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Saturday, September 04, 2010

Bob Brinker Muni, GO and Bond Fund Advice

Many callers have asked Bob Brinker about the potential to lose money in bond funds when interest rates "normalize" from historically low rates. For example, on April 5, 2010 the 10-year US Treasury Bond had a yield of 3.99%. (move the cursor over the chart here for TNX to April 5 to see the rate quoted as a "price").   Much of this year's gains in bonds are due to the yield falling to 2.70% as investors have fled stocks while pouring money into bond funds.  See:
Brinker says if you hold a bond fund the simple thing to do is use a mental stop loss as I explain in the article Bob Brinker's GNMA Advice.
Brinker also points out another way to avoid losing money is to buy bonds directly and hold them to maturity. If you buy US Treasuries or GNMAs directly, then you are guaranteed to get your interest payments plus principle back since the government can borrow money from the Federal Reserve which will turn on the printing press if there are not enough interested in the low rