Corporate bonds and holding to maturity

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DeDad
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Corporate bonds and holding to maturity

Post by DeDad »

I picked up some excellent bonds (AA to BB rated) over time, some at a discount to face value. Has anyone held such bonds to maturity and received a return of the principal? Just curious to know others' thoughts. The events are so far off (2020 and beyond) that it is hard to wrap my mind around actually holding these to completion and getting my money back.
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Summit111
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Re: Corporate bonds and holding to maturity

Post by Summit111 »

DeDad,

I buy individual bonds and hold to maturity...so do other members of my family. We've always had the entire principal returned. Most recently were Microsoft and Johnson and Johnson corporate bonds.

Summit
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larryswedroe
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Re: Corporate bonds and holding to maturity

Post by larryswedroe »

FWIW
I would never buy individual corporate bonds, way too much risk to buy individually. If buying corporates (which I don't generally recommend anyway as the risk premium has been historically small and in portfolios not rewarded either, except at short end) than should use a mutual fund to get the diversification needed---same principal that applies to individual stocks----too much idiosyncratic risk

Best wishes
Larry
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plannerman
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Re: Corporate bonds and holding to maturity

Post by plannerman »

I used to buy intermediate-term corporate bonds and hold them to maturity for known retirement cash flow. In the early 2000s, I owned GMAC and Ford Motor Co. bonds. When I bought these bonds in the early '90s there was no hint that these blue chip companies might default. Then the auto industry melted down, and I though I wasn't going to get my principal back. I decided then and there that the risk simply wasn't worth the small increase in return.

I still buy individual bonds, but only Treasuries.

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dbr
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Re: Corporate bonds and holding to maturity

Post by dbr »

It should also be noted that the nominal but not the real principal was returned.
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jeffyscott
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Re: Corporate bonds and holding to maturity

Post by jeffyscott »

Buying your own long term corporate bonds does not seem to me to be worth the trouble. I'd rather hire Wellington Management Company to do that for me at a cost of 0.12% per year. https://personal.vanguard.com/us/funds/ ... =INT#tab=0

I think the current spread between treasuries and corporates is still high by historical standards :?: , vanguard long term treasury is at 3.6% and long term inv. grade at 4.86%.

Also in the safer category, an alternative to long term treasuries, for up to $10K per person per year would be EE bonds. If held 20 years yield is about the same as a 20 year treasury held to maturity.
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Artsdoctor
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Re: Corporate bonds and holding to maturity

Post by Artsdoctor »

Bear in mind that a "BB" bond is not excellent, and it is not invesetment grade. Any portion of your fixed income portion of the portfolio should be considered safe. A long-term corporate bond rated BB is not what I would generally consider safe.

Corporates can be tricky. They are often down-graded so even if you purchase an AA rated bond, you can find the slow drip of downgrades (or rapid deluge). If you really had your heart set on individual corporates, short-term, high-grade would be the only way to go. However, you are currently not being rewarded for that.

You also need to pay particular attention to call features, especially if you're buying a premium bond. In your particular case, it appears that you bought a discount bond (and you will pay a capital gain when it matures).
huntertheory
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Re: Corporate bonds and holding to maturity

Post by huntertheory »

DeDad wrote:I picked up some excellent bonds (AA to BB rated) over time, some at a discount to face value. Has anyone held such bonds to maturity and received a return of the principal? Just curious to know others' thoughts. The events are so far off (2020 and beyond) that it is hard to wrap my mind around actually holding these to completion and getting my money back.
This is the entire concept behind "yield to maturity," the most universal metric (aside from credit rating/credit worthiness) in evaluating bonds.

Bonds frequently trade at a discount, but they do so for very different reasons. The more "benign" reason is that the stated interest rate (the coupon) is lower than the market rate, i.e. you could buy a new similar bond at a higher coupon rate, so in order to sell the bonds on the market the seller must discount the principal amount. When you add together the coupon plus the extra principal at the end, you get the total "yield to maturity."

The other reason bonds trade at a discount is because the market has revised downward the issuer's ability to repay the bond's principal from the time it was issued, the so-called "fallen angel" problem. (Note that a junk or high-yield bond can still trade at par or even a premium so long as the creditworthiness of the issuer is comparable to when the bond was issued.) There is a class of sophisticated investors known as "distress debt investors" who specialize in buying various forms of corporate debt (bonds but also bank loans) trading at heavy discounts and either holding them to maturity or negotiating with the company for repayment or sometimes even control of the company. This is obviously not suitable for your retirement portfolio.

The upshot is that these two discounts imply very different things for the likelihood you will be paid back, so you should understand *why* the discount exists. Yet even if the bond trades at par or a premium, most on this board recommend against holding individual corporate bonds, even in a bond ladder. There is too much idiosyncratic risk in the individual bond, even for supposedly high rated bonds. (Not to mention commissions/fees/bid-ask spreads, etc.)

