Bonds good, Bond funds Bad, Suze Orman on CNBC

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Bonds good, Bond funds Bad, Suze Orman on CNBC

Postby SpringMan » Wed Dec 12, 2007 10:40 am

I watched Suze Orman on CNBC last night. She was adamant about investors not buying bond funds. She recommended people roll old 401ks to a discount brokerage IRA so they can purchase bonds or ETFs. She specifically warned not to buy bond funds. Is Suze just plain wrong. I understand individual bonds can be held to maturity and by doing so you get your initial purchase back. That to me is not a reason to avoid bond funds. Individual bonds still fluctuate in price on the secondary market. I am a buy and hold bond fund owner. According to Suze, a big mistake. Comments?

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Postby thirdcamper » Wed Dec 12, 2007 10:48 am

Bond funds entail paying the expense ratio. However, bond funds have the advantage of diversification across the entire bond market. For most individual investors, especially those who don't understand the intricacies of bonds, funds make perfect sense.
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Re: Bonds good, Bond funds Bad, Suze Orman on CNBC

Postby old_dominion » Wed Dec 12, 2007 10:57 am

SpringMan wrote:I understand individual bonds can be held to maturity and by doing so you get your initial purchase back.


Exactly! An individual bond is always worth its par amount!

SpringMan wrote:Individual bonds still fluctuate in price on the secondary market.


Well, if you own an individual bond you don't have to mark to market, like those bond funds do...
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Postby SpringMan » Wed Dec 12, 2007 10:57 am

thirdcamper,
That is my take also. I only own admiral shares of Vanguard bond funds, er=.11. I also admit to not understanding intricacies of bonds.
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Postby stratton » Wed Dec 12, 2007 11:00 am

I can see her reasoning if your bond fund costs you 0.75%. The same bond fund at Vanguard will run 0.20% or less. Admiral shares will be an even better deal.

For example, Admiral shares of Vanguard's muni bond funds are 0.09%. At that point its hard to buy individual munis when you can have essentially unlimited diversification in convervative holdings for 9 basis points. The beauty of this is because of the low ER Vanguard's funds can take considerably less risk to get equivalent returns of their competitors who charge more. A fund that charges 0.5% more ER has to dip into lower investment grade or even junk bonds to get an equivalent return.

Fido has Vanguard like ER on their Spartan Treasury funds. There are also a variety of fixed income ETFs with similar low ERs. Isn't competition wonderful!

If you intend on holding a bond to maturity then it can cost you less. If you invest in anything but treasuries you probably should have a couple hundred thousand dollars to insure you have diversification on bonds you buy. And even then you should stick to the highest quality. Natural AAA or AA only in municipals.

Paul
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Postby SpringMan » Wed Dec 12, 2007 11:06 am

old_dominion,
You give the pros of individual bonds. Are you in Suze's camp regarding bond funds being bad? I have owned individual bonds in the past and when you go on the web to view your brokerage account, the bonds are marked to market in your account. Older folks may not live long enough to hold an intermediate or long bond to maturity. If you sell a bond on the secondary market you will pay a commission. Diversity is another benefit of the funds.

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Try as I might to understand Suze on this,

Postby dm200 » Wed Dec 12, 2007 11:11 am

I have to conclude that Suze is just plain wrong. Her math and logic do not make sense to me.

Buying and selling individual bonds (according to what I understand) can not be done by individuals for the same prices and costs that are available to large investors, like bond funds. The costs of bond funds from a company like Vanguard are very low (well under 1/2 of 1%), and you get professional management, liquidity and diversification.

For open end bond funds, the price (NAV) you get or pay adjusts daily, according to the market (mostly interest rate changes). As I recall, Suze seems to claim that folks moving in and out of bond funds financially harms the folks who were there first. BUT - since the purchases and sales are at NAV, there is no harm.

Her "logic" makes some sense in several situations, that I can think of:

1. In government bonds (where divserification is not needed) AND the bond portfolio is large (several hundred thousand dollars).

2. Where the investment time frame is very focused and specific. For example, a person needs to have $50,000 in mid 2012. Then, they could buy a bond with a maturity at the day when they need the money.

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Re: Bonds good, Bond funds Bad, Suze Orman on CNBC

Postby jeffyscott » Wed Dec 12, 2007 11:15 am

SpringMan wrote:I watched Suze Orman on CNBC last night.



