Does anyone invest only in bonds?

[FirstTimer90]

I have been reading a lot of information about bonds (not bond funds), and mostly muni bonds which has caught my attention. Is there anyone else out there who invests in bonds and if so I would enjoy learning from you or a link, about how to best select bonds as a long term investment plan.
Researching some Mutual funds has brought to light all the fees (which means more risk) associated with mutual funds and that is the reason for my curiosity in bonds.

i look forward to reading your helpful information.

[Retired To Win]

It Depends On Your Investment Objective

A portfolio with only bonds in it would be right in some situations and not in others. You've got to ask your question in the context of your situation. What are you investing for? How long have you got to get there? How much are you starting with? How much risk can you handle in exchange for higher returns?

You've got to pin down a lot more info before you -- or anyone else -- can come up with a reasonable answer as to whether all-bonds investing is right for you.

Good luck!

[FirstTimer90]

It is my understanding that most people talk about a mutual fund gaining 10-12% over the course of a couple decades and that is more of a myth than a fact. the information I saw used the dates of 1990-2010 which he says was a 10% gain, but since the markets move up and down each year, the mutual fund is compounding interest on a smaller balance some years and the actual rate of return over these two decades would have been 8.08%. Then, the expense ration fee, money manager fee, and transaction fees must be taken into account. and finally on any years where a mutual fund gains money based on stocks, taxes must be removed and that results in a final annual interest rate of 3.87%

When I see this, I am shocked. Also, this investment is not a guarantee it may be higher but this can be lower and that risk for such a low actual interest rate caught my attention. There would be much less risk in a tax free muni bond and with bond laddering, it would be likely to see a higher or at least similar annual interest rate (again, with less risk).

Of course we could talk about index funds or highly rated Corp Bonds, adding in a bit more risk but yielding a higher annual interest rate. And I am hoping to open such a discussion, specifically I am interested in learning about bonds since i think there is less talk about bonds than stocks (M.Funds, and Index Funds). I welcome all replies, thank you in advance for helping me with these questions.

[kork13]

I do not know anyone who is 100% bonds, or even anyone with more than 80% bonds. Quite honestly, doing so would be borderline foolish in almost every scenario, just like being 100% in stocks would be.

The problem is that there is often a fundamental error in many investors' thinking. Bonds ≠ Safety .... Bonds = Different Risks. The reason you have an asset allocation is to balance the many different TYPES of risk, in order to effect a reliable, moderate rate of return. Stocks are subject to one set of risks, Bonds are subject to a separate set of risks. It's not that bonds necessarily carry LESS risk, but they simply have DIFFERENT risks. By combining multiple asset classes, each with their own set of risks, you reduce the overall threat of losses to your portfolio, because it is less likely for a single set of events to significantly decrease the value of your entire portfolio at the same time. This balancing of risks moderates your risk, moderates losses, and yes, moderates gains. But by balancing risk between different asset types, you can reduce your overall portfolio's risk level.

As an example, think of it this way: In 2008, stocks crashed. People freaked out, because too many of them were invested too heavily (80%-100%) in stocks. Had they balanced their portfolio with fixed-income assets like bonds and real estate, and some real assets like commodities & precious metals, their portfolio's overall losses would have been less severe. Same issue could theoretically face us today. If interest rates & inflation were to spike upward even just to 5%-6% (as it has in the past), then people with a 100% bond portfolio today would be crushed by inflation & dramatic losses in bond values. By holding some stocks & commodities, you would likely protect your overall portfolio from such extreme losses. Manage your risk. Win.

[FirstTimer90]

If interest rates & inflation were to spike upward even just to 5%-6% (as it has in the past), then people with a 100% bond portfolio today would be crushed by inflation & dramatic losses in bond values. By holding some stocks & commodities, you would likely protect your overall portfolio from such extreme losses. Manage your risk. Win.

