- quote -

Correct. Or as bond geeks say, you "roll down the yield curve."

- quote -

Correct again. The bond fund is constantly trading bonds, in order to
maintain whatever duration the prospectus requires.

- quote -

Yet another truism. And the greater the bond fund's duration, the greater
the interest rate risk.

- quote -

I would suggest this is a little misleading. Yes, over ten years the
principal deposited into a bond fund will vary as the NAV fluctuates in
response to changing interest rates. And I supposed it's true that if the
value of the principal goes down that "may be quite different from what
was expected" if the investor was unsophisticated and thought that bond
funds work just like a savings account or money market fund. (Sadly, this
is the case for many fixed income investors there days who are so
desperate for yield that they are investing in bond funds with long
durations (and poor credit quality) not realizing the risk to their
principal.)

But my original point was that *if* you reinvest dividends, and hang on
for ten years, your rate of return in an investment grade bond fund will
not be negative. I concede the point made by another poster that your rate
of return and your total investment value will be less predicatable in the
bond fund than with individual bonds. But I remain convinced that over ten
years you can be confident you'll make money.

For the Vanguard paper on this topic, see: http://tinyurl.com/5mmrt.
Vanguard's conclusions:

1. If you're investing for income, a decline in principal won't affect
your income stream. As your fund's share price
declines, its yield will rise, but the dollar amount of your monthly
distribution is unlikely to change much.

2. If you're invested for diversification, it pays to stay focused on
the long term. If you're taking advantage of bond
funds for the diversification they offer, you're likely reinvesting the
interest income. Remind yourself that as you reinvest the
income, the higher yields over time will more than compensate for any
decline in principal. In the meantime, because bond
returns tend to be out of sync with stock returns, your bond fund should
provide valuable diversification benefits to your
portfolio.

3. If you're losing sleep over falling bond prices, shift to shorter
maturities. It's possible that when you first purchased
your bond fund, you picked one that doesn't match your time horizon or
risk tolerance. If you'll need to redeem the money
in your bond fund within the next few years, or if you can't stomach the
recent price declines, then perhaps you need to
shift to shorter-maturity investments. Check the average maturity of
your funds. If your fund's average maturity is more
than 12 years‹or if its duration (a more precise measure of a bond
fund's sensitivity to interest rate changes) is more than
10 years‹then you might want to shift to a fund with a shorter time
horizon. Most funds have average maturities in the
short range (1 to 5 years) or intermediate range (5 to 12 years).

Finally, my earlier post was less than clear about the distinction between
a person who needs current income from bonds and one who is investing in
the long term. For the person who needs current income, it may indeed be
smarter to join the ranks of the "coupon clippers" and buy individual
bonds, because the return is so predictable and because of the
ever-shortening duration. This strategy is not without risks, however. A
bond ladder must be constructed to reduce rate risk. Credit quality of
individual bonds must be assessed. And there are still those pesky
transaction fees. For the younger investor who's looking to diversify a
portfolio that is predominantly in equities, I continue to believe that
bond funds are the best option. Just follow the rule that you be prepared
to hold the fund at least as long as the fund's average duration.

pmb[at]his.com (Paul Michael Brown) writes:
- quote -

The term that's missing here is 'duration'.

Over the course of those ten years, the duration of the
bond held directly gets shorter and shorter - until it's
zero on the day the bond is due.

Over the course of those ten years, the duration of the
bond fund will probably vary, but it will *not* go to
zero.

At the end of 10 years, the bond position becomes,
effectively, a cash position. At the end of 10
years, the bond fund position *remains* a bond position
still subject to interest rate risk. (with the
exception of something like the target-maturity
funds which invest in zero-coupon bonds all with
a single target maturity)

If your concern is principal at the end of the 10 year
period, the bond fund's will vary - from the beginning
to the end of that period - and may be quite different
from what was expected.

Assuming dividends are held as cash (or reinvested at
a fixed rate or used in other predictable way), we can
tell you precisely what the bond position will be worth
at the end of the 10 years. We cannot do that with the
fund.

- quote -

Inasmuch as it's not predictable, it's not "just as safe".


--
Plain Bread alone for e-mail, thanks. The rest gets trashed.
No HTML in E-Mail! -- http://www.expita.com/nomime.html
Are you posting responses that are easy for others to follow?
http://www.greenend.org.uk/rjk/2000/06/14/quoting

Paul Michael Brown wrote:
- quote -

Assertion (2) is dubious and should be checked using data at (for
example) http://aida.econ.yale.edu/~shiller/data/ie_data.htm . There is
no reason earnings cannot increase for many years in a row during an
economic expansion. Statistically, the time series of earnings probably
follows a random walk with positive drift (tracking GDP), whereas the
P/E ratio should be mean-reverting (it cannot rise or fall
indefinitely).

I agree with your general point that future stock market returns will
probably not match historical returns, because an expansion in P/E
ratios should not be counted on.

"Paul Michael Brown" <pmb[at]his.com> wrote
- quote -

See above.

- quote -

Again, the context was such that it is assumed the dividends are not
reinvested but used for income.

Otherwise, I don't know why you think an assumption of reinvestment is
necessary. Assuming reinvestment of dividends is not apples-to-apples.

- quote -

Of course. I have tried to state here and there that all bonds under
discussion are investment grade; we're not talking junk bonds.

Granted there are tiers of "investment grade," but it's not a big deal to
obtain a mutual fund or individual bonds which are predominantly, say S&P
rated AA.

- quote -

If you have a citation for this study, I'd like to see it.

I started a separate thread a week or so ago on this, and your assertion
was put in doubt by others. I personally am not so sure. My data seems to
support what you say. Also, as I posted elsewhere, what you're saying makes
rational sense. (This disregards some of the inevitable noisiness of bond
prices due to non-interest-rate factors.)

- quote -

They've come down considerably. $20 one time for a $10k trade at Fidelity,
for example. That's a much better rate than what the annual expense ratio
of most (all?) bond mutual fund offers.

- quote -

I will look forward to reading what Vanguard says on this point.


======================================= MODERATOR'S COMMENT:
Please trim the post to which you are responding.

- quote -

Barron's looked at this in an article last summer, and they dug into why
equities have returned (roughly) nine percent over the long term. The
breakdown was as follows:

Three percent dividend yield
Three percent earnings growth
Three percent price-to-earnings multiple expansion

Going forward, will this pattern hold? Who knows. But Barron's pointed
out: (1) that fewer stocks pay smaller dividends than in the past
(although there is some data suggesting this trend may be reversing); (2)
earnings in the past couple of years are at an all-time high, which
suggests they have nowhere to go but down; and (3) the broad market's P/E
(using legit numbers for earnings actually booked, not bogus "forward
earnings") is also quite high by historical standards.

That said, I infer the original poster is still in his 50s. Assuming his
health is good, he can look forward to decades of retirement. IMHO, at
least for the foreseeable future he could probably have 50 percent of his
liquid assets in equities. As he ages (or if his health deteriorates)
he'll likely want to move more toward fixed income holdings.

Elle Navorski <elle_navorski[at]nospam.earthlink.net> wrote:

- quote -

I respectfully disagree. To do an apples-to-apples comparision, you need
to assume the bond fund investment reamins undisturbed for ten years (just
like holding an individual bond for ten years). You also need to assume
that you reinvest the dividends that the bond fund pays. Finally, you need
to assume the bond fund has the same credit quality as the individual
bonds.

Assuming all the above is true, I think you'll find that at the end of ten
years the risk to your principal in a bond fund is VERY low. As in
practically ZERO. Sure, if rates goe up the NAV of the bond fund will
drop. But the yield will increase and over time you won't lose any
principal. (Vanguard has a study on this point on their web site,
including some interesting examples.) Simply put, I think there are very,
very few bond funds that invest in investment grade paper where the total
rate of return (capital gains - capital losses + yield) will be negative
over a ten year period.

Finally, let's not forget diversification and transaction costs. Unless
you are Thurston Howell III, it's tough to buy enough individual bonds to
construct a truly diversified portfolio. But you can easily do so by
investing in something like Vanguard's Total Bond Market index fund.
Moreover, if you buy individual bonds (especially in small amounts) the
transaction costs can be substantial. Not so for a bond index fund.

All in all, I believe that over a ten year time period your principal is
just as safe in a bond fund as it is in individual bonds -- provided you
reinvest the dividends and you are patient enough to ride out the changes
in NAV. This describes most folks saving for a long term goal. It does
not describe investors who depend on bonds for current income to live on.

<beliavsky[at]aol.com> wrote
- quote -

Many people hold stocks for over a decade. Why wouldn't many do the same
with a bond?

To me, this popular assumption (deriving from the days when bonds had a
worse name than today?) is definitely not a one size fits all deal.

I believe there's been a surge of media attention on bond ladders, for
example, in the last few years. Bond ladders assume bonds are held to
maturity.

- quote -

We don't agree on this. There are important tradeoffs in owning a bond vs.
a bond mutual fund when an investor plans to hold the bond to maturity.
Whether one is more risky than the other depends on the investor's
situation.

I'm not trying to argue. I am posting my differing point of view.

- quote -

One will lose principal as the shift is made from long-to-short-term bond
funds. Plus, the investor has to try to time shifts with the direction of
interest rates. That's no easy feat.

Not so with the individual bond.

Elle Navorski wrote:
- quote -

If you buy a long term bond when long term yields are 4% and they rise
to 6%, and you try to sell the corporate bond before it matures, you
will suffer a significant loss.

Is owning individual stocks somehow less risky than owning stock mutual
funds? No. The same principle applies to bonds. It is true that a
10-year bond today is a 1-year bond 9 years from now, with less
intererest rate risk, while a long-term bond fund will have a fairly
stable duration. However, you can gradually shift from a long term bond
fund to a short term bond fund and then a money market fund, over the
10 years, getting the same effect.

"Elle Navorski" <elle_navorski[at]nospam.earthlink.net> writes:

- quote -

If the person can guarantee they'll never need to redeem the fund,
you're right. Otherwise, you have to keep in mind that funds never
mature (like individual bonds do) and there is a very real risk of
significant loss of principal that may not be recouped for many years.

For example, imagine a bond fund with a 12 year duration. Pretend it
is currently yielding 4% and that you put $10,000 into and are not
reinvesting dividends. It'll currently throw off $400/yr. Now
imagine interest rates rise to 7%. The principal value will drop by
roughly 36%, leaving you with principal of $6,400. At a 7% yield,
that'll throw off $448 per year. So it'll take about 8 years to make
up the $3,600 loss of principal.


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

<beliavsky[at]aol.com> wrote
- quote -

Can you explain this?

It seems to me that for someone investing in a bond fund for income, the
concern is not what the yearly return is, but how the yield changes.

I have started a discussion of this in another thread.

- quote -

But what about the risk that the principal may decline in a bond fund,
whereas it won't decline by owning a few corporate bonds outright?

It seems to me that, if one knows one isn't going to touch the principal
for ten years, one would be far better off with a few 10-year AA rated
bonds than a long-term bond fund. With the individual bonds, I get the
interest plus ALL the principal. Not necessarily so with the bond fund.

Now ten-years may be imprudent to some people, but the idea is the same for
an intermediate term bond or bond fund.

- quote -

I personally am not finding many high yield, non-REIT, non-electric
utility, non-bond mutual funds.

Even the funds that are higher yield and mostly REIT or electric utility do
not pay yields that compete all that well with individual stock positions.

Of course, there is the risk associated with individual stock positions...

<gabe[at]brennerfinancial.com> wrote in message
news:1104379545.353378.139160[at]c13g2000cwb.googlegroups.com...
- quote -

Hot damn, I'm undercharging! =)

Stochastic analysis shouldn't cost that much. There's not much more than
data entry, and the computer does the rest.

And given what I see in the field -- the work product of the amateurs and
so-called experts (certifeid and otherwise) -- most of them aren't worth the
paper they are printed on. To many people doing them aren't qualified, and
being a CFP doesn't qualify one as an expert on proper execution and
interpretation of a stochastic analysis.

Brent D. Gardner, ChFC
Chartered Financial Consultant
http://members.cox.net/brentdgardner1378/
http://www.topgunproducers.com/
http://forum.topgunproducers.com/

Si vis pacem para bellum!

"Be ever questioning. Ignorance is not bliss. It is oblivion. You don't go
to heaven if you die dumb. Become better informed. Learn from other's
mistakes. You could not live long enough to make them all yourself." - Hyman
George Rickover (1900-86), Admiral, US Navy, advocated development of
nuclear subs & ships

The Chartered Life Underwriter (CLU) and Chartered Financial Consultant
(ChFC), designations owned and exclusively offered by The American College,
signify the highest standards of academic study and professional excellence
in the financial services industry.

Andy- your third paragraph was well put.

"Another concern: Lets say you draw down the bonds over the 10 year
period as planned, but, as luck may have it, the market is in the
middle of a downturn when the bond money runs out. By steadily drawing
down the bonds you are putting more and more reliance on the stock
market. If it makes sense to diversify now, doesn't it makes sense to
be equally diverified 10 years from now? The only reason to reduce
diversification over time is if you believe the market will be
radically less volatile 10 years from now than it is now. What is the
evidence for that?"

valjean793[at]hotmail.com wrote:

- quote -

This seems like very odd advice to me.

I don't know how you can say that "given the historical performance of
the market" you should have "a large nest egg" after a 10 year period.
If you are using the market's average return over its entire history to
predict its performance over a 10 year period you are mixing apples and
oranges. There have been a number of 10 year periods over the last 75
years where equities have done pretty poorly, and we have just seen a 5
year period where the total market return has been about 0%.

Another thing to take into account is something which I read recently
in the NY Times. The market's historical performance over the last 75
years has not just been based on growth in corporate profits; it has
also been fueled by a doubling of the Price/Earnings ratio. In other
words, if the P/E ratio has stayed the same over that whole period the
historical performance would be about half of what it is (at least I
think that is mathematically correct). As the person pointed out in
this article, no one expects the P/E ratio to keep climbing at that
rate in the future. This means that historical performance really
points to an adjusted performance of about half of what it has been
over the last 75 years.

Another concern: Lets say you draw down the bonds over the 10 year
period as planned, but, as luck may have it, the market is in the
middle of a downturn when the bond money runs out. By steadily drawing
down the bonds you are putting more and more reliance on the stock
market. If it makes sense to diversify now, doesn't it makes sense to
be equally diverified 10 years from now? The only reason to reduce
diversification over time is if you believe the market will be
radically less volatile 10 years from now than it is now. What is the
evidence for that?

Andy

"Frank" <franksplace2[at]email.com> writes:

- quote -

Because your life expectancy decreases with age. As your remaining life
expectancy drops, you have fewer years that your money has to last,
which means, all things being equal, that you can be more conservative
with it, hence moving to less risky investments.

That doesn't mean I agree with the specific rule-of-thumb in
question, but there are good reasons to make your allocation
get more conservative as you age.

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

I have never understood the basis for this rule of thumb. Why should
your allocation change with age? What is the basis for 55-45? A
person who is 67 has a good chance of living another 20 years. Will an
all bond portfolio support that?

You may disagree with my 5 years and 25% bonds but at least it is based
on facts.

Frank


noreplysoccer[at]hotmail.com wrote:
- quote -

First please understand that every pension plan is different. So my
general reservations can not be taken as specific advice that you will
be able to apply to your siuation. Have your unique circumstance
reviewed by a fee-only Certified Financial Planner. I look at
withdrawals from a lump sum as a matter of statistics. Given the
standard deviation and average return of a given portfolio, one can
measure the likelihood, bases on historical market perfromance, that a
specific rate of withdrawal will be sustainable. For example, it is
very unlikely that one would be able to withdraw 6% annually from a
portfolio and not run out of money, but it is very likely that a
withdrawal rate of 2% is sustainable. It all depends on the asset
allocation of the portfolio in question and the period over which the
withdrwals must continue. That said, if one assumes a withdrawal equal
to what the pension would pay, and measures the likelihood that they
will not deplete the lump sum before their death, they can make an
educated decision about what makes sense. If the analysis indicates
that the lump sum has only a 50% chance of performing as well as the
pension, why take the risk. But when there is greater than a 75%
chance of doing as well as the pension (and potentially better) than it
is a harder choice. Net, net, this i snot a casual rule of thumb
decision. Analysis based on your specific situation is critical. Pay
a fee only Certified Financial Planner from $3,000 to $7,000 to do the
analysis and you may save tens or hundreds of thousands of dollars. It
is a good deal.

it appears the advisor's advice goes "against" conventional wisdom-
start at 55% stock and 45% bond at age 59, then increase stock exposure
and decrease bonds over time.

at age 67 you would be 100% stock and 0% bond.

guessing at ages, but the stock-bond ratio is a question I would put
back to the advisor.

I took a lump sum in 1997 and I have been very happy with the decision.
I have more protection against inflation and I did not have to take a
"spouse survivor option" to contiune my pension if I die before my
wife.

I don't like annuities. It is like paying someone to give you back
your own money. It reduces uncertainty but at a cost.

My rule of thumb is to keep five years income in bonds. Based on
history, there is a very small chance that the market will be down for
five consecutive years. If you draw down at 5% of your portfolio, that
works out to 25% of your portfolio. If you are not comfortable with
this level of risk, then keep more. But rebalance when the market is
high.

Index funds are fine but keep an assortment: large cap, small cap,
international.


valjean793[at]hotmail.com wrote:
One advisor told me to put 45% of my
- quote -

pmess wrote:
- quote -

If a bond fund is risky, buying a few corporate bonds of the same
maturity is even riskier, because you are taking on undiversified
credit risk. To own dividend-paying stocks, one can buy an "equity
income" fund.

I have a situation almost identical to the original poster and
plan on taking retirement next
year and self-managing my investments, including a lump-sum pension
payout. I am
interested in your comment about lump sums ("And I am
very skeptical of the advice to take the lump sum. ). Is that due to
the risk of having a
manager manage the lump sum or do you have other reasons??
Thanks,
TB