Reaching retirement age makes one see the world through very different glasses. But then, I guess that could be said about just any experience one lives through. There is no teacher like experience - none like it anywhere!
So, when I talk about bond funds today, I speak from 40 years of experience and will try to help you use that 40 years to your best advantage - that is, help you make a good retirement investment with a great percentage of the potential land mines removed.
I will be focusing on bond funds today, an investment that is almost exactly like a stock fund, but with less volatility, but clearly with more hidden problems than you might expect if you are not alert.
Here is our agenda:
(1) I will start by first helping you determine whether a bond fund is right for your retirement investment needs, then
Story Continues Below
(2) Move on to describing the various types of bond funds available out there, then
(3) List a number of the basic considerations to be reviewed before you invest in a bond fund, and finally
(4) Tell you how I think you can best begin a search for a fund that meets your needs.
PART 1 - Is a Bond Fund Right for Me?
There are many specific considerations when it comes to making ANY investment, as we all know. Things like total portfolio value, obligations expected after retirement, what kind of estate arrangements have you made for the estate upon your passing (here trusts, annuities, etc. need to be taken into consideration), and a host of others that are usually specific to your retirement plan need to be taken into account.
I will not try to address all these today, for obvious reasons (after all, I only get 2 1/2 pages a week to talk with you!), but let's address the more important ones, like portfolio size, the need to preserve principal, and the need for a fixed monthly income stream after retirement.
First, portfolio size. If your portfolio is under $150,000, my advice is that you need to have the very highest reliability in the income stream you develop and bond funds do not really fit into this category of investment. Over $150,000, I also recommend that no more than twenty percent (20 percent) of the bond portion of your retirement portfolio be in bond funds.
Retirement, for most, will be a 15-25 year proposition and you should expect that inflation will eat into the purchasing power of your portfolio over this long period. I have spoken before in this column of how I believe a portfolio should be apportioned. Not wanting to repeat myself to much, I would send you to my archive at MoneyNews.com.
[Editor's Note:5 highest yielding, safest investments for 2007]
In brief, my philosophy is that bonds should be the backbone of your retirement portfolio. But, the one short-coming of this approach is that the fixed income will not change for the life of the specific bond (at least until your bond matures and the money is reinvested in a new bond holding).
The only way I know to "stimulate" bond returns is to use bond funds. One characteristic of bond funds is that there is a constant turnover in most of them and the income usually varies over time, normally closely mirroring the return on bonds at any one moment in time.
For example, many years ago (in 1986 to be exact), my dad invested in long-term bonds to lock in a then prevalent rate of about 12 percent being paid on most bonds (yes, that is really true!). Those bonds are still in my mother's portfolio (she turned 88 last month). But, over the last 21 years bond returns have fallen to the 5 percent range paid today.
In this instance, if my dad had bought a bond fund instead of fixed return bonds, my mom would have been deprived of a huge chunk of retirement income. Had it been the other way around and interest rates went up, mom would have enjoyed the extra income from the bond fund. So, your risk is in which way rates go over the life of your fund.
Knowing of this interest rate risk, I recommend that any portfolio over $150,000 using bond funds keep the bond fund portion to no more than one-fifth (20 percent) of your total bond investments. Frankly, this single criteria is all I would use in determining how much to put into bond funds. Just keep it simple.
PART 2 - The Type of Bond Funds
There are two ways of looking at the type of bond funds. The first is my maturity type. These are the three very basic types of bond funds by maturity: Long term, intermediate term and Short term Ahhh-Duh. So, I don't use these designators, though many do. Too simplistic.
Instead I prefer to look at the sources of issue. I prefer to call bond funds: municipal bond funds - those issued by a township, village, town or city, possibly even regional bond issuers like a county or a state. These bond funds pass through the tax free advantages that accompany "muni" bonds.
The second type are corporate bond funds - these funds specialize in bonds issued by corporations and thus do often carry a higher level of risk than some of the government type bonds.
Third are the mortgage-backed securities funds (quite self-explanatory here), high-yield bond funds - those that are not for the risk adverse investor, in that they purposely look for bonds that are risky and as incentive offer a higher return than most other bonds will, and last the U.S. government bond funds.
