Would a bond fund be appropriate?

**Scanner** · 08-29-2009, 10:34 PM

My suggestion is no, a bond fund would not be appropriate because it is subject to market risk. That is, a negative return is definitely possible. If you are cool with that, then go for it. If it's for emergencies, you probably aren't cool with that.

An alternate suggestion may actually be bonds themselves, specifically insured municipal bonds, depending on your tax bracket.

An insured muni bond can be bought for around 5K usually and you could ladder their maturity that you had access to the money within a reasonable amount of time in case of job loss (like you would ladder CD's). The interest you earn is tax-free and the prinicpal is insured. There is no market risk unless you need to sell it before maturity.

**zetta** · 08-30-2009, 08:06 AM

I might be open to some market risk because we have so many other assets to fall back on in a pinch. How would I quantify how much risk I would be taking on? Would it be substantially less risk than a stock mutual fund?

How long are bond maturities? Can you get 3 and 6 months like you can with CD's?

**Broken Arrow** · 08-30-2009, 02:42 PM

To be exact, a bond fund is subject to bond market risk, not stock market risk. I know in these extraordinary times, perhaps a case can be made about even the two being connected....

But please also realize that there are different types of bond funds out there, with different types of exposures to different levels of risk. For example, a short-term corporate bond fund or ETF is going to have higher relative risk than a fund containing mid-term treasuries.

I think a bond fund is worth looking into. True, I agree anything beyond 2% return may have some principle risk associated to it, but I think that risk is relatively low (and perhaps even unavoidable in order to pursue higher gains). Also, you can mitigate the risk some more by specifying the fund with types of preferred bonds.

Lastly, bond funds are relatively liquid, and often can be bought and sold fairly quickly. There are short-term bonds that are 3 to 6 months as well, but you'd have to shop around for quality and risk, as short term funds are typically risky to begin with.... All things being equal though, it's best to just stick with bond funds rather than individual bonds.

But as I've said before, I love Walmart store bonds. Sure, they're corporate bonds, and some are a year or less. But come on, seriously, are you really under that much principle risk with a company like that? And for the risk you are supposedly taking, they will pay anywhere from 5% to 6.8%.

**MomofFour** · 08-30-2009, 03:49 PM

Originally posted by Broken Arrow View Post

But as I've said before, I love Walmart store bonds. Sure, they're corporate bonds, and some are a year or less. But come on, seriously, are you really under that much principle risk with a company like that? And for the risk you are supposedly taking, they will pay anywhere from 5% to 6.8%.

So, how do you buy a Walmart store bond? In a bond fund, or is it individual?

**disneysteve** · 08-30-2009, 06:30 PM

I think it is appropriate to point out the difference between a bond fund and an individual bond.

An individual bond has a set maturity date and interest rate, similar to a CD. The market value of the bond can fluctuate up and down but as long as you hold it until it matures, you will get back your full principal (unless the issuer defaults).

A bond fund is made up of many different individual bonds. Therefore, a fund has no set maturity date and no fixed interest rate. Rather, it will state an average maturity, perhaps holding short term bonds that all mature within 6 months. The yield will be the average of the fund's holdings and will change as the holdings change. Because the fund holds many different bonds maturing at different times, the NAV of the fund can and will fluctuate based on market conditions. You are not assured of getting your principal back regardless of how long you own the shares.

**Broken Arrow** · 08-30-2009, 07:49 PM

Yes, thank you for clearing that up Steve. I might have made things more confusing by talking about the two together in my last comment.

So, how do you buy a Walmart store bond? In a bond fund, or is it individual?

The answer is "Yes" and "Yes".

If you want individual bonds, you may be able to buy them directly (and usually online) from the company in question. Many large and mega-large cap companies offer that.

The downside is that all the terms are slightly different, and it is most likely going to cost you capital gains tax as a taxable investment.

The other way is to go through intermediaries such as discount brokerages. Scottrade, for example, will can actually purchase it on your behalf, and even do it for free! Plus, you can do this in a tax shelter such as an IRA. The downside is that they won't do it for anything less than lots of $10k each (and $1k increments after that). Great if you have the money, not so great if you don't.

But the easiest way is just to buy a bond fund, which is really a mutual fund containing a basket of dozens, if not hundreds of different bonds. Unlike individual bonds, they are fairly liquid, and depending on the investment company you are with, you could buy it for very little starting money, and sell it just about any time.

