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Update on Time Out of the Market

Nov 19th, 2010

paintbox by Zixii As an update to the article I wrote last month about the Cost or Benefit of Time Out of the Market, as promised I went back and ran the numbers for all the S&P 500 data that I could locate, starting in January, 1871. This information is taken from an ongoing study by Robert Schiller for his book “Irrational Exuberance”, and since the S&P 500 index hasn’t actually been around for that whole time, the earlier numbers are an approximation of the index.

So anyhow, I looked at both five-year and ten-year data for a buy-and-hold strategy and the same periods for our momentum strategy (discussed in the earlier article).

In the buy-and-hold strategy, in the average five year period the return averaged approximately 6% per year, an aggregate of 31.49%, and for the ten-year periods, the average was a little higher, at just over 7¼%, for a total return of 72.60%. Using the momentum strategy, these numbers increased for each period on average, to over 8% (42.49% total) and more than 10½% (105.38% total).

In the buy-and-hold tests, this strategy resulted in a positive (greater than zero) return in 68.34% of the five-year periods, and 75.76% of the ten-year periods. By comparison, in the momentum tests, the results were even better: 94% positive returns in the five-year periods, 99.61% in the ten-year periods.

This is good information, but what about comparing the two strategies in terms of how often one is better than the other? Not as often as you might think, given the results we see in the other categories: 67.90% of the time in the five-year tests the momentum strategy came up with a better result, and 69.62% of the time in the ten-year tests.

So, in roughly 7 out of 10 circumstances, you could be better off with the momentum strategy… when does the momentum strategy not work? That is, when does a buy-and-hold strategy pay off better than the momentum strategy?

There are a few sustained examples (just using the 10-year periods, for brevity) where a buy-and-hold strategy gives a better result than the momentum strategy. Those are the ten-year periods ending during these dates:

March, 1952 to May, 1966
August, 1967 to April, 1970
April, 1980 to May, 2002

If you don’t recognize these periods, these were the most rampant economic expansion timeframes that our market experienced over the past 140 years. During these periods, the average monthly return on the S&P 500 was 0.66%, while the 140 year average was only 0.42%. The aggregate return of the buy-and-hold strategy during these periods averaged 129.54% for each 10-year period, while the momentum strategy only returned an average of 109.54%, losing 2% for each year in the ten-year period.

So, the conclusion is that, while this is an interesting strategy, it’s not fool-proof. If you’re looking only to have a positive return on your 10-year investing horizon, the momentum strategy seems to be almost waterproof on that score. Just keep in mind that, as I mentioned previously, this strategy requires the utmost of discipline to the task – missing a few days here and there can derail the strategy altogether. It might be interesting (if you’re so inclined) to use this momentum strategy on a small portion of your portfolio – but as I’ve mentioned before, you can certainly do much worse than following the buy-and-hold strategy.

I’ll keep doing the research on this (since I never met a spreadsheet I didn’t love!), most likely adding in analysis of the P/E ratios and any other pertinent information that I can track. I’ll keep you posted!

Photo by Zixii

The Cost or Benefit of Time Out of the Market

Oct 18th, 2010

by jblankenship.

2 comments

evolution of vans by Spencer C. Curtis I don’t know if you’ve ever heard it before, but there have been studies done with the intent to help folks realize the benefit of remaining invested in the market… with the outcome being if you missed the ten best days of the market’s returns over a particular period of time, your overall results are significantly diminished.

I’ve always been intrigued by the concept of these studies, so I decided to undertake a similar study of my own, using a few different circumstances in order to hopefully reflect what might happen in real life.

The Study

I used S&P 500 data to represent the stock market, and for the sake of better understanding and applicability to the present, I have limited the data used to the time period of January 1990 to present. In order to better represent what most folks would do in real life, I used monthly results, rather than daily – because I figure that most folks, if they change a position (i.e., sell out of stocks, for example), most likely they would not jump right back into the same position the next day. I figured 30 days was a little more realistic of a timeline for making changes to your holdings.

Also, I did not include dividends in the analysis, although these can be a significant part of your returns. It was much simpler to work with the actual returns, rather than try to estimate when dividends might be paid and whether or not you were currently invested at that time. I figure the results would be very similar, either way.

Lastly, transaction fees and taxes have not been factored in to these calculations. Depending upon the circumstances these two factors can have a drag on your results – but taxes won’t come into play in an IRA, for example, plus transaction fees may not apply to your case. In addition, if you’re working with traditional mutual funds, sometimes there are repercussions to changing your position frequently – such as holding periods. These have also not been factored into the results.

Results

For the long-term benchmark, I assumed that the investor made an investment in January 1990, and left it alone until the end of September, 2010. If you did this, you would have seen a total return of 230.05% – that’s a simple average of 11.5% per year. Now we’ll start making some assumptions to change things up a bit.

What happens if we got out of the market for just one month during that twenty year period? If we did this and happened, just by chance, to miss the month during that period with the best return of all of them, we’d have reduced our overall return to 194.63%. The month was April 2009, if you wondered, and the return was 12.02% for that month.

On the other hand, what if we were extremely lucky and missed the very worst month during the period? (October 2008, at -20.39%, in case you were wondering.) That would result in an overall result of 314.59%, or an average annual increase of more than 4%! But how in the world can you guess that you’ve got the right month? The very best month and the very worst month in 20 years were only six months apart…

Here’s another option to consider: what if you took two months out of the market during the 20 year period? If it was the best two months that you missed, you’d drop your overall return to 164.73% (the second-best month during the 20 years was February of 1991). But if your timing was immaculate and you skipped the two months in the 20 year period with the worst possible returns, you’d boost your results to 367.72% (the second worst month was September 2009).

Lastly, I took the data and calculated what would happen if you had the worst luck of all and missed the 10 best months during the 20 years studied… your result would be a paltry 46.45%, only 2.32% per year. On the other hand, if you had near-perfect timing and happened to miss out on the ten worst months of the period – you’d have pulled down a total return of 816.90%, a yearly average of 40.85%!! Clearly it would benefit you to have a crystal ball.

Add In Human Nature…

Since one month is a very short period of time, I took the same data and calculated what would happen if you not only missed the months in question, but then you also delayed an extra month before getting back in the market. Here are the results under those circumstances:

Missed best month and the month following: 176.92%
Missed best two months and the months following: 142.11%
Missed best ten months and the months following: 25.06%
Missed worst month and the month following: 354.85%
Missed worst two months and the months following: 397.91%
Missed worst ten months and the months following: 943.74%

Clearly, once again, it pays to have had a degree of clairvoyance working in your favor. But obviously you can’t plan to have this kind of timing – so far I think we’ve learned that staying the course has benefits. Although it would be pretty cool if you had hindsight working in your favor and could miss all those bad months, the likelihood of hitting it just right is pretty low.

