Bond Fund or CD

[smooch]

We have 65K in an IRA (liquidating ML funds and moving to VG). It needs to go into fixed income to keep our AA where we want it. We can purchase a 1 year CD paying 5.25% at VG or put it into one of the bond funds. Is there any reason not to put it in a CD?

 

[Danny]

http://intelligentspeculation.blogspot.com/2007/03/cds-vs-bonds.html

 

[Sundance Kid]

I'd go for the CD! Seems like, a pretty sure thing.

 

[mathjak107]

i think the bond funds pretty much have at least 1 and possibly 2 more increases factored in already...another month or so and longer term bonds may be a good deal not for the interest rate but for a little capital gain plus the interest rate if you sell em shortly after...dont forget once we see a pause the longer end is driven not by the fed but by investor sentiment..the markets being what they are will start to figure in the next rate cut...i think interest plus capital cains could give an investor willing to take the risk about an 7 to 9% return over all....

 

[brewer12345]

I am going to come down firmly in the camp of "it depends." You are contemplating a 1 year CD versus what? Something like the total bond market index? You don't say more than this is going into your FI allocation: is it a cash/near-cash piece, or just FI as part of a diversified total return portfolio?

If this is meant to be cash/near cash, I think the CD or maybe even a money market fund at VG would be the best choice. You don't want to take too much risk or reach too far for yield with cash.

If this is a part of a longer term FI allocation, I would actually argue for the bond fund. An FI allocation is and always should be about total eturn. With a 1 year CD, we know exactly wat that is: the yield. With a bond fund, you have two sources of potential return: yield and capital appreciation. The latter is important in a number of ugly scenarios where the US economy slides into recession. Given the offset to equities that this part of the FI potential return provides, I think it makes a lot of sense to put the money into something like the total bond market fund.

 

[smooch]

We are targeting a 40% FI allocation for the portfolio. This $65k would just about get us there. We don't plan to touch our accounts for another few years, but we are transitioning to part time jobs and don't know exactly what the next year will bring. So I'm thinking it's best to go with the 1 year CD until we see how this year goes.

 

[mathjak107]

i like agg and fidelity total bond index at this point...you need to get in a little early and collect the interest for a while,than hopefully harvest some nice capital gains in 2007 as the markets look ahead to the perception of the next rate cut....time and time again the studies show investors putting money into bond funds to late and pulling out to early...fidelity has a white paper that shows how bond timers always get it wrong ....you need to get in a little early and reap the following year for a very nice 2 year return

 

[2B]

If you want to be sure you'll get all of your money back, never buy a bond fund. Individual bonds and CDs can be timed to mature when you plan on needing the money. In a severe rising interest rate environment, your bond fund could fall in value (although still paying its original yield).

 

[mathjak107]

you will get your money pretty much back in a bond fund as long as you hold for the duration rating of the fund..unlike an individual bond which has a fixed yield a bond funds yield is changing all the time,the funds swapping lower bonds as they mature for higher rate bonds and you benefit.....
as an example a bond funds yield is 5% and 10 bucks a share when you buy it...the funds duration is 5 so it means the fund will fall 5% in nav for every point rates rise....if rates go to 6% your funds nav will fall 5% to 9.50 but you interest has gone up to 6%....after 5 years you will earn an extra 5% interest which offsets the 5% drop in nav......a bond fund is all about staying in for the duration length

 

[brewer12345]

If you want to be sure you'll get all of your money back, never buy a bond fund.  Individual bonds and CDs can be timed to mature when you plan on needing the money.  In a severe rising interest rate environment, your bond fund could fall in value (although still paying its original yield).

Like I said, if it is intended to be a cash allocation, a CD of money market makes sense. If it is part of a diversified portfolio, a bond fund probably makes more sense.

 

[Alex]

Persoanlly, I think CD's are the prudent choice right now. Just stay with short terms -no longer than 6 months to 1 year. Then when rates level off you can roll into a bond fund or individual bonds.

 

[mathjak107]

to make any money and the effort worth it in bonds you need to get in early before the herd does and wait...collect your interest for 6-8 months and then sell at a nice capital gain as the mad rush to get into bonds starts as the johny come latelys jump in after the easy money is gone.....by the time rates level off its to late...they are already bid up to high and the creams gone

 

[Alex]

to make any money and the effort worth it in bonds you need to get in early before the herd does and wait...collect your interest for 6-8 months and then sell at a nice capital gain as the mad rush to get into bonds starts as the johny come latelys jump in after the easy money is gone.....by the time rates level off its to late...they are already bid up to high and the creams gone

sounds like gambling to me.....

 

[mathjak107]

not really gambling ,you just need to stay in for the duration of the bond fund in a rising rate enviornment if the nav drops and goes against you....i think i once read no one has ever lost a dime in a treasury bond fund if you stay in long enough to match the funds duration.

 

[2B]

not really gambling ,you just need to stay in for the duration of the bond fund in a rising rate enviornment if the nav drops  and goes against you....i think i once read no one has ever lost a dime in a treasury bond fund if you stay in long enough to match the funds duration.

You must be talking about a closed end bond fund. A "typical" bond mutual fund has not maturity date. That's equivalent to what I've been recommending which is a fixed maturity date when you get your original investment back.

 

[mathjak107]

You must be talking about a closed end bond fund.  A "typical" bond mutual fund has not maturity date.  That's equivalent to what I've been recommending which is a fixed maturity date when you get your original investment back.

every high quality (no credit risk) bond fund has whats called a duration value..that means if rates drop or rise 1% its the percentage rise or fall your fund will take...now since a bond fund never matures because they are always buying and selling bonds they do have by design an average weighting based on their investment time frame..they vary little too from that value over time...going back 2 years i see fidelity's duration values dont move more than a few months or so....so heres how it all works

you buy a fund at 10.00 bucks a share ,its paying 5% ..the fund has a duration value of 5....rates creep up over the next few years to 6%...your principal drops to 9.50 but you are getting 6% interest, thats 1% more than when you started.unlike a regular bond which has a fixed interest rate a bond funds rate is variable as they replace older lower paying bonds with newer higher paying ones....after 5 years in the fund you made an extra 5% in interest offsetting the 5% nav loss

 

[mathjak107]

you loose money in a bond fund under 2 conditons...speculating about where rates are heading and darting in and out of the fund trying to get it right or more likely mis-matching the bond fund to their goals and time frame....buying a 7-10 year intermediate bond fund and selling it when rates are rising because you need short term cash , or buying long term bond funds and selling them early...like stocks longer term bond funds have to be a long term investment

 

[JB]

I was faced with the same decision last year and went with CDs. For most people the fact that your principal is preserved with a CD isn't really an advantage. The only reason why this is the case is because CDs aren't liquid. In the end it depends on how much work you want to do. If you're in a bond fund you just coast. With CDs you need to keep track of your rate vs. market rates, decide whether or not to cash out early, and how to invest your proceeds when the CD matures. I ended up making a spreadsheet which tells me what interest rates need to rise to in order for it to make sense for me to cash out of my CDs early. These CDs are a pain in the ass. In the future I'll stick with bond funds.