Does anyone invest only in bonds?

[kv968]

Also, regarding bonds, I prefer bond funds to individual bonds (and yes, I buy the index).

Why? Because as a small individual investor, it would not be possible for me to create a diversified bond portfolio.

Sometimes, I read statements such as "When interest rates rise, bond fund prices fall". This is absolutely true. However, individual bonds also fall in price. If the owner of the bond decides to sell, they will find that they must sell at a discount.

Sometimes, the counter to this argument is "Yes, but, if I hold my bond to maturity, I will collect the full value". This statement is true. What is not stated though, is that in the meantime you are receiving lower-than-market-rate interest. If you buy a bond fund, when rates rise, your fund begins buying new issues which pay a higher interest rate. This translates to more income for the investors.

So I remain unconvinced that individual issues are superior to bond funds.

In my opinion, some bonds belong in every portfolio.

Utilizing a bond fund ladder (muni's, corp, etc...) would somewhat eliminate the opportunity cost of higher interest rates that Petunia's talking about however as she also stated, as a small investor, do you have enough money to properly construct a diversified ladder? My guess is no.

Most bond issues require a minimum investment of $5000 (yes you can get them for as little as $1000 for some corporates but most, and all munis, are traded in $5000 lots). With that, say you have $25,000 to invest and want to do a ladder where a bond comes due every year for 5 years so you can keep rolling them to keep up with interest rates. That's fine, however each year is only holding one bond and what if something goes wrong with that particular bond. Granted if you invest in high-grade issues there most likely won't be a problem but you never know.

Whereas if you invest a bond fund which can hold anywhere from 300 to over 1000 bonds you'll have the diversification and the ability of the fund or manager to roll over those issues as rates go higher. I'm not saying that bond funds can't and won't lose money, however if you pay attention to the duration of the fund you can somewhat factor in what loses are possible.

[scfr]

As a conservative investor, I would never invest all of my money in only one asset class. That is too much of a crapshoot for me.

[FirstTimer90]

I've been debating this very issue. I started a thread about it a few weeks ago. I also invest in a bond fund (Vanguard's Total Bond Market Index) and have been thinking about switching to individual bonds. I'm just not sure if that's the way to go for the very reasons you mentioned.

My understanding (and I'm not an expert so hopefully someone out there can correct me if I'm wrong) is that bond funds are only to be used if you have interest in lower rated bonds. Because if you own a few low rated bonds with High coupons you can withstand one not paying back the original investment.
However, with highly rated bonds, the actual bond is better because while a fund can easily drop below you're $10,000 investment (as an example), it is less likely a highly rated bond will become worthless (you can still hold to maturity and get its par value). I hope this helps Steve or I hope someone can correct me

[disneysteve]

My understanding (and I'm not an expert so hopefully someone out there can correct me if I'm wrong) is that bond funds are only to be used if you have interest in lower rated bonds. Because if you own a few low rated bonds with High coupons you can withstand one not paying back the original investment.
However, with highly rated bonds, the actual bond is better because while a fund can easily drop below you're $10,000 investment (as an example), it is less likely a highly rated bond will become worthless (you can still hold to maturity and get its par value). I hope this helps Steve or I hope someone can correct me

There is also the issue of diversification, though, as kv968 mentioned. If each bond purchase costs you $5,000, you can't diversify without a substantial amount of money. With a bond fund, however, for $3,000 you can own a piece of hundreds of bonds from day one.

Another factor is the convenience. With a bond fund, you don't have to spend time researching individual issues and making all of the transactions. You just send your money to the fund and you're done.

[FirstTimer90]

If you are investing outside of a Roth or 401k or other tax-advantaged account, fees and taxes are particularly important. That is a place where bonds could be beneficial, particularly muni bonds from your home state (unless you live in Detroit of course).

In a 401k fund, would you recommend index funds or mutual funds? I hope to retire at a higher tax bracket than I'm in today.

Are index funds and mutual funds covering similar investment areas or do you recommend both for diversification?

[FirstTimer90]

There is also the issue of diversification, though, as kv968 mentioned. If each bond purchase costs you $5,000, you can't diversify without a substantial amount of money. With a bond fund, however, for $3,000 you can own a piece of hundreds of bonds from day one.

Another factor is the convenience. With a bond fund, you don't have to spend time researching individual issues and making all of the transactions. You just send your money to the fund and you're done.

I'm new to this, but isn't the purchase of bonds already diversification? (Also owning stocks, commodities, real estate etc). Or must there be diversification within the bond market itself? Are AAA Muni bonds within a state that will bailout bankrupt cities, not enough to ladder....must that still be diversified ?

[disneysteve]

In a 401k fund, would you recommend index funds or mutual funds? I hope to retire at a higher tax bracket than I'm in today.

Are index funds and mutual funds covering similar investment areas or do recommend both to diversify?

Index funds ARE mutual funds.

I think what you are asking is index funds vs. actively managed funds. Index funds track a particular index like the S&P 500 or Russell 2000. Actively managed funds have a person who group of people actively picking which stocks to buy and sell within the fund. The problem with active funds is that they almost always underperform the market, they have higher trading costs, and typically generate more capital gains (which isn't a problem in a tax-free account like a Roth but is a big issue in a taxable account). So yes, I recommend index funds primarily, though I do own both kinds.

[disneysteve]

I'm new to this, but isn't the purchase of bonds already diversification? (Also owning stocks, commodities, real estate etc). Or must there be diversification within the bond market itself?

Yes and yes.

Investing in bonds adds diversification to a portfolio that is all stocks, but just as you wouldn't put all of your money in a single stock, you also wouldn't put all of your money in a single bond. You want a variety of issuers, a variety of maturities, etc.