Bonds vs. Savings Acct

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strcmp
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Bonds vs. Savings Acct

Post by strcmp » Thu Jul 12, 2007 1:23 pm

Hi

I was wondering if anyone can explain the advantages of putting $ into an index bond fund like Vanguard Total Bond Mkt Index (BND) vs. putting it into a savings acct earning 5+% APY interest. I am trying to understand the nuances of both.

They both seem like safe investments and return approximately the same?
Do bonds always return more than a savings acct or vice versa?

I am going to follow the advice of a 90% stocks/10% bonds allocation, but I was wondering if that 10% bonds could be interchanged with 10% cash savings acct. Would 10% cash savings be too conservative for a 24 year old?

Thanks

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Orion
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Post by Orion » Thu Jul 12, 2007 1:49 pm

Here's my take on banks:

When short-term interest rates drop, banks will follow. Once this happens, you'll probably think that now is not a good time for a bond fund but last year would have been. Oh darn. Wait a while...

When short-term rates go back up, many bank accounts will NOT follow. You have to notice this, and then contact them. They will politely inform you that you their old (silly-name) account, and they would be happy to transfer you over to their new (silly-name) account of the same type that pays a competitive rate.

As long as you're willing to keep watching and change accounts and occasionally change banks to chase the rates, you can do OK or maybe even well if you stay alert. If you don't you can end up with a once hot bank Money Market account that is now paying 0.1% in a 4-5% environment. (Actual local bank example.)

Your banks may vary, but I got tired of keeping on top of my banks. Vanguard was simpler in the long run. Today the yield curve is very flat so my money is mixed between vanguard MMs and bond funds. This is very dependent on your state and federal tax levels too. In my case both treasury funds and munis come out better after taxes than a fully taxable bank account. For my tax bracket and the current yield curves, a treasury money market and a limited or intermediate tax exempt fund works well. (Plus the TIPS fund for the unexpected inflation hedge.)

Does that 10% cash include your emergency fund?

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dm200
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A bond fund (just like the bonds in it)

Post by dm200 » Thu Jul 12, 2007 5:27 pm

can drop in value, as interest rates change. A savings account can not drop in value.

While savings accounts rates generally follow market rates to some degree, banks may pay more or less depending on the degree to which they need to attract funds.

dan

2stepsbehind
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Post by 2stepsbehind » Thu Jul 12, 2007 5:40 pm

Orion wrote:Here's my take on banks:

When short-term interest rates drop, banks will follow. Once this happens, you'll probably think that now is not a good time for a bond fund but last year would have been. Oh darn. Wait a while...

When short-term rates go back up, many bank accounts will NOT follow. You have to notice this, and then contact them. They will politely inform you that you their old (silly-name) account, and they would be happy to transfer you over to their new (silly-name) account of the same type that pays a competitive rate.

As long as you're willing to keep watching and change accounts and occasionally change banks to chase the rates, you can do OK or maybe even well if you stay alert. If you don't you can end up with a once hot bank Money Market account that is now paying 0.1% in a 4-5% environment. (Actual local bank example.)

Your banks may vary, but I got tired of keeping on top of my banks. Vanguard was simpler in the long run. Today the yield curve is very flat so my money is mixed between vanguard MMs and bond funds. This is very dependent on your state and federal tax levels too. In my case both treasury funds and munis come out better after taxes than a fully taxable bank account. For my tax bracket and the current yield curves, a treasury money market and a limited or intermediate tax exempt fund works well. (Plus the TIPS fund for the unexpected inflation hedge.)

Does that 10% cash include your emergency fund?
could you explain how this works?

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hollowcave2
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bonds usually return more

Post by hollowcave2 » Thu Jul 12, 2007 6:05 pm

They both seem like safe investments and return approximately the same?
Do bonds always return more than a savings acct or vice versa?
The yield curve is so flat now, it's hard to see the advantages of bond funds over a savings account. The only data we have to go on is the historical record, and the historical record generally has shown that bonds return more than money markets over the long run. But over the short run, that doesn't need to be so.

Just go to Vanguard's page on their funds and compare the money market returns to any of the bond funds. It's no contest. Bonds win.

But to take advantage of this, you need to only put investment money for the long term in the bond funds. Short term money for specific purposes or emergency money could go in the savings account.

Steve

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Orion
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Post by Orion » Thu Jul 12, 2007 6:11 pm

2stepsbehind wrote:could you explain how this works?
The bank interest gets US tax and state tax (adjusted somewhat for the state tax being deductible since I don't take the standard deduction.)

The Treasuries are taxed by the US but not the state.

The Munies are taxed by the state (except for in-state and Puerto Rico munies) but not the fed.

Both of the latter two start with a lower rate but both of my tax rates are high enough that lately they both end up a little higher after taxes. Of course tax rates, whether you deduct your state tax, bond rates and bank rates are all variables in this so you have to calculate these for your own situation.

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Index Fan
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Post by Index Fan » Fri Jul 13, 2007 9:59 am

Over the long term, bonds have outperformed cash, while cash has far less risk, unless you factor in inflation's impact upon returns.

With money market rates of 5% right now, it's pretty easy to have money in cash. Perhaps a 50/50 split between bonds and cash for fixed income would be an option?
"Optimum est pati quod emendare non possis." | -Seneca

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