Recommended corporate bonds and bond funds?

[Peanut]

I am looking to diversify into bonds, and DH thinks we should buy corporate bonds. I thought municipal bonds were supposed to be safer, but then places like Detroit do go bankrupt, I guess. Does anyone hold individual corporate bonds or bond funds that they can recommend?

[bibacula]

Corporate bonds are generally a bad deal. You have stock-like risks of credit downgrades and defaults without much upside potential.

For proof, check the 10-year returns on treasury bond funds and corporate bond funds at Vanguard or Fidelity. The long-term returns are the same because corporate bonds as a group slowly lose value due to credit downgrades. Corporates bonds pay a higher yield than treasuries, but lose value over time.

If you still want corporate bonds, then buy a short-term bond fund. Funds offer diversification of risk, and a short-duration corporate fund will usually slightly outperform a short treasury fund, because short funds hold the bonds to maturity.

I've parked money in Vanguard's VSCSX fund and had good results.

[bad_LNIP]

Other things to consider are rising rates and miniscule yield. Bonds are going to start getting hit as rates rise, and for what in yield? 1.8% or so? I just don't think it fits the risk/reward profile.

People have been using REITs as bond proxies and while they MAY get hit when rates rise, I think it is going to be less than the blood bath coming in bonds.

[Dragline]

Diversify against what?

Diversification by definition means that the assets are uncorrelated, or better yet, negatively correlated. So the first question is what else are you holding?

The best thing you can do is to find a proxy fund or funds for what you are holding and then compare it historically against different bond funds. Find a muni, a corporate, a government bond funds, both short and long, and run some historical charts on yahoo finance or marketwatch or wherever, especially focused on the last time your assets crashed. Pick the type of bond that does the best when your investments are doing the worst.

But also understand the purpose of diversification. Its not to make your returns better -- its to even them out in any given year, and hopefully reach similar long-term returns. That's why the fundamental question is "what does well when my favored investments are doing poorly"? -- and NOT which kind of bond fund does the best overall.

[IlliniDave]

Vanguard has a bunch of good bond funds. Before I would offer any particular advice I'd ask, what is your intent for the money over the medium/long term, and how long would you hold the bond fund in question. Muni bonds are in general considered somewhat less risky than corporate bonds, although some muni's are a little suspect and some corporates are pretty high quality( i.e., of "investment grade"). Of course many muni bonds are exempt from federal income tax which give them extra appeal for folks in the higher marginal brackets. I use intermediate-term municipal bonds for what I call the upper tier of my emergency fund. I hold a generic "total bond market" index fund in my 401k as a long-term counterweight to my stuck fund holdings. But from past threads it's clear our investment approaches are quite dissimilar so neither of those may be appropriate or of interest to you. In the interest of full disclosure, I have a small dollop of high-yield corporates in my little baby Roth account, which is my speculative play space where I blatantly gamble for fun. That fund, while suiting my purpose for that account, wouldn't be something I'd "recommend" to anyone.

[IlliniDave]

Other things to consider are rising rates and miniscule yield. Bonds are going to start getting hit as rates rise, and for what in yield? 1.8% or so? I just don't think it fits the risk/reward profile.

People have been using REITs as bond proxies and while they MAY get hit when rates rise, I think it is going to be less than the blood bath coming in bonds.

Emphasis in the quote is mine.

The way to avoid that is to keep your durations short and be willing able to to hold the bond/fund for it's term. If you can do that the downside is limited to the reduced earnings over the term (e.g., you might only make 2%/year for 5-7 years versus making say 3%/year for over the 5-7 years with an intermediate-term fund in the event of an instant 1% interest rate jump the day after you purchased). That is of course undesirable, but far from devastating. I would agree that long-bonds seem like a bad idea right now, because 20-30 years is a long time to hold something, much less something that is paying below market rate.

[Peanut]

Thank you, thank you all for your comments. Perhaps short-term bond funds are the way to go, @bibacula and @IlliniDave.

Clarifying a few points: this would be money for the medium-long term, so access is not really an issue. If I hold to maturity, the risks are low, correct? Perhaps waiting until after interests rates finally start rising (Sept?) would be a good idea.

@bad_LNIP: I am extremely wary of anything real-estate related, as I think we are well past the beginning of another bubble.

@IlliniDave: High-yield corporate means almost junk-bond status? Sounds exciting.

@Dragline: Points taken, diversify is maybe not the right term, especially as I read this about how stocks and bonds are moving in tandem recently:
http://www.bloomberg.com/news/articles/ ... ees-losses
Good suggestion about doing some research. RIght now we are 100% in equities with all money not in real estate, so 60% overall. Makes me a bit nervous these days.

Maybe I'll finally call the etrade fixed income specialist today. Let you all know if he has anything interesting to say.

[IlliniDave]

"High-Yield" Corporates are below investment grade but are probably a cut above outright junk bonds (at least the fund I have a little of at Vanguard). I suspect the term high-yield could mean different things in different places.