What About Reacting?

So – since we don’t have a crystal ball available to us, what’s the next most obvious way to handle things? Reacting, of course. So I took the same data and ran the calculations based upon those same months, only instead of missing the best or worst, you missed only the month following the best or worst months, in reaction to the prior months’ results. Here’s how that turns out:

Missed the month after the best month: 210.21%
Missed the months after the best two months: 201.86%
Missed the months after the best ten months: 164.90%
Missed the month after the worst month: 262.10%
Missed the months after the worst two months: 251.36%
Missed the months after the worst ten months: 312.20%

This shows us that there may be some benefit to be had by taking the reactionary stance – for the worst ten months example, you’d have improved your overall return by over 80% for the period, more than 4% per year. But how would you know if you were choosing the right 10 months to react to?

The other thing that this shows us is that reacting to a positive result by locking in your returns and standing pat doesn’t help – I suspect that the momentum of the market is working for both cases. This means that, if the market is on the rise, more often than not, it will continue to rise in the following month, and vice versa.

Practical Application

Since we don’t know for sure what the best and worst months will be in advance, what if we used the prior month’s return against a benchmark result and then reacted by getting out of the market for the following month?

On the upside, once again, locking in your positive results in any month with better than a 4% return (an arbitrary number that I chose), you’d wind up with a result less than half (at 111%) of what you’d have gotten by just buying the market and staying in it for the full period (which was 230%). There were 32 months in the 20 year period that met this criteria.

The market momentum once again works its magic (at least with the data I used). If you chose to get out of the market on the first day of any month following a downside month (of which there were 97 in the period studied), you would have wound up with an overall result of 355.93%. This is a good thing! By putting this easily-understood method into play, your overall results increased by better than 6% per year.

Keep in mind that the study only covered the previous 20 years – a relatively small period of time, with some pretty dramatic results, both positive and negative. I’m going to do some further study on the historical data and I’ll let you know more about those results after I’ve done that analysis.

Even with that fact in mind, I think this might be a useful tactic to consider putting into place. I still think that the core of your portfolio should be left in place for the long term – especially with your well-balanced portfolio. But it could work in your favor to put such a plan into place for a small portion of your portfolio, such as maybe 10-20% of your domestic stock holdings. The critically important fact here is that for this to work you have to stay disciplined and make your moves at the correct times. Otherwise this won’t work.

And if you don’t want to hassle with this kind of manipulation, it’s still pretty clear that you can definitely do worse than the long-term hold tactic, which is the simple, tried and true way to handle your portfolio.

Photo by Spencer C. Curtis

The Truth About Health-Care Reform

Sep 20th, 2010

by jblankenship.

1 comment

Income tax The health-care reform legislation that passed earlier this year was incredibly broad in scope, so it’s probably not surprising that there’s a good deal of confusion, and a number of false or misleading claims being circulated. Here’s the truth behind two of the claims that have gained the most traction lately.

Tax on Health Insurance

The claim: Beginning in 2011, you’ll be taxed on the value of your employer-provided health insurance.

There are several email campaigns making their way around right now claiming that, beginning in 2011, taxable income on Forms W-2 will be increased to reflect the value of employer-provided health insurance. A typical email warns: “You will be required to pay taxes on a large sum of money that you have never seen. Take your last tax form and see what $15,000 or $20,000 additional gross income does to your tax debt. That’s what you’ll pay next year. for many it also puts you into a new higher bracket so it’s even worse. This is how the government is going to buy insurance for the 15% who don’t have insurance and it’s only part of the tax increases.”

The facts: While it’s true that, beginning in 2011, the health-care reform legislation requires employers to begin reporting the cost of employer-provided health-care coverage on an employee’s Form W-2, the cost is included for informational purposes only, to show employees the value of their health-care benefits. The amount reported is not included in income, and will not affect your tax liability.

Sales Tax on Real Estate

The claim: Beginning in 2013, a new federal sales tax will apply to the sale of a home.

The claim is that, beginning in 2013, all real estate sales will be subject to a new 3.8% federal sales tax. The emails making this claim generally contain some variation of the following text: “Under the new health-care bill – did you know that all real estate transactions are now subject to a 3.8% sales tax? The bulk of these new taxes don’t kick in until 2013… if you sell your $400,000 home, there will be a $15,200 tax.”

The facts: This claim, though inaccurate, has a basis in fact. There is no federal sales tax being imposed on the sale of homes. But, beginning in 2013, the health-care reform legislation does impose a new 3.8% Medicare contribution tax on the net investment income of high-income taxpayers (individuals with adjusted gross income (AGI) exceeding $200,000, and married couples filing joint returns with AGI exceeding $250,000). Net investment income will include only gain on the sale of a home. However, the tax will not apply to any gain that is excludable from income. Individuals, if they qualify, can generally exclude the first $250,000 in gain on the sale of a principal residence, while married couples filing jointly can generally exclude up to $500,000. That means that in most cases, at least where a principal residence is concerned, the 3.8% tax would kick in only if your AGI exceeds the threshold above and only if profit on the sale of the home exceeds $250,000 ($500,000 for couples filing jointly).

In Closing

These two claims are good examples of how things can get out of hand when the complete facts aren’t fully understood. The only way to completely understand what’s going on with the new law is to educate yourself – and to use trusted sources when educating yourself. It’s important to know that not all emails and internet articles are to be fully trusted. Know the source of the communication – and make sure that it’s someone you can trust to give you the complete picture. And if you want to get a second opinion on something you’ve read, just let me know. I’ll be happy to help out, as always.

Photo by alancleaver_2000

The 2010 Roth Conversion Opportunity

by jblankenship.

4 comments

opportunity knocks by Watt_Dabney Time is swiftly running out to take advantage of the unique opportunity for deferral of tax payments on Roth IRA Conversions in 2010. In case you’re not up-to-snuff on this, in 2010 all taxpayers with traditional IRAs or qualified retirement plans that are eligible for rollover have the opportunity to convert the account (or part of the account) to a Roth IRA – and perhaps delay payment of the tax on the conversion to the following two years. In addition, beginning in 2010 all individuals, regardless of income, can enact a Roth Conversion – whereas in the past there was an income limit on these conversions.

