Bonds vs. Bond Fund?

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BeanCity
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Bonds vs. Bond Fund?

Post by BeanCity » Mon Dec 02, 2019 3:10 pm

A friend of mine, who happens to be a financial planner, mentioned to me that he does not advise his clients to go into bond funds, and directs them to actual bonds. He does not manage my money, but I was intrigued that he had said that.

Let's say I am about to make a decision to go 60% stocks (VTI)/40% bonds (BND), is there any benefit to go into actual bonds vs the bond fund?

I am sure this is discussed heavily, but I haven't found an answer I can be satisfied with either way.

UpperNwGuy
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Re: Bonds vs. Bond Fund?

Post by UpperNwGuy » Mon Dec 02, 2019 3:43 pm

Stick with a bond fund and spread your risk over many bonds. It's also a lot less work for you as you won't have to buy and sell individual bonds.

retired@50
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Re: Bonds vs. Bond Fund?

Post by retired@50 » Mon Dec 02, 2019 3:48 pm

Did he say why he prefers individual bonds?

Personally, I prefer the convenience of a bond fund like BND. It prevents me from having to deal with finding and buying acceptable bonds. I also believe that a large fund like BND is more likely to get a better price when buying bonds on the open market than a small investor or adviser.

If his goal is to appear to his clients that he's earning his AUM fee or commission, then going through the motions of buying individual bonds may help toward that image. The question is whether or not his clients earn a higher return than BND with a similar risk, duration, etc.

Regards,

dbr
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Re: Bonds vs. Bond Fund?

Post by dbr » Mon Dec 02, 2019 4:51 pm

BeanCity wrote:
Mon Dec 02, 2019 3:10 pm

I am sure this is discussed heavily, but I haven't found an answer I can be satisfied with either way.
https://www.bogleheads.org/wiki/Individ ... _bond_fund

What does the advisor say is the reason for his advice?

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BeanCity
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Re: Bonds vs. Bond Fund?

Post by BeanCity » Mon Dec 02, 2019 5:53 pm

dbr wrote:
Mon Dec 02, 2019 4:51 pm
BeanCity wrote:
Mon Dec 02, 2019 3:10 pm

I am sure this is discussed heavily, but I haven't found an answer I can be satisfied with either way.
https://www.bogleheads.org/wiki/Individ ... _bond_fund

What does the advisor say is the reason for his advice?
His reasoning is that the "principal" fluctuates, and that we don't know whether yields are going to be low or high. He says by purchasing an individual bond, you are guaranteed your principal back, unless the bond goes bust.

This seems like a very obvious point to make, however, I don't believe it is as cut and dry as what he leads me to believe.

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Phineas J. Whoopee
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Re: Bonds vs. Bond Fund?

Post by Phineas J. Whoopee » Mon Dec 02, 2019 5:57 pm

BeanCity wrote:
Mon Dec 02, 2019 5:53 pm
dbr wrote:
Mon Dec 02, 2019 4:51 pm
BeanCity wrote:
Mon Dec 02, 2019 3:10 pm

I am sure this is discussed heavily, but I haven't found an answer I can be satisfied with either way.
https://www.bogleheads.org/wiki/Individ ... _bond_fund

What does the advisor say is the reason for his advice?
His reasoning is that the "principal" fluctuates, and that we don't know whether yields are going to be low or high. He says by purchasing an individual bond, you are guaranteed your principal back, unless the bond goes bust.

This seems like a very obvious point to make, however, I don't believe it is as cut and dry as what he leads me to believe.
Run.

He is conflating principal (the face, or par, value of the bond) with its current market price. It works the same for an individual bond or a portfolio of many bonds, such as a fund holds. Either he's ignorant or he's a grifter.

PJW

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BeanCity
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Re: Bonds vs. Bond Fund?

Post by BeanCity » Mon Dec 02, 2019 6:05 pm

Phineas J. Whoopee wrote:
Mon Dec 02, 2019 5:57 pm
BeanCity wrote:
Mon Dec 02, 2019 5:53 pm
dbr wrote:
Mon Dec 02, 2019 4:51 pm
BeanCity wrote:
Mon Dec 02, 2019 3:10 pm

I am sure this is discussed heavily, but I haven't found an answer I can be satisfied with either way.
https://www.bogleheads.org/wiki/Individ ... _bond_fund

What does the advisor say is the reason for his advice?
His reasoning is that the "principal" fluctuates, and that we don't know whether yields are going to be low or high. He says by purchasing an individual bond, you are guaranteed your principal back, unless the bond goes bust.

This seems like a very obvious point to make, however, I don't believe it is as cut and dry as what he leads me to believe.
Run.

He is conflating principal (the face, or par, value of the bond) with its current market price. It works the same for an individual bond or a portfolio of many bonds, such as a fund holds. Either he's ignorant or he's a grifter.

PJW
So if I was to buy an individual bond, the value of the bond will still fluctuate if yields change?

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Phineas J. Whoopee
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Re: Bonds vs. Bond Fund?

Post by Phineas J. Whoopee » Mon Dec 02, 2019 6:13 pm

BeanCity wrote:
Mon Dec 02, 2019 6:05 pm
Phineas J. Whoopee wrote:
Mon Dec 02, 2019 5:57 pm
BeanCity wrote:
Mon Dec 02, 2019 5:53 pm
dbr wrote:
Mon Dec 02, 2019 4:51 pm
BeanCity wrote:
Mon Dec 02, 2019 3:10 pm

I am sure this is discussed heavily, but I haven't found an answer I can be satisfied with either way.
https://www.bogleheads.org/wiki/Individ ... _bond_fund

What does the advisor say is the reason for his advice?
His reasoning is that the "principal" fluctuates, and that we don't know whether yields are going to be low or high. He says by purchasing an individual bond, you are guaranteed your principal back, unless the bond goes bust.

This seems like a very obvious point to make, however, I don't believe it is as cut and dry as what he leads me to believe.
Run.

He is conflating principal (the face, or par, value of the bond) with its current market price. It works the same for an individual bond or a portfolio of many bonds, such as a fund holds. Either he's ignorant or he's a grifter.

PJW
So if I was to buy an individual bond, the value of the bond will still fluctuate if yields change?
Yes, that's correct. For a plain, uncomplicated bond like a Treasury the cash flows stay the same, but the yield changes.