The down side to bond funds is that obviously you can't buy only specific bonds. More importantly, bond funds will typically charge an expense ratio, and they're typically not cheap. Some may argue that it's still worth the money, and I would agree.

Personally though, I'm tempted to just buy select bonds and do it all for free. Of course, you don't get the safety net of diversification, but I have a fairly high risk tolerance, and I honestly believe there are very good deals out there.

**zetta** · 08-31-2009, 04:31 AM

Is the value of a bond fund directly tied to the value of the underlying bonds, just as the value of a mutual fund is the value of all the individual stocks divided by the number of shares in the fund?

I'm more comfortable investing in a fund if the value is directly related to the underlying securities rather than people's opinion of which way the market is going to go next...

**Broken Arrow** · 08-31-2009, 05:08 AM

Originally posted by zetta View Post

Is the value of a bond fund directly tied to the value of the underlying bonds, just as the value of a mutual fund is the value of all the individual stocks divided by the number of shares in the fund?

You ever see a question where, at first, you think it's pretty simple, but the more you read it, the more confused and unsure you become?

Yeah, I'm looking at one now.

A bond fund a specific type of mutual fund, and as such, should still operates under the same basic guidelines. Bond ETFs would be the one that is subject to market forces.

**simpletron** · 08-31-2009, 06:29 AM

Originally posted by zetta View Post

Is the value of a bond fund directly tied to the value of the underlying bonds, just as the value of a mutual fund is the value of all the individual stocks divided by the number of shares in the fund?

I'm more comfortable investing in a fund if the value is directly related to the underlying securities rather than people's opinion of which way the market is going to go next...

the answer to the first question is yes, a bond fund value is directly tied to the value of the underlying bonds.example: total value of all bonds in the fund divided by the total number of shares is the price you pay per share.

but the underlying value of the bonds will change on things like interest rates changes and people's opinion of that future rate change. to see this, say you buy a 1000 2 year bond at 5% today. then the following year, interest rates go up to 10%. to sell your 5% bond on the market, you have to discount the princple such that it looks like a 10% bond because people aren't goint to pay the same price for your 5% bond when they can get 10% elsewhere. similarly if people think interest rates will be 10% next year, then they will try to price that fact into today price, and thus you would have to discount princple some(but not as much as if they knew for certian) to sell.

edit:
this also work in reverse. if you buy a 10% bond and interest rates down to 5% then they would have to pay a premium for your bond.

**Scanner** · 08-31-2009, 01:00 PM

Yes, a corporate bond (ie: Walmart) is an option but I thought this was an emergency fund.

You are assuming principal risk if you buy a corporate bond but I would agree with Broken Arrow that Walmart would be relatively low and if they dangle a 6% interest rate out in front of me, I may bite.

Remember, GM was offering corporate bonds only a few years ago.

**Scanner** · 08-31-2009, 01:07 PM

It brings up an interesting discussion relevant to me.

When I get my divorce settlement, it will be 38% of the home equity, about 60K.

That will be a short-term proposition for savings/investing until I get my own place 12-24 months, I figure.

If I were to stuff it in Walmart bonds. . .that's about 3600/year in interest I would earn. If I put it in a 2% CD, it's 1200/year.

Is the $2400 really worth risking the principal, no matter how well-endowed Walmart is?

My opinion (and like BA, I am a risk taker) - no. I can earn $2400 in a relatively short amount of time. I can't earn 60K in a relatively short amount of time.

This would be one time I would tip my hat to the FDIC product or some short term insured muni bonds. The principal risk is too great (and gosh, I haven't held a CD in years. . .almost thinking they are a joke for an investment vehicle).

**Scanner** · 08-31-2009, 01:26 PM

Sorry that I keep adding to the discussion but this short-term investing/parking money discussion has me thinking.

Why do we all chase returns? Well beyond just making more moola. . .one reason we do it is inflation risk - the risk that goods and services will outpace what our return on the CD or bond is.

However, it could be argued we are in a period deflation now (esp. housing ad even energy to a certain extent). . .so if that risk isn't really there and probably going to change soon. . .why endure any market or prinicipal risk?

Maybe this is why everybody anywhere and everywhere is snatching up US Treasuries.

Would a bond fund be appropriate?