Critique My Investments Please

**EEinNJ** · 03-29-2010, 07:44 AM

I give you credit for being conservative rather than greedy/risky. Now here's the critique. Bond funds are riskier than you might think. Schwab, for example, had a total bond fund that did badly because of investments in mortgage obligations. The other risk is interest rates- currently lots of money has flowed into bond funds, but the outlook is rates will have to go up in the next year or so. When that happens the NAV of bond funds is going to go down, and you could find yourself "out of the money" if you have to sell. For these reasons, I got out of the ones I was in for a long time.
If only one of you is working, you might not be in a high enough tax bracket for muni bonds funds to pay off. Having heard about California's fiscal state, again, they might be riskier than you think.

My suggestion, since you're a younger person, is to think about your financial goals in the next 3-5 years. Things like buying a house, cars, etc., keep that money in cash. With only 10,000 or so to invest an extra 1% yield is only going to get you 100 bucks, anyway.
If your horizon is longer than that, put it in an allocation of equity index funds.

**jefffou** · 03-29-2010, 08:17 AM

You are obviously a conservative investor, aehardin. So, there's nothing at all wrong with the funds and account types you have chosen.

I, however, would like to throw out a possibilty for you.

A common misconception is that when an investor invests only in bonds, the investor has decreased market risk, namely volatility. However, this is not always true.

In fact, when one adds a small portion of other asset classes (stocks in this example) volatility risk is often decreased.

For example, if you had invested just 5% of your assets in a fairly aggressive (let's use the Vanguard Mid-Cap Investor) mutual fund ten years ago, you would have had slightly higher returns with slightly lower volatility risk for those ten years. Meaning more money with more consistent returns.

This phenomenon is really the crux of successful investing. First, identifying your tolerance for risk, then inveseting as efficiently as possible to maximize returns at that level of accepted risk.

Jeff

**safari** · 03-29-2010, 08:29 AM

Even the most conservative investors should not put all their assets into bonds. You have a long way to go until retirement, so you should focus on the big picture and not worry about the daily market fluctuations. By the way, if you have been following the market, the bear market ended a year ago, but it's never too late to get in. A good way to diversify your investments when you don't have much money to invest is by putting your money into a target retirement fund. You can pick a fund with the target date in the near future, for example, 2020, since you're a conservative investor. It doesn't have to be your actual retirement date. The closer the date, the more conservative the fund is. In my opinion, it's a much better option than putting all your money into bonds.

**jIM_Ohio** · 03-29-2010, 08:40 AM

you need to know your risks. You understand market risk (you chose bond funds to avoid that risk) but I am not sure you know about liquidity risk, default risk, inflation risk and other possible risks associated with bond investing.

Best way to hedge bets is to not put all investments into 1-2 asset classes (cash and bonds in your case).

Read these 2 threads and if you have questions ASK...
they are designed to make you think about what retirement planning is (to you) and what risks exist.

Saving Advice Forums

http://www.savingadvice.com/forums/investing-banking/50669-questionaire-people-starting-retirement-planning.html

Saving Advice Forums

http://www.savingadvice.com/forums/investing-banking/50734-investment-risk-questionaire.html

both threads are on page 2 of this forum

**feh** · 03-29-2010, 08:41 AM

Originally posted by aehardin View Post

I know market index funds have historically earned over 10% annual returns, but in today's bear market, my wife and I did not want to risk no gains or loses in such a volatile market.

Well, you need to invest according to your risk tolerance. You are being very conservative; only you can say whether that's good or bad. IMO, assuming this money is for retirement and you are a long way from retirement, I'd recommend at least 80% in equities.

Not sure why you think it's a bear market - major indices are all up at least 50% over the last year.

**aehardin** · 03-29-2010, 11:15 AM

Thanks for the advice everyone - I'll take it into consideration and look into moving some of my money out of bonds and diversifying it to hedge some of the risks involved with holding solely bonds. I have been considering target date retirement funds...so that is a possibility.

We have a good $10+ stashed away in liquid cash, but we wanted to start setting up our IRA's and invest in some tax-efficient funds too. Would you all recommend moving at least one of our IRA's into a target date retirement fund?

Also, regarding my tax-free bond fund...do you think I should move it into something that is not tax-free with higher yields since it is such a small amount?

Thanks!!!

**jIM_Ohio** · 03-29-2010, 11:41 AM

I want to reiterate these 2 threads, and read my signature too

Questionaire for people starting retirement planning

Investment risk questionaire

the tax free bond fund depends on tax situation- and you did not state what tax bracket you are in (for example), if you itemize, and if you need to reduce your taxes as part of financial planning.

Most threads here which start like yours did will take some twists and turns, for you to get good answers you either need to do 1 of 2 things

1) post more information, including taxes, retirement plans, spending plans and similar
2) learn about the taxes, retirement planning, spending planning and other information to answer questions yourself.

If you are in a high tax situation, the muni bond funds are good choices.
If you are in moderate or low tax situation, the taxable bonds usually are better (still depends, but muni bonds favor people in high tax situations). I believe I blogged on this a few years ago or posted to this effect somewhere many years ago.

The math is something like this

(1-tax bracket %)* taxable yield needs to be compared to tax free yield. At 33 and 35% fed tax rates, that usually makes the tax free look really attractive.

Because you have some cash tucked away, I would question holding muni bonds for retirement... but again read my signature- we don't know your income or tax situation anywhere close to being able to give decent planning information or help with decisions like that for you...