Now, as a bond approaches maturity its market value must, of necessity, approach its face value. Who would pay much more, or accept much less, than $1,000 for a thirty-year $1,000 face value bond that matures tomorrow?

The measure that includes the effect is Yield to Maturity, YTM.

The fact doesn't stop people from pretending their bond's market value doesn't fluctuate, but doing so is simply to blind oneself to reality. Bonds do not work like savings accounts.

PJW
Last edited by Phineas J. Whoopee on Mon Dec 02, 2019 6:17 pm, edited 1 time in total.

UpperNwGuy
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Re: Bonds vs. Bond Fund?

Post by UpperNwGuy » Mon Dec 02, 2019 6:15 pm

And the same applies to certificates of deposit.

dbr
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Re: Bonds vs. Bond Fund?

Post by dbr » Mon Dec 02, 2019 6:31 pm

BeanCity wrote:
Mon Dec 02, 2019 5:53 pm
dbr wrote:
Mon Dec 02, 2019 4:51 pm
BeanCity wrote:
Mon Dec 02, 2019 3:10 pm

I am sure this is discussed heavily, but I haven't found an answer I can be satisfied with either way.
https://www.bogleheads.org/wiki/Individ ... _bond_fund

What does the advisor say is the reason for his advice?
His reasoning is that the "principal" fluctuates, and that we don't know whether yields are going to be low or high. He says by purchasing an individual bond, you are guaranteed your principal back, unless the bond goes bust.

This seems like a very obvious point to make, however, I don't believe it is as cut and dry as what he leads me to believe.
It isn't that cut and dried because you have to have a need to get exactly that face value back at exactly that time. Someone may indeed have that need, but most investors in portfolios of stocks and bonds who expect to gather wealth and then spend it bit by bit in retirement don't need any single investment or even all their investments to return exactly the face value at exactly a certain time. In the meantime, as explained, the value of the holding does fluctuate and if there are sales before maturity a person can gain or lose money at the time of sale.

Probably the most credible example of using individual bonds is the idea of building a ladder of thirty year TIPS to provide a baseline of inflation indexed income during thirty years of retirement. But that is an explicitly constructed special case that is not similar to just buying individual bonds.

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Re: Bonds vs. Bond Fund?

Post by Hector » Mon Dec 02, 2019 6:33 pm

BeanCity wrote:
Mon Dec 02, 2019 5:53 pm
dbr wrote:
Mon Dec 02, 2019 4:51 pm
BeanCity wrote:
Mon Dec 02, 2019 3:10 pm

I am sure this is discussed heavily, but I haven't found an answer I can be satisfied with either way.
https://www.bogleheads.org/wiki/Individ ... _bond_fund

What does the advisor say is the reason for his advice?
His reasoning is that the "principal" fluctuates, and that we don't know whether yields are going to be low or high. He says by purchasing an individual bond, you are guaranteed your principal back, unless the bond goes bust.

This seems like a very obvious point to make, however, I don't believe it is as cut and dry as what he leads me to believe.
I buy short treasuries for bond.
Lately I have been moving from short term treasury index fund to individual treasuries. If yield goes higher, principle is almost gurenteed. If yield stays the same or goes lower, I benefit from capital appreciation.

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Re: Bonds vs. Bond Fund?

Post by dmcmahon » Mon Dec 02, 2019 8:28 pm

I use individual bonds in a ladder. I don't need diversification because they are 100% US government backed bonds. Why not a bond fund? It's because I don't know enough about the internal mechanics of funds to be confident of avoiding tax side-effects and capital losses. By holding a bond to maturity I'll get the principal back with no tax side effects. It's true that, if interest rates decline, the bond may have a market value above what I paid for it. So what? I don't plan to sell it before maturity, so it's irrelevant. Ditto if rates rise and the bond temporarily has a value below what I paid for it. With a bond fund, I'm not quite sure what the managers or algos running the fund are doing to maintain their average maturities. Supposed it's an intermediate term fund - does it automatically sell bonds out of its portfolio as they run down to, say 2-3 years left? If so, then these mechanics inside the fund will generate tax side effects. Also, these mechanics may make the fund look like it has a better yield than it actually does, because, unless the yield curve is inverted, it's likely making a small gain as it sells off the bonds, and possibly an even better gain in a falling rate environment. In a rising rate environment this will all run in reverse, throwing off losses. Or at least, it could in theory. JMHO.

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Re: Bonds vs. Bond Fund?

Post by Kevin M » Mon Dec 02, 2019 8:38 pm

dbr wrote:
Mon Dec 02, 2019 4:51 pm
BeanCity wrote:
Mon Dec 02, 2019 3:10 pm
I am sure this is discussed heavily, but I haven't found an answer I can be satisfied with either way.
https://www.bogleheads.org/wiki/Individ ... _bond_fund
Did you actually read this? What is missing in the article?

Most of the replies are saying things that are covered in the Wiki article.

Kevin
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Re: Bonds vs. Bond Fund?

Post by Ferdinand2014 » Mon Dec 02, 2019 8:49 pm

BeanCity wrote:
Mon Dec 02, 2019 3:10 pm
A friend of mine, who happens to be a financial planner, mentioned to me that he does not advise his clients to go into bond funds, and directs them to actual bonds. He does not manage my money, but I was intrigued that he had said that.

Let's say I am about to make a decision to go 60% stocks (VTI)/40% bonds (BND), is there any benefit to go into actual bonds vs the bond fund?

I am sure this is discussed heavily, but I haven't found an answer I can be satisfied with either way.
The only individual bonds I would ever own are U.S. Treasury bills/notes/bonds including savings bonds, ibonds and TIPS. The are rock solid safe, free to purchase at auction with Fidelity, treasury direct and other investment houses. You could not reproduce BND with individual bonds. My entire fixed income is in fact treasury bills.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett

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Re: Bonds vs. Bond Fund?

Post by MotoTrojan » Mon Dec 02, 2019 9:46 pm

BeanCity wrote:
Mon Dec 02, 2019 5:53 pm
dbr wrote:
Mon Dec 02, 2019 4:51 pm
BeanCity wrote:
Mon Dec 02, 2019 3:10 pm

I am sure this is discussed heavily, but I haven't found an answer I can be satisfied with either way.
https://www.bogleheads.org/wiki/Individ ... _bond_fund

What does the advisor say is the reason for his advice?
His reasoning is that the "principal" fluctuates, and that we don't know whether yields are going to be low or high. He says by purchasing an individual bond, you are guaranteed your principal back, unless the bond goes bust.

This seems like a very obvious point to make, however, I don't believe it is as cut and dry as what he leads me to believe.
If you keep rolling individual bonds your principal fluctuates too, it is just more obvious with a fund. The only time I would advise someone to hold individual bonds is if they are treasuries, since corporate/muni bonds are much riskier in terms of default and thus benefit immensely from the diversification a fund can provide. With treasuries there really is no diversification benefit to holding more bonds, it just makes managing a constant duration easier for the fund.

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Re: Bonds vs. Bond Fund?

Post by glock19 » Mon Dec 02, 2019 10:40 pm

I have used individual Treasuries, held to maturity, for the fixed income side of my portfolio for years. Very easy to buy through Fidelity, both at auction and on secondary market. Virtually no expense ratio.

However, now that I'm getting to that "advanced age" I'm moving to short and intermediate funds and ETF's. The reason is convenience. Individual treasuries spin off interest payments every six months. Obviously, no reinvestment feature, so you have to manually do something with the payments, as well as replace bonds at maturity.

If someday my wife or kids have to manage this portfolio they wouldn't have a clue as to how to manage a portfolio of individual bonds. With funds and ETF's reinvestment of dividends are automatic and require no management skills other than rebalancing with the equity side of the portfolio.

I honestly feel there are advantages to both strategies, but long term I doubt it will make a lot of difference.

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Re: Bonds vs. Bond Fund?

Post by LISD » Mon Dec 02, 2019 11:54 pm

"Stick with a bond fund and spread your risk over many bonds"

Why not reduce your risk significantly and just buy individual CDs for all of your 'bond' allocation? FDIC/NCUA Insured. CDs are bonds too. And they are paying more than treasuries right now. I just went to a local credit union today and they had 2.5% for 1 year, 2.75% for 22 months.

A 1 YEAR Treasury is at ~1.6% (although state tax free).

VG total bond market ETF has a SEC yield of 2.3% with a duration of 6.2 years (some of the interest is probably state tax free since they invest some in Government bonds).

A 2.75% 22 month CD is the equivalent yield of an intermediate term corporate bond fund, without any of the risks of that fund.

To be fair, I think the 2.5%/2.75% is probably higher than most institutions, but if you look around you can probably find similar.

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Re: Bonds vs. Bond Fund?

Post by Scooter57 » Tue Dec 03, 2019 4:52 pm

CDs bought directly from credit unions and banks are a better choice for individuals, but the finamcial industry ignores them because advisors can't charge a percentage for putting you into them. So all the academic discussions of fixed income always talk about bonds.

CDs can pay much higher rates than treasuries and are insured by the NCUA or FDIC. You get back exactly what you expect when they mature and you can get out by paying a small penalty if rates soar.

I don't like bond funds because they have only been in use by large numbers of investors during the 35 years when rates have been steadily declining, so NAVs have risen most of the time. In a period where over the longterm rates gradually rise and NAVs sink the crowd is likely to head for the exits, and, given the lack of liquidity in many of the bonds held in funds, fund prices could plummet as funds and ETFs are forced to sell in a market with few buyers.

Nonbrokered CDs are not tradeable so their prices do not fluctuate and you know exactly what you will get if you close the CD before its term is over. Scaremongers here used to warn that early withdrawals would be refused, but that didn't happen last year when rates went up quite a bit.

Plus you can extend the insurance dramatically by adding beneficiaries, so the limits on insurance are only a problem if you have well over ten million bucks, which is not a common problem.

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Re: Bonds vs. Bond Fund?

Post by mary1492 » Tue Dec 03, 2019 5:15 pm

.....
Last edited by mary1492 on Wed Dec 04, 2019 10:01 pm, edited 1 time in total.

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Re: Bonds vs. Bond Fund?

Post by mary1492 » Tue Dec 03, 2019 5:25 pm

.....
Last edited by mary1492 on Wed Dec 04, 2019 10:01 pm, edited 1 time in total.

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Re: Bonds vs. Bond Fund?

Post by Kevin M » Tue Dec 03, 2019 6:25 pm

Scooter57 wrote:
Tue Dec 03, 2019 4:52 pm
Plus you can extend the insurance dramatically by adding beneficiaries, so the limits on insurance are only a problem if you have well over ten million bucks, which is not a common problem.
Well, it depends what you mean. Do you mean $10M of coverage at a single bank or credit union, or a total portfolio of $10M, where much less would be invested at a single bank/CU?

First, in an IRA there is no way to get more than $250K of coverage. Naming multiple beneficiaries does not change this.

Second, the coverage rules are straightforward for revocable trust accounts with up to five beneficiaries: $250K per beneficiary, regardless of allocations to each beneficiary, across all formal and informal (e.g., POD) revocable trust accounts. So pretty easy to get up to $1.25M. My wife and I have named each as 1% POD beneficiaries on some accounts to get an extra $250K of coverage, with the bulk going to our children. Naming one or more charities with a small allocation would be another way to go, as long as the bank or CU allows unequal allocations.

With more than five beneficiaries, the coverage rules are more complex if the beneficiary allocations are unequal. For equal allocations they're the same.

Kevin
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Re: Bonds vs. Bond Fund?

Post by Scooter57 » Tue Dec 03, 2019 6:47 pm

Kevin,

I am sorry I wasn't clear enough. I meant that it would not be that difficult invest up to about $10M in a reasonable number of different institutions with heirs as beneficiaries. But I would never put that much money in any one institution or brokerage, if I had that much, which I don't.

But I have enough that I try to ensure that my investment isn't going to be a big chunk of any CU's list of CD holders. Years ago when rates were near zero I took advantage of a very good deal at a local CU, back before I was familiar with depositaccounts.com, only to discover when I found that site and read up on my CU's financials, that my add-on CD, to which I had added on a lot, was a very significant percent of all their assets. I hadn't realized how small they were and was very relieved when that CD matured. Now I check the financials very carefully before putting a lot of money into any CU.

I haven't ever considered that 1% beneficiary idea, but it is a good one, though I am pretty sure that the institutions I'm invested in now only allow equal shares.

The one issue with POD CDs that I was made aware of is that they would be distributed directly to the beneficiaries on my death and be excluded from the assets distributed under the terms of my will. So I have to be very careful to apportion them using the same percentages as I have applied in my will so no one gets stiffed.

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Re: Bonds vs. Bond Fund?

Post by jmk » Tue Dec 03, 2019 6:59 pm

mary1492 wrote:
Tue Dec 03, 2019 5:15 pm
Purchasing individual bonds allows you to be in complete control, knowing everything about your cash flows on the purchase date, whereas with the bond fund, you have absolutely no control nor ability to be certain of what your cash flows will look like.
Adding to what Mary said, the reason this would cash flow control would matter would be if you were using the bonds to pay for certain important liabilities. A bond fund--even one of the same average maturity or duration--could leave you short depending on factors like rising interest rates and flows out of fund. But if you weren't using the bonds to cover specific liabilities it might not matter to have that cash flow control, and the bond fund might be fine.

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Re: Bonds vs. Bond Fund?

Post by hudson » Tue Dec 03, 2019 7:01 pm

BeanCity wrote:
Mon Dec 02, 2019 3:10 pm
A friend of mine, who happens to be a financial planner, mentioned to me that he does not advise his clients to go into bond funds, and directs them to actual bonds. He does not manage my money, but I was intrigued that he had said that.

Let's say I am about to make a decision to go 60% stocks (VTI)/40% bonds (BND), is there any benefit to go into actual bonds vs the bond fund?

I am sure this is discussed heavily, but I haven't found an answer I can be satisfied with either way.
Individual bonds work for some. I agree with the contributor who said that individual treasury bonds that you buy directly from the US Treasury or directly from Vanguard/Fidelity would probably be OK. Individual bond buying is probably not for new investors. If I wanted to do that, I would start slowly. (What would the benefit be? There would be no expenses...just like CDs have no expenses.)

I doubt if I will every buy any more individual bonds. I hold mostly CDs from credit unions. I hold a handful of bond mutual funds/etfs at Vanguard/Fidelity.

I like INTERMEDIATE AAA/AA/A bond funds with...
low ER
Vang. Risk Potential 1-2
I look hard at the SEC Yield and the Distribution Yield

I do own some BND.

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Re: Bonds vs. Bond Fund?

Post by willthrill81 » Tue Dec 03, 2019 7:06 pm

LISD wrote:
Mon Dec 02, 2019 11:54 pm
Why not reduce your risk significantly and just buy individual CDs for all of your 'bond' allocation?
That may be a challenge for certain types of investment accounts. It's not possible in most 401k plans, for instance. But in IRAs, it's very feasible.
LISD wrote:
Mon Dec 02, 2019 11:54 pm
CDs are bonds too.
They are are referred to by the broader category of fixed income. CDs are not bonds.
LISD wrote:
Mon Dec 02, 2019 11:54 pm
And they are paying more than treasuries right now.
Yes, and that's actually common. There is often an easy premium for buying CDs available for retail investors.
Scooter57 wrote:
Tue Dec 03, 2019 4:52 pm
CDs bought directly from credit unions and banks are a better choice for individuals, but the finamcial industry ignores them because advisors can't charge a percentage for putting you into them.
That's definitely part of it, although a few advisors like Larry Swedroe are adamant in their recommendation for retail investors to own CDs.
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Re: Bonds vs. Bond Fund?

Post by abuss368 » Tue Dec 03, 2019 9:26 pm

BeanCity wrote:
Mon Dec 02, 2019 3:10 pm
A friend of mine, who happens to be a financial planner, mentioned to me that he does not advise his clients to go into bond funds, and directs them to actual bonds. He does not manage my money, but I was intrigued that he had said that.

Let's say I am about to make a decision to go 60% stocks (VTI)/40% bonds (BND), is there any benefit to go into actual bonds vs the bond fund?

I am sure this is discussed heavily, but I haven't found an answer I can be satisfied with either way.
I would pass on the advice. The portfolio you are considering of Total Stock and Total Bond is an excellent option and is the portfolio recommended by Jack Bogle. I would keep it simple and own Total Bond. Set it and forget it. There is good reason Total Bond is the largest bond fund on the planet.
John C. Bogle - Two Fund Portfolio: Total Stock & Total Bond. "Simplicity is the master key to financial success."

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Re: Bonds vs. Bond Fund?

Post by abuss368 » Tue Dec 03, 2019 9:27 pm

In addition, with Total Bond, you are investing in thousands of underlying bonds held by the fund. Diversification has often been called the only free lunch in investing.
John C. Bogle - Two Fund Portfolio: Total Stock & Total Bond. "Simplicity is the master key to financial success."

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Re: Bonds vs. Bond Fund?

Post by mary1492 » Wed Dec 04, 2019 12:43 am

.....
Last edited by mary1492 on Wed Dec 04, 2019 10:01 pm, edited 1 time in total.

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Re: Bonds vs. Bond Fund?

Post by willthrill81 » Wed Dec 04, 2019 1:24 am

mary1492 wrote:
Wed Dec 04, 2019 12:43 am
willthrill81 wrote:
Tue Dec 03, 2019 7:06 pm
LISD wrote:
Mon Dec 02, 2019 11:54 pm
CDs are bonds too.
They are are referred to by the broader category of fixed income. CDs are not bonds.
CD's certainly are bonds.

From Investopedia:
What Is a Bond?

A bond is a fixed income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental). A bond could be thought of as an I.O.U. between the lender and borrower that includes the details of the loan and its payments.
When you purchase a CD, you are making a loan to the financial institution that issues it.
A CD is not a loan. It is a time deposit that's FDIC insured (or NCUA insured in the case of a credit union) and can be broken to access the funds before it matures, albeit with an early withdrawal penalty. Only banks and credit unions offer CDs.

A bond is a debt security and not FDIC insured, and you cannot generally force the bond issuer to return the loaned funds to you before maturity.

https://www.investopedia.com/ask/answers/03/061403.asp

https://www.ally.com/do-it-right/bankin ... ifference/

https://smartasset.com/checking-account/bonds-vs-cds

https://www.nerdwallet.com/blog/banking/bonds-vs-cds/

https://www.bankrate.com/investing/bonds-vs-cds/

https://www.depositaccounts.com/blog/bonds-vs-cds.html
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Re: Bonds vs. Bond Fund?

Post by LadyGeek » Wed Dec 04, 2019 7:51 pm

I removed an off-topic post. As a reminder, see: General Etiquette
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Re: Bonds vs. Bond Fund?

Post by Kevin M » Wed Dec 04, 2019 9:21 pm

Scooter57 wrote:
Tue Dec 03, 2019 6:47 pm
The one issue with POD CDs that I was made aware of is that they would be distributed directly to the beneficiaries on my death and be excluded from the assets distributed under the terms of my will. So I have to be very careful to apportion them using the same percentages as I have applied in my will so no one gets stiffed.
I consider it a benefit, not an issue.

A POD account is not subject to probate--just like a formal living trust. My main objective in naming beneficiaries is to avoid probate in a simpler manner than holding the CDs in the name of my living trust. A secondary objective is to increase FDIC insurance, which my trust also does, but usually it's more complicated to open trust accounts, especially at credit unions.

But yeah, I generally allocate to beneficiaries similar to my living trust, except I may modify that somewhat depending on how my trust beneficiaries are behaving. :twisted:

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jdilla1107
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Re: Bonds vs. Bond Fund?

Post by jdilla1107 » Wed Dec 04, 2019 9:42 pm

Everyone that I have ever encountered that recommends individual bonds over funds is either completely ignorant on the issue or is tricking themselves with the "money illusion". Bond Funds are the right choice for individual retirement investing. Period.

The money illusion with bonds is that "getting your face value back at maturity" represents a different amount of purchasing power than when the bond was purchased.

https://en.wikipedia.org/wiki/Money_illusion

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Re: Bonds vs. Bond Fund?

Post by averagedude » Wed Dec 04, 2019 10:02 pm

My 2 cents. If you are going to be a long term bond investor, funds are the way to go. With individual bonds, you will need a rather large amount of money to be diversified. Also with individual bonds, you could potentially be setting your self up to trying to time where interest rates are headed, and making investment mistakes due to your emotions. There will be times that individual bonds or CD's make sense in the short term due to rising rates, but rates can reverse itself rather quickly. I think we all seen this recently in the last 15 months.

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Re: Bonds vs. Bond Fund?

Post by Scooter57 » Thu Dec 05, 2019 10:54 am

Kevin M,

I live in a state that taxes estates pretty heavily, and am too happy about living here to move, after putting in several years checking out more tax friendly alternatives that would be hell for me to live in. So while it would be a benefit to avoid probate with my POD CDs, the assests left to be distributed through my will would be paying tax on the whole estate, which would place an unfair burden on someone whose share came only out of those assets.

My attorney has told me to gift heavily to my heirs while I am still alive, as that won't be taxed, which is what I am starting to do.

BTW, do you happen to know if the beneficiaries I've listed on my Vanguard accounts get those assets distributed without going through probate, too? Vanguard never answers any tax-related questions I ask and I don't currently have an accountant since I have decades of experience in doing small business taxes and hence do ours. (The one time I hired a guy to do our taxes, he screwed up and did them wrong!) I have allocated those beneficiaries the way the will works, but now that I'm getting older, I do wonder.

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Re: Bonds vs. Bond Fund?

Post by shaqnel » Thu Dec 05, 2019 3:47 pm

A bond fund is just a collection of individual bonds. If you own a bond fund and interest rates rise, you could theoretically sell the fund and buy the individual bonds and hold them to maturity and get your principal back. So there is no real difference.

Also, when you hold a (conventional) bond or a CD to maturity, you are guaranteed to get your principal back, but there is no guarantee as to what that principal will be worth.

The only reason to hold an individual bond is to match a dollar specific nominal liability. But retirement liabilities vary depending on inflation.

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Re: Bonds vs. Bond Fund?

Post by Scooter57 » Thu Dec 05, 2019 5:36 pm

shaqnel.

A bond fund is a collection of individual bonds that is continually buying and selling bonds. Many funds do not hold their bonds to maturity and hence may sell them at a loss. Many funds have a lot of long-term holdings purchased over the past decade when rates were in the toilet, that won't age out and be replaced by higher paying bonds for a long time.

I don't like that bonds are now being traded in ETFs that can be bought and sold every few seconds by computers running programmed trading algorithms that buy and sell them with no regard at all to what the ETF holds. I don't like that 50% of corporate debt is rated at the very bottom of Investment grade, so that in a recession those bonds could be downgraded and all those funds and ETFs would have to sell them. I also don't like that many bond funds and ETFs hold bonds that are not widely traded, and that we have never had a run on bond funds--yet, so no one knows what will happen should one occur.


And I really don't like that we are way out in completely unknown territory, with a decade of suppressed rates kept lower longer than they have been in any recent historical period, and that very little of that money has gone into stock buybacks funding executive options instead of new plants, new products, and R&D.

Wall Street always comes up with these great ideas that come back to bite investors, be they Portfolio Insurance or bundled CLOs. Bond ETFs and more cheap money than has ever been seen before could lead to a doozie. No one knows nothing, so yes everything could turn out perfectly fine. But there is a significant possibility that they won't. And when that happens I'll be very happy not to be in bond funds.

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Re: Bonds vs. Bond Fund?

Post by Kevin M » Thu Dec 05, 2019 5:53 pm

Scooter57 wrote:
Thu Dec 05, 2019 10:54 am
Kevin M,

I live in a state that taxes estates pretty heavily, and am too happy about living here to move, after putting in several years checking out more tax friendly alternatives that would be hell for me to live in. So while it would be a benefit to avoid probate with my POD CDs, the assests left to be distributed through my will would be paying tax on the whole estate, which would place an unfair burden on someone whose share came only out of those assets.
I don't know about your state law, but holding assets in a trust (or POD) does not remove them from your estate for estate tax purposes. Just because you avoid probate doesn't mean you avoid estate tax.

Case in point. My children are inheriting a significant amount from their grandmother. There will be no probate because the vast majority of her assets were in trusts, however, a very hefty estate tax will be paid. Yes, the estate was worth more than $11.4M, the current lifetime gift/estate tax exemption amount.

So if you state estate taxation is similar to federal (other than the exemption amounts), this is a non-issue
Scooter57 wrote:
Thu Dec 05, 2019 10:54 am
BTW, do you happen to know if the beneficiaries I've listed on my Vanguard accounts get those assets distributed without going through probate, too? Vanguard never answers any tax-related questions I ask and I don't currently have an accountant since I have decades of experience in doing small business taxes and hence do ours. (The one time I hired a guy to do our taxes, he screwed up and did them wrong!) I have allocated those beneficiaries the way the will works, but now that I'm getting older, I do wonder.
Yes. For taxable accounts, Vanguard calls it Transfer on Death (TOD). Beneficiaries on IRAs, TOD, POD or formal living trust accounts get access without going through probate.

Regarding the gift thing, my children's grandmother really blew it by not making more gifts up to the annual exclusion limits during her lifetime, which is costing her heirs boatloads of money in estate tax. But she was old school I guess, and didn't feel comfortable making such gifts, other than one year when someone talked her into it.

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Re: Bonds vs. Bond Fund?

Post by wolf359 » Thu Dec 05, 2019 6:12 pm

dmcmahon wrote:
Mon Dec 02, 2019 8:28 pm
I use individual bonds in a ladder. I don't need diversification because they are 100% US government backed bonds. Why not a bond fund? It's because I don't know enough about the internal mechanics of funds to be confident of avoiding tax side-effects and capital losses. By holding a bond to maturity I'll get the principal back with no tax side effects. It's true that, if interest rates decline, the bond may have a market value above what I paid for it. So what? I don't plan to sell it before maturity, so it's irrelevant. Ditto if rates rise and the bond temporarily has a value below what I paid for it. With a bond fund, I'm not quite sure what the managers or algos running the fund are doing to maintain their average maturities. Supposed it's an intermediate term fund - does it automatically sell bonds out of its portfolio as they run down to, say 2-3 years left? If so, then these mechanics inside the fund will generate tax side effects. Also, these mechanics may make the fund look like it has a better yield than it actually does, because, unless the yield curve is inverted, it's likely making a small gain as it sells off the bonds, and possibly an even better gain in a falling rate environment. In a rising rate environment this will all run in reverse, throwing off losses. Or at least, it could in theory. JMHO.
in your case, buying individual government bonds makes sense because you are allowed to buy the treasuries at auction for no fee. You can also cash them out for no fee, and it costs nothing to hold them. Your effective expense ratio is zero.

Compare this to the Vanguard Intermediate Term Bond Fund. That creates a rolling bond ladder, which gives you the same return as if you were creating that ladder yourself. However, they charge you 0.07% per year. Although that is pretty low for a bond fund, it is not free.

Individual corporate bonds are more complicated. They may have a commission to buy/sell, and they will have a spread. You also have to select individual issues. And you have to buy a sufficient number to get diversification.

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Re: Bonds vs. Bond Fund?

Post by dmcmahon » Thu Dec 05, 2019 6:29 pm

wolf359 wrote:
Thu Dec 05, 2019 6:12 pm
dmcmahon wrote:
Mon Dec 02, 2019 8:28 pm
I use individual bonds in a ladder. I don't need diversification because they are 100% US government backed bonds. Why not a bond fund? It's because I don't know enough about the internal mechanics of funds to be confident of avoiding tax side-effects and capital losses. By holding a bond to maturity I'll get the principal back with no tax side effects. It's true that, if interest rates decline, the bond may have a market value above what I paid for it. So what? I don't plan to sell it before maturity, so it's irrelevant. Ditto if rates rise and the bond temporarily has a value below what I paid for it. With a bond fund, I'm not quite sure what the managers or algos running the fund are doing to maintain their average maturities. Supposed it's an intermediate term fund - does it automatically sell bonds out of its portfolio as they run down to, say 2-3 years left? If so, then these mechanics inside the fund will generate tax side effects. Also, these mechanics may make the fund look like it has a better yield than it actually does, because, unless the yield curve is inverted, it's likely making a small gain as it sells off the bonds, and possibly an even better gain in a falling rate environment. In a rising rate environment this will all run in reverse, throwing off losses. Or at least, it could in theory. JMHO.
in your case, buying individual government bonds makes sense because you are allowed to buy the treasuries at auction for no fee. You can also cash them out for no fee, and it costs nothing to hold them. Your effective expense ratio is zero.

Compare this to the Vanguard Intermediate Term Bond Fund. That creates a rolling bond ladder, which gives you the same return as if you were creating that ladder yourself. However, they charge you 0.07% per year. Although that is pretty low for a bond fund, it is not free.

Individual corporate bonds are more complicated. They may have a commission to buy/sell, and they will have a spread. You also have to select individual issues. And you have to buy a sufficient number to get diversification.
Does VG allow the bonds to mature? If so, well worth the 0.07% fee and I should consider it. My concern is that some bond funds may sell off bonds at the low edge of the ladder to keep their duration and average maturities in line with the fund's objectives. And it is these mechanical issues that I desire to avoid (because they potentially involve losses in a rising rate environment).

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Re: Bonds vs. Bond Fund?

Post by Kevin M » Thu Dec 05, 2019 7:40 pm

jdilla1107 wrote:
Wed Dec 04, 2019 9:42 pm
Everyone that I have ever encountered that recommends individual bonds over funds is either completely ignorant on the issue or is tricking themselves with the "money illusion".
Have you ever encountered Larry Swedroe? He is neither "ignorant on the issue", nor is he tricking himself with any type of illusion.

Here's just one of many examples of why individual bonds could be a superior choice for certain investors, although bond funds probably are best for most investors.

As a CA resident, if I want to hold bonds in a taxable account for retirement purposes (there are a various reasons I might do so), and my marginal tax rates justify muni bonds, if I stick with funds I can either use a CA muni fund or a national muni fund. If I use only the former, I may be exposing myself to more state specific risk than I want. If I use a national fund, I am paying higher prices for the CA munis in the fund, since they are priced for CA residents who get the state tax exemption, but I don't get any state tax exemption for them, since a national muni fund won't meet the requirements for taking the state tax exemption on the CA muni bonds in its holdings.
Bond Funds are the right choice for individual retirement investing. Period.
This is an overly dogmatic view. Many of us use or have used individual bonds as well as bond funds. Direct CDs also often are a superior choice, due to the high yield premiums over Treasuries of the same maturity--sometimes 100 basis points or more. My allocation to direct CDs is much higher than my allocation to bond funds, as I (and others here) have found a number of extremely attractive CD deals in recent years.
The money illusion with bonds is that "getting your face value back at maturity" represents a different amount of purchasing power than when the bond was purchased.
Not with TIPS, which can be owned in the form of individual bonds (or in a fund).