You have until December 31, 2010 to enact a conversion to take advantage of this unique, once-in-a-lifetime opportunity to defer taxes to 2011 and 2012. This not to say that a Roth IRA Conversion makes sense in all cases… many times it is a poor choice, but in lots of cases it makes a lot of sense. It all comes down to several questions.

The Questions

Tax rates now versus later. Since a Roth IRA Conversion subjects your tax-deferred funds to taxation today (or at best next year and the year following), determination of the effective tax rate on your conversion versus the planned payout many years later is an important factor. If it is determined that the tax rate today is lower than you expect the rate to be in the future, then of course it would make sense to convert the IRA to a Roth now. Then in the future, when the tax rates are higher, your Roth IRA funds will not be taxed.

But it’s not always so cut-and-dried – and specifically it is often the case that tax rates are not going to be lower in your retirement years. But that doesn’t shut the door on Roth Conversion.

Source of funds to pay conversion taxes. One of the key items to address in a Roth Conversion is where you’ll get the money to pay the taxes. When you convert funds from an IRA to a Roth, you must pay tax on the money that was taxable in the IRA. If you have money from another source that you can use to pay the taxes, you’ll keep the converted funds that you deferred over time intact, rather than depleting the funds to pay tax. Plus, if you’re under age 59½ you’ll also incur a 10% penalty on any funds that you take out of the account to pay tax.

But even if you don’t have funds from elsewhere to use for tax payment, you can still benefit from a Roth Conversion…

Deferral period after conversion. Whenever you plan to use the funds in the account (converted or left where it is in the IRA), will make a big difference in whether a conversion will pay off for you. If you will need the funds immediately after the conversion or after a short period of time, your Roth account will not be able to grow enough tax-free to make up for the tax you had to pay on the conversion.

If, however, you are able to delay your need for the funds until later (even just a few years), it could pay off to do the conversion.

Putting it all together

All of these factors for your unique situation must be put together in order to determine if a Roth Conversion will work for you. And the good news is that you can work out details on a conversion that might make sense for you later (after 2010), since the rule about income limitation has been lifted indefinitely (at least under current tax law).

But the question now is whether or not the Roth Conversion with the extra tax payment deferral is advantageous to you, in 2010. It is, as you might have guessed, a complicated undertaking to fully understand the questions and how they might impact you. If you need assistance in working through these questions – you can always give me a call. I’ll be happy to help you work through the decisions to understand if it makes sense to put a conversion into play this year or not.

Photo by Watt_Dabney

The Lost Decade and What it Means

Jun 15th, 2010

by jblankenship.

1 comment

last decade of 1st century bc by Maulleigh By now you’ve likely heard plenty about the “lost decade” in the stock market: On January 3, 2000, the S&P 500 index closed the day at 1,455.22, and on May 28, 2010, the index closed at 1,089.41 – for a negative return on the nearly 10 1/2 years… I’m sure you’ve noticed in your investment statements.

But what does this mean? There are plenty of folks out there (in the mass media) who will tell you that stock market investing is no longer a wise move… why, after all, if you’d had your money in a savings account you’d have done better! So does this mean it’s time to chuck all of your stock investments and switch everything to bonds? Of course not.

Remember, it’s long term

No matter who you are as an investor, if you expect to achieve any return above inflation, you have to include equities (stocks) in your portfolio to some extent. And when developing portfolio allocations, pretty much anyone under age 70 should be considering a time horizon of 30 years or more – and those over age 70 should be thinking similarly, since your chance of living to age 95+ is continuing to increase every year.

What I mean by this long-term view is that you need to stop thinking about stocks in a day-to-day, quarter-to-quarter, year-to-year or even decade-to-decade context, but rather in the context of thirty, forty, fifty and more years. A college graduate, just starting a new job this year and investing in a sparkly-new 401(k) may likely be continuing to take distributions from that 401(k) in the year 2080, for example. Even if you’re retiring this year at age 62 – you may still have 30 or more years of investment activity ahead of you.

Think about all that has happened in our history over the past 30, 40, 50, 60, and 70 years – 70 years ago we were still over 18 months away from Pearl Harbor and the US entry into World War II. We’re talking about a significant amount of history that has occurred – and a likewise significant amount of returns that stocks have provided over that time.

So let’s look at the numbers for the S&P 500 more closely:

	Decade Annualized Return	30-year Annualized Return	70-year Annualized Return
1870′s	10.90%	8.16%	6.81%
1880′s	8.31%	7.20%	5.80%
1890′s	5.21%	3.59%	6.88%
1900′s	7.63%	7.09%	6.85%
1910′s	(1.84%)	5.27%	5.54%
1920′s	16.78%	7.20%	7.53%
1930′s	1.88%	7.12%	7.23%
1940′s	3.36%	8.24%	6.44%
1950′s	16.45%	6.44%
1960′s	5.30%	5.02%
1970′s	(1.34%)	8.09%
1980′s	11.48%	7.35%
1990′s	15.14%
2000′s	(3.16%)
Average	6.86%	6.73%	6.64%

* These annualized numbers are inflation-adjusted and include re-invested dividends

Notice how the numbers fluctuate pretty wildly among the 10-year periods, but begin to calm down as you look at the longer-term time horizons. While there is nearly a 20% differential between the best and worst 10-year periods, when you look at the 30-year periods the differential is less than 4.75%, and over the 70-year periods the differential is even less: only 2% separates the best period from the worst.

So, while you may have an off decade or two in your overall investing experience, in the long term you’re likely to approach the average return, as long as you keep your head and remain vigilant with your investment allocation in good times and bad.

Why A Decade?

The other thing about this “lost decade” business that bothers me is that it’s an arbitrarily-chosen timeframe – why do we only want to measure in terms of an exact decade? What if we started these periods in March of the years ending with 3?

	10-year Annualized Return	30-year Annualized Return	70-year Annualized Return
3/1/1873	10.39%	8.49%	6.22%
3/1/1883	6.91%	6.36%	6.19%
3/1/1893	8.14%	4.51%	7.00%
3/1/1903	4.29%	3.37%	6.62%
3/1/1913	1.45%	4.73%	5.84%
3/1/1923	4.40%	7.66%	7.23%
3/1/1933	7.44%	10.38%	8.21%
3/1/1943	10.22%	9.34%
3/1/1953	12.64%	5.45%
3/1/1963	5.43%	5.11%
3/1/1973	(0.89%)	5.38%
3/1/1983	11.05%
3/1/1993	5.82%
3/1/2003	4.59%
Average	6.56%	6.43%	6.76%

* These annualized numbers are inflation-adjusted and include re-invested dividends

As you can see, within reason, these periods averaged out very similar when compared to the exact decades, but the differential between the best and worst decades was much different (this would be referred to as the “deviation” of the returns). And as we noted in the first table, as the time horizon increases, the deviation reduces to very near the average for that timeframe.

