I am considering buying bond funds and would welcome your recommendations. I recently read in Time magazine that you could get hurt if you’re invested in a bond fund. How can I get hurt holding bonds?
Many people think bonds are risk free, but that is not actually true. There are multiple risks associated with bonds, but they can be an extremely important component of a portfolio despite those risks. And, if properly allocated, they can provide a level of security above and beyond the equity markets. Of course there is no free lunch, and the added stability of bonds requires a tradeoff. Namely, you are foregoing the equity premium associated with stocks.
We recommend using a mix of high quality short- and intermediate-term government and Treasury issues. For tax-deferred accounts we include Treasury Inflation Protected Securities (TIPS). This allocation is purposefully designed to be very conservative. Nonetheless, it is still subject to certain risks. Interest rate and inflation risk make the top of the list. You can alleviate the risk of inflation through the use of TIPS. Interest rate risk is somewhat of a different story.
There is an inverse relationship between bond prices and interest rates. As rates rise, bond prices fall and as rates fall, bond prices rise. Longer-term bonds are hit hardest in a rising rate environment; short-term issues are hurt the least. Of course shorter-term issues generally pay less interest. If you want an appreciable return – especially in today’s low rate environment – you need to extend beyond extremely short-term debt. Our solution is to limit risk exposure and also gain some additional yield by using high quality short- and intermediate-term US government and Treasury debt.
I am retired and have my IRA invested with a conservative 40% equity allocation in the Vanguard equity funds you recommend. For the fixed-income part of my portfolio, I’m using the four funds you suggest for monthly income. This is because I plan to take out the income next year, and I want to build up that part of my portfolio with higher-yielding funds. Am I making a mistake doing this?
Unless you have an above-average ability and willingness to accept price volatility in your portfolio, I think you could be making a mistake. Your overall allocation and the wording of your question suggest that you see yourself as cautious. So it is important to understand that these two bond allocations are quite different.
In general, we build our portfolios to take risks on the equity side, where we believe risk is more likely to be rewarded, and avoid as much credit risk as possible on the fixed-income side. Accordingly, the fixed-income part of our Vanguard Tax-Deferred Portfolio is made up exclusively of U.S. Treasury and agency securities in order to stabilize the overall portfolio and mitigate the effect of falling equity prices. (more…)
I am saving money for two children who are heading for college. One will start this year, and the other will start in six years. I have saved approximately $20,000. What asset allocations would you recommend in these 529 accounts at Vanguard?
First, I have to say your children are very fortunate to have a parent who supports them in this way.
To address your question, I assume you have two separate 529 accounts, one for each child.
With a total of $20,000 saved for two presumably four-year college educations, I do not believe you can afford the risk of losing what you have set aside. Some people might be tempted to invest in equities for a student, who is starting this year, in the hope of growing those savings over the next three years.
However, I believe you should expect any growth in that account to come from additional savings you can add, not from market gains. (more…)
Editors Note: Burt Mayer, a senior at Lakeside High School in Seattle, WA interned at Merriman this summer with the intention of creating educational material for young investors. This three part series featured on FundAdvice.com is perfect for those investors who are looking to get started but need to know the basics first.
Investors at all levels spend a tremendous amount of time and energy looking for hot stocks and attractive funds. They track fancy-looking graphs and complicated ratios because they’re fancy looking and complicated. Ultimately far more time is spent thinking about individual stocks and bonds than what percentage of their money is invested in stocks versus bonds.
Meanwhile, many academic studies by very smart people have concluded that the way we distribute investments across asset classes is far more relevant to a portfolio’s return than the specific securities or funds in that portfolio. A famous 1986 study by Brinson, Hood, and Beebower (he’s the smart one) called “Determinants of Portfolio Performance” concluded that a full 93.6% of the variation in a portfolio’s quarterly returns can be explained simply by what proportion of the portfolio is put in different asset classes. (more…)
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