May I ask why :?: :? :lol:
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Postby greg24 » Wed Dec 12, 2007 11:17 am

thirdcamper wrote:Bond funds entail paying the expense ratio. However, bond funds have the advantage of diversification across the entire bond market. For most individual investors, especially those who don't understand the intricacies of bonds, funds make perfect sense.


Thirdcamper sums it up perfectly. Suze typically is informing the uninformed, so its a horrible idea to tell her viewers to avoid bond funds and buy individual bonds. I have a slight clue about bonds, but there is still no way I'd avoid bond funds and buy individual bonds. I don't have the time or the knowledge required to pull it off.
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Postby Sunny Sarkar » Wed Dec 12, 2007 11:26 am

Bond funds provide me with:

(1) Diversification - I'd go broke before I could buy all the bonds in a fund
(2) Liquidity - I can sell 17.23% of my shares on any given day
(3) Convenience - Just like buying shares of any other fund

All this for for a very small fee per year that wouldn't even buy one lunch for all the managers of the fund. Good value!

p.s. Mr. Bogle answered this question in the Q&A at Diehards IV in Denver. Video available here: http://www.diehards.org/forum/viewtopic.php?t=691
He joked that if he wanted to own individual treasuries instead of a treasury index fund, the cab ride to the treasury would cost more :)
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Postby grayfox » Wed Dec 12, 2007 11:37 am

Springman wrote:
I also admit to not understanding intricacies of bonds.


To me, individual Treasury bonds are a lot easier to understand than bond funds. With bonds you know things exactly like the Yield-To-Maturity, Yield-to-Call, whether you are buying a discount or premium bond, how much you get back at maturity, what and when each coupon payment will be, what your return will be for the next x years. There is no uncertainty.

With bond funds, all that stuff is hard to determine or just plain unknowable so there is more uncertainty.

Which is more risky? An investment that the return is certain or one that the return is uncertain?
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Re: Bonds good, Bond funds Bad, Suze Orman on CNBC

Postby CyberBob » Wed Dec 12, 2007 11:42 am

SpringMan wrote:I watched Suze Orman on CNBC last night. She was adamant about investors not buying bond funds. She recommended people roll old 401ks to a discount brokerage IRA so they can purchase bonds or ETFs.

She doesn't recommend bond funds, but she is recommending bond ETF's?
If that's the case then she may just be saying favor the bond ETF because of it's generally low expense ratio, as compared to the generally high expense ratio of an actively managed bond fund. Sounds pretty Bogle-headed to me.

Bob
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Postby SpringMan » Wed Dec 12, 2007 11:53 am

Cyberbob,
My understanding was that she was recommending stock ETFs. This was not clarified but why would she recommend a bond ETF when she does not like bond funds? She did not come across as a boglehead, IMHO.
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Postby bottlecap » Wed Dec 12, 2007 11:57 am

I watched her last night, too. Let's just say I was trying to get to sleep....

I think she's wrong on a lot of things, and this is one of them. Here are my reasons:

1. Bond funds offer diversification;

2. Bond funds do flucuate, but as a part of an diversified portfolio, there is nothing wrong with this;

3. Who in her audience is actually going to take the time to learn how to even purchase individual bonds? I like this investment stuff, and it's not worth my time to jump through the hoops to keep a portfolio of individual bonds. These folks who can't keep current on their house payments and credit card bills are going to take the initiative to understand and maintain such a portfolio? Not likely.

If you want advice on how to make and keep a budget, Dave Ramsey's your man. If you want to learn about investing, this board is the place. If you want to learn that a low FICO score means you'll pay a higher rate of interest on loans, by all means, tune into Suzy Orman.

JT
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Postby CyberBob » Wed Dec 12, 2007 12:04 pm

SpringMan wrote:Cyberbob,
My understanding was that she was recommending stock ETFs. This was not clarified but why would she recommend a bond ETF when she does not like bond funds? She did not come across as a boglehead, IMHO.
Best,

Well in that case, I agree with the people above that she's focusing on a sort of non-problem.

True, a bond fund does not have a fixed maturity date, and so isn't as definite as owning actual bonds. And when you buy and hold individual bonds you pay one-time costs as opposed to the ongoing annual costs for a fund. It sounds simple and logical, but it's not that simple.