So, don’t get hung up on an arbitrary measure such as this to begin with. Recent history has a very poor track record for predicting the future (in short term views, especially) – remember how heady the market was after the 1980′s and 1990′s dramatic returns? No fool would have suggested that you shouldn’t be in stocks at the turn of the millennium – but look at what has happened since then. Same thing goes for the end of the 1970′s – stocks looked like a terrible place to be, but then along came the bull markets of the 1980′s and 1990′s.

Taking another view – when there’s a downswing in the markets, when you’re in the position of continual investing, you’re actually getting more shares for your money than in the upswing periods. In the long run this gives you a much better footing than a single lump sum invested at (perhaps) the wrong time.

The Point

The point of all this is that if you have a long-term horizon (and we all do, to some degree) and you hope to earn something more than the level of inflation, stocks are your best bet. And holding your properly-diversified portfolio of stocks through thick and thin is the best method for investing in the market – lost decade or not. Because in the long run, stocks are most likely to return their historical long run average – which is much better than any other alternative investment out there.

Photo by Maulleigh

Financial Checkups – Have You Had Yours Lately?

May 15th, 2010

by jblankenship.

No comments yet

checkup Many of us are diligent about maintaining the “stuff” in our lives… we get regular oil changes in our cars (and have the tires rotated when we think of it), we try to make it to the dentist regularly, and we have the annual inspection of our furnace/air conditioner. But one aspect of our lives sometimes doesn’t get the attention that it really needs: our financial plans.

For lots of folks, we’d almost rather spend time in the dentist chair than gather all of those statements together, along with our previous plans (if we have any), and do a thorough review of where we are, where we’re headed, and if we’re on track for our goals – retirement being the goal of foremost importance to most. Yes, we may have gone to a financial planner and talked over our financial situation, then implemented well… some of the recommendations. After that, we put the plan documents on the shelf and have pretty much forgotten about it.

Things Change

As time passes by, things have a tendency to change – and that change is likely to have rendered your financial plans (you do have a plan, right?) hopelessly out of date. Remember how your financial planner pointed out that the plans you discussed were only a “point in time” review? And how the projections and recommendations would only be good for a short period of time?

Perhaps you’ve changed jobs, had a new addition to your family, or moved to a new home. All of these things will have had an impact on your financial situation, for sure. Have you gone back and reviewed your plans to include the changes? Have you adjusted your insurance coverage to account for the new child? Have you rolled over the 401(k) plan from your old employer? These are all things that you need to do to maintain your financial life.

Maybe you’re thinking about putting into motion that Roth IRA conversion plan that you and your planner discussed a couple of years ago. Some of the tax laws have changed since then, have you factored that into your plan?

Final Thoughts

I’m not saying you need to camp out on your financial planner’s doorstep any time something changes – many folks get along just fine in a “do it yourself” mode. But if you’ve (wisely) chosen to utilize the services of a financial planner in the past and it’s been more than a couple of years – it would likely be well worth the effort to get back together and do a review. This is especially true if you’ve had any major changes in your life, such as retirement or changes to your family.

And if you don’t already have a working relationship with a Fee-Only financial planner, you can always find one at the National Association of Personal Financial Advisors’ website, or the Garrett Planning Network’s website. Both websites feature “Find a Planner” maps that can help you to locate an advisor to work with. And of course you could always just give me a call if you like.

The point is that it makes sense to update your planning information – even if that just means developing a spreadsheet and tracking your savings, debt reduction, spending habits, and goals. Without regular “checkups”, things can go awry for you without your knowing about it – and waiting too long between checkups can make small problems much larger that necessary. So do yourself a favor and get a checkup!

Photo by Wikipedia

Economic Indicators – What’s Important to Watch?

Apr 16th, 2010

by jblankenship.

4 comments

2CARU plan position indicator by kenhodge13 You see them on the news, in the newspaper, on the internet. Not every day, but certainly it seems like a new one every week: Key Economic Indicators. There’s the CPI, GDP, and Unemployment. There’s also the Consumer Confidence Index and Leading Economic Index. What’s this all about? What do these numbers mean? And most importantly, which ones should we pay attention to?

Below I’ve listed several of the more important economic indicators and what makes up the indicator, along with my commentary on what the indicator may tell us. If I’ve left out any of your favorites, let me know!

Key Economic Indicators

Gross Domestic Product (GDP) – this is the value of all goods and services produced in the United States, minus the value of imported goods and services. This broad measure of economic health shows the quarter-by-quarter growth or shrinkage of the US economic output. Comparisons are most often made between the current figure and the previous quarter and year. These numbers are reported quarterly, and are revised in following months as more complete data is gathered.

The main number that you’ll see referenced is the “real” GDP or “real” GDP growth – meaning that the numbers are inflation-adjusted to a reference point (these days the reference is to the year 2005). In other words, real GDP growth for a year is based upon the GDP figure from the previous year to the most current figure, with inflation factored in. For the most recent quarter reported, you can go to the website of the Bureau of Economic Analysis.

As you might expect, it’s a positive sign to see the real GDP growing. In the past year though, GDP has reduced, which is why our current economic cycle has technically been called a recession. A recession is defined as two quarters of decline in GDP, amounting to less than a 10% decline. If the decline is 10% or more, the economic cycle is technically a depression. From the second quarter of 2008 to the second quarter of 2009, we saw four quarters of GDP decline in a row, amounting to a total decline of 9.6% – close to a depression, but no cigar. Since that point, we’ve seen two quarters of GDP growth through the fourth quarter of 2009 (most recent data as of this writing).

Although this is an important number to understand what has happened in our economy – because it can help explain the real outcome economic activity – it’s usefulness is limited since it is reported so long after the fact. Knowledge of this index is helpful in your decision-making process, but you need more information to make good decisions about your investments.

Consumer Price Index (CPI) – this index, which is based upon the cost of a basket of consumer goods and services such as housing, transportation, food, energy and clothing, is a good measure of inflation within our economy. The current figure, reported monthly and adjusted as more data becomes available, is compared to the previous month, quarter, and year (typically) to determine the rate of increase in the costs of these items to the consumer. This particular index is used to develop cost-of-living adjustments (COLAs) for things like Social Security benefits.

As you might expect, we would always like to see this index increasing at a controlled pace – annually in the 3% to 4% range is considered “normal” – since increasing costs of goods and services presumably indicates that the overall economy is growing. Put differently, if the consumer is willing and capable of paying an increased cost for a basket of goods and services, then the economy has grown, providing the consumer with additional funds to pay the increased cost. It’s not a perfect way to measure economic growth, but it’s what we have.

In the past year, for example, we’ve seen an annual inflation increase (as evidenced by CPI) of roughly 1.8% through February of 2010 (most recent data as of this writing). Annual inflation from 1980 to the present has ranged from 10.3% to -0.37%, and has averaged 3.37%. You can view the most recent data at the Bureau of Labor Statistics Consumer Price Index site.

As with the GDP growth discussed above, CPI is interesting to understand general overall increases in inflation and very important in determining COLAs, but being a historical piece of data that lags in reporting by months, it really doesn’t help us much as we plan for the future. CPI does give us indication of what inflation we’ve experienced in the past so that we can estimate future inflation, but as always, the past doesn’t necessarily predict the future.

toe art by VinothChandar(AWAY) Consumer Confidence Index – this is a survey of 5000 consumers regarding their attitudes concerning the present economic situation and expectations for the economy going forward. This report can be helpful to understand how the current economy is affecting the point of view of “everyman” – and it often is an insightful prediction of the direction of the economy.

The Consumer Confidence Index’s month-to-month changes are the most important viewpoint to consider: any time there is an increase or decrease of 5 points or more, it’s worth noting. The amount of the change isn’t as important as the direction of the change, as a significant change in either direction often denotes a trend for the overall economy in that particular direction. You can view the most recent information on the Conference Board’s Consumer Confidence Index website.

Producer Price Index (PPI) – this index is pretty much the same as the CPI, except that the pricing is taken at the wholesale, or producer level, rather than at the retail level. This index, especially the core PPI (made up of food and energy prices alone) is a useful indicator of future increases in the CPI. The Bureau of Labor Statistics also maintains the Producer Price Index.

Leading Economic Index (LEI) – while not a perfect prediction of the future, the LEI gives us a forward-looking view of economic activity. This index is made up of 10 separate components:

Average weekly hours (manufacturing sector)
Average weekly jobless claims for unemployment insurance
Manufacturer’s new orders for consumer goods and materials
Vendor performance (slow delivery diffusion index)
Manufacturer’s new orders for non-defense capital goods
Building permits for new private housing units
S&P 500 stock index
Money Supply (M2)
Interest rate spread (10-year Treasury vs. Federal Funds target)
Index of consumer expectations

With all of these factors compiled, this index gives a somewhat reliable forecast, especially of recessionary periods, but as I mentioned earlier, it’s not without fault. The index often gives a false signal of recession just prior to an economic upswing, and so should not be utilized alone as your determinant of future economic activity. You can see the LEI and its components at the Conference Board’s Leading Economic Index website.

What’s very interesting is to review the LEI’s activity as a composite index, and then take a look at the activity of the underlying components. If the entire index is indicating a downturn (legend has it that three consecutive months of downturn foretell a recession, but this is the false signal referred to above, as well), then review the data for all of the underlying components. If there is a broad-based downturn noted by all (or most) of the components, chances are the indication of future economic downturn is real.

Beige Book – anecdotal information on general economic conditions is gathered by each District of the Federal Reserve System and then combined into this report. The Federal Open Market Committee (FOMC) uses this information, along with other economic indicators, to help make decisions regarding the rate of Federal Funds, which often drives changes to rates across the overall marketplace.

While this data may not make a difference in your own investment decisions, it’s helpful to see the information that the Fed is using to make their decisions – although it’s not always readily apparent why they’ve made one decision or another, even seeing the Beige Book information. You can view the Beige Book at the Federal Reserve website.

Unemployment Rate – pretty much self-explanatory, the unemployment rate is the percentage of potential workers in our economy who are not currently employed. This factor is also a useful gauge of the overall health of the economy, as reductions in the unemployment rate indicates that companies are expanding operations (and payrolls) in preparation for growth. You can see the current Unemployment Rate at the BLS website as well.

Summary

While no single index or economic indicator is the best or most important piece of information, those I’ve presented above are some of the more common and insightful indicators of economic activity. Paying attention to these indicators and their trends over time can be insightful as you make decisions about your financial life. Don’t imagine for an instant that there is a cut-and-dried predicter of the future in all of these – there’s no such thing as a crystal ball. So pay attention, but don’t put all your faith in the numbers…

How about you? Do you have a particular index or indicator that you follow religiously? Tell us all about it in the comments below!

Photo 1 by kenhodge13
Photo 2 by VinothChandar(AWAY)

The Great Recession – What We Did Right

Mar 15th, 2010

by jblankenship.

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recess by earlycj5 The “Great Recession” may have not been officially declared over just yet, but things we’re seeing in the financial world are showing that we’re regaining momentum, or at least solid ground in the markets. We’ve seen the stock market gain more than 60% since the low a year ago, which is remarkable even though we’re still a ways off the peak of 2007.

Now is the time to look back and review our actions during this difficult period – review is useful for us to understand what helped us weather the storm and wind up with positive outcomes. According to some of the things I’ve been seeing and reading, it appears that many folks came through the financial crisis pretty much unscathed.

What We Did Right

We Didn’t Panic – As in most “crisis” situations, it’s a good thing to maintain calm. In this specific crisis, we held true and didn’t make sudden moves to react to the situation. Since we had a well-thought-out plan in place, we stuck to it and, even though we saw our accounts decrease in value – we were able to take advantage of the increases that the stock market provided later.

Good diversification across all asset classes also kept us from feeling the pain that concentrated positions could have caused. We found that investing globally helps to balance out any one country’s problems so that we are able to retain and grow our funds through thick and thin.

We Didn’t Listen to the Pundits – You know that in this information-deluged age we live in, you can get opinions on the financial world at any moment from dozens of talking heads on the TV and internet. At any one time you can find someone telling you to buy the market and another telling you you’re crazy if you don’t sell the market. You did the right thing by recognizing that these folks are entertainers first and foremost. If it’s fantastic and draws attention, they’ll say it – whether it has merit or not.

