Beachside Resident #9 Fixed Income (Bonds)

Last, but not least of our asset classes is Fixed Income. Before interest rates started stinking up the place after falling to near zero, fixed income products were popular with seniors as a safe and steady source of income. As with most investments, they go by many names but bottom line, we’re talking about debt. If you buy a bond, you’re loaning someone money.

A corporate bond is a loan to that corporation and any risk is based on that company’s ability to pay the interest and eventually repay the principle. A Treasury bond is a loan to our government and is about as risk free as you can get depending on how you feel about our country. Local governments can issue municipal bonds and these come with special tax benefits. Check with a tax specialist for specifics.

There’s a direct, inverse relationship between interest rates and bonds. For example, if you have a bond that yields 2% and interest rates start to climb, your bond will lose value. When other bonds are yielding 4%, your bond will look like a Yugo with three flat tires and no engine. You might resolve to hold it until maturity just to get your investment back.

When interest rates go back up (and they will), that’s the best time to buy bonds. Then, when interest rates start to come back down (and they will), your bond will increase in value in addition to all the juicy interest you earn while holding it.

Commissions to buy a bond are buried in the price. I’ll explain further on the website. As with anything else, the discount broker can sell you the same bond for less but they won’t hold your hand.

Is there a caboose to this train of thought? Yes. Don’t buy bonds right now unless you’re prepared to hold it for the duration which could be as much as 30 years.

With interest rates on the rise, consider a bond ladder if you build a bond portfolio. This is nothing more than a series of bonds with different maturities. Instead of locking in one rate for 30 years, they will mature at different times and hopefully yield better returns as interest rates rise. The two benefits are diversification and no market risk so long as you hold until maturity.

In other news, let’s talk to our elected peeps about fixing the Indian River before it’s too late. Maybe get a little crazy and talk common sense water management.

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Beachside Resident #8 Index Funds

In the January issue, we used index funds to build a portfolio but never really defined what that means. Let’s do that now.

A common question from the beginning of time has been “How’d the market do today?” Originally, the answer was “How the hell would I know?” Then someone came up with the idea of an index or, a number of stocks that when grouped together might represent the market. Some early examples are the Dow Jones Industrials or the Dow Jones Transports, etc. Standard and Poor’s got into the mix with the S&P 500 index. It covered most of the market by using the 500 largest companies in America. Today there are hundreds of indexes covering everything.

Before, during or after this time, another bright idea was to group different stocks together to create an easier way to invest and mutual funds were born. A mutual fund can consist of stocks, bonds, options or just about anything.

It was only a matter of time before someone stuck their chocolate into someone else’s peanut butter and voila! Index Mutual Funds.

Exchange Traded Funds (ETFs) soon followed offering an alternative to Mutual Funds. Either one will work when building a portfolio. The web site listed below will provide more detail if you’re not sure which one is best for you.

The bottom line is watch out for expenses. If your mutual fund is a “loaded fund”, that’s a fee paid to your advisor. Some are paid when you buy, some when you sell and some bleed you out for the duration that you hold it. “No Load” mutual funds are what to ask for and demand from your broker. They’re very common. Both kinds of funds will have annual fees called an Annual Expense Ratio. The smaller the better.

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Beachside Resident #8 Mutual Funds Supplemental

In the January issue, we built a portfolio using index funds but did not stop to explain. For our purposes, a fund is a collection of investments. They come in a variety of styles but we will focus on the two most common: open end mutual funds and exchange traded funds (ETFs). An index fund is one that invests in the same components of an index, like the S&P 500 for example.

Let’s set ETFs aside for now and look at mutual funds. A mutual fund is a pool of money that is managed by a fund manager. Shares of the fund are bought directly from the fund. When sold, they’re sold directly back to the fund. The shares are valued every day at the close based on the investments held to determine the price per share. The share price is called NAV or Net Asset Value. This is the price the shares can be sold for. It the fund is a no load fund, they can be bought for that same price. If a fund has a load (commission), it will show a POP price. Discount brokers will say there’s no statistical evidence that paying the load leads to better results so why pay the fee? Advisors who sell loaded funds will have a different story.

All funds will have an annual charge that’s used to pay management fees called an expense ratio. A fund’s focus is supposed to be evident in its name. If a fund is managed to play the market it will have higher fees. Sometimes these funds beat the indices and sometimes they don’t. Comparing their return of the last 5 and 10 years is a good indication but doesn’t guarantee anything. One of the advantages of using index funds is the lower fees. Index funds won’t outperform or underperform the market. They are the market.

For the portfolio we built, the index funds are easy and straight forward. The name of the fund should clearly describe its focus. For the more adventurous, managed funds come in a variety of flavors that can focus on a specific industry and/or theme. Some funds will use derivatives to magnify the markets. Stick with the index funds. They’ll get you there with much less drama.

Market risk is everywhere. It can be diluted with diversification.

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