**aehardin** · 03-29-2010, 01:38 PM

Thanks Jim for the advice. I don't know my marginal tax bracket but it's not that high. I'll probably move the $3,000 we have invested in the tax-free bonds to into Vanguard's 500 Index Fund or something a little more aggressive like the Vanguard Small-Cap Index Fund. Hopefully this will help decrease my portfolio risk.

Jim in regards to bond investing risks, I'm aware of the various risks (theoretically) but it's difficult for me to apply them.
- Liquidity risks: long term bonds are less liquid than short-term bonds or cash
- Inflation risk: As inflation increases, the PV of your bonds decrease
- Interest rate risk: Increases in interest rates decrease the PV of a bond
- Default risk: If the corp defaults on the bond...you're out of luck...
- Reinvestment risk: if you bond is called, good luck because interest rates have dropped.

I understand that liquidity, inflation and interest rate risk are a major issue, but for most investment grade bonds, default risk is not as big of an issue because most of the investments are in AAA down to BBB rated bonds. Also, call protection protects you against call provisions. I understand how this all works for a single bond, but I'm sure it can get a bit daunting for a bond fund that holds several bonds.

**jIM_Ohio** · 03-29-2010, 01:57 PM

Originally posted by aehardin View Post

Thanks Jim for the advice. I don't know my marginal tax bracket but it's not that high. I'll probably move the $3,000 we have invested in the tax-free bonds to into Vanguard's 500 Index Fund or something a little more aggressive like the Vanguard Small-Cap Index Fund. Hopefully this will help decrease my portfolio risk.

Jim in regards to bond investing risks, I'm aware of the various risks (theoretically) but it's difficult for me to apply them.
- Liquidity risks: long term bonds are less liquid than short-term bonds or cash
- Inflation risk: As inflation increases, the PV of your bonds decrease
- Interest rate risk: Increases in interest rates decrease the PV of a bond
- Default risk: If the corp defaults on the bond...you're out of luck...
- Reinvestment risk: if you bond is called, good luck because interest rates have dropped.

I understand that liquidity, inflation and interest rate risk are a major issue, but for most investment grade bonds, default risk is not as big of an issue because most of the investments are in AAA down to BBB rated bonds. Also, call protection protects you against call provisions. I understand how this all works for a single bond, but I'm sure it can get a bit daunting for a bond fund that holds several bonds.

You probably want BOTH the small cap index and the 500 index... the question is how much of each? Possibly look at wilshire 5000 index (total market index) which combines them both.

You have a handle on the risks based on reply, and I agree how you are applying them is an issue. For example- you itemized the risks based on the BONDS and the bonds alone. If you analyze risk on whole portfolio, ask yourself these questions

1) How much liquidity does my portfolio need? In general you need 3 months expenses 100% liquid (in cash). If you work in sales, have a volatile income, or are self employed, you want more liquidity. Once you have a given amount of liquidity, you have that risk taken care of (meaning the fact the bonds or stocks you own, or your house is not liquid, or that rare art is not liquid does not matter, because you have some investments which are liquid.

2) How much do I need to combat inflation? If you needed bonds to combat inflation, buy TIPS. Other than that, inflation is a portfolio issue, not an individual investment issue. If you have 40k of annual expenses, you will need $1 M to live off investments (4% withdraw rate) which builds inflation into the 4% rule anyway. The issue you need to deal with is can your investments handle the 4% rule, and 100% bonds does not pass that test. 60-40 does (60% equity-40% bonds), and with 40-60 you might need to use 3.5% or 3%... so if you do not like market risk, you need to counter that with a lower withdraw rate in retirement.

3) Think of overall risk being described as % stocks and % bonds of whole portfolio. The comments made before this were to NOT do 100% bonds. 40-60 is lowest allocation I would start with for retirement planning. The last good article on retirement planning I read was to do 80-95% equity until about 10 years before retirement, then put breaks on fast and get portfolio to the 40-60 or 60-40 or whatever allocation will generate the income needed for retirement within 10 years of retirement. The logic here is that the high equity portfolio generates MUCH better returns, so when market is up 10 years before retirement, put breaks on... if market was down that 10th year, put breaks on in years 9 and 8 and 7...

If you have time, use time to smooth out volatility. I lost close to 40% in 2008, but have earned most of it back already. I did not like losing money, but I don't need it to be liquid (see point 1) so its OK to put it at risk when I do not need liquidity. When you see liquidity as a short term problem, sell at market highs.

to go back to replying to your reply and getting off my soap box, default risk is covered by owning a bond fund and not buying individual bonds... and reinvestment risk is something we live with whether it be dividends from a stock or interest paid on a bond- we want more shares at this point of investing career, so any principal or interest paid to us is reinvested. If you were spending proceeds of the bond sale (being cashed in) then that is a different risk based on stable portfolio vs accumulating or growth portfolio.

**cni2010** · 03-29-2010, 06:17 PM

Go to Wells Fargo and ask about their "stock market" tracking Note. I forget what it's called exactly, but the way it works is: It's like a CD, so your deposit is secure. You can buy 1 year, 2year, 5 year notes. Your return on the Note is proportional to the stock market regardless of whether it goes up or down. So if you get a 5 year note and the stock market goes up 40% then you get 40%. If it goes down 40%, you still get 40%. However there is barrier limit. If the barrier is 33% (for example) and the stock market goes up 40%, then you make some fixed amount like 12%. So if you had a 3 year note it would be 4%.

So it gives you better yield than a CD.
Your returns are proportional to the stock market without the risk of losing money.
There is a cap on total return.

Critique My Investments Please