As an example, I had a relative who in retirement bought a slew of bonds from an "A" rated issuer on the recommendation of a broker, only for the company to file for bankruptcy within the year and she ended up selling the bonds for around 20 cents on the dollar roughly two years after purchasing them. The issuer? Lehman Brothers.
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ThePrune
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Re: Corporate bonds and holding to maturity

Post by ThePrune »

If you insist on purchasing corporate bonds, let me recommend the following guidelines:

(1) All maturities should be short, under 5 years, and maturities should be laddered.
(2) Stick with the higher credit ratings: AAA, AA, or A+
(3) Diversify across industry segments. Tougher than you'd think, since most readily available corporates are financials!
(4) Limit bond holdings from any single issuer (including all subsidiaries) to less than 1% of your portfolio, and less than 0.5% is better.
(5) Pay no more than $1 per bond commission (possible through Vanguard and Fidelity; maybe others also).
(6) Keep the Bid-Ask spread under $5 per $1000 bond (i.e. under 0.5% of face value).
(7) Use the TRACE system database to study how prices and bid-ask spreads have been trending over the last month(s).

Others could certainly add their own suggestions. Bottom Line: purchasing corporates is a lot of work! If you want to make life easy on yourself, purchase Treasuries or bond mutual funds.
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nedsaid
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Re: Corporate bonds and holding to maturity

Post by nedsaid »

This is not a bad strategy. One just needs to be aware of the pitfalls.

A family member did just this. The problem is that the credit quality of bonds changes over time. A couple of the bonds the family member purchased had the experience of two of the companies going through bankruptcy. The two companies looked bulletproof when the bonds were purchased.

Since most bonds are sold through networks of brokers rather than exchanges, pricing is not transparent and the transaction costs might be more than you think. Particularly the bid/ask spread.

You also wind up being your own credit analyst. Your broker isn't going to monitor these on a day to day basis. So you are mostly on your own.

You also have the issue of call dates. Depending on the direction of interest rates your call date might be the effective maturity of your bond. If rates drop, the bond issuer will do what homeowners do and that is refinance.

You also have to know how high up the pecking order those bonds are in case of default. Secured or unsecured? Senior debt or is your bond further down the ladder?

Corporate bonds have their risks and pitfalls. They are more complicated instruments than what is generally perceived.
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DeDad
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Re: Corporate bonds and holding to maturity

Post by DeDad »

Thanks, all :sharebeer for the very sage advice. You have given some very good pointers too for those who are trying to understand these murky bond markets.
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magician
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Re: Corporate bonds and holding to maturity

Post by magician »

dbr wrote:It should also be noted that the nominal but not the real principal was returned.
As with most Treasuries.
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Re: Corporate bonds and holding to maturity

Post by magician »

Artsdoctor wrote:Any portion of your fixed income portion of the portfolio should be considered safe.
Why is that?
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Artsdoctor
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Re: Corporate bonds and holding to maturity

Post by Artsdoctor »

You could decide to take risks on the fixed income side of the portfolio. But it doesn't seem like it would be risk worth taking when the equity returns SHOULD be higher in the long run. You'll find people who will chase after yield, perhaps shoveling into junk bonds and emerging market bonds, but you will most likely (not certainly, but most likely) be rewarded by placing that money in "riskier" equity assets. In another words, take risk on the equity side of your portfolio and use your fixed income side as a ballast.

If you really want to venture out into the riskier fixed income side of things, perhaps you should count much of those bond investments as equities since they ultimately behave more like equities (correlation is higher with equities).

Just my two cents. I expect my equity side of my portfolio to be volatile. I'm less enamored with volatile bonds.
Erwin
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Re: Corporate bonds and holding to maturity

Post by Erwin »

jeffyscott wrote:Buying your own long term corporate bonds does not seem to me to be worth the trouble. I'd rather hire Wellington Management Company to do that for me at a cost of 0.12% per year. https://personal.vanguard.com/us/funds/ ... =INT#tab=0

I think the current spread between treasuries and corporates is still high by historical standards :?: , vanguard long term treasury is at 3.6% and long term inv. grade at 4.86%.

Also in the safer category, an alternative to long term treasuries, for up to $10K per person per year would be EE bonds. If held 20 years yield is about the same as a 20 year treasury held to maturity.
WOW! Long Term Corporate Bonds? I wonder your logic. Do you care to explain, I may learn something new!!
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magician
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Re: Corporate bonds and holding to maturity

Post by magician »

Artsdoctor wrote:You could decide to take risks on the fixed income side of the portfolio. But it doesn't seem like it would be risk worth taking when the equity returns SHOULD be higher in the long run.
But shouldn't equity risks be higher as well?

It just seems to me that never taking any risk in fixed income is a bit extreme. Surely, in a well-diversified portfolio, say, some risk in bonds is justifiable.
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Artsdoctor
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Re: Corporate bonds and holding to maturity

Post by Artsdoctor »

Magician,

As the spectacle in Washington this past fall shows, there is probably NOTHING that is without some risk, even treasuries.

Of course one needs to take risk with bonds. If it's not credit risk, it's inflation risk, currency risk, call risk, etc. There is no investment that doesn't have some degree of risk.