Many highly knowledgeable Bogleheads construct ladders of individual TIPS for retirement investing.

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Re: Bonds vs. Bond Fund?

Post by Kevin M » Thu Dec 05, 2019 7:47 pm

dmcmahon wrote:
Thu Dec 05, 2019 6:29 pm
Does VG allow the bonds to mature? If so, well worth the 0.07% fee and I should consider it. My concern is that some bond funds may sell off bonds at the low edge of the ladder to keep their duration and average maturities in line with the fund's objectives. And it is these mechanical issues that I desire to avoid (because they potentially involve losses in a rising rate environment).
Most Vanguard bond funds do not hold bonds until maturity. This actually can be a benefit if the yield curve is positively sloped and yields don't increase too much, since there will be some roll-down return by selling before maturity. But as you say, if rates increase enough, you'll end up with a negative "roll-up" return instead.

However, holding the bonds in your ladder does not really save you from this, as you are incurring the loss in terms of opportunity cost by not being able to reinvest at the higher yields until the bonds mature.

The only thing I know of that can give one an edge in this scenario is a direct CD with a low early withdrawal penalty, which caps your downside loss to the EWP if you redeem before maturity, and this loss could be much less than what you'd incur with a marketable security, whether a bond or a brokered CD.

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Re: Bonds vs. Bond Fund?

Post by Hector » Thu Dec 05, 2019 7:53 pm

dmcmahon wrote:
Thu Dec 05, 2019 6:29 pm
wolf359 wrote:
Thu Dec 05, 2019 6:12 pm
dmcmahon wrote:
Mon Dec 02, 2019 8:28 pm
I use individual bonds in a ladder. I don't need diversification because they are 100% US government backed bonds. Why not a bond fund? It's because I don't know enough about the internal mechanics of funds to be confident of avoiding tax side-effects and capital losses. By holding a bond to maturity I'll get the principal back with no tax side effects. It's true that, if interest rates decline, the bond may have a market value above what I paid for it. So what? I don't plan to sell it before maturity, so it's irrelevant. Ditto if rates rise and the bond temporarily has a value below what I paid for it. With a bond fund, I'm not quite sure what the managers or algos running the fund are doing to maintain their average maturities. Supposed it's an intermediate term fund - does it automatically sell bonds out of its portfolio as they run down to, say 2-3 years left? If so, then these mechanics inside the fund will generate tax side effects. Also, these mechanics may make the fund look like it has a better yield than it actually does, because, unless the yield curve is inverted, it's likely making a small gain as it sells off the bonds, and possibly an even better gain in a falling rate environment. In a rising rate environment this will all run in reverse, throwing off losses. Or at least, it could in theory. JMHO.
in your case, buying individual government bonds makes sense because you are allowed to buy the treasuries at auction for no fee. You can also cash them out for no fee, and it costs nothing to hold them. Your effective expense ratio is zero.

Compare this to the Vanguard Intermediate Term Bond Fund. That creates a rolling bond ladder, which gives you the same return as if you were creating that ladder yourself. However, they charge you 0.07% per year. Although that is pretty low for a bond fund, it is not free.

Individual corporate bonds are more complicated. They may have a commission to buy/sell, and they will have a spread. You also have to select individual issues. And you have to buy a sufficient number to get diversification.
Does VG allow the bonds to mature? If so, well worth the 0.07% fee and I should consider it. My concern is that some bond funds may sell off bonds at the low edge of the ladder to keep their duration and average maturities in line with the fund's objectives. And it is these mechanical issues that I desire to avoid (because they potentially involve losses in a rising rate environment).
iShares iBonds ETFs and BulletShares from Invesco offers target date maturity bond ETFs.

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Re: Bonds vs. Bond Fund?

Post by jdilla1107 » Thu Dec 05, 2019 9:47 pm

Kevin M wrote:
Thu Dec 05, 2019 7:40 pm
Bond Funds are the right choice for individual retirement investing. Period.
This is an overly dogmatic view. Many of us use or have used individual bonds as well as bond funds. Direct CDs also often are a superior choice, due to the high yield premiums over Treasuries of the same maturity--sometimes 100 basis points or more. My allocation to direct CDs is much higher than my allocation to bond funds, as I (and others here) have found a number of extremely attractive CD deals in recent years.
The idea of replacing CDs with bond funds has cost me about $16K in 2019.

Here goes:

- 5 years ago I bought a 5 year cd for above treasury rates just like you describe.
- At of the start of 2019 I then owned a cd with ~12 months left
- Interest rates drop, my intermediate bond funds go up 12%!
- My CD with 12 months left goes "up" effectively maybe around 1.5%.

Shame on me for not understanding that I should have built a rolling ladder of CDs and included some 7 year CDs(?). But, really there is no reason for a retirement investor to own a CD with a duration of 0-3 years. It's too little risk/return. (Some more dogmatic comments for you)

When people make recommendations like this, they are forgetting to say "make sure you implement all of the complex ideas being used in a bond fund." (And definitely don't forget to roll down the yield curve!)

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Re: Bonds vs. Bond Fund?

Post by hudson » Fri Dec 06, 2019 5:38 am

jdilla1107 wrote:
Thu Dec 05, 2019 9:47 pm

The idea of replacing CDs with bond funds has cost me about $16K in 2019.

- Interest rates drop, my intermediate bond funds go up 12%!
I agree that bonds are so simple but so complex.
I really like CDs because of their safety.
I also like intermediate bond funds that hold high quality bonds; but they aren't as safe as CDs.
It's tough to break a CD, but a bond fund can be sold today...no penalty...except capital gains...in a taxable account.
I know it sounds like I'm talking out of both sides of my mouth.
Maybe one should own both?

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Re: Bonds vs. Bond Fund?