Because it's very difficult for an individual to determine the fair price of a bond, there is certainly a chance that you may end up paying such a high price that it will overwhelm the money you save by not investing in a fund and paying its annual costs. My pessimistic general assumption is that if you are investing a small amount of money in bonds as an individual investor, you are almost never going to get a fair price unless you are buying U.S. Treasury bonds directly from the U.S. Treasury at an auction.

Most of the time, a low-cost bond fund is the lesser of the evils and the better way to go.

Bob
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Postby RobHoop » Wed Dec 12, 2007 12:04 pm

If you own individual bonds in an IRA, but are not retired, what do you do with the interest? I like bond funds because the interest is reinvested in the fund.

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Postby bnwest » Wed Dec 12, 2007 12:07 pm

Doesn't Ms. Orman invest heavily in treasury bonds? This might have colored her opinion of bonds and bond funds. If pressed, she might say that one should invest in treasury bonds and not corporate???

Personally, I do not like bond funds (due to the interest play) or individual corporate bonds (due to not trusting the bond rating agencies and thus not knowing the actual quality of the bonds). From here on, I am investing in either FDIC insured CDs or treasury bonds (in my 10 year "bond" latter).

Brian
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Postby SpringMan » Wed Dec 12, 2007 12:16 pm

bnwest wrote:
Doesn't Ms. Orman invest heavily in treasury bonds? This might have colored her opinion of bonds and bond funds. If pressed, she might say that one should invest in treasury bonds and not corporate???

My understanding is that Suzie Orman is a big fan of and invests heavily in tax free municipal bonds. It would make sense in her tax bracket.

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Postby Prokofiev » Wed Dec 12, 2007 12:22 pm

Suze Orman is often wrong and gives snap advice to people without knowing all the details. The bond fund answer was just plain loony - although it is clear that many people just don't understand bond funds.

She is an entertainer like Cramer, but with far less knowlege.

Don't listen to her advice . . .
Everything should be made as simple as possible, but not simpler - Einstein
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Postby SamB » Wed Dec 12, 2007 12:37 pm

*****
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Postby old_dominion » Wed Dec 12, 2007 1:27 pm

SpringMan wrote:old_dominion,
You give the pros of individual bonds. Are you in Suze's camp regarding bond funds being bad? I have owned individual bonds in the past and when you go on the web to view your brokerage account, the bonds are marked to market in your account. Older folks may not live long enough to hold an intermediate or long bond to maturity. If you sell a bond on the secondary market you will pay a commission. Diversity is another benefit of the funds.

Regards,


No, I was just being silly and speaking tongue-in-cheek.

Except for individual investors with extremely high net worth or a willingness to invest only in Treasuries, investing in individual bonds reduces liquidity, adds transaction costs (particularly if you plan to harvest capital gains should a bond's price rise before maturity), and provides inadequate diversification. Unlike stock markets, which feature transparent pricing (instead of matrix pricing for all but the most liquid issues) and massive liquidity (instead of being based on dealer inventories), bond markets are generally best left to institutional investors.
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Postby Buddtholomew » Wed Dec 12, 2007 2:27 pm

My intention is not to hijack this thread, but does it make sense for an individual investor to hold a bond fund (the bond fund is Dreyfus Investment Grade Intermediate Term - DRITX) in their 401K with an ER of .80? I am rebalancing to 10% fixed income and cannot determine whether investing in the bond fund or an MM/Stable Value fund is more sensible.
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Postby oneleaf » Wed Dec 12, 2007 2:37 pm

This type of quick advice without deep analysis of the details is so commonplace, and caters to people with short attention spans (which is probably most people). This is why you get advice like "don't invest in Roth, take the tax savings NOW, not LATER!" or "Young people are crazy to put any of their retirement savings in bonds! Go for growth!"

Suze Orman is doing the same thing here. As this thread has shown, there is much more to consider regarding bond funds vs. individual bonds for ordinary investors, and the answer is not so simple. Unfortunately, these types of discussions would bore most people to tears.
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Budd . . .

Postby Prokofiev » Wed Dec 12, 2007 2:39 pm

An ER of .8 is far too expensive for me. But what are your alternatives?

VG ERs are between .1 and .2% and even lower for some Admiral class.

That's .6-.7% per year every year down the drain. It adds up.

-P
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Postby Buddtholomew » Wed Dec 12, 2007 2:53 pm

An ER of .8 is far too expensive for me. But what are your alternatives?