Kork thank you for this great information. It was helpful to read.
But I would like to question what you wrote about the interest rates. While its true a bond purchased today could only be sold lower than face value interest rates and inflation spike tomorrow, the par value if held would remain the same when the bond reaches maturity and the total payments received in a year's time would also remain the same. So I'm not fully grasping how this is as big of a negative as you're making it sound. Also with bond laddering, this risk would be even less wouldn't it? And please keep in mind that I'm trying to educate myself so this is a general question and not something directed specifically at you. Thanx

[kork13]

While its true a bond purchased today could only be sold lower than face value interest rates and inflation spike tomorrow, the par value if held would remain the same when the bond reaches maturity and the total payments received in a year's time would also remain the same. So I'm not fully grasping how this is as big of a negative as you're making it sound.

You are correct, if you buy an individual bond, the par value will not change in a rising-rate environment -- your bond will always be worth that face value, and if held to maturity, will always pay stated yield. What you also must consider, however, are:
(A) Bond yields will rise around you, which means the money you have tied up in the lower-paying individual bond becomes an opportunity-cost that you lose out on. Instead of earning the higher yields, you're stuck earning the low yield with your bond from 3 years ago (or whatever).
(B) When interest rates rise, inflation tends to be riding shotgun. Whether inflation follows interest rates or interest rates follow inflation....that's a macroeconomics question I'm not prepared to answer. But typically, as one rises, so does the other. Thus, your steady-yielding bond presents you with additional lost opportunity-cost, because your 3%-yielding bond is now falling behind the 5% inflation.

Also with bond laddering, this risk would be even less wouldn't it?

Also correct. Bond laddering (and CD laddering) is an effective way to manage (though not eliminate) the interest rate risk involved with holding bonds. As older bonds mature, you can buy new bonds at the current rates. That is a good way to reduce this particular asset's level of risk.

Don't think that I'm not trying to boo-hoo bonds -- they're an excellent, and really, an essential part of every healthy investment portfolio. I'm only saying that there are risks involved with every type of investment. You need to account for those risks, and build a balanced, diversified portfolio in order to manage those risks effectively. By holding too heavy of a position in any single asset class or investment sector, you're opening yourself up to excessive unnecessary risk. As the old adage says, you don't want "too much of a good thing."

[disneysteve]

It is my understanding that most people talk about a mutual fund gaining 10-12% over the course of a couple decades and that is more of a myth than a fact.

It isn't a myth at all. It is a long-term, average annual return.

Here are examples from my own portfolio. I've listed the fund symbol and the 5-year average annual return. These are real numbers after any expenses.

VFIAX 17.60%
VIGAX 19.82%
VGTSX 13.51%
VGHCX 20.27%
JDGAX 17.62%
HRTVX 20.63%

since the markets move up and down each year, the mutual fund is compounding interest on a smaller balance some years and the actual rate of return over these two decades would have been 8.08%. Then, the expense ration fee, money manager fee, and transaction fees must be taken into account. and finally on any years where a mutual fund gains money based on stocks, taxes must be removed and that results in a final annual interest rate of 3.87%

I don't know where you got these numbers. If you are investing in no-load mutual funds with low expense ratios, you wouldn't lose anywhere near that much to expenses. There are no loads, no transaction costs, and very little in expense ratios. Plus, the stated returns already factor in those fees.

Also, this investment is not a guarantee it may be higher but this can be lower and that risk for such a low actual interest rate caught my attention. There would be much less risk in a tax free muni bond and with bond laddering, it would be likely to see a higher or at least similar annual interest rate (again, with less risk).

It is true that equity funds aren't guaranteed but that doesn't mean you should ignore them especially if you have a long time horizon. I could dig back into the funds I referenced above and find years when they were down or flat but what matters to me is the long term return. I'm not going to touch that money for another 15-20 years and I've been in those funds for as long as 21 years already. The short term gyrations don't matter. Actually, they do matter since I'm still actively investing so those short term drops are buying opportunities.

I am interested in learning about bonds since i think there is less talk about bonds than stocks (M.Funds, and Index Funds).

I think you're right. We do talk more about stocks than about bonds because most of us are in the accumulation phase of our investing lives. Our goal is long term growth. You don't get that with bonds.

