Retire at the Coffeehouse
- honeyoneohone
- SCoe46
- Kirk
- bob90245
- bob90245
- pbradford6
- bob90245
- bob90245
- SCoe46
- bob90245
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» honeyoneohone - Re: Great work bob!
In response to Great work bob! posted by SCoe46:.
Thanks, Bob! Fabulous information.
-- posted by honeyoneohone
» SCoe46 - Bond funds for fixed income
bob, this article by Jonathan Clements also contributed to my decision to go with a diversified bond fund in retirement instead of attempting to ladder individual corporate/municipal bond issues.-----------------------------------------------------------------------------------
Bond Mutual Funds Aren't
As Bad as Investors Think
June 8, 2002 9:41 a.m.
Wall Street's least-loved innovations include a surprise contender: bond mutual funds.
If you want to invest in bonds, I believe funds are almost always your best bet. But that sure isn't the consensus. I often receive vociferous e-mails from readers, decrying funds as a lousy alternative to individual bonds.
What bothers these folks? Suppose you have a choice between a five-year bond and a fund that targets bonds with an average maturity of five years.
If you buy the individual bond, you will collect a steady stream of interest while enjoying a gradual reduction in volatility. Your five-year bond will become a four-year bond, and then a three-year bond, and so on until the bond matures, at which point you will get back the bond's principal value.
But if you buy the fund, you won't enjoy this gradual risk reduction, because the fund's portfolio will change constantly as the manager strives to maintain an average maturity of five years.
Result: You can't be sure what your investment will be worth after five years and you don't know how much annual interest you will receive. Adding insult to injury, funds often charge hefty fees.
A searing indictment? Maybe not. Here's why bond funds are better than you think:
Trading Places
Sure, when you sell your bond fund, your shares might be worth a few pennies more or less than your purchase price. But at least you are protected against a far more devastating risk -- defaults.
That's not a worry with individual Treasury bonds, because the bonds are backed by the U.S. government. But if you dabble in corporate bonds, you really need the broad diversification that funds offer.
Indeed, to limit the damage done by defaults, you have to own 100 corporate bonds, figures Ian MacKinnon, head of the fixed-income group at Vanguard Group in Malvern, Pa. Sound daunting? It gets worse. If you buy a small quantity of a corporate bond, you will likely find the bond market is a rough place to do business.
Purchasers of such "odd lots" often pay too much when they buy and get a rotten price when they sell. Mr. MacKinnon reckons you need to invest $50,000 in any one corporate bond "to get away from the pirates and into more accommodative waters." For those on small budgets, the math isn't encouraging: To invest $50,000 in 100 different bond issues, you need $5 million.
What to do? If you are determined to buy individual bonds, you can avoid the perils of the resale market by sticking with new bond issues. In fact, there is a growing effort to sell bonds directly to individual investors.
The U.S. Treasury has long sold bonds directly to small investors, via the Treasury Direct program (www.treasurydirect.gov1). Now, corporate-bond issuers are trying the same thing, through Internet services such as Direct Access Notes (www.directnotes.com2) and InterNotes (www.internotes.com3).
But even if you can buy bonds at a decent price, there is still the problem of selling, should you bail out before maturity. "A fund is a lot easier to get out of than a portfolio of odd-lot bonds," Mr. MacKinnon notes.
Price Is Right
While individual bonds can be more costly to trade than a no-load fund, you do avoid continuing fund expenses. Many bond funds snag close to 1% a year in annual fees.
To avoid that hefty hit, stick with low-cost managers like TIAA-CREF, USAA Investment Management and Vanguard, where some bond funds charge less than 0.4% a year.
What do you get for that money? In addition to broad diversification, funds offer the chance to reinvest your investment income, something that's far trickier with individual bonds. How important is this reinvestment? Let's say you invested $1,000 for 20 years and earned a steady 6% a year in interest.
Over the 20 years, your initial $1,000 will garner you $60 a year in interest, for a total of $1,200. But your total earnings will be more than $2,200. Where did the extra $1,000 come from? You got that by reinvesting your interest each year, and then earning interest on that interest.
Risky Business
Fans of individual bonds may concede that funds offer diversification and easy reinvestment. But on one issue, they are adamant: Funds are more risky. A five-year bond gradually becomes less risky. A fund that targets bonds with a five-year average maturity never enjoys this risk reduction.
But this comparison is unfair. To understand why, suppose a fund mimicked individual-bond investors, buying five-year bonds and then holding them to maturity. Our hypothetical fund owns a slew of such bonds, some bought years ago that are now close to maturity and others that were bought recently and that still have five years to run.
The initial time to maturity on all these bonds may have been five years. But the average time to maturity for the whole portfolio will be around two and a half years.
"The proper comparison is not between a single five-year-maturity bond and a five-year-average-maturity fund, but between a single five-year-maturity bond and a two-and-a-half-year-average-maturity fund," argues William Bernstein, author of "The Four Pillars of Investing."
