Looking for Better Rates on Savings
November 29, 2010 4:06 PM Subscribe
Bond fund: is this a rational move for savings to get a higher yield?
Given the low interest rates on savings accounts, CDs and money market funds, I am considering moving a chunk of my savings to an income-producing bond fund that pays interest monthly. This is money that I won’t need for, say, 3-5 years, if that.
I’d prefer not to get into the name of the multi-sector bond mutual fund I’m considering, because I’m interested in the principal of the question stated below, not the specifics of one bond fund over another, except to say that I’m familiar with it as one of my 401K choices, it invests in the orginator’s own income funds, its expense ratio is below average and its YTD yield is 3.98%. (Which is a heck of a lot better than anything I’m getting now.)
I know that there is at least one bond fund out there that currently yields twice that, but 60% of their holdings are mortgage CMOs and pass-throughs, which I don’t understand, and their fees are double.
My question: is this a rational move, given that my aims are to maximize return, minimize risk and preserve liquidity?
For bonus points, how much am I giving up that a bond fund isn’t FDIC insured?
Many thanks!
Given the low interest rates on savings accounts, CDs and money market funds, I am considering moving a chunk of my savings to an income-producing bond fund that pays interest monthly. This is money that I won’t need for, say, 3-5 years, if that.
I’d prefer not to get into the name of the multi-sector bond mutual fund I’m considering, because I’m interested in the principal of the question stated below, not the specifics of one bond fund over another, except to say that I’m familiar with it as one of my 401K choices, it invests in the orginator’s own income funds, its expense ratio is below average and its YTD yield is 3.98%. (Which is a heck of a lot better than anything I’m getting now.)
I know that there is at least one bond fund out there that currently yields twice that, but 60% of their holdings are mortgage CMOs and pass-throughs, which I don’t understand, and their fees are double.
My question: is this a rational move, given that my aims are to maximize return, minimize risk and preserve liquidity?
For bonus points, how much am I giving up that a bond fund isn’t FDIC insured?
Many thanks!
its expense ratio is below average and its YTD yield is 3.98%
You need to subtract from the quoted yield any fees. You likely would do better holding a portfolio of bonds directly than investing in a bond fund.
posted by dfriedman at 5:06 PM on November 29, 2010
You need to subtract from the quoted yield any fees. You likely would do better holding a portfolio of bonds directly than investing in a bond fund.
posted by dfriedman at 5:06 PM on November 29, 2010
Best answer: given that my aims are to maximize return, minimize risk and preserve liquidity
Maximizing return while minimizing risk are mutually exclusive. You can decide what risk you want to take, then maximize returns consistent with that risk. If, for example, you want to be as sure as you possibly can to get your money back then the maximum return associated with that risk today is roughly zero. It isn't always, but it is today. Or you can decide what return you want then find the minimum risk associated with that return. But you cannot have both.
My guess is that the fund you are talking about will have a risk someplace between the CD and the stock market, in compensation for offering you a return someplace between the CD and the stock market. I find this a difficult investment environment. Taking your lump of money and buying a low volatility bond fund is one reasonable compromise today. Another is leaving say 3/5 of your money in the CD and putting 2/5 in a stock fund.
posted by shothotbot at 5:17 PM on November 29, 2010
Maximizing return while minimizing risk are mutually exclusive. You can decide what risk you want to take, then maximize returns consistent with that risk. If, for example, you want to be as sure as you possibly can to get your money back then the maximum return associated with that risk today is roughly zero. It isn't always, but it is today. Or you can decide what return you want then find the minimum risk associated with that return. But you cannot have both.
My guess is that the fund you are talking about will have a risk someplace between the CD and the stock market, in compensation for offering you a return someplace between the CD and the stock market. I find this a difficult investment environment. Taking your lump of money and buying a low volatility bond fund is one reasonable compromise today. Another is leaving say 3/5 of your money in the CD and putting 2/5 in a stock fund.
posted by shothotbot at 5:17 PM on November 29, 2010
YTD yield is 3.98%
Are you sure you mean YTD yield? Generally, bond funds post an SEC yield and a YTD return. The SEC yield is close to what you can expect from dividend payments going forward. The return includes past dividends and any underlying capital gains/losses that have already occurred. Most likely the 3.98% is the YTD return, because interest rates have fallen since the beginning of the year causing capital gains in bonds. As a new investor comparing this fund to other options such as CDs, you need to look at SEC yield.