[FirstTimer90]

I don't know where you got these numbers. If you are investing in no-load mutual funds with low expense ratios, you wouldn't lose anywhere near that much to expenses. There are no loads, no transaction costs, and very little in expense ratios. Plus, the stated returns already factor in those fees.

This 13 min video is where I found the numbers. I would love to hear their errors Steve (or anyone), because I don't want to avoid investments in mutual or index funds - but this video has me worried about the mutual funds.

http://m.youtube.com/watch?v=Bajo7_aZc1k

Also Steve can you tell me more about "no load" and how I can avoid all these potential fees.
Thanks!

[Petunia 100]

It is my understanding that most people talk about a mutual fund gaining 10-12% over the course of a couple decades and that is more of a myth than a fact. the information I saw used the dates of 1990-2010 which he says was a 10% gain, but since the markets move up and down each year, the mutual fund is compounding interest on a smaller balance some years and the actual rate of return over these two decades would have been 8.08%. Then, the expense ration fee, money manager fee, and transaction fees must be taken into account. and finally on any years where a mutual fund gains money based on stocks, taxes must be removed and that results in a final annual interest rate of 3.87%

Taxes aren't an issue in a tax-advantaged account, FirstTimer.

It is absolutely true that expense ratios, money manager fees, transaction fees, and more eat directly into an investor's return. This is a good reason to keep investing costs low, not a good reason to avoid investing.

You are referencing CAGR (compound annual growth rate) as opposed to average return. The long-term average return of the US stock market is about 11%, but the long-term CAGR of the US market is about 9%. You are absolutely correct that CAGR is the number which matters.

While we cannot invest directly in an index, we can purchase a mutual fund or ETF which tracks an index. We expect to trail the index by the costs of our investment.

Index funds and ETFs are available with very low costs. For example, Vanguard's Total Stock Market Index ETF, symbol VTI, has an expense ratio of .05%. If you open a brokerage account directly with Vanguard, you can buy/sell any of Vanguard's ETFs with no transaction fees. You can get a similar deal with Schwab, which offers a total market ETF with an expense ratio of .04%.

I have my brokerage account at WellsTrade (part of Wells Fargo), and receive 100 free trades per year.

If one prefers mutual funds, Vanguad's Total Stock Market Index Fund has an expense ratio of .17%. When the balance in the mutual fund reaches 10k, it automatically converts to admiral shares, which have an expense ratio of .05%. No purchase fees, no annual account fees, nothing to pay but the expense ratio.

[Petunia 100]

This 13 min video is where I found the numbers. I would love to hear their errors Steve (or anyone), because I don't want to avoid investments in mutual or index funds - but this video has me worried about the mutual funds.

http://m.youtube.com/watch?v=Bajo7_aZc1k

Also Steve can you tell me more about "no load" and how I can avoid all these potential fees.
Thanks!

Not trying to speak for Steve, but "no load" funds mean a fund which is purchased without commission. You avoid paying loads by avoiding commissioned salespeople. Instead, you buy your funds yourself. Fund families such as Vanguard, Fidelity, and T. Rowe Price are all
"no load".

[disneysteve]

I only watched about half the video so far but he uses examples of high cost, adviser-brokered funds to get his 3% expense ratio. As Petunia pointed out, there are plenty of good funds out there that have expenses of far less, like 0.05% which is 60 times less than the example in that video.

I'll be the first to agree that Dave Ramsey's 12% assumption is faulty but not by nearly as much as this video suggests. Look again at the 5-year track record of the funds I listed earlier. Every single one is over 12% and a couple even broke 20% for that period. Of course the long term average isn't that high. It's more in the 8-10% range generally, but it certainly isn't under 4%.

As for taxes, if you are in a 401k or Roth, the taxes aren't relevant.

[FirstTimer90]

I only watched about half the video so far but he uses examples of high cost, adviser-brokered funds to get his 3% expense ratio. As Petunia pointed out, there are plenty of good funds out there that have expenses of far less, like 0.05% which is 60 times less than the example in that video.

