Elle Navorski wrote:
- quote -

Duration is always best used for that point-in-time kind of estimate of
change in value. Remember as time ticks along the duration of a bond
changes. And for a bond mutual fund you have all sorts of additional
factors because it holds dozens/hundreds of bonds.

- quote -

I know you've looked at old discussions on this but google "flattening
yield curve" and you might see less reason to invest in long-term bonds
right now. But without going into the derivation: if you put $10k in a
passively managed bond fund that provides $400 in income today, after
costs, tracking error, etc., you can only bank on that level of income
going forward if interest rates remain the same or higher.

I believe my daily word limit is up.

-Tad

This thread shows the need (some might say, "Screams for") a class on
posting and communication skills.

Henceforth all posters to this thread will be limited to 150 words
daily (we will use the SWAG method in lieu of actually counting.)
That limit applies to everything: header, quoted material from
previous post, message and signature.

If you experience difficulty, remember that the class motto is "More
words do not contribute to comprehension." Towards that end we note
that most word processing programs have a word count feature, making
them ideal for homework/practice.

Failing grades (F) will be returned to those with a valid address.
Well, maybe only the first F.


-HW "Skip" Weldon
Columbia, SC

"TB" <borekfm[at]pacbell.net> wrote
- quote -

This makes sense to me, and the data seem to support it (noisiness aside).
But then it seems like you're implying that duration is a pretty crude tool
for estimating changes in NAV. Is that right? Duration is pretty crude and
maybe best used *only* for very short-term calculations or to compare one
fund to another?

- quote -

I agree the fluctuation is plenty "noisy," consistent with what you say
above. That doesn't bother me. I'm mostly worried about losing principal. I
think...

For the interested reader, here's a graph of the NAV since 1988 of the
long-term fund I've been contemplating:

http://finance.yahoo.com/q/bc?t=my&s...=on&z=m&q=l&c=

I wish I had it going back further, but I can't put my hands quickly ona
better equities historical grapher.

- quote -

I was really just contemplating parking the money in the long-term bond
fund and ignoring the NAV for, say, the next 20 years. But if I'm not going
to get my steady, pretty much guaranteed $400 bucks or so (from our
examples), then maybe not.

- quote -

Okay.

- quote -

I'm not quite convinced this is the case, especially since above you seem
to imply there's a pretty rational basis for how the NAV changes, but I am
hoping Rich will post again with his comments to shed more light on this.

Regardless, today I am leaning against any long-term bond funds. I may also
minimize my intermediate bond funds.

- quote -

Yes, as I mentioned, since after I first posted, I am now considering
parking a chunk in a number of IG individual bonds and CDs. I think I'll
have enough to have sufficient diversity.

- quote -

If I do go the bond mutual fund route, that's a good suggestion.

BTW, a few hours ago I reviewed the thread Rich, you and I had from about a
year ago about bond ladders, including the bond "living yield curve"
(showing yields since 1977 of various maturity government bonds). So I am
bearing in mind what you all said then. Hopefully I am not being
repetitious or forgetting your and his points.

Thanks for taking the time to give this a look and post your opinion.

"Elle Navorski" <elle_navorski[at]nospam.earthlink.net> wrote in message
news:rnWBd.15393
- quote -

I though that was the question I was answering - "what happens to principal
be darned". In that case, no, you can't lock in an interest rate, it will
fluctuate. However, since you seem to (conversely) want to factor in a
fluctuation of principal, then yes, sort of, your income can remain
constant. However, I note that that is a problem with fixed income
securities. The income is fixed, while purchasing power (usually) erodes. I
see you're smart enough to know this, but it doesn't sound as if this is
part of your planning. Excuse me if I'm wrong about that.

Elizabeth Richardson

Elle Navorski (latest nom de plume?) wrote:
- quote -

These different posts seem to consider only what would happen at the
moment of "shock" when you have a sudden X% change to interest rates. If
rates rise X%, the NAV drops, and yield rises to match the new
prevailing rates (two sides of same coin really).

But after that Big Bang (or for those in certain states, after the
intelligent designer deems it), it's going to drift. And not in a neat
and predictable way...keep in mind that bond funds trade their holdings
constantly and bonds in the portfolio mature regularly. Those dollars
would be invested at the newer rates. And which dollars? You don't know
because you need to know how the yield curve changed relative to where
it had been, and what effect that had on the bond's holdings. Maybe the
fund manager will need to sell a bunch of something to get the duration
or overall bond mix back in line - who knows?

It's not as if the fund holds a bunch of perpetuities - say, something
like a $25/share preferred stock that pays a fixed dividend more or less
forever. There you would see a closer relationship between NAV and
yield, assuming the company's prospects don't change. In a bond mutual
fund though you need to consider the nearly constant changes to the bond
portfolio. And really, it's not something you can predict.

The basic question I think was how to secure say $400/month in income. A
fund won't do that because rates could turn on you. That is one scenario
where the individual bond may better fit the need (esp Treasury, with no
default risk). Another alternative, if you're confident the bond fund's
total return will easily sustain $400/month, is to reinvest your
interest and request a withdrawal of $400/month, without worrying about
where it's really coming from this month.

-Tad

"Elizabeth Richardson" <erichktn[at]worldnet.att.net> wrote
- quote -

I'm not sure we're quite on the same page here. I'd appreciate it if you
and others could keep reviewing new posts to this discussion and poke any
possible holes in my reasoning.

For the moment let's assume that:
a) Interest rates will only go up from whatever Monday's long-term,
investment grade rates are.

b) The current yield on a long term bond fund such as VWESX is 5%. Call
this C for current.

c) Interest rates rise 0.5% point a year for the next several years. Call
this R for rise.

d) the long term bond fund duration is 11 years.

The way I understand it, my income, in absolute dollars, after N years will
be

Yearly Income = Original Principal*Bond Fund Yield*Reduction in NAV

Original Principal, $ = some constant = $10,000 here
Bond Fund Yield, % = C + NR
Reduction in NAV = 1 - Duration*R*N/100

With the assumptions above, C+NR increases more quickly than the reduction
in NAV. The result is that the yearly income, in absolute dollars, rises as
interest rates rise, even though the net asset value of the fund, and so
one's principal is declining.

For example, after 1, 2, and 3 years, the yearly incomes will be about:
$5200
$5300
$5400

The catch is that if I cash in my shares in the fund after three years, I
will get back only 83.5% of the principal, or about $8350 of the original
$10k.

To back up this contention of mine, I have four data points, representing
peaks and lows of net asset value (NAV), from about 1993 to the present for
the long term fund VWESX:

NAV Fund Yield
9.76 5.89%
7.7 7.96%
9.76 5.79%
10.17 4.68%
7.89 8.45%

Moving from a NAV high to a NAV low always gives a higher income, in
absolute dollars.

I bear in mind that my original assumptions above may be wrong. I agree
that there are problems if, for example, long term interest rates go down.

Letting more years pass also changes the picture, but if you could check
the above for now and give me your thoughts, I'd appreciate it.

- quote -

Again, to try to get us on the same page (maybe we are; I'm just not sure
of it yet), I'm not talking about locking in interest rates. I'm talking
about whether one can lock in an absolute dollar figure of income via a
bond fund (what happens to principal be darned), particularly on the
assumption that interest rates are currently at record lows and can only go
up.

I appreciate your taking the time to mull this over.

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

Agreed. I have some actual examples of NAV vs. yield for the fund VWESX in
the last ten years that seem to back up what happens when rates rise.

But it seems to me that, as long as interest rates rise no more than 6
percentage points (rising from 4% to 10%), my yearly income from the fund
investment will always be at least $400. After a rise of interest rates to
10%, the value of my shares would have declined to about $4000.

- quote -

So on this theory, a ride back down, starting from a yield of 10% and an
investment of $4000, to a yield of 4% and a worth of $6400, will leave an
income of only $256 ( = 4000*1.6*0.04) per year. Assuming interest rates
keep falling to, in theory, 0 (let's not get into negative interest, though
the possibility is there), then the most my investment would be worth is
$8000. Repetition of this cycle would keep reducing my investment until
nothing was left. That doesn't quite make sense to me. I wonder whether
we're abusing the definition of duration somewhat.

I'm not saying you're wrong. I know the basic definition of duration is but
I don't know very well what the assumptions are on which this definition is
based.

Consider some actual NAV and yield data on a fund like VWESX over about the
last ten years, I identified some peaks and troughs in the NAV curve and
looked up the yields corresponding to them. The Vanguard web site provides
the yields on this fund for every day back to about 1993.

NAV Fund Yield
9.76 5.89%
7.7 7.96%
9.76 5.79%
7.89 8.45%

For NAVs that are close, the yields are about the same. This seems to
contradict our assumption above that riding some kind of cycle (up and then
down) will diminish the principal.

What am I missing?

- quote -

I realize you're not necessarily recommending this. But to further flesh
out from where I'm coming:

I discovered last night that Fidelity brokerage has greatly streamlined
individual bond purchases (which can now be done online) and lowered the
concession (the fee or "commission" for a bond purchase). I bear in mind
that I lose diversity and so have a bit more risk with individual bonds but
will likely have a better yield.

I also bear in mind our discussion of about a year ago that bond ladders of
more than about five-years length are likely imprudent given today's low
interest rates. (Tad and you convinced me of this.) Still, I must say I am
tempted to buy a few 10-year bonds, not as part of a ladder, but as a small
part of my income portfolio. Any thoughts?

I just don't know how fast interest rates will rise and would like to have
the income from the 10-year bonds, as well as their low risk, in the
meantime.

Thank you for giving some of your time to this discussion.

Rich Carreiro wrote:
- quote -

OR an Annuity, which provides a GUARANTEED potential LIFETIME Income
at a FIXED Interest Rate (with or without the addition of Current Interest)
Cal Lester CLU

"Elle Navorski" <elle_navorski[at]nospam.earthlink.net> wrote in message
news:mYBBd.14265$RH4.11639[at]newsread1.news.pas.earthlink.net...
- quote -

No, you won't.

Imagine $10,000 invested in a 10-year duration fund yielding 4%.
Assume (as was the original poster's scenario) that dividends are not
reinvested. This will currently throw off $400/yr.

Assume a rise in rates to 6%. The value of the fund holdings will
then drop by about 20%, to $8,000. At a 6% yield, that'll now provide
$480/yr.

Conversely, if rates fell to 2%, the value would rise by around 20%,
to $12,000, and at a 2% yield would only throw off $240/yr.

The only way to guarantee income is to buy something with guaranteed
income payments (like an individual bond or a CD).

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

"Elle Navorski" <elle_navorski[at]nospam.earthlink.net> wrote in message
news:mYBBd.14265$RH4.11639[at]newsread1.news.pas.earthlink.net...
- quote -

No. The dividend on a bond fund fluctuates in tandem with interest rates for
like securities. So, while logic says that interest will rise from here, and
if they do, your income will also rise, it is possible that interest rates
will fall, and your income will fall also. I believe the only way you can
"lock" in an interest rate on bonds is to buy the bonds directly, but
someone else will surely address this.

Elizabeth Richardson

I am setting up a portion of my portfolio for income. That is, the
dividends from this portfolio will not be re-invested; they will go into my
pocket. This portion of my portfolio will provide some amount of income to
me for the next 20 years or more. Preferably a pretty consistent amount,
and preferably maximized.

Of course I want this portion of my portfolio to be fairly conservative. (I
am bearing in mind the effects of inflation, too, but I have a whole other
part of my portfolio dedicated to growth; no income.)

I am thinking about whether a LONG term, investment grade (IG) bond fund
should be a part of this (income) portion of my portfolio, despite interest
rates being at record lows.

Am I correct in assuming the following about this LONG-term bond fund
portion?

1.
While the yield on this will inevitably rise and the NAV will of course
fall (perhaps quite slowly) in the next few years, the absolute dollar
figure for income from this portion will stay pretty fixed. Indeed, based
on several samplings from the VWESX fund (one of Vanguard's three long term
IG bond funds; duration = 11 years(?)), it seems that the absolute dollar
figure for income will go up as the NAV goes down. I can provide several
real-life data points from VWESX since 1993 in short order. I'm just not
sure whether this is true in general, as a mathematical rule as well as a
rule of conservative instrument markets.

2.
By buying into this fund (VWESX) right now, I will have "locked in" a rate
of return on my initial investment pretty much forever. That is, if I put
$10,000 into VWESX on Monday, and if it's now yielding 5%, I'll make $500
per year from this portion of my portfolio forever.

3.
If I do as described in 2. above, the principal invested in VWESX will vary
all over the map over the next few decades. If history and duration offer
any lessons, then I'll probably see the principal drop 50% or more over
time. Then too it might bounce back up to the original value.

4.
While this $10k is sitting in the long term bond fund, I put the rest of my
income portfolio into less risky investments, which also right now pay a
lower yield. But as interest rates rise, I move these into higher yielding,
but still low risk, vehicles. E.g. a five-year IG bond/CertDeposit ladder.
Eventually the bond ladder gives me a pretty decent average yield, with
virtually no risk to principal.

5.
Of course I'd like to have more than $500 per year from my initial
investment in the bond fund. That's a pretty low return, based on
historical returns of long- and intermediate-term bonds. So to avoid any
loss on the principal in the long term bond fund, I have to weather the ups
and downs in NAV for awhile; maybe a decade or more (that's not trivial,
admittedly). When I've "locked in" a good interest rate with a five-year
bond ladder (among other instruments), and when the NAV of my long term
bond fund investment is about where it was when I bought in, I sell the
VWESX bond fund shares and move them to low risk low yield vehicles,
gradually moving this into the 5-year bond ladder.

I don't want to put all of my income portfolio into short or intermediate
term IG bond funds, because their yield is less than the long term bond
fund.

But I'm not sure. My gut says that a diversity of income producing
instruments is prudent, as who knows how long interest rates will be low?

Thanks in advance,

Elle
(formerly posted here under "Caroline")