Bond funds are a good choice, provided three things. One, the expense ratio is low. For example, Vanguard's Total Bond Market Index has an expense ratio of 0.22%. This is especially important now because interest rates are so low and the expense ratio can take a big chunk of your return. Two, the duration of the bond fund is roughly less than or equal to your time horizon for the investment which would be more sensitive to rising interest rates. In your case of 3-5 years, you probably don't want a long-term bond fund. Three, you must understand the average credit quality of the fund. Bonds are highly liquid and the relationship of risk and return is well established. If you stick with safe bonds like treasuries or AAA-rated bonds, you will have less risk but you will be compensated with less return. Conversely, if you pick non-investment grade bonds (junk bonds) because of their high yield, they will have significantly more risk. Just choose what you're comfortable with, but don't be surprised if the higher yielding fund fluctuates more.
posted by Durin's Bane at 5:29 PM on November 29, 2010
Are you sure you mean YTD yield? Generally, bond funds post an SEC yield and a YTD return. The SEC yield is close to what you can expect from dividend payments going forward. The return includes past dividends and any underlying capital gains/losses that have already occurred. Most likely the 3.98% is the YTD return, because interest rates have fallen since the beginning of the year causing capital gains in bonds. As a new investor comparing this fund to other options such as CDs, you need to look at SEC yield.
Bond funds are a good choice, provided three things. One, the expense ratio is low. For example, Vanguard's Total Bond Market Index has an expense ratio of 0.22%. This is especially important now because interest rates are so low and the expense ratio can take a big chunk of your return. Two, the duration of the bond fund is roughly less than or equal to your time horizon for the investment which would be more sensitive to rising interest rates. In your case of 3-5 years, you probably don't want a long-term bond fund. Three, you must understand the average credit quality of the fund. Bonds are highly liquid and the relationship of risk and return is well established. If you stick with safe bonds like treasuries or AAA-rated bonds, you will have less risk but you will be compensated with less return. Conversely, if you pick non-investment grade bonds (junk bonds) because of their high yield, they will have significantly more risk. Just choose what you're comfortable with, but don't be surprised if the higher yielding fund fluctuates more.
posted by Durin's Bane at 5:29 PM on November 29, 2010
Response by poster: Thanks, DB. I had not heard of 'duration' before. The fund I'm looking at has an SEC yield of 3.57% and a duration of 4.3.
3.57% is still better than what I can find for any other short-term investment.
But I may as well say, at this point, that the fund I'm looking at is RPSIX, which has an expense ratio of .72%. VBMFX looks more attractive on that front.
Thank you for educating me, dfriedman, shothotbot and Durin's Bane!
posted by Short Attention Sp at 6:18 PM on November 29, 2010
3.57% is still better than what I can find for any other short-term investment.
But I may as well say, at this point, that the fund I'm looking at is RPSIX, which has an expense ratio of .72%. VBMFX looks more attractive on that front.
Thank you for educating me, dfriedman, shothotbot and Durin's Bane!
posted by Short Attention Sp at 6:18 PM on November 29, 2010
The value of the bonds in a fund can fluctuate and you may lose money on paper. If you don't intend to sell, that won't matter, or at least it will seem so. This is why bond funds should become an larger part of your retirement fund as you get closer to retirement. But you may be forced to sell if the fund liquidates. For this reason, you should not invest in a single bond fund.
This happened to me with a PIMCO closed-end fund while I was still underwater. I had five bond funds, which turned my 10% loss on the PIMCO fund into an overall 2% loss over two years, which was more than made up for by the 8% annual interest I earned on it. If I had been better aware of the possibility that a fund might liquidate, I would have diversified further.
posted by kindall at 8:47 PM on November 29, 2010
This happened to me with a PIMCO closed-end fund while I was still underwater. I had five bond funds, which turned my 10% loss on the PIMCO fund into an overall 2% loss over two years, which was more than made up for by the 8% annual interest I earned on it. If I had been better aware of the possibility that a fund might liquidate, I would have diversified further.
posted by kindall at 8:47 PM on November 29, 2010
Best answer: With a 'safe' bond fund you still have to worry about the management being morons. Case in point the Charles Schwab YieldPlus funds were marketed as being nearly as safe as cash and having durations and yields consistent with a 'safe' bond fund. Yet they lost significant value during the financial crisis (more than typical for an ultrashort bond fund even during those times).
Accordingly, I would recommend an indexed bond fund. There are indexed bond funds for all types of bonds: short, medium, long, international, treasury etc.
posted by stchang at 9:18 PM on November 29, 2010
Accordingly, I would recommend an indexed bond fund. There are indexed bond funds for all types of bonds: short, medium, long, international, treasury etc.
posted by stchang at 9:18 PM on November 29, 2010
Response by poster: I will check out indexed bond funds.
Thanks kindall and stchang!
posted by Short Attention Sp at 4:38 AM on November 30, 2010
Thanks kindall and stchang!
posted by Short Attention Sp at 4:38 AM on November 30, 2010
This thread is closed to new comments.
A bond fund's principal value fluctuates based on the value you could get by selling the basket of bonds it represents. Interest rate changes, underlying creditworthyness, general market fluctuations can all change how much your bond fund is "worth".
Basically: it's not a savings account, it's closer to a stock market fund that pays dividends.
posted by cschneid at 4:26 PM on November 29, 2010