managing their own individual stocks and bonds. I just had a different goal.

 

[GreenER]

V

 

[pb4uski]

I got burned by a managed bond fund in 2008. My 401k offered an "Evergreen Core Bond Fund" that looked to be a broad based managed bond fund and I invested in that. At the end of 2008, I noticed that the drop in Vanguard Total Bond and other similar bond funds, both indexed and managed, were a lot less than the much bigger drop in Evergreen Core Bond Fund.

After investigating why it was so different, I discovered that the bond fund managers had made outsized bets on MBS securites that ended up taking a beating... but that the bet they made was within the guidelines of the fund. So as a result of that experience I am very wary of managed bond funds.

 

[ncbill]

The standard investment advice is to take risk on the equity side, not fixed income.

Which is easier to follow currently since there seems to be little premium for investment-grade corporate vs. government.

 

[OldShooter]

S ... But here is a question for you bond DIY-ers: what is the minimum amount of money one should allocate to bonds to make it worth the effort of researching and buying them? Assume the investor has a neutral outlook on the process: the feeling of pride in successfully managing his monies is equal to the concern over making a mistake. And how many hours a year does it take to research bonds enough to hold a diversified set with appropriately staggered maturity dates? Also please assume the investor kinda likes the research, but would honestly rather be doing something different. There is a cost to her research time. ...

The answer to a question like this has to be, of course: "It depends."

The safer the bond portfolio is, the less effort it requires and the lower the minimum amount of money is. For example, sticking to US government securities, which have essentially no risk, you don't need to do much research other than picking maturities and you don't need to diversify, so even a small amount of money is fine.

On the other extreme is junk and non-US bonds. IMO it is not feasible for an individual investor in the US to adequately research such a portfolio and it would take a fairly large, six-figure at least, portfolio to adequately diversify. Personally, I wouldn't consider this category for the "safe" side of my portfolio. I agree with @ncbill.

In the middle are investment grade corporates. Some research is warranted, attention to sector diversification is warranted as is, of course, issuer diversification. Default rates are very low and few defaults end in zero for the bondholders, so portfolio size is a matter of deciding how much risk you want to take based on the small probabilities.

For ourselves, we just buy TIPS and call it good. I think they are a fantastic bargain, especially in tax sheltered accounts. Guaranteed preserved buying power with a little real interest paid in addition.

 

[RetireAge50]

The only bonds we hold are held in Wellington and T.Rowe2030. I don’t like bonds much, overall AA 76/20/4 at the moment.

 

[sengsational]

When there's a flight to cash, bond funds must sell low, right? Like Freedom and others, I'm not a fan of bond funds. After the bond fund in my 401k didn't zag when the market zigged, I called BS on that whole idea and haven't held a bond fund since. That was 18 years ago. And I was working, so the bond percent was small. Since then, I've owned individual bonds, mostly tips. And now I've got the bond portion in a guaranteed income fund. What I realize is that a lot of what happens on the bond side is about what the custodian offers.

 

[Safe Harbour]

Simple, Easy, Happy

Before I retired I decided that I was not going to buy any individual stocks/securities except the occasional CD, Treasury or iBond which are super easy.

This was simply because I was not interested in doing and maintaining the research during retirement. I wanted my retirement portfolio to be very low maintenance, one that I could ignore for a whole year if I wanted to. Just occasionally rebalance, preferably no more than annually: run off and enjoy retirement and ignore investments for months at a time.

I certainly understand that many folks do like buying individual securities and managing their own individual stocks and bonds. I just had a different goal.

Retired 9 years now. Withdrawals have increase 25% in that time. Simple, Easy, Happy.

We put the Fixed income portion into CD's. They are easy to maintain as a 5 year ladder. They're FDIC insured so I see them the same as Treasuries but with a little higher yield. I only have to buy a new CD about once a year. Right now the ladder is yielding 2.3%. I have no risk of loss due to a sell off, like a bond fund would. Or to owing tax based on others selling. Or loose a management fee. These mixed equity/fixed income funds make you sell both equities and fixed income when you sell them (or buy for that matter).

The purpose of our Fixed Income is to protect during an equities market sell off, so I want a number of years worth to allow a return to "normal" in equities without requiring me to sell low. All of my equities are in Vanguard low-cost index funds. The overall portfolio has seen 10.1% IRR for the last 10 years. I know this includes the recovery period but I'm very happy with it and I only look to rebalance once a year. If they market is high this means I sell a little of my mutual funds at high price. If they are down I buy a little a low price. Sell high, buy low isn't that the idea? I take the rest from maturing CD to fund my living for the next 12 months. Simple. Easy. Happy.

 

[audreyh1]

Retired 9 years now. Withdrawals have increase 25% in that time. Simple, Easy, Happy.

We put the Fixed income portion into CD's. They are easy to maintain as a 5 year ladder. They're FDIC insured so I see them the same as Treasuries but with a little higher yield. I only have to buy a new CD about once a year. Right now the ladder is yielding 2.3%. I have no risk of loss due to a sell off, like a bond fund would. Or to owing tax based on others selling. Or loose a management fee. These mixed equity/fixed income funds make you sell both equities and fixed income when you sell them (or buy for that matter).

The purpose of our Fixed Income is to protect during an equities market sell off, so I want a number of years worth to allow a return to "normal" in equities without requiring me to sell low. All of my equities are in Vanguard low-cost index funds. The overall portfolio has seen 10.1% IRR for the last 10 years. I know this includes the recovery period but I'm very happy with it and I only look to rebalance once a year. If they market is high this means I sell a little of my mutual funds at high price. If they are down I buy a little a low price. Sell high, buy low isn't that the idea? I take the rest from maturing CD to fund my living for the next 12 months. Simple. Easy. Happy.

I like the liquidity of bond funds and it doesn’t bother me at all that they are marked to market. The index bond fund expense ratio is minuscule - 0.03%. The main thing is that I rebalance when the AA goes out of whack, and if stocks are way down, the kind of bond index funds I own are up, so I indeed get to sell high buy low.

 

[GravitySucks]

I have about half my fixed income in a managed bond fund for the past 3 years. It's high fee but it has performed well compared to the indexed bond fund I also hold.
Thinking of trading half of the fixed income for treasury bonds though.