We Slowed Borrowing and Living On Credit – Recent reports tell us that consumer non-mortgage credit has dropped off during the past year and a half, when compared to mortgage debt. Both figures are still high (more than 10% of income is servicing mortgages, and nearly 6% is spent servicing other credit), but these figures have come down from the all-time highs we saw a few years ago. If what I believe about you, my readers, is true, you are on the much more conservative side of those figures, and you have strived to improve your situation through this crisis when possible.

We Continued Saving – From what I read, it appears that most everyone who is in the position to add to savings and retirement accounts, continued to do so during the financial crisis. According to Vanguard, a high percentage of retirement plan participants (especially younger participants) have higher balances in their accounts now than they had two years previous – at some of the market highs.

As we all know, one of the most important factors of success in a saving and investing plan is to continue with systematic savings in good times and bad. Continuing to save and invest even when all the noise going on around you said that you should stay away from investing has worked and worked well forever. By doing so, you benefited from the dollar-cost-averaging aspect of systematic investing, buying low during the market downturn, and then riding the massive increases we have seen in the market over the past year.

Bottom Line

All in all, we did a good job of recognizing that the markets can’t be controlled, but that we can exercise a degree of control by having a diversified investment plan and by determining that we’ll continue to put aside funds for that eventual sunny day we’re all hoping to see. As I mentioned in a previous article, it’s always good to save 10% to 20% (or more), live within our means, and invest, diversified, for the long term. These few tenets have served us well – in good times, and as we’ve now seen, in bad. Keep up the good work!

Photo by earlycj5

Understanding the 2010 Estate Tax Repeal

Feb 15th, 2010

by jblankenship.

3 comments

The start of a new year often signals a time for change–especially when it comes to taxes, and 2010 has brought some major changes. As of January 1, the federal estate and generation-skipping transfer (GST) taxes are repealed, and the step-up in basis rule is modified for 2010. While it’s possible (and some believe very likely) that Congress will reinstate these taxes, until that time, it’s important to understand these significant federal tax law changes and how they might affect you.

Federal estate tax repeal

In 2009, the top estate tax rate was 45%, and estates received an exclusion of $3.5 million, (meaning that up to $3.5 million of assets were exempt from estate tax). However, as part of the tax cuts initiated in 2001, the estate tax is repealed for 2010 but is scheduled to return in 2011, albeit with a reduced $1 million exclusion and an increased top tax rate of 55%.

It’s possible Congress may reinstate the estate tax retroactively, that is, back to January 1, 2010, in which case heirs who already received their inheritance may have to reimburse the estate to enable it to pay the reinstituted estate tax. On the other hand, heirs who haven’t received their inheritance may have to wait for their gifts until the likely challenges to the constitutionality of instituting the estate tax retroactively have been resolved in the courts. In any case, until these issues have been cleared up, it may be wise for executors and trustees of estates in 2010 to retain sufficient assets in the estate to pay a potential estate tax.

What should you be doing about the estate tax? Review and, if necessary, revise your estate planning documents, like wills and trusts. For example, many wills and trusts drafted with an estate tax in mind leave an amount of assets up to the applicable exclusion amount to children, with the balance going to the surviving spouse. However, in 2010, since there is no estate tax, there also is no exclusion. Depending on how documents are worded, this could create a situation where all of the assets pass to the children with nothing going to the surviving spouse, or vice versa. Thus, it’s important that your estate planning documents be reviewed to ensure that your intentions are actually carried out.

Generation-skipping transfer tax repeal

The generation-skipping transfer tax is a federal tax on transfers of property made, either during life or at death, to an individual who is more than one generation below you, such as your grandchild. The tax, also repealed for 2010, had a $3.5 million exemption in 2009 and a top tax rate of 45%. However, like the estate tax, the GST tax is also scheduled to be reintroduced in 2011, with a $1 million exemption and top tax rate of 55%.

What should you do about the GST tax in 2010? The repeal of the generation-skipping transfer tax in 2010 means the elimination (albeit temporarily) of one of the taxes on gifts made during life. The other applicable tax is the gift tax, which provides a $1 million lifetime exemption and a top tax rate of 35% in 2010. The gift tax rate is scheduled to increase in 2011 to 45%. Thus, assets can be gifted in 2010, either directly or through a trust, to grandchildren and younger generations while accounting only for the gift tax, unless, of course, the GST tax is reinstated, retroactively or otherwise.

Step-up in basis repeal

Along with the 2010 repeal of the estate tax and GST tax is the partial elimination of the step-up in basis rule. In 2009, the tax basis of property in a decedent’s estate was generally increased, or stepped up, to the asset’s fair market value as of the decedent’s date of death. However, in 2010, the cost basis of estate assets is equal to the lesser of the decedent’s adjusted cost basis or the fair market value of the assets on the date of the decedent’s death. This means that estate assets likely will retain the decedent’s cost basis. Absent Congressional action to the contrary, the modification of the step-up in basis rule is temporary, with the full step-up in basis rule scheduled to return in 2011.

The law does allow estates to exempt up to $1.3 million of gain (generally, the difference between the decedent’s cost basis in property and its date-of-death fair market value), which executors and trustees may allocate among estate assets. Also, an additional $3 million of gain may be exempted for assets passing to a surviving spouse. This means that estates in 2010 may be able to increase the cost basis of assets up to $4.3 million.

The modification of step-up in basis can lead to some issues for estate administrators. For example, executors or trustees of estates larger than $1.3 million will have to figure out which assets should receive the step-up in basis. This is especially important for heirs and beneficiaries other than a surviving spouse.

In addition, heirs who want to sell inherited assets not covered by the step-up in basis will have to try to figure out the decedent’s cost basis in order to calculate potential capital gain. For example, assume you inherit shares of XYZ Company stock in 2010. You sell them and now have to determine whether you owe a capital gains tax. First, you need to know if any of the $1.3 million step-up in basis applies to these shares. If your XYZ stock didn’t receive a basis step-up, you’ll have to figure out the cost basis of your inherited stock. Arriving at the cost basis of inherited property may prove difficult, if not impossible, especially if the decedent didn’t keep accurate purchase records, or if the stock split over the years, or if the decedent received some of the stock by gift or inheritance.

What’s next?

Most observers believe Congress will restore these taxes retroactively sometime in 2010. There are a number of proposals under consideration and exactly what plan will be adopted and when are important questions that remain unanswered.