It's a matter of degree. Each one of us will need to decide where they want that bar. Treasuries, agencies, TIPS, munis, corporates, junk, international . . . short-term, intermediate-term, long-term . . . those are all areas that have to be individualized. Cash-equivalents, CDs, stable value funds, etc., etc.

The safer the bond, the less need to diversify that risk (I don't buy treasuries in a fund, for example). The riskier the bond, the more you might benefit from a fund (corporate fund versus individual corporates, for example).

For me, my fixed income is for security. I personally am not bothered at all by equity volatility, but I expect my bonds to provide an anchor. I would rather increase my equity allocation and keep my bonds relatively safe, than lower my equity allocation and increase my fixed income to junk bond purchases.

The stereotypic answer to "take the risk on the equity side" but there's sound reasoning behind that reasoning.
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magician
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Re: Corporate bonds and holding to maturity

Post by magician »

Artsdoctor wrote:Of course one needs to take risk with bonds. If it's not credit risk, it's inflation risk, currency risk, call risk, etc. There is no investment that doesn't have some degree of risk.

It's a matter of degree.
Which is exactly my point. The platitude "take risk on the equity side, not on the fixed income side" is an overstatement (some - Bill Gross, as an example - might say it's a (pardon the pun) gross overstatement). Take appropriate risk everywhere in your portfolio; that's a much better statement.

The problem is that the lion's share of the investing public only hears the overstatement, and hasn't the knowledge to recognize it as such.
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Re: Corporate bonds and holding to maturity

Post by nisiprius »

DeDad wrote:I picked up some excellent bonds (AA to BB rated) over time, some at a discount to face value. Has anyone held such bonds to maturity and received a return of the principal? Just curious to know others' thoughts. The events are so far off (2020 and beyond) that it is hard to wrap my mind around actually holding these to completion and getting my money back.
2020? Seven years off?

Not corporate bonds, but I have held a number of ten-year TIPS to maturity, and collected the inflation-adjusted principal--with distinct feelings of sadness, as those early ones were earning more than 3% over inflation. In a fit of... inexperience, I once bought a Berrien County, Michigan municipal bond and held it to maturity.

But then again, I've also paid off a 25-year mortgage.

Yes, it is possible to live long enough to see 7-year plans come to fruition.

(Even though I am only an early boomer, around the 1990s I started to have a superstitious dread that I might miss out on seeing the millennium change. John O'Hara, January 31, 1905-April 11, 1970, speaks somewhere of the wistful sadness who know they are "trapped within the century"--that is to say people, like O'Hara, born so near the beginning of a century that they likely to live their entire lives within that century.)
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Artsdoctor
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Re: Corporate bonds and holding to maturity

Post by Artsdoctor »

magician wrote:
Artsdoctor wrote:Of course one needs to take risk with bonds. If it's not credit risk, it's inflation risk, currency risk, call risk, etc. There is no investment that doesn't have some degree of risk.

It's a matter of degree.
Which is exactly my point. The platitude "take risk on the equity side, not on the fixed income side" is an overstatement (some - Bill Gross, as an example - might say it's a (pardon the pun) gross overstatement). Take appropriate risk everywhere in your portfolio; that's a much better statement.

The problem is that the lion's share of the investing public only hears the overstatement, and hasn't the knowledge to recognize it as such.
I think we could all agree that the lion's share of the investing public could benefit from an entry level investing course. If the majority of investors would stick to simple truisms (or platitudes, or cliches), they would probably do just fine. In fact, the Three Fund Portfolio would suit the vast majority of investors better than most alternatives. On the other hand, a novice investor could wind up doing plenty of damage indeed without understanding what it is that he/she is investing in.

Using bonds for safety is an established investment tool. No one's saying that you personally can't walk on the wild side; I'd just be cautious about advising others to do it.
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Re: Corporate bonds and holding to maturity

Post by jeffyscott »

mpt follower wrote:
jeffyscott wrote:Buying your own long term corporate bonds does not seem to me to be worth the trouble. I'd rather hire Wellington Management Company to do that for me at a cost of 0.12% per year. https://personal.vanguard.com/us/funds/ ... =INT#tab=0

I think the current spread between treasuries and corporates is still high by historical standards :?: , vanguard long term treasury is at 3.6% and long term inv. grade at 4.86%.

Also in the safer category, an alternative to long term treasuries, for up to $10K per person per year would be EE bonds. If held 20 years yield is about the same as a 20 year treasury held to maturity.
WOW! Long Term Corporate Bonds? I wonder your logic. Do you care to explain, I may learn something new!!
Three things:

I look at a mix of 2/3 stable value (with yield of about 1.8%) and 1/3 long term investment grade as having a bit shorter duration than bond index. The bond index has a yield of about 2.2%, while my custom mix has a yield of about 2.8%.

Assuming 2.5% inflation, the real return of long term should be around 2.3%. At current prices the expected returns of stocks is perhaps about 3.5% real :?: , with much higher risk.

In 2008/09 I became much more skeptical of corporations. I feel I am safer lending to them than being a pretend owner (shareholder). Also due to this, our stake in equities is smaller than most, currently about 38%.

(note that essentially all our assets are in tax deferred accounts)
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