Post by jdilla1107 » Fri Dec 06, 2019 10:51 am

hudson wrote:
Fri Dec 06, 2019 5:38 am
jdilla1107 wrote:
Thu Dec 05, 2019 9:47 pm

The idea of replacing CDs with bond funds has cost me about $16K in 2019.

- Interest rates drop, my intermediate bond funds go up 12%!
I agree that bonds are so simple but so complex.
I really like CDs because of their safety.
I also like intermediate bond funds that hold high quality bonds; but they aren't as safe as CDs.
It's tough to break a CD, but a bond fund can be sold today...no penalty...except capital gains...in a taxable account.
I know it sounds like I'm talking out of both sides of my mouth.
Maybe one should own both?
I went with both previously. So, CDs would have done better if interest rates had increased dramatically. However, I still can't get over that it seems entirely pointless for me to own a CD with less than 2-3 years of duration remaining.

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Re: Bonds vs. Bond Fund?

Post by hudson » Fri Dec 06, 2019 12:17 pm

jdilla1107 wrote:
Fri Dec 06, 2019 10:51 am
However, I still can't get over that it seems entirely pointless for me to own a CD with less than 2-3 years of duration remaining.
I'd likely go with a fund in that case. A month or so back a credit union was offering a 3 year CD with 3%.
It was PA State Credit Union. Now they are offering 5 years at 2.52%.
3% 5 Year CDs work for me. For my fixed, I like at least 20% Vanguard Credit Rating 1-2% bond funds....the rest in CDs....at least until I find a better deal.

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Re: Bonds vs. Bond Fund?

Post by Scooter57 » Fri Dec 06, 2019 2:02 pm

hudson wrote:
Fri Dec 06, 2019 5:38 am
It's tough to break a CD, but a bond fund can be sold today...no penalty...except capital gains...in a taxable account.
I had no difficulty breaking several online CDs last year. A phone call to customer service got it done within two days. I had already set up Vanguard to pull the money from the associated savings account.

Kevin M,

I am all too aware that all my CDs are taxed as part of my estate but it is a lot easier for the executor to pay the taxes out of the undistributed part of the estate rather than ask the heirs to kick in after they get the money.The heirs are reasonable people, but you never know...I had a sibling who was reasonable until they married someone who was not.

If I'm lucky, I will decline slowly enough to move to New Hampshire before I go. We are just over the border, and NH has some very nice assisted living places, so that was where we moved my parents when they couldn't take care of themselves. At the time I didn't even know that NH doesn't tax estates. I just liked the facilities a whole lot better than anything available locally. Worked out well for us and I would go to the same facility if I needed one. NH has punitive Real Estate taxes and taxes small businesses and investments worse than where I currently live. So if I were to move there now and live a reasonable time longer, I'd pay them pretty much what I'll pay MA, just in the form of property, business and investment taxes. Massachusetts gives us excellent services, regulates the health insurers so our plans are decent, and is where I like to live. I just wish they'd raise the $1M level where the estate tax kicks in--which applies to the entire amount if your estate is one buck over a million.

No problems with that 11 M Federal limit for me unless I hit the lottery (which I don't play) or my next book turns into a runaway bestseller (very unlikely). My mom died in 2010 when there was no estate tax, (not on purpose of course <sigh>) but she had always been extremely lucky with money and it carried through to her end.

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Re: Bonds vs. Bond Fund?

Post by Kevin M » Fri Dec 06, 2019 3:41 pm

jdilla1107 wrote:
Thu Dec 05, 2019 9:47 pm
Kevin M wrote:
Thu Dec 05, 2019 7:40 pm
Bond Funds are the right choice for individual retirement investing. Period.
This is an overly dogmatic view. Many of us use or have used individual bonds as well as bond funds. Direct CDs also often are a superior choice, due to the high yield premiums over Treasuries of the same maturity--sometimes 100 basis points or more. My allocation to direct CDs is much higher than my allocation to bond funds, as I (and others here) have found a number of extremely attractive CD deals in recent years.
The idea of replacing CDs with bond funds has cost me about $16K in 2019.

Here goes:

- 5 years ago I bought a 5 year cd for above treasury rates just like you describe.
- At of the start of 2019 I then owned a cd with ~12 months left
- Interest rates drop, my intermediate bond funds go up 12%!
- My CD with 12 months left goes "up" effectively maybe around 1.5%.

Shame on me for not understanding that I should have built a rolling ladder of CDs and included some 7 year CDs(?). But, really there is no reason for a retirement investor to own a CD with a duration of 0-3 years. It's too little risk/return. (Some more dogmatic comments for you)

When people make recommendations like this, they are forgetting to say "make sure you implement all of the complex ideas being used in a bond fund." (And definitely don't forget to roll down the yield curve!)
First, you are looking at this the wrong way. Second, you are confusing strategy with outcome. Let's look at each point.

If we want to compare fund return to CD return, we should be looking at the 5-year holding period, not just the last year. Since a CD has no credit risk, we should compare to an intermediate-term Treasury fund. Vanguard
Intermediate-Term Treasury fund 5-year return as of 11/30/2019 was 2.29%. The 5-year Treasury yield on 11/28/2014 (five years ago) was about 1.5%. Since my average yield premium over Treasuries since late 2010 has been more than 100 basis points, a good CD yield five years ago would have been about 2.5%. So you would have made more in the CD than in the fund.

If we hadn't seen a really high fund return in the last year due to declining yields, which no one could have forecasted reliably, the CD would have beat the fund by an even larger margin.

The strategy of buying a direct CD with a high yield premium over a Treasury of same maturity is solid, assuming you were to hold the Treasury to maturity. An intermediate-term bond fund does not hold Treasuries to maturity, so there may be some roll-down return when they sell at say 3-year maturity and reinvest at say 10-year maturity, but that is a speculative return component. You just as well could end up with a negative roll-up return if 3-year yields were to increase enough.

In other words, a Treasury fund has a risk component that a CD or direct CD ladder does not have, and that risk may pay off as higher return, or it may "show up" as lower return. If taking that additional risk makes sense to you, you should do it.

Keep in mind that a direct CD does not have any upside term risk. If rates fall, you will not get more for selling your CD before maturity, even though the present value of the cash flows could be argued to be higher. The big advantage of a direct CD is significantly lowering the downside term risk, by limiting it to the EWP. If you want both the upside and the downside of term risk, you should buy marketable securities, like bonds or bond funds.

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