Another potential issue surrounds the constitutionality of Congress reinstating the estate tax and/or GST tax retroactive to January 1, 2010. Congress has imposed taxes retroactively in the past and when challenged, taxpayers have lost the majority of the time. Whether Congressional reinstatement retroactive to January 1 will withstand a challenge is conjecture at this point since Congress has yet to act, but the possibility of reinstatement of either or both taxes further adds to the estate planning conundrum in 2010.

One case that is likely to receive a lot of attention deals with the estate of author J. D. Salinger, who recently passed away. Salinger, author of the classic book The Catcher in the Rye, died in 2010 with the film rights to his book unspoken for – as Salinger repeatedly denied offers from a multitude of Hollywood luminaries to turn the book into a blockbuster. Those rights, plus the purportedly written and unpublished works Salinger left behind, could be worth a huge fortune to his heirs. And with the current limbo of estate tax laws, this situation is likely to become a defining test case for the ages. As Salinger’s character Holden Caulfield stated “… money. It always ends up making you as blue as hell.”

And don’t forget to consider possible state taxes. Currently, 16 states plus the District of Columbia impose their own estate and/or inheritance tax, separate from any federal estate tax.

Despite all of this uncertainty, do not put off making or reviewing your estate plan. Not having an estate plan, or having an outdated plan, could mean your intentions aren’t carried out and could cost your surviving spouse and heirs.

The table below summarizes the evolution of the estate, generation-skipping transfer, and gift taxes over the three years affected, barring any changes by Congress:

Year	Estate tax	Generation-skipping transfer tax	Step-up in basis	Gift tax
2009	$3.5 million exemption 45% top tax rate	$3.5 million exemption 45% top tax rate	Full step-up in basis	$1 million lifetime exemption 45% top tax rate
2010	Repealed	Repealed	First $1.3 million gets step-up Assets to spouse get added $3 million step-up	$1 million lifetime exemption 35% top tax rate
2011	$1 million exemption 55% top tax rate	$1 million exemption 55% top tax rate	Full step-up in basis	$1 million lifetime exemption 45% top tax rate

Year

Estate tax

Generation-skipping transfer tax

Step-up in basis

Gift tax

2009

$3.5 million exemption

45% top tax
rate

$3.5 million exemption

45% top tax
rate

Full step-up
in basis

$1 million
lifetime
exemption

45% top tax
rate

2010

Repealed

First $1.3
million gets
step-up

Assets to
spouse get
added $3
million
step-up

$1 million
lifetime
exemption

35% top tax
rate

2011

$1 million exemption

55% top tax
rate

$1 million exemption

55% top tax rate

Full step-up in basis

$1 million
lifetime exemption

45% top tax
rate

Copyright 2010 Forefield Inc.

Bonds and Bond Funds

Jan 15th, 2010

by jblankenship.

No comments yet

james bond street by Dan Zen There is a question that often comes up when discussing investment strategies, especially for an astute investor who has done some research on various kinds of investments. Specifically the question often is: why would we choose a bond fund or a bond index fund versus purchasing a specific bond (or several bonds)?

Bonds in General

To answer the question, we have to start with a basic understanding of bonds in general. A bond is a loan – either to a corporation, the US government (or a foreign government), a state, or a municipality, among others. For this loan there are very specific terms, which include: maturity of the bond (how long it exists), the coupon rate (what amount of income it provides), whether the bond is “callable” – meaning, if circumstances change and the issuer wants to pay off your bond early, is that allowed?

If you had a bond with a corporation that was worth $1,000, had a maturity of 30 years, and pays you $60 every year, your yield is 6% ($60 divided by $1,000). Here’s where it starts to get complicated though: when you purchased the bond, you likely didn’t purchase it for $1,000 – the purchase price is discounted due to the fact that you won’t get your money back for 30 years, so the price might have been something like $900.

If nothing changes, you will receive your annual $60 payment for the next 30 years, and then you’ll receive the $1,000 value of the bond. However (and there’s always a however in life, right?), if you decided after 15 years that you wanted to get your money out of the bond, you would sell it on the secondary market – but not likely for $1,000, or even for the $900 that you paid. If nothing else has changed (current rates are the same, credit risk of the corporation is the same, etc.) then this bond is likely worth somewhere between your purchase price and the redemption value of $1,000.

If other things have changed, this bond could be worth much more than the $1,000 or much less than the $900 that you paid. Let’s say that interest rates had dropped off for new issues of similar bonds to 3%. Obviously your locked-in 6% is worth much more to a new investor coming to the market, so your bond might bring $1,100. Vice versa is true if rates had climbed – your bond could be worth less than you paid for it. In either case, if you don’t sell the bond, at maturity it will still be worth $1,000, the face value.

Likewise, if the company that issued the bond was facing hard times and their creditworthiness was in question, the value of the bond would decrease to reflect this situation, and vice versa if things had improved for them.

Adding to this, if the bond happens to be callable (which most are), if a situation arose wherein the company could obtain loans at a more favorable rate after, say, 18 months of your purchase, they would pay you the value of the bond and end your loan with them. This would leave you having to purchase another bond at the new, prevailing lower rates.

Bond Funds

So, armed with the knowledge of individual bonds, we can now define a bond fund. A bond fund is an investment vehicle that owns many bonds. There are many types of bond funds, some defined by the maturity (or duration, a term related to maturity), some defined by creditworthiness of the bond issuers, and others defined by the governmental entity that issues the bonds. We won’t get into specifically discussing all these types of funds at present, just suffice it to say that all of these types (and many more) exist.

Since a bond fund holds many bonds, the result that the bond fund receives is the aggregate of all of the bonds it is holding. So, if the majority of the bonds in the fund are experiencing price increases (perhaps due to a market-wide decrease in rates for new bonds), then the price of the fund will increase. If nothing changes, the yield for the fund (in dollar terms) will remain the same.

But bond mutual fund managers are constantly buying and selling their holdings. One bond may show a hefty increase in value, prompting the manager to sell it for a gain, replacing it with a less-costly bond that achieves a similar yield. Or maybe the manager is looking to the future and believes that a particular bond’s value could increase due to circumstances that will improve the creditworthiness of the issuer, and so the manager might purchase that bond.

All this buying and selling make the contents of a bond fund fluctuate quite a bit over time, but the manager always pays close attention to the price of shares in his fund – if not enough new money is flowing into the fund to maintain the present price level, the manager may take some moves with his holdings that have the effect of keeping his fund’s price stable or growing slightly. If a major event occurred that the manager didn’t foresee, such as a dramatic market-wide increase in rates for new bonds, the price value of his fund could drop – or vice versa for a drop in rates for new bonds.