If the issuer of the bond has essentially zero credit risk, e.g., US Treasuries then the only real risk is if you hold them to maturity is the differential interest in the event of rising rates/inflation. In a fund it's a little more complicated if you reinvest dividends. It's a bit different with less creditworthy payers as there is increased likelihood of a default. Don't completely take my word for it, but I recall seeing somewhere that a typical junk bond fund will lose about 1%/year due to credit defaults, which would basically subtract from your aggregate coupon rate. It could be worse if the manager picks a bad portfolio, war and pestilence arrive, etc.

[billc]

Given that inflation is relatively low right now I would probably rather be in cash than in a bond yielding 1.5% or something.

If I'm going to invest in an asset that's going to get hurt when rates rise I may as well invest in utility stocks and get a better yield.

I just don't think the yield is enough to bother with in the short term when compared to holding cash or CDs and long bonds are too expensive given the likelihood of rising rates in future.

[workathome]

I don't know much about bonds, but Vanguards funds are pretty cheap. From what I read, they tend to filter out the worst stuff from their general muni funds. There's a high-yield one if you want some more risk.

[Chad]

Yes, in general Vanguard funds are cheap, but don't get completely caught up with Vanguard. ETFs have forced other companies to have similar expenses. Schwab is even cheaper on similar stock funds now. Though, I have no idea about their bond funds. All I'm saying is don't just search Vanguard. They may have the best, but they may not.

[bad_LNIP]

Peanut,
Keep in mind I am talking more about commercial RE than residential, but fair point on RE assets being bid up as bond proxies. There are some concerns that REITs might be a bit frothy right now, but I'm a bit more concerned about bonds getting bid up, negative yields, etc... because it isn't quite a safe haven if everyone is rushing into it.

I should note, I prefer investing via closed end funds more than anything else. You might be interested in some option-income type closed end funds. They underperform in raging bull markets but do better in down/sideways markets. It isn't something you will typically hear about in the typical media/publications. There is some market risk, but they yield a heckuva lot more that I think makes it worth it. Most pay monthly dividends as well.

[Peanut]

I finally talked to the Etrade fixed income specialist. He recommended that I buy a Janus Short Term Bond Fund Class T--JASBX-- and a Pimco Real Return Fund Class D--PRRDX. He didn't mention Vanguard at all, I'm assuming because you go directly to them to buy a fund? I should email him and ask. I guess these look okay to me. I suppose I'll put in some money and see how it goes. I swear, I find it so much less intimidating to just buy some more shares of NFLX.

I welcome your opinions, if you have any.

[billc]

http://quotes.morningstar.com/fund/PRRDX/f?t=PRRDX

http://quotes.morningstar.com/fund/JASBX/f?t=JASBX

Both funds have high expenses compared to Vanguard and other low fee outfits.

How much are you looking to invest? What specifically are you trying to diversify away from? Bonds are very expensive right now (read: low yields)

If you're strictly into preservation of capital in short term - check out Series I Savings Bonds. They're a pretty good place to stash money you want to use is 2-5 years. You can redeem them at Par value and collect modest interest.

[Peanut]

Thank you for your reply. I didn't see the fees on the links, but I know that is something to take careful note of. I'll ask the guy about that.

I am trying to diversify away from 100% equities in retirement. Right now I'd move maybe 10% to bonds. They seemed like a better bet than CDs.

Series I does look good, 1.5% for 1 year? PIMCO is 0.67% trailing 3 years, that's terrible right?
I don't know if I can buy these through my Etrade IRAs though. I think I'm pretty limited with those. Maybe I need to think about transferring out? Ugh it's so complicated.

[billc]

My best advice... better to leave money in cash than to buy something you don't understand or don't feel comfortable with.

Take your time and learn about it. Don't jump into something based on quick advice from internet forum or E*Trade salesman.

You're not going to miss out on anything. Slow down and take this opportunity to learn.

Just about all investment grade bonds have low yields right now - that's the nature of the current interest rate environment. It's also why bond duration is very important because the longer the bond the bigger risk you have in terms of present value if interest rates go up.

I recommended the Series I bonds because they are hard to hurt yourself badly with. Your worst case scenario is you fall just shy of inflation. You don't risk wipe out. If the money is in a traditional IRA then it is definitely not recommended that you take the money out and pay taxes + penalty. That's a bad idea.

[Peanut]

My best advice... better to leave money in cash than to buy something you don't understand or don't feel comfortable with.

Take your time and learn about it. Don't jump into something based on quick advice from internet forum or E*Trade salesman.

You're not going to miss out on anything. Slow down and take this opportunity to learn.

Just about all investment grade bonds have low yields right now - that's the nature of the current interest rate environment. It's also why bond duration is very important because the longer the bond the bigger risk you have in terms of present value if interest rates go up.

I recommended the Series I bonds because they are hard to hurt yourself badly with. Your worst case scenario is you fall just shy of inflation. You don't risk wipe out. If the money is in a traditional IRA then it is definitely not recommended that you take the money out and pay taxes + penalty. That's a bad idea.

Yes, I agree. I'll study it a bit more. I like the safety of CDs but the yield is just too low right now.

No, I didn't mean pulling money out of a traditional IRA. I'm not quite that clueless, thank goodness. I just meant transferring our accounts out of Etrade to someplace that gives me more options. I think I can do that with an IRA. Thanks again.