These five types of bond funds give you a wide variety to choose from and you will find they offer such a choice of characteristics and advantages that somewhere in the field you can be pretty sure one or more of them will usually meet 95 percent of your investment needs in the bond fund area.
[Editor's Note:The 99 stocks you need to dump in 2007 . . . and the 10 to buy! Get our free report today.[
PART 3 - Basic factors to consider when looking for a bond fund
First, the preservation of capital should be the major risk consideration when investing in any type of bonds. The same holds true for bond funds. However, unless they specifically state it, you will seldom find any bond funds offering to preserve your base investment principal.
The problem is simple. They are constantly buying and selling bonds in their fund and will take gains AND losses as they do. In good markets they make money. In bad markets, they lose money. It is the bad market that bites the investor in the hand.
With bond funds you want to look at their past history to see if they are maybe too aggressive with their trading activities or whether they have shown restraint and principal has generally done better than other more aggressively traded funds.
Second, look carefully and compare the costs charged to your account monthly or yearly by the managers of the fund. About 0.75 percent is a reasonable average to use as a guide post. Also, check to see if there are any more "quiet" charges, such as withdrawal charges if you exit the fund before a certain time has elapsed.
Check to see if there is a "front-end" charge to enter the fund. And check to see if there are any charges based on performance - a part of your profit being paid to their fund managers. This last item is not a very often seen one, but check for it anyway.
Third, be aware that you will be paying capital gains taxes on the sale of your bond funds if you make a profit. And any capital gains made by the fund in its steady buying and selling of bonds will still require that you pay additional taxes on the capital gains they "pass-through" to you.
Last, check to see how often the fund is "turning over" its portfolio. This means if the average fund value for the year (starting value + ending value divided by 2) is $2 million and the total activity of selling and buying is $4 million, the "turnover" was 2.
A low turnover rate often means a more conservative fund manager. A higher rate generally means a manager that is much more aggressive and your principal may be more at risk.
Now, I don't want you to think that these are the only factors to look for, but if your needs are in sync with the above four considerations, 85 percent of the time you will likely find yourself happy with the fund.
But, just so you know, here are a few the other kinds of risks that might affect your fund
1) Foreign exchange rates
(2) Interest rate volatility,
(3) Credit t market shifts,
(4) Liquidity of certain markets invested in,
(5) Leverage risk possibilities, and the ever present
(6) Management change risks
[Editor's Note:Buffett, Soros, Templeton, Rogers: Learn Their Money-Making Secrets]
See, I told you that there are a lot of factors to think about. But, again, most of the latter factors are not usually going to affect your buy/sell decision about a fund.
PART 4 - Locating bond funds.
This primarily involves using the internet, unless you opt for the public library and its business section. My experience is that the public library will require a lot more time, as you will need to sort through many books to narrow down your choices.
I suggest that you go to web sites like Morningstar.com, mutualfunds.com, sec.gov, smartmoney.com, or any one of the many "brand name" fund sites (Fidelity, T Rowe Price, Vanguard, etc.) Any one of these sites will help you begin your search for candidates that will meet your needs.
Some will have what are called "screens" that let you fill in answers to a number of questions about what kind of fund you want. Then, based on your group of answers, they will give you a list of funds that meet all the criteria you set.
Well, that about does it for today. I trust that the material presented today will help you answer the four questions we posed at the beginning. If not, and you still want more information, email me at NewsMax and I will be glad to try and answer your specific question (that is unless I get a waterfall of questions, in which case it may take more than a day or two to get back to you!).
So, I do hope you have a good investment week coming up. And, as ever, you keep in touch. I do! See you next week.
Editor's note:
5 highest yielding, safest investments for 2007
The 99 stocks you need to dump in 2007 . . . and the 10 to buy! Get our free report today.
Buffett, Soros, Templeton, Rogers: Learn Their Money-Making Secrets
High blood pressure kills . . . Cure It! Click Here
Doctor Reveals `Fat Burner` Supplement - Go Here Now
Stop believing the cholesterol myth – Click Here