So what happens if you compare an individual five-year bond with a fund that owns bonds with an average maturity of two and a half years? You find that the individual bond will be more volatile when it's first bought and a little less risky as it approaches maturity. But on average, over the five years, the risk of the two investments will be similar.
-- posted by SCoe46
» Kirk - Re: Conclusion
.In response to Conclusion posted by bob90245:
This concludes my presentation of the “Retire at the Coffeehouse” strategy.
Great job Bob!
I love your charts! They make it so easy to see what you are saying to do.
Have you done any analysis to see how much available return is lost by not rebalancing after down years? I understand your reasons for not rebalancing but I wonder if the Monte Carlo analysis for allowed spending would have to be significantly reduced when you "one side" a return distribution? 4% is "safe" for a 30 year time frame with rebalancing, but what if it drops to only 3% when you don't rebalance? Are you willing to give up 25% of your income just to avoid rebalancing after a down year?
I'd like to see the data before I'd sign up for no rebalancing, especially since I am looking at 40 or 50 yrs with a 3.5% rate...
-- posted by Kirk
» bob90245 - Re: Bond funds for fixed income
In response to Bond funds for fixed income posted by SCoe46:This is what the retiree will see:
VBIIX Vanguard Intermediate-Term Bond Index
Year_Ended Capital_Return Income_Return
2004 0.35% 4.87%
2003 0.60% 5.05%
2002 4.66% 6.20%
2001 2.59% 6.69%
2000 5.36% 7.41%
1999 -8.95% 5.95%
So the dividend stream will be comparable to a laddered portfolio. Just know that your principle value will bouncing around year to year. Each person will have to weigh the trade-off of convience using a fund versus the NAV volatility.
BTW, thanks for the kind words, guys.
-- posted by bob90245
» bob90245 - Re: Re: Conclusion
In response to Re: Conclusion posted by Kirk:Thanks for the kind words, Kirk.
There's no question that rebalancing would have boosted returns in this 5 year example (I haven't calculated by how much). And let me reiterate that I did write that for someone who has a high risk tolerance can go ahead and rebalance. So perhaps I was letting my "conservative bias" seep into my strategy when I suggested not to rebalance. I still have strong memories of the bear market. I can imagine the pain of regret if I rebalanced in 2001 only to see even steeper losses in 2002. Ouch! And then ask me to rebalance at the end of 2002? With terrorism threats? A looming war in Iraq? A sluggish economy and loss of jobs? It's only in hindsight that we see that things eventually worked out.
So yes, rebalancing into the lagging funds looks good on paper. Not so easy to do in real time.
-- posted by bob90245
» pbradford6 - Re: Re: Re: Conclusion
In response to Re: Re: Conclusion posted by bob90245:An absolutely great job. Thanks, Bob for your careful explanation.
I only wish I could live on $40,000/year. My expenses are sure running higher, and I own my home! I hope we aren't in a secular bear market but I suspect we are and it may be difficult keeping up with inflation!! As Allan has pointed out we might just have to forgo inflation increases if we have a series of down years.
-- posted by pbradford6
» bob90245 - Chapter 14: A Better Approach?
In response to Re: Conclusion posted by Kirk:Curiosity got the better of me. So I decided to examine Kirk’s suggestion to always rebalance from all funds -- including from fixed income. In this study, I didn’t use the 60:40 stock:bond allocation because I knew the returns would be higher.
However, I figured a good test would be to have a compromise if you will. In exchange for always rebalancing all funds -- even during the dark days of 2002 -- I decided to try a 50:50 allocation instead of 60:40.
I was very surprised by the results. Not only did this change simplify the calculations, but the year-end balances were nearly the same.
Here are each year’s calculations for the “Always Rebalance” approach using a 50:50 allocation:
-- posted by bob90245
» bob90245 - Re: Chapter 14: A Better Approach?
In response to Chapter 14: A Better Approach? posted by bob90245:Again, I was curious about always rebalancing from all funds. So I went back and crunched the numbers for 60:40 allocation.
So yes, the “60:40 Always Rebalance” version came out on top. But not by much.
-- posted by bob90245
» SCoe46 - Re: Chapter 14: A Better Approach?
bob, did you rebalance once a year or more often in your calculations?TIA, Seb
In response to Chapter 14: A Better Approach? posted by bob90245:
-- posted by SCoe46
» bob90245 - Re: Re: Chapter 14: A Better Approach?
In response to Re: Chapter 14: A Better Approach? posted by SCoe46:I rebalanced once a year.
I know what you're thinking. <img src=http://www.suite101.com/images/emoteicon...> Vanguard provides quarterly returns. I may like math, but even thinking about doing this makes my head hurt. <img src=http://www.suite101.com/images/emoteicon...>
-- posted by bob90245
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