msgrinnell[at]charter.net (Michael Grinnell) writes:

- quote -

Here's the rule of thumb (which falls out of the definition
of duration):
If a bond (or a fund) has a duration of N years, its value
will rise (or fall) by N% for every 1% fall (rise) in
relevant interest rates.

So if you have a fund with an average duration of 8 years,
and then 10 year rates rise by 2%, the NAV of the fund will
fall by approximately 16%.

--
Rich Carreiro rlcarr[at]animato.arlington.ma.us

Again, there has been much discussion about long, intermediate, and
maybe, short-term bonds, but really, what do these mean? Fidelity has
the following bond funds (among others, obviously), but the point is
how they are named:

Intermediate: Avg Maturity 4.5 years, duration 3.6
Short: Avg Maturity 2.4, duration 1.9
Ultra short: avg maturity 1.6 duration .5

All figures are, of course, in years.

Returns on these bond funds have been
Ultra short
1 year: 1.87
10 year: n/a

Short
1 year: 3.57
10 year: 5.13

Intermediate
1 year: 4.96
10 year: 6.22

Given the above average maturity/duration, what sorts of risk profiles
does the list see given the current economic climate and are these
funds really representative of ultra-short, short, and intermediate
funds in general?

Thanks,
Mike

- quote -


I wanted to trim the message and was not sure since it all seems
relevant, so just left the above. There has been a lot of discussion
both below and above this posting about bonds per se. I am a relative
newbie in this arena (so I know just enough to be dangerous). I
believe bond funds act and react at least somewhat differently from
holding a single bond, especially to maturity. When I look at, for
example, Fidelity's chart for their intermediate, short, or even
ultra-short bonds they seem to all tend up over the years seemingly
regardless of inflation or interest rates. They have a mix of
maturities, obviously, so one does not get stuck with all old bonds or
get all new bonds in the fund as interest rates/inflation change. Can
someone please describe how these funds could seemingly always be
proving decent returns and also how bond funds basically work.



Thanks,

Mike

Caroline wrote:
- quote -

Hard to read w/much precision off that site...it was somewhere around
(-0.2) last I checked, I think it's moved a bit closer to 0. (try the
Ibbotson's book).

Even if it were 0.5%, that's not much compensation for a bond with a
duration that's ~3X higher, especially when you're looking at
historically low rates.

- quote -

This is very strategy-dependent, but generally speaking yes, longer-term
debt isn't a big part of what I do, except perhaps with munis and some
trust/preferreds. Things are so much more interesting on the equity side
of things, why waste volatility with bonds?

And again, individual bonds make sense strictly in larger portfolios,
unless you're sticking with gov't issues (or are willing to add risk).
The inventory just isn't there in retail (as you found w/Fido), and
there won't be enough bonds to be truly diversified. Not too long ago a
poster to this NG was quoted - in the Wall St Journal, no less - about
losses from a WorldCom bond holding which was high-grade debt (or close)
when purchased. One of those is all it takes. Who can say what companies
will be around 10, 20 years from now? That's why I said, most people do
better if they pay Vanguard their 23 basis points.

These are subjective opinions, of course, guaranteed to be worth at
least the price paid!

-Tad

"Rich Carreiro" <rlcarr[at]animato.arlington.ma.us> wrote
- quote -

I was constructing a hypothetical bond ladder recently as part of my effort to
research bond ladders. I started with current rates and so happened to have
those handy. Now I'm investigating historical rates and trends.

- quote -

I wasn't sure. This is why I asked. Would have been stupid not to.

You have pretty much sold me to hold off on going long on bonds given the
current climate. The comments below are the salient points of the argument,
should anyone else actually be following this thread.

- quote -

The web site you give above was a terrific start to further examination of
what's going on with yields today and what might happen in the future.

A few observations:

The article itself calls a curve that indicates long-term bond yields to be
greater than short-term bond yields the "normal" one.

As you note, the curve does indicate several times since March 1977 where the
yield curve is inverted (meaning short-term bonds are paying more than long-term
bonds).
- quote -

So over 27 years, about six years of inversions occur.

Most of the time the curve is normal.

The average of all curves from March 1977 to Oct 2003 is normal.

Importantly for these last 27 years, the "average" curve shows a
difference between 5-year yields and 20-year yields seems to be about 0.5%?
Maybe a bit more or less. The numbers and differences between them on the chart
at site http://www.sharelynx.com/chartsfixed/BondYield1985.gif are easier
to read. Click on the lower right of the chart to zoom in. It suggests
differences of minimally about 0.5% and maximally a couple of percent.

http://www.sharelynx.com/chartsfixed/BondYield.gif goes back to 1960, when
interest rates were at lows like today's. I couldn't draw any conclusions from
the 1960-1977 trend that really differ from the above observations about 1977 to
2003.

A little more research shows the average of all 5-year Treasury yields for every
June from 1977-2001 (the period when 30-year Treasuries were available) was
7.4%. For 30-year Treasuries, the average was 8.5%.

But I think the point you're trying to drive home is that timing of the bond
market can be done. We're at a historic low. So this is the wrong time to go
long, even with a bond ladder.

I understand. More below.

- quote -

With one's own broker and local banks, I think bankrate.com is a good tool for
shopping around for CDs.

But this is a digression.

- quote -

Do you admit the possibility of not being able to hold the principal of any
investment vehicle (stocks, real estate, the money in the mattress) to maturity?
That one always risks loss of principal (and/or its purchasing power) with any
investment vehicle?

- quote -

Have you ever actually owned bonds because you needed (not wanted) income?

Foremost in the minds of such people is that they need income on a regular
basis, like monthly or semi-annually.

Many corporate bonds provide their income on such a basis, at no penalty. My
understanding is this is not the case with many (most) CDs.

- quote -

You're not providing many alternatives.

- quote -

Okay. I understand your reasoning.

I agree interest rates are headed up.

History provides some ideas on this.

- quote -


- quote -


Yields today are probably more like the early 1960s for a few reasons (first and
foremost, unprecedented lows).

The only question remaining seems to be if yields stay flat how long will they
do so? You say, "not as long as five years." I agree history backs this up, too.

- quote -

And in investing, there is no way to know a priori whether one vehicle will have
the same success as another.

- quote -

Oh I am curious about the historically low rates all right. Your comments along
with further research today compel me to hold off on buying any long-term bonds
given today's climate. Should an investor detect a peak in yields after maybe
five years, a bond ladder might pay better than continuing to buy 5-year (or so)
bonds.

"Tad Borek" <tadborek[at]pacbell.net> wrote
- quote -

Depends on what you mean by "long haul."

At the site both Rich and you provided, the curve showing the "average" spread
in yield since 1977 shows that the lower the maturity, the lower the yield. On
average.

That's a terrific site, btw.

- quote -

I'd say the chart shows a difference of around 0.5 point from 5 yrs. to 30 yrs.

This is not large, but I don't think 0.5 point is anything to sneeze at,
either.

- quote -

It's there. You mean it's not large enough to you to justify the "lower
liquidity."

- quote -

It depends on what one thinks interest rates will do.

That's the rational response. ;-)

For data going back to 1960 (when interest rates were comparable to those now),
I found the following helpful:

http://www.sharelynx.com/chartsfixed/BondYield.gif

What I'm taking out of this is that a 20-year bond ladder begun today is likely
not going to be as lucrative as one might presume from the current steep yield
curve. This is based on how the yield curve has changed since about 1977 (and
maybe as far back as 1960). I agree this is an important point.

Yet, assuming one's liquidity needs are minimal, that one has enough money to
diversify well among bond choices, and barring better low risk alternatives, a
20-year bond ladder still seems to me to be an entirely rational option.

Assuming historical trends continue, right now some favor investing in I guess
all five-year maturity bonds (instead of a 20-year bond ladder) for about the
next five years. Is this your position too?

As a crude estimate, I'm thinking a 1.5 point difference in yield compounded for
five years results in a difference of about 7.7%. Or (1.04)^5 < (1.055)^5 by
about 8 percentage points. Again, maybe this isn't enough to offset the lower
liquidity of the 20-year ladder to some people. To others, it is.

Is the only time you would suggest buying 20-year bonds when interest rates are
at historic highs? Otherwise, are you saying never buy any bond with a maturity
more than about five years?

Caroline wrote:
- quote -

No, in the ladder spanning 20 years only 1/20th of your portfolio
adjusts in yield because only 1/20th matures each year. The rest keeps
ticking along at yesterday's rates, and if the rates are lower, the
bonds fall in value to the point where they match today's yield curve
(so you can't sell/reinvest at today's rates, it will be a wash).

In a ladder (or fund) of short-term bonds the whole account turns over
very quickly, and you earn the latest rates that much sooner. The
long-term bond porfolio takes so long to get reinvested at higher rates
that the short-term bond portolio wins the horse race - or so goes the
scenario.

This rapid reinvestment in a short-term fund, incidentally, is a risk
factor in itself. It can work both in your favor & against. It's the
risk someone took on 5 years ago buying a 5-year bond that is now
reaching maturity, facing today's lousy rates, instead of going long.
With 20/20 hindsight, when rates are falling you want to be as long as
possible, and vice versa. [for a better description of long/short,
google "duration"]

- quote -

Over the long haul that hasn't actually been the case, though it's a
common belief. It certainly should be that way - hence the idea of
"unrewarded risk." Here's a good visual illustration, though it doesn't
show the volatility side of things very well:
http://www.smartmoney.com/onebond/in...ory=yieldcurve

Couple things to see there...first, that current yields are really low,
as compared to historical rates. Second, that the curve inverts or
flattens from time to time, meaning long-term rates are either equal to
or lower than short-term rates. Last, click on the box to display the
green (average) yield curve, which isn't a curve at all, it's basically
a line going from 5 yrs to 30 yrs. You do get some reward moving out
from bills to bonds. But the reward for going long just hasn't been
there, over the long haul anyway.

- quote -

Actually the rational arguments have been laid out! Arguably going long
is contrarian at this point, not conservative.

You might not have hard data in front of you...a good resource to look
for at a local library is Ibbotson's "Stocks bonds bills & inflation"
book which lays out some of this in detail, over long time periods. On
the general short vs. long issue check out fixed-income white papers &
info at www.dfaus.com (I use their funds in client accounts, but my
focus is on risk-adjusted return rather than income generation).

RE: ladders generally: funds make more sense than ladders for all but
the largest portfolios, at least for corporates. Considering the bond
face values, the spreads, the need for diversification across both time
& issuer, it easily adds up to something in the $500k+ range. Pay
Vanguard their 23 bps!

- quote -

Sentence speaks volumes.

-Tad

"Caroline" <caroline10027remove[at]earthlink.net> writes:

- quote -

Why the fixation on recent yields when one of the the big points of
the discussion is that there's (at least!) a 20-year horizon going on?
I don't consider today's yield curve to be very representative of
what'll happen going forward. Right now we have the dual interesting
events of historically low yields and a historically steep yield
curve.

Take a look at http://www.smartmoney.com/onebond/in...ory=yieldcurve
to see how the yield curve has looked at various times over the
past 25 years.

- quote -

Of course there have been. Many times. Mid 1995 through early
2001 for example. Mid 1977 through 1990. Heck, in August 2000,
through January 2001, 3 month bonds yielded more than 30 year bonds.

- quote -

Not everyone does the bankrate.com thing. My credit union (one of the
largest in the US) has 5-year CDs with an APY of 5.00% with a $20K min,
and 4.75% with a $1K min. I bet it's not alone.

- quote -

Surely if you have the time horizon to hold a 20-year bond to
maturity, it should be no problem at all to hold a 5-year CD to
maturity. And once you admit the possibility of not being able to
hold to maturity, a 20-year bond (even a 5-year bond) has a
significant risk of principal, vs. a mere 3 or 6 months of interest
penalty and no risk of principal for the CD.

- quote -

We'll have to agree to disagree then. I side with Tad on this one and
believe you are wrong, and the unrewarded risk is there regardless of
how you hold (B).

- quote -

No, it doesn't omit that fact. At any given time, there are still
10 bonds in the ladder with maturities of 10 years or more (or 15
with maturities of 5 years or more). So you always have significant
long bond exposure, something I think your analysis overlooks when
you focus on the near-term bond maturing.

- quote -

Where did that come from?

- quote -

Yes, that's probably what I'd do if I were going to be investing in
bonds right now.

- quote -

True, but not all gambles carry equal chances of success. Given how
historically anomalous today's interest rate climate is, I'd be quite
leery of a strategy that inherently assumes that climate is the way
things will be for a long time.

--
Rich Carreiro rlcarr[at]animato.arlington.ma.us

"Rich Carreiro" <rlcarr[at]animato.arlington.ma.us> wrote
- quote -

You are talking about new issues, right?

If you have a citation for this, I would welcome it. I have been watching
recent, new issue bond yields. My December search turned up the following new
issues (investment grade and treasury notes only):

Five year: 3.4%, 3.5%, 3.6%, 3.7%, 3.8%.
Twenty year: 5.4%, 5.6%

(Some of these are callable at certain points, so feel free to comment on how
you would factor this in.)

So there's about a 1.9 point difference (3.6 vs. 5.5) between the five-year and
20-year bonds.

I would call this significant. Are you saying it is small? Or are you thinking
of some other time period in history where, according to you, the difference was
much smaller?

- quote -

New issue treasuries and IG corp. bonds (of the same maturity as the treasuries)
are not that different in yield.

I haven't noticed any one year new issue corporate bonds of investment grade,
anyway. I guess they're out there, but in my preliminary search of new issues
using Fidelity's site, none arose.

- quote -

Bankrate.com says the nationwide average for 5-year CDs is 3.56%

The best rate I saw was 4.31%. The bank offering this requires a min. $10k
deposit.

Also, one does not necessarily receive a CD's interest payments regularly
without risking loss of advertised maximum yield.

This came up here recently, and a few people said they knew of banks where there
was no such penalty. The few banks I checked at bankrate.com supported my
position.

- quote -

Again, not if the bonds are held to maturity.

We can go back and forth on how well an individual investor "knows himself" and
so how prudent it is to assume he/she won't need the principal. If we do, what
we're doing is second-guessing what an investor says he wants. To caution an
investor like this is your right, but continuing to go on this assumption
definitely changes the premise of this discussion. So much so that my arguments
would change radically, of course, and there would be no point in Tad, you, and
I talking about this. ;-)

- quote -

Sure one can just assume that. Perhaps one has other resources on which to draw
in an emergency.

- quote -

I don't think new issue 30-year treasuries are available right now. Are you
quoting a secondary market yield? For old 30-year treasuries that will mature
in less than 30-years?

Also, treasury yields tend to be a bit lower than investment grade bond yields.
Less risk, of course, with the treasuries.

- quote -

I think this analysis omits the fact that every year, a person has a set of
bonds maturing and is re-investing. So he/she will be taking advantage of rising
interest rates every year.

What's the alternative? Stick the money in a money market account? Buy some
5-year bonds paying much lower rates than 15-year and 20-year bonds and hope
that interest rates go way up after five years? This is something to consider,
but I can't judge it to be definitely superior. Whatever one does is a gamble,
after all.

"Caroline" <caroline10027remove[at]earthlink.net> writes:

- quote -

(1) Most of the time the incremental YTM of something like a 20-year
bond over something like a 5-year bond is pretty small.
(2) And sometimes short-term bonds actually have a higher YTM
than long-term bonds.

- quote -

There's some apples and oranges going on there. Better comparisons
would be to one-year corporate bonds (if you're talking about
20-year corporates) or to appropriately long-term T-bonds (if you're
talking about one-year T-bills).

Also, if you're willing to step away from bonds to bank/credit union
CDs, you can find 5-year CDs yielding 5%.

- quote -

True, but that doesn't refute that (B) carries unrewarded risk, which
was Tad's point.

- quote -

My argument against it is that I think a ladder of 20-year bonds
exposes you to more risk than you want. You say you "have the time"
at any given time to see much of the ladder make it to maturity. But
you can't just assume that -- you need to consider the chances
something might come up that forces you to cash in some/all off your
ladder well before the maturity date of the bonds in it at the time,
factor that into the calculations, and then decide that the yield
spread on the longer bonds makes up for their increased risk. At the
moment, the yield index for 1-year treasuries is at 0.897%, the index
for 5-year treasuries is at 3.06%, the index for 10-year treasuries at
4.087%, and the index for 30-year treasuries is at 4.949%. And
especially with the availability of 5% 5-year CDs, which have no
risk of loss of principal, I personally would find it very hard
right now to set up a ladder of 20-year bonds. If interest rates
were near historic highs instead of near historic lows, I may
well think otherwise.

--
Rich Carreiro rlcarr[at]animato.arlington.ma.us

"Tad Borek" <tadborek[at]pacbell.net> wrote
- quote -

If by "short in the ladder" you mean the bonds in the ladder are all short-term,
while "long in the ladder" means the bonds are a mix of short to long-term but
ultimately are all long-term, and the rungs of both are one-year apart, then the
yields adjust every year for both ladders.

I agree the *percent change* in yield will likely be larger for the "short-term
bond" ladder, measuring the percent change every year.

But, you seem to be forgetting that, the lower the maturity of new issue bonds,
the lower the yield.

- quote -

Not with lower yields. Remember, one-year T-bills are paying probably under 1.5%
now (that's probably generous!). New issue 20-year high grade bonds yielding 5%
may be had right now.

But I don't think we're on the same page as to "laddering." I describe the
ladder I am contemplating below, so if you can hang on to the end of the post,
this might be helpful.

- quote -

"A" does not realistically exist, so of course people might rationally pick B.

- quote -

I disagree that a 20-year bond ladder is not a viable option for many. More
below.

- quote -

You're changing the premise of my post. I said the plan was to hold the bonds to
maturity.

I agree that if someone is not sure he/she can hold the bonds to maturity, then
they had darn well better factor in secondary market effects on the value of
their bonds. That's a fair point. Anyone reading this needs to pay close
attention to the premise of my argument vs. the premise of Tad's argument.

- quote -

Because the investor may need income with minimal risk to principal.

Also, I personally feel 20 years is just a bit too short to ensure that the
stock market will pay higher than the long-term bond market.

If we were talking about someone who didn't need the income, and the timeframe
was in the neighborhood of 30 years, then I'd give your point more credibility.

- quote -

Are you talking about a bond ladder that magically expires at year 20?

This is not what I meant. I meant in year 0, a person buys 20 bonds. These 20
bonds are as follows: Bond 1 has a 1-year maturity. Bond 2 has a 2-year
maturity. Etc. until we get to Bond 20, which has a 20 year maturity.

After year 1, the first bond matures. The investor then socks the principal into
a new 20-year bond.

After year 2, the second bond matures. The investor then socks the principal
into a new 20-year bond.

And so forth. Eventually, the yield will be an average of all 20-year bonds. One
could start dissolving the bond ladder when one hits retirement. Each year, he
gets the principal of one bond back in full. He can sock it into a money market
or wherever, living until death on an increasingly conservative portfolio.

So who has this kind of time (20 plus years)? Maybe few.

But who has the time for a ten-year bond ladder? Many.

I am contemplating a bond ladder for the "conservative" portion of my portfolio,
on the assumption that some fraction of the portfolio of a person in middle age
should be conservatively invested. I also want the income and low risk, and I
have the time. I am having a hard time finding rational arguments against this.
So I welcome your further comments.

(And yes, oh mighty salespeople, I am looking at some annuities as an
alternative.)

Caroline wrote:
- quote -

Whether or not you decide to trade the bonds, the risk is still there,
and it is indeed unrewarded. I hear your point about the apparent
insulation you get if you hold till maturity, it's a common one to
make...but consider:

1. opportunity cost - if you'd been short in the ladder, your bonds
would have rolled over enough times that your yield would adjust much
more rapidly to changes in interest rates. You'd have more money, and
the account value would have been less volatile along the way. This is
something that surprises most people - that long-term bonds haven't
actually returned more than short-term bonds over the long haul. Sure,
they have their runs of really high returns, but that's when rates
decline. It's hard to conceive of bonds declining from 4%-range yields,
and even if they did, there just isn't far to go. And when you look at
the long term issues you see more than 5X the volatility with
negligibly-higher returns, when comparing the track records of long-term
bonds to short-term bonds. That's the definition of "unrewarded risk" -
higher volatility without higher returns. If you don't agree that it's
risk, or that it's unrewarded, compare two hypothetical investments: A
returns 5% per year, is always priced at $10,000, and pays back $10,000
in year 20. B returns 5% per year, interim pricing is set by the market,
but it also pays back $10k in year 20. Are you indifferent between these
two? Of course not...but why? Because B is a much riskier investment.
Does it matter if you plan to hold 20 years anyway? No, it doesn't, it's
still riskier, and you get nothing in return. Nobody would pick B given
the choice. Especially because...

2. changes in plans - few can truly commit to a 20-year ladder "knowing"
that they'll hold the bonds till maturity. Who can say what the plans
will be? Well, pension funds and insurance companies can, and that's
fine for them, but for individuals volatility of value is a true risk
factor for any investment you buy. I think this point gets lost when
volatility is referred to mostly in the context of things like
mean-variance optimization...that kind of stuff doesn't connect really
with an individual investor. The point is, volatility matters, not just
because of the discomfort of receiving a lower account statement, but
because you might need to fund a significant need sooner than currently
expected. If price volatility truly didn't matter, you probably wouldn't
be looking at bonds. Which brings up...

3. lack of symmetry to "risk" analysis - the principal objection to
investing in stocks is that they're volatile investments. And they are,
over shorter time periods. But the same arguments you made about bonds
apply to stocks: true, the market might temporarily devalue them, but
the losses are only "real" if you sell. That doesn't change the fact
that it's a risk factor though. If you're indifferent to volatility, why
not commit the dollars to an asset class that has in the past rewarded
the volatility with higher returns?

4. inflation - this is really #1 restated...I think extreme examples
help illustrate it...let's say you hold a $10k bond for 20 years to
maturity, and it's paying 5.2%. In year six interest rates hit 14% while
inflation is 12%. Let that tick along several years to unwind, and then
things get a bit more normal...few more years pass...then you get your
$10k back. It might be more like $2k in "old" dollars. Can you really
say that you didn't bear risk? If you'd been shorter your bonds would
never be more than a few-years stale, and of course, when inflation is
12%, short-term bonds tend to catch up very quickly.

There's nothing wrong with bonds, of course, I just think people
consider them less risky than they actually are...applying different
rules than are applied to stocks.

-Tad

"Tad Borek" <tadborek[at]pacbell.net> wrote
snip
- quote -

You mean changes in interest rate have a huge effect on the secondary market
price of the bond, and thus the yield, right?

So this damage you allege is due to active bond trading, right?

- quote -

In the same vein as my statements above--
Does any of your argument change if one plans to hold the long-term (or even
intermediate-term) bonds from new issue to maturity?

Changes in interest rate of course have no effect on the yield of bonds held to
maturity. One might lose purchasing power due to inflation, but inflation has to
be considered for any investment.

So for example a bond ladder where the longest maturity is, say, 20 years, and
where all bonds are held to maturity, probably won't beat the stock market, but
nor would I argue that it was vulnerable to "unrewarded risk."

[sorry if repost, NNTP probs...]
Michael Grinnell wrote:
- quote -



Yes, I think that a continued deficit will end up pushing up bond yields
as the US gov't borrows more cash (from overseas, incidentally). The CPI
might not be going up at the same time, or at the same rate, so I can
envision a period where Treasuries returned more than "old" TIPS.

Still I should emphasize that TIPS (& I-bonds) are a very interesting
kind of investment with different/lower risks than regular Treasury
bonds. If you buy & hold you're guaranteed a real return that is very
close to the original fixed rate. That's an unusual kind of bond, and it
reduces what is one of the main risks of long-term bonds...that we'll
get hit with 12% inflation and you'll end up with very low real returns.
("real return" means after factoring in inflation)

- quote -


I think the OP is about a short-term goal and the more conservative
route is to match your investment with your goal...ie short-term bonds
and cash-like investments. Going to intermediates or TIPS adds some risk.

The TIPS have the advantage of increasing rates as inflation drifts
upwards; normal intermediate-term bonds would simply fall in value. So
between the two I see TIPS as less risky.

One piece of info that may be helpful: when you look at the long-term
historical returns of short, intermediate, and long-term bonds, you see
a big leveling off in returns, and a big increase in volatility of
returns, once you go out beyond 5-year bonds. The finance speak for this
is "unrewarded risk." The source of this is the risk introduced by
future changes in interest rates. It has only a minor effect on a
short-term bond, but it's noticeable on the longer issues, and a huge
factor on truly long-term bonds (20 years+). You can use this risk to an
advantage, but not when we're at historically low yields.

So generally speaking it's questionable why you'd ever hold long-term
bonds, and even intermediates arguably provide so little extra returns
that they might not be worth it.

TIPS are hard to fit into this, though, because a lot of the risks of
normal longer-term bonds are offset by that inflation adjustment. Again,
I can envision a period where TIPS and Treasuries deviated in rates,
with the TIPS not catching up because CPI hadn't increased yet. A
longer-term investor probably wouldn't be too concerned with that, but
with a short-term goal it strikes me as a risk with a TIPS fund. I-bonds
would avoid that risk.


- quote -


But I don't think that's any reason to try to eke out some additional
return from your cash. You keep money in cash so you can get your hands
on it, and perhaps so you have something to invest when your other
investments take a dive. Seeking out additional returns is doing
something different; if you do it when MM funds are yielding 1% and
inflation is 1%, you should equally well consider it when MM funds are
yielding 5% and inflation is 4.1%. Really those are much the same, it's
just that now the low real return is easy to see.

I think it's perfectly acceptable to "do nothing" and wait until the low
yields pass - they will, and if it doesn't happen in 3-5 years you
haven't really lost much in returns. Consider a portfolio as a
whole...it wasn't such a bad year after all, was it? While MMs were
ticking along at 1% or less, stock investments put on 25-30% or more.
Even if that represented 10% of the portfolio, it added more to the
bottom line than the other 90% (this was an example of how stocks are
said to reduce risk, as compared to an all-cash portfolio). So who cares
really about cash yields? A year, two years, whatever from now there
won't be any talk on this board about "how can I get more than 2% from
my cash?"

-Tad

Just reviewing these very interesting points. The posting got a
little goofy and I stopped paying close attention to this list as a
result. But, have been reviewing it since.


- quote -

Easily understood...

- quote -

Ditto.


- quote -

So, the rather large deficits the US is running (and seems likely to
run into the future) will likely push up interest rates. This would
theoretically push up the NAV on a TIPS fund. But, the inflation part
of this is unknown and may not be favorable.

In sum, it seems that both intermediate and TIPS funds are not
particularly recommendable in the current climate (with interest rates
going nowhere but up, seemingly).

The current climate seems very difficult for someone to find a decent
3-5 year investment other than money market or CDs. There just seems
to be a real lack of direction in where the economy and interest rates
are going. Every time I think that interest rates just have to go up,
they don't. Now, I see forecasts pushing interest rates up in May or
during the summer.

Mike

- quote -

I am not too terribly eager to use the money. I don't have anything I
have to use it for anytime soon and I have emergency funds for that
anyway. I have not really wanted to put it into my retirement since it
will then be inaccessible when I do eventually need it. I would also
like to begin putting a part of it away for a retirement home in
Thailand when the time comes (in at least 20 years, I suppose). Or,
should I put that part into my 403b/IRA and pay for it out of that??
Perhaps wiser from a tax standpoint since I would not theoretically be
using it until retirement anyway.


- quote -

Have the whole amount now, but would like to add a little bit
periodically to help fund other eventual projects I don't want to
borrow for.


- quote -

In considering this more, I think if I can diversify it nicely I can
stagger any needs across what I want to use if for. For example, a
car would be needed in 3-5 years; new roof and siding in 15 or so, and
a retirement home in Thailand in 20-25? Is this totally unwise for
some reason?

- quote -

For the longer-term stuff (10 years +), a fair amount of risk.

- quote -

I am trying for a good mixture. What would the list think of the
following mix:

Money market 25%
Blue Chip Fund 10%
Intermediate Bond Fund 20%
Inflation-protected bond fund: 20%
Loan Participation fund, CD, or some other better idea for the rest??



- quote -

Only have my mortgage and some student loans at around 2% right now.


- quote -

Not particularly. I have no aversion to any particular asset class
except maybe precious metals. I don't know that much about them, but
have read they have been over-rated recently.

- quote -

Thanks a ton for all the resources.

- quote -


There is really no "soonest". These are purchases I will eventually
have to make, but ideally don't want to borrow to make them. If the
money was tied up in something when the purchase became necessary I
could always borrow the money and pay off the loan when circumstances
became more fortuitous. I could put it in my 403b or Roth IRA, but
then I would be forced to borrow the whole amount later and either pay
it off slowly and pay the interest the whole time or reduce, at that
time, my payments into my Roth and/or 403b to quickly pay down the
debt.

- quote -

Have the whole amount now, but am considering adding small amounts
each month for other eventual costs such as re-roofing and
re-shingling (in maybe 15 years?).
- quote -

I'll do some checking on the jumbo CD to see what rates really are. I
have zippo experience with internet banks. Have others had good
experience with them?


- quote -


Good ideas, all. Treasure Notes on Treasure Direct have been
mentioned before. BTW, the URL for Treasure Direct is
www.treasuredirect.gov, not .com. Small matter...

- quote -


Glad you mentioned the tax issue. I am not in a high tax bracket, but
that certainly affects the calculations to some extent..



- quote -


No better use of the money. Only debt I have is a 15 year fixed
mortgage at 4.875 and some student loans currently at less than 2%
(get a rate reduction for automatic payment and also for having never
been late on payment).


- quote -


No strong preferences. I plan on diversifying to some extent just
because I do have several different time horizons: 3-5 for a car,
later than that for other home maintenance issues. For those further
out I can always go higher risk investments.


- quote -

Great. Nice resources... Thanks

American Skandia ASL II is also no surrender charges, not as familiar with
and I haven't book marked the prospectus, yet.

"Michael Grinnell" <msgrinnell[at]charter.net> wrote in message
news:237a8ae7.0401150647.3029a671[at]posting.google.com...
- quote -

In article <237a8ae7.0401131922.66f118c6[at]posting.google.com> ,
msgrinnell[at]charter.net (Michael Grinnell) writes:

- quote -

There are several things I would consider:

- The "3 to 5 years" doesn't sound so definite. What is the soonest range you
would need that money? For example, if it is possible you may need the money
under 1 year, Savings Bonds are out. (Series I Savings Bonds and Series EE
Savings Bonds cannot be redeemed in less than 1 year from month of issue unless
the Bureau of Public Debt declares your area a disaster area.)

- Do you have the whole amount right now or will you be adding to it? (If
adding, if you have the money in Savings Bonds, you could buy more Savings
Bonds, but find a new home to park new money when you are within 1 year of
needing that money. Likewise, with CDs, you could buy more CDs, but it is
unlikely they would be "jumbo" CDs for subsequent purchases.)

- How much flexability on withdrawals do you need? This could affect whether
you want part or all of the money in a money market account, money market fund,
or a higher-yielding savings account such as the Ing Direct Orange Savings
Account (currently yielding 2%APY) or one of the other Internet bank money
markets--you might visit http://www.bankrate.com and check on the interest for
money markets, savings accounts, and one bank even offers decent interest on a
_checking_ account, and don't forget to visit the financial institutions you do
business with because sometimes they may have good deals that they don't
publish on bankrate.com. Or it may be a deciding factor on whether to get one
large CD (a "jumbo CD") or a number of smaller CDs (since early redemption is
usually a function of the amount in the CD, but the details do vary between
issuers), or one large Savings Bond or a number of smaller Savings Bonds. (My
Savings Bond purchases have been $500 issue price as a compromise between
granularity in redemption ability and keeping the number of Savings Bonds from
getting too unreasonable.)

- How much risk are you willing to take? Normally I consider the stock market
too volatile for money one needs in less than 5 years, but even bond funds and
individual bonds (other than Savings Bonds) can lose value if the interest rate
for that segment of the bond market rises, and that risk includes individual
bonds if you end up having to sell them before maturity. The safer the money,
the lower the yield is that you are likely to find. (I have seen people
advocate GMAC "money market" and Ford "money market" for their higher yields,
but those accounts invest strictly in the debt of the issuing company and thus
most savy investors would consider an individual company's debt to be more
risky than having a broad diversification among issuers or having federal
insurance or the full faith and trust standing behind the instrument.)
Generally, though, when people think of "3 to 5 years" they want the principal
to be protected, or at least reasonably safe, and seldom in anything riskier
than a short-term bond fund or in individual bonds that will mature _before_
one needs the money (e.g., Treasury Bills and possibly Treasury Notes, as long
as they mature _before_ the money is needed).

Watch out for early redemption fees.

Savings Bonds (specifically, Series I Savings Bonds and Series EE Savings
Bonds) have a 3-month interest forfeiture if redeemed within 5 years of month
of issue, so one has to consider the penalty when comparing it to other savings
instruments. Even with the 3-month interest forfeiture, they may be a good deal
compared to some other insturments, and the interest can be deferred until
redeemed, reach final maturity (30 years from month of issue), or have a
taxable reissue, whichever is first. (Not all reissues are taxable.) The same
election--whether to pay federal income tax on the interest every year or wait
until a taxable event--has to be used for all of one's Series I Savings Bonds
and Series EE Savings Bonds. Also, the interest on Savings Bonds (and dividends
on Treasury Bills, Notes, and Bonds) are exempt from state and local taxes.

CDs (Certificates of Deposit) also have an early liquidation penalty, but the
penalty varies between issuers. One issuer, for example, will penalize the most
recent 3 months of interest if the term of the CD was longer than a year,
another issuer would impose a penalty of _half_ the interest the CD would have
earned over the term of the CD, so check the penalties carefully! And make sure
that if you need to redeem them early, that the issuer would allow you to
perform an early redemption (with penalty).

Some banks, thrifts and credit unions may have fees for closing accounts, so
that, too, has to be considered if at the end of "3-5 years" you will be
closing that account.

Nothing says that all of one's money has to be in the same insturment(s).
Sometimes a mixture of instruments is a good fit for one's situation. For
example, I have part of my cash sitting in my credit union's money market
account (currently with dismal returns) and a good part in Savings Bonds (more
recent purchases have been Series EE Savings Bonds because the fixed rate
component of Series I Savings Bonds is so low), and until last week I had a
small chunk in a credit union CD because it was offered at a decent promotional
rate 15 months ago for a 15-month CD. And all this is separate from my
long-term investments, which are in more volatile instruments (stock funds and
bond funds for taxable account, stock investment account, bond investment
account, and a real estate investment account for my 403(b)). But with my money
market account and Savings Bonds, I have both the flexability of
arbitrary-sized withdrawals from to deposits to the MMA for that part of my
cash and the higher yields that I can get with Savings Bonds (even better when
considering that my state marginal tax rate of 9% doesn't apply to Savings
Bonds, unlike the MMA and CDs).

- Do you have a better use of the money? In many cases, one is better off
paying off high-interest consumer debt than investing in "safe" short-term
instruments, at least once one has saved enough for their emergency fund.

- Do you have strong preferences? Sometimes one can save more whole-heartedly
if one's heart is behind even a low-yielding account than in a better yielding
instrument one isn't comfortable with. (When I first purchased a Savings Bond,
I purchased only one with the idea that I would try it out and get used to it,
and it wasn't until I was comfortable with it that I eventually moved half my
emergency fund over to Savings Bonds. And before that I had to get used to CDs.
And before that, it was getting comfortable with a money market account with
its limited number of withdrawals per month compared to a savings account.)

These links might be of use (other than bankrate and Savings Bonds links, I
haven't tried some of these for some time):

bank ratings, etc: http://www.bankrate.com
CD and MMA: http://www.banxquote.com
CDs: http://www.money-rates.com/cdrates.htm
CDs: http://www.amazingrates.com/
MMAs: http://www.money-rates.com/mmarket.htm
MMFs: http://www.ibcdata.com/index.html
Treasuries: http://www.treasurydirect.gov/
Savings Bonds: http://www.savingsbonds.gov/
http://www.treasurydirect.gov
I-Bond vs EE-Bond: http://www.publicdebt.treas.gov/sav/sbieevsi.htm


Mark A. Young

Michael Grinnell wrote:
- quote -

I believe the fund holds primarily TIPS which are a traded version of
the I-bonds (savings bonds) that I mentioned in the last post. Not
exactly, but that's the gist...TIPS are US Gov't bonds, they pay a fixed
rate plus an additional return tied to the inflation rate (as defined by
increases in CPI). TIPS are tradeable, though, while a savings bond sits
in your drawer until you cash it in at the bank. Also, TIPS income is
taxable each year while I-bond income is tax-deferred until you cash it
in (unless you choose to report it each year which based on my
experience, nobody does).

In theory TIPS returns are simple, there's an interest rate set by
auction that is applied to the principal. At first the principal value
is, say, a $1k multiple, but it is adjusted upwards (or not) based on
the changes in the consumer price index. So you get that base return
plus an inflation-based return, because the base return is applied to
the inflation-adjusted principal rather than the flat $1k. (I hope that
makes a little bit of sense!)

But in a fund it's a bit more complicated because you're talking about
interest earned plus NAV changes. The returns of the fund will depend
not only on the CPI (which determines the rate earned on the portfolio)
but also on the relative attractiveness of the fund's bonds in the
market, which affects the NAV of the fund. Imagine a TIPS auction where
the fixed rate was 4.5%, and a fund buys up those bonds. Let some time
pass. Now imagine another TIPS auction where the fixed rate is just
3.0%. Both are US-gov't Grade A, and both will see CPI adjustments, so
clearly the 4.5% bonds are now worth more, right? Other than that fixed
rate it's the same bond, so the two need to be priced the same so that
the effective yield is the same. More or less - don't want to complicate
this too much.

So there is a bit of volatility introduced in a TIPS fund because if
future TIPS auctions produce better fixed interest rates, then the past
bonds will be less attractive, and vice versa. Over the past couple of
years a TIPS investor would have benefitted from that, because the fixed
rates tended to drop, so older bonds paying the higher rates became more
valuable. That's why you see 7% returns on bond funds holding bonds that
clearly weren't paying 7%.

Separate point: compensation for inflation risk is in theory a major
component of bond returns, but it's conceivable that corporate or
government bond rates could rise faster than CPI. For example let's say
someone facing a trillion dollar deficit decides to send a man to Mars
to take a picture of the nice red rocks...we'd end up seeing some
big-time borrowing in the form of US Gov't bonds and that wave would
probably drive yields up. But who knows what CPI would be doing at that
point. So the TIPS could end up falling behind other bonds in their
returns. Or put another way, CPI might not be the best way to adjust a
bond's returns and still keep you happy.

That's the long way of saying that when you buy a TIPS fund there is a
bit of risk tied to future evaluations of the TIPS bonds held by the
fund. To the extent other bonds are available that pay more, the NAV of
the fund could drop. You avoid this risk when you buy I-bonds.

-Tad