A MM or Stable Value fund are the only options in my 401K at this time. Other tax-deferred accounts (SEP, TIRA) hold REIT and the Extended Market and FTSE ex-US in taxable. Excuse my ignorance, but what would I be giving up if I allocate 10% to a MM/Stable Value fund in lieu of a bond fund. I know I will be savings substantially with the ER reduction.
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Postby SpringMan » Wed Dec 12, 2007 2:55 pm

Buddtholomew,
I agree with Prokofiev, .8% is too much for that bond fund. I am sympathetic to your cause since my wife's 401k has similar poor choices. I am considering the stable value option for her. She has available an S&P500 index fund with an expense ratio of .65%, IMHO just too high. Her stable value is paying 3.x% but may be the best option. She is currently in two funds, Am Funds Gr Fund of AM (RGACX) .96% ER and Am Funds Balanced (RLBCX) .9%. It is a sin how these 401ks rip off. She works for a small company and the 401k was a good deal for the company at the expense of the employees. No match either, bummer.

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Postby Buddtholomew » Wed Dec 12, 2007 3:08 pm

SpringMan,

Thank you for sharing your situation as well. How does a Stable Value investment track to the Total Market and correlate with Intermediate bonds? In other words, what types of gains/losses can I expect to achieve?

--Budd
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SUZE ????????????????????????????

Postby mephistophles » Wed Dec 12, 2007 3:20 pm

Best I can tell, her audience is full of people with massive credit card debt paying 18%+ in interest and who do not have a clue about basic finance.

And, she is telling these people to go out and buy individual bonds on the open market!

Sorry about that. Give me a break!

ole meph
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Postby SpringMan » Wed Dec 12, 2007 3:23 pm

Buddtholomew,
The stable value option is likely to never lose money but its rate of return is low. It is similar to a short term bond fund or money market fund, very low risk and very low return. I plan to count it as part of our fixed income, or short term reserves. For us, using the stable value for a chunk of our fixed income, simplifies our portfolio (fewer total number of funds). Soon as possible we will roll over this 401k to an IRA. Unfortunately, they won't allow rollovers on an active 401k.

Best,
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Postby Quasimodo » Wed Dec 12, 2007 3:45 pm

A different opinion from Suze Orman's about bond funds:

http://www.thornburginvestments.com/lit ... d_Fund.pdf

Having the dividends automatically reinvested in more shares which in turn throw off more dividends, and so on, seems a good selling point in favor of bond funds to me...

John
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Postby jeffyscott » Wed Dec 12, 2007 3:47 pm

Stable value can vary, mine is made up of intermediate bonds and currently yields 5.17%. Over time, I'd expect mine to have similar returns to what it contains, which is intermediate bonds.
press on, regardless - John C. Bogle
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Postby georgepds » Wed Dec 12, 2007 3:57 pm

FWIIW, Orman is not the only one who raises this issue. Jane Bryant Quinn has a section on the difference between bonds and Bond funds in Making the most of your money. The issue is that bond funds fluctuate in value, but that individual bonds (held to maturity, provided that there is no default) do not fluctuate in principal. As someone has pointed out the difference is liquidity. If you need to sell the bond before term,you sell it at market prices just as a bond fund does. OTOH, if you hold to maturity you get all your principal back.

From there it gets interesting. One feature of bonds is that some can be cashed in at par value (what they were issued at, nominally 100) on the death of the holder. Suppose you are planning for someone about to "cross over." You can purchase the bonds on the secondary market for the portfolio at the lower market rate (I've seen 64 for particularly bad issues). On death you can exercise the conditional put and get paid back at par (100)

I'm guessing Ms Orman did not touch on this possibility;)

As to her personal holdings, the NY times did an article on her. IIRC she is worth ~ $25 million, and has it all invested in Munis.

--G
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Postby Prokofiev » Wed Dec 12, 2007 4:16 pm

georgepds wrote:FWIIW, Orman is not the only one who raises this issue . . The issue is that bond funds fluctuate in value, but that individual bonds (held to maturity, provided that there is no default) do not fluctuate in principal . . . if you hold to maturity you get all your principal back.
--G


Well, sure. That part IS true. But it is totally misleading.

You buy a 30-yr bond at 5% and suddenly rates jump to 10% due to high inflation. Wow! You just just lost almost 50% of your investment. Much better to hold the 5% bond for 30 years, right? NO, in a 10% rate environment you lose out to inflation by holding the low yielding bond those 30 years (5% vs 10%) and then get you finally get $1000 bucks back . . . although it is worth only 8% of what you paid!