Bond managers are always managing their fund to maintain a stable price level and yield, but they can’t always make the right decisions. Sometimes the value of a fund will drop off because the manager misinterpreted some signal on the forefront, or a major holding in the fund declines in creditworthiness.

Bond Index Funds

Bond index funds aren’t managed actively, but rather (like all index funds) they track a specific index, and as such hold bonds representative of that index. When the index’s makeup changes (bonds are added or removed), the index automatically makes those changes. This takes the decision-making process out of the fund, so a fund manager won’t make a mistake (or a big winner) decision that results in a dramatic drop-off in value (or a dramatic rise in value).

So, if you are holding a bond index that always invests in medium-term bonds (maturity of 5-7 years), the bonds in the index will be constantly changing as bonds mature and new bonds are added to the mix. But in general you’ll experience much less volatility with the index fund, as you are taking that “forecasting” risk out of the picture.

An example of the “steadiness” or lack of volatility in a bond index can be seen with the Vanguard Total Bond Market Index (VBMFX). Over the 23-plus years of this index fund’s existence, the price has fluctuated from a low of $8.92 (the only time this fund was ever below $9, in 1987) to a recent high of $10.43. In general this fund fluctuates approximately 25 to 30 cents on either side of the $10 range, while providing a steady 5% to 6% yield annualized over the past 10 years.

Risks Associated with Bonds

Credit Risk. The issuing entity, whether it’s a corporation or a governmental entity, brings the risk that they could go bankrupt. With governmental entities this is less common, but it still occurs… and actually going bankrupt isn’t the whole risk, either. As the ratings agencies (Moody’s and Standard & Poors, primarily) review the issuing entity’s results and earnings forecasts, the rating of the bond can be changed. As this changes, the value of the bond may decrease or increase, depending upon which way the rating changed.

Interest Rate Risk. I mentioned this earlier, but this is the situation where the bond you hold has a rate of, for example, 5%, and the rates on new bonds is higher, perhaps 6%. This would cause the value of the bond you’re holding to drop. This isn’t a problem if you plan to hold the bond to maturity, but if you need to cash it in early, you might lose money on the deal. Of course, on the other end of the spectrum, if the rates on new bonds decreased to 4%, your bond would be worth more if you cashed it in. But again, this situation would subject your bond to be called by the issuer, leaving you in a lurch with no bond.

Inflation Risk. This is similar to interest rate risk, except that this is where general economic growth might cause the value of your bond to decrease. If inflation picked up to a point where your bond was only just keeping pace with inflation (such as a 4% bond and inflation at 4%), then of course new bonds being issued would have a higher rate, and as such your bond’s value would drop. Again, not a problem if you’re holding the bond to maturity, but would be a problem if you needed to cash it in early.

Characteristics of Bonds, Bond Funds, and Bond Index Funds

The chart below describes the major characteristics of individual bonds, managed bond funds, and bond index funds. Hopefully this will help you to understand the benefits of one type of bond investing versus the others for your individual situation.

	Individual Bonds	Managed Bond Fund	Index Bond Fund
Maturity	Definite. Individual bonds have a specific maturity date when you will receive the face value of the bond.	Indefinite. The fund will indicate an average maturity of all bonds held in the fund, but there is no specific maturity date.The benefit is that your fund will always have the same average maturity, whereas a bond’s maturity is always declining.
Holdings	Known – you should be able to list out your individual bond holdings at any time.	Generally known but a specific list of bonds held at any point in time is not available.	The index is generally available and the holdings can be listed.
Volatility	May have significant fluctuation in price over the life of the bond, although value at maturity is always known.	Generally less volatile than stocks but depending upon maturities and interest rate fluctuations, can have some volatility.	Minimal volatility as compared to Managed Bond funds.
Liquidity	Generally liquid (depends upon the bond) but may have to accept a much lower value than face value, or delay liquidation to maturity.	Very liquid, with a ready market.
Income	Regular, known quantity coupon payments are made on a semi-annual basis.	Interest income may fluctuate with changes to the underlying portfolio. However, bond funds generally make interest payments on a monthly basis, rather than semiannually (as with individual bonds).
Diversification	Must purchase many diversified bonds to achieve diversification.	Diversification is achieved via the ownership of the fund, as well as by owning more than one fund with different classifications. (see Entry Point for additional information)
Entry Point	Individual bonds are generally priced at $1,000, however, many brokerages have minimums for purchase of $10,000 or greater.	Most funds have very low entry points, often between $1,000 and $3,000.	Same as Managed Funds, although ETFs can lower the entry point even more.
Default Risk	This will vary by the credit quality of the bond.	Varies by credit quality of the class of bonds in the fund, but limited by diversification.
Interest Rate Risk	Exists but declines as bond nears maturity.	Exists and sensitivity to interest rates depends on portfolio of holdings.
Expenses	Purchase and sale will involve sales charges that are typically hidden in the purchase/sale transaction; no maintenance or annual costs.	Annual fees are present, and may have front-end or back-end sales charges.	Annual fees are present but usually lower than Managed Funds. Sales charges are not typical.
Management	An individual bond will not have an inherent professional manager. You may hire a professional manager to help you manage a portfolio of bonds.	Active professional management.	Passively managed.
Reinvestment	No reinvestment of dividends.	Reinvestment is usually a feature of these funds.	Reinvestment is usually a feature of these funds. ETFs do not typically include a reinvestment feature.

The Bottom Line

So, we started this discussion to answer a question: why would you choose a bond fund or an index bond fund over investing in an individual bond? Hopefully discussion above has helped you to understand the benefits of one type of investment over another. The bottom line for me is – unless you have a pretty large sum of money to invest in bonds, in excess of a couple hundred thousand dollars, it costs an awful lot of time and money to build, diversify, and manage a portfolio of individual bonds. There is one important overriding factor that may cause some wary investors to choose individual bonds: the principal guarantee at maturity.

The convenience of mutual funds for their low entry point, instant diversification, reinvestment of dividends, and moderately stable value makes the choice pretty simple for most folks. Managing individual bonds is cumbersome, can be costly, and can cause liquidity problems (depending upon the term of the bonds).

Indexed bond funds reduce the volatility associated with managed bond funds, plus they generally have the lowest overall cost structure of all options out there (especially ETFs). It is for this reason that index bond funds are the overall best choice for most investors, and therefore index funds and ETFs are the bond investment option that I most often recommend.

Photo 1 by Dan Zen

Photo 2 by rioncm

Photo 3 by allyrose18

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