I'll be the first to agree that Dave Ramsey's 12% assumption is faulty but not by nearly as much as this video suggests. Look again at the 5-year track record of the funds I listed earlier. Every single one is over 12% and a couple even broke 20% for that period. Of course the long term average isn't that high. It's more in the 8-10% range generally, but it certainly isn't under 4%.

As for taxes, if you are in a 401k or Roth, the taxes aren't relevant.

Thanks to everyone for their posts.

This money Steve, will be a separate way for me to save for retirement, outside of my Roth (maybe both).
If tax free muni bonds offer a 6.5% coupon, would that make it more attractive (less risk?) than a MF? If not what rate would a 30 year muni bond need to be for you to like it more than a MF?

To complicate this issue a bit more, can you touch upon index funds? Are they more or less attractive than MF or are both needed for diversification ? What are some advantages or disadvantages of each and do you have a preference of index or mutual funds for long term investing?

[Petunia 100]

Also, regarding bonds, I prefer bond funds to individual bonds (and yes, I buy the index).

Why? Because as a small individual investor, it would not be possible for me to create a diversified bond portfolio.

Sometimes, I read statements such as "When interest rates rise, bond fund prices fall". This is absolutely true. However, individual bonds also fall in price. If the owner of the bond decides to sell, they will find that they must sell at a discount.

Sometimes, the counter to this argument is "Yes, but, if I hold my bond to maturity, I will collect the full value". This statement is true. What is not stated though, is that in the meantime you are receiving lower-than-market-rate interest. If you buy a bond fund, when rates rise, your fund begins buying new issues which pay a higher interest rate. This translates to more income for the investors.

So I remain unconvinced that individual issues are superior to bond funds.

In my opinion, some bonds belong in every portfolio.

[disneysteve]

This money Steve, will be a separate way for me to save for retirement, outside of my Roth (maybe both).
If tax free muni bonds offer a 6.5% coupon, would that make it more attractive (less risk?) than a MF? If not what rate would a 30 year muni bond need to be for you to like it more than a MF?

To complicate this issue a bit more, can you touch upon index funds? Are they more or less attractive than MF or are both needed for diversification ? What are some advantages or disadvantages of each and do you have a preference of index or mutual funds for long term investing?

If you are investing outside of a Roth or 401k or other tax-advantaged account, fees and taxes are particularly important. That is a place where bonds could be beneficial, particularly muni bonds from your home state (unless you live in Detroit of course).

Would a muni paying 6.5% carry less risk than a mutual fund? That's ultimately an unanswerable question. There are literally thousands of mutual funds. You can't just generalize and say a bond is better or worse than a mutual fund. It depends on what you are comparing it to. It also depends in part on your tax bracket. The higher your bracket, the better deal the muni bond becomes. It also depends where you live and whether or not there is a state income tax.

As for index funds, they are generally more tax efficient and a good choice for taxable accounts particularly because they don't throw off as much taxable income typically. Most of us also like index funds because they don't try to beat the market, an impossible task.

Yes, I have a preference for index funds even though some of the funds I mentioned earlier are not index funds. I hold both in my portfolio but definitely more in index funds.

[disneysteve]

Also, regarding bonds, I prefer bond funds to individual bonds (and yes, I buy the index).

Why? Because as a small individual investor, it would not be possible for me to create a diversified bond portfolio.

Sometimes, I read statements such as "When interest rates rise, bond fund prices fall". This is absolutely true. However, individual bonds also fall in price. If the owner of the bond decides to sell, they will find that they must sell at a discount.

Sometimes, the counter to this argument is "Yes, but, if I hold my bond to maturity, I will collect the full value". This statement is true. What is not stated though, is that in the meantime you are receiving lower-than-market-rate interest. If you buy a bond fund, when rates rise, your fund begins buying new issues which pay a higher interest rate. This translates to more income for the investors.

So I remain unconvinced that individual issues are superior to bond funds.

In my opinion, some bonds belong in every portfolio.

I've been debating this very issue. I started a thread about it a few weeks ago. I also invest in a bond fund (Vanguard's Total Bond Market Index) and have been thinking about switching to individual bonds. I'm just not sure if that's the way to go for the very reasons you mentioned.