Holding to maturity to avoid marking to market solves NOTHING.
Everything should be made as simple as possible, but not simpler - Einstein
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Postby magellan » Wed Dec 12, 2007 4:55 pm

I can't count the number of times I've had to explain to my finance students that individual bonds are not somehow superior to funds with respect to the "feature" that you don't lose any money if you don't sell the bond. There are plenty of other things to consider about the pros and cons of bonds vs bond funds, but this one "feature" shouldn't go into the calculation.

Many students (and perhaps Ms. Orman as well) don't seem to understand that whether you sell the bond immediately or hold it to maturity, your overall financial well-being is no different. If rates go up, the value of the bond, as defined as the present value of all future payments, goes down.

I've had to explain this many times and I'm not sure I've gotten any better at it over the years, but here goes...

Consider this hypothetical case...

Last year, Fred bought a 10 yr bond for $1000 with a 4% coupon payment. Over the past year, market interest rates have risen to 5%. If Fred tries to sell his bond today, he'll only be able to get $928.92
(to verify this in excel use =PV(.05, 9, 40, 1000) )

Some will argue that Fred is better off as long as he doesn't sell his bond, since he can still get $1000 for the bond when it matures. The problem with that logic is that it only accounts for one of the future cash flows that the bond will generate in the next 9 years (the last cash flow). It doesn't take into account that Fred is only getting a 4% coupon rate, while other bond buyers in the market today with $1000 will get a 5% coupon rate.

Now let's consider two scenarios of what Fred could do with his bond...

1) Fred keeps his bond.

He continues to get his $40 annual coupon payment for the next 9 years and at maturity he gets his $1000 back.


2) Fred sells his bond for $928.92 and buys another bond at the market price.

Assume he can buy a 9 yr bond with a face value of $928.92 that pays a coupon of 5% (this is the current market rate). This bond will be worth only $928.92 when it matures, but in the meantime he'll get annual payments of $46.45 instead of annual payments of $40 because the market rate is now 5% instead of 4%.
(in excel $928.92*.05 = $46.446).

Assume that every year, Fred spends the first $40 of the coupon payment just as he would have with the original bond. In addition, he takes the extra $6.446 he's getting in extra coupon payments each year and invests it at 5% (the prevailing interest rate) in a savings account.

At the end of 9 years, his savings account will be worth $71.08 ( in excel use =FV(.05, 9, -6.446, 0) )

So for scenario 2, he gets his $40 in coupon payments each year, just like in scenario 1, and he gets $928.92 when the bond matures, and he also gets the $71.08 from the savings account (928.92+71.08 = $1000).

So you can see that he is exactly as well off under scenario 2 (selling the bond) as he is with scenario 1 (keeping the bond to maturity).

Maybe this just makes things muddier, but hopefully it helps to erase this "non difference" between individual bonds and bond funds.

Jim

(note: transaction costs and minor differences in taxes between the two scenarios are ignored for simplicity).
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Postby peter71 » Wed Dec 12, 2007 5:57 pm

hi all,

i agree with most of the criticisms of orman here but suppose one was dealing with some superhuman automaton who had known with 100% confidence 10 years ago that they needed the money from their bond or bond fund on a particular date this summer. while i know that's a ridiculous premise, isn't orman presumably thinking that the person who bought a bond that matured on that particular day would be insulated from a short-term exogenous price shock to bond funds unrelated to interest rates (such as the ones we saw this summer when hedge funds had to cash in munis at low prices to raise cash)?

again, i don't think investors (and least of all the credit card debt crowd) are automatons with perfect information, but i'm just guessing that this is part of what she's thinking, no?

all best,
pete
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Postby snray02 » Wed Dec 12, 2007 6:04 pm

This is nothing new. Suze has been anti bond funds as long as I have noticed her columns. At least she is consistent in her advice.

Also, Suze does invest primarily in munis. And real estate. I read someplace that she owns 5 houses and you can be sure they aren't house trailers.
Sam
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Postby sergeant » Wed Dec 12, 2007 6:18 pm

At the end of every "State of the Union" speech a member of the opposing party is given a few minutes to counter what the President just spoke of. Maybe a Boglehead should be given "equal time" after the market porn of the "experts"?
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Postby tarnation » Wed Dec 12, 2007 11:31 pm

In the movie "Maxed Out" Scurlock shows her stressing the importance of FICO scores and then claims she has a deal with FICO's parent company. Maybe she has a deal with bond issuers ;)
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Postby peter71 » Wed Dec 12, 2007 11:50 pm

apparently it's true she has a deal with Fair Isaac -- here's a press release to that effect -- i saw her recent show myself and she certainly was over the top on telling people to constantly check their scores and shoot for a particular number . . . i remember thinking at the time, suppose someone already has their house and car paid off . . . do they really need constant monitoring from all three bureaus and to shoot for a 760 (or whatever it was). come to think of it, i can't recall any references to myfreecreditreport.com either, though perhaps there were and i've forgotten.

http://findarticles.com/p/articles/mi_m ... i_n6043484

all best,
pete
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Postby tetractys » Thu Dec 13, 2007 12:00 am

tarnation wrote:In the movie "Maxed Out" Scurlock shows her stressing the importance of FICO scores and then claims she has a deal with FICO's parent company. Maybe she has a deal with bond issuers ;)


Worst case imaginary senario: Mis Orman receives a gratuity from various junk bond dealers each time one of her starry eyed fans begs her for a dealer tip and falls into her trap.

Best case imaginary senario: Mis Orman gently guides her starry eyed fans to commission free treasuries, custom selected by her for their precise needs.

:lol: Tet
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Postby nisiprius » Thu Dec 13, 2007 10:15 am

magellan wrote:Many students (and perhaps Ms. Orman as well) don't seem to understand that whether you sell the bond immediately or hold it to maturity, your overall financial well-being is no different. If rates go up, the value of the bond, as defined as the present value of all future payments, goes down.

I understand that perfectly.

The part I don't understand is why I should care about the market value of the bond if I have no intention of selling it prior to maturity. A lot of these explanations I've been seem to me assume that an individual investor has no control at all over his investment policy.

I understand fully that "stuff happens" in real life, but it's also true that sometimes things do go according to plan. Let's say the purpose for which I bought a bond was e.g. to generate retirement income through interest, and to hold it to maturity. If there's a 100% chance that I do what I planned, then why do I care what someone's opinion of the bond's value is in between? If there's an 80% chance that I do what I planned, then why should I give more than 20% weight to the "market value" number on my brokerage statement?

Now, on the other side... my belief is... and if I'm right, I think it's something that people don't understand... that the a bond fund can fluctuatate, but not in the same way as a stock fund. The hypothetical growth of $10,000 curve can wiggle a bit, but it can only go so far. It's constantly being pulled back to a smooth ascending curve by a) the value of bonds approaching their face value as they mature, and b) the constant effect of reinvested interest being poured in, at a slowly changing average rate.

I don't think there's a big difference between individual bonds and a bond fund. If the bond fund has short maturities, it won't fluctuate much. On the other hand, if an individual bond has a long maturity, the chances that "stuff happens" and you'll be forced to liquidate it before maturity rise, so the importance of its fluctuating market value increases. Either way, with short maturities the fluctuations don't matter much and with long maturities there's risk.
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diversification / rebalancing

Postby brisni » Thu Dec 13, 2007 11:28 am

Thanks Jim (megallan) for the explanation. This is how I thought it worked but haven't seen a good example like that.

I think that for anyone in the asset-accumulation phase and is using bonds only to diversify against stocks, the fund is clearly the way to go. Yes, the value fluctuates but isn't that what you want? Say you have an IRA and want 20% bonds. You put it all in a bond index fund, re-invest the dividends, and occasionally rebalance back to 20%. Using individual bonds would add far more complexity than is necessary.

- Brian
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Postby baw703916 » Thu Dec 13, 2007 11:53 am

I can't resist parodying the thread's title:

Bonds good, (some) Bond funds Good, Suze Orman on CNBC Bad :D

Best wishes,
Brad
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Postby georgepds » Thu Dec 13, 2007 11:58 am

Prokofiev wrote:
georgepds wrote:.. The issue is that bond funds fluctuate in value, but that individual bonds (held to maturity, provided that there is no default) do not fluctuate in principal . . . if you hold to maturity you get all your principal back.
--G


Well, sure. That part IS true. But it is totally misleading.

You buy a 30-yr bond at 5% and suddenly rates jump to 10% due to high inflation. Wow! You just just lost almost 50% of your investment. Much better to hold the 5% bond for 30 years, right? NO, in a 10% rate environment you lose out to inflation by holding the low yielding bond those 30 years (5% vs 10%) and then get you finally get $1000 bucks back . . . although it is worth only 8% of what you paid!

Holding to maturity to avoid marking to market solves NOTHING.



The point you make is that the present value (PV) of the bond and the fund are identical. The point you ignore is the perceived value in the guarantee of return of principal at par value. (I also note,parenthetically, you chose an example in which the interest increased and the PV of the bond /fund decreases. You could make your point equally well by considering the case in which interest rates decrease and the PV of the bond/fund increases.)

In both cases (interest rates go up or down) the net PV of the bond/fund are identical, should the holder decide to cash in. In both cases, the guarantee of return at par value holds only for the bond, not the fund.

Now you may not value that difference, and we agree that there is no difference from a net PV perspective, but the difference is there.

--G
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More confusion . . .

Postby Prokofiev » Thu Dec 13, 2007 12:52 pm

" The point you make is that the present value (PV) of the bond and the fund are identical. The point you ignore is the perceived value in the guarantee of return of principal at par value . . . the guarantee of return at par value holds only for the bond, not the fund . . . Now you may not value that difference, and we agree that there is no difference from a net PV perspective, but the difference is there"

If the present value of both investments are identical, what is the "perceived value"? A false sense of security?
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Nisiprius

Postby Prokofiev » Thu Dec 13, 2007 1:09 pm

" The part I don't understand is why I should care about the market value of the bond . . . "

Among other reasons, to be able to value your portfolio. How can you rebalance or even make reasonable decisions about your portfolio if you don't know the value of your fixed income? And for retirees with 50%-70% fixed income this is huge.


" my belief is... that the a bond fund can fluctuatate, but not in the same way as a stock fund . . . a) the value of bonds approaching their face value as they mature, and b) the constant effect of reinvested interest being poured in, at a slowly changing average rate "

Again, I don't think you understand bond funds or PV. Interest is reinvested in the fund, just as you need to do something with the interest on your individual bonds.

" if an individual bond has a long maturity, the chances that "stuff happens" and you'll be forced to liquidate it before maturity rise, so the importance of its fluctuating market value increases "

Again, how is it different for individual bond holders? If "stuff happens" and you sell your bond you will get the same price as the fund. Not marking your portfolio to market, doesn't mean you can dump it at par when rates go up. Just because you don't KNOW the price, doesn't change the price.
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Re: More confusion . . .

Postby georgepds » Thu Dec 13, 2007 1:32 pm

" If the present value of both investments are identical, what is the "perceived value"? A false sense of security?"

No, just a feature that holds no value (perceived or otherwise) to you; except, of course, for the opportunity for sarcasm.

I do not think we disagree on the substantive element of the discussion, that both bonds and bond funds have the same net PV when interest rates change

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Postby magellan » Thu Dec 13, 2007 2:53 pm

nisiprius wrote:The part I don't understand is why I should care about the market value of the bond if I have no intention of selling it prior to maturity. A lot of these explanations I've been seem to me assume that an individual investor has no control at all over his investment policy.

I think the answer depends on why you're holding the bond or bond fund in the first place.

If you're implementing a liability/income matching strategy (like some pension funds), then you probably don't need to worry about day-to-day market values as long as you've set things up to assure you'll have funds available when you need them to meet your obligations.

On the other hand, if you're trying to maintain a target allocation to bonds over a long investment horizon, then the current market value of your bond holdings is something you'll need to evaluate at portfolio rebalancing time.

Jim
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It's the NAV

Postby azxcvbnm321 » Fri Dec 14, 2007 7:37 am

It seems very unlikely that you will get back exactly the amount of principal you put into a bond fund. How likely is it that the NAV of the fund on the day you decide to withdraw exactly matches the NAV on the day you decided to purchase?

One huge difference between bonds and bond funds is that bond funds never mature so when you cash out of a bond fund, you are in effect, selling your bonds at market price. The difference in NAV probably won't be all that much, but then again, you don't receive all that much in interest to begin with so a few percentage points of difference could be significant.
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Re: It's the NAV

Postby jeffyscott » Fri Dec 14, 2007 11:56 am

azxcvbnm321 wrote:One huge difference between bonds and bond funds is that bond funds never mature so when you cash out of a bond fund, you are in effect, selling your bonds at market price.


If you own a bond you also can only sell at the market price. When it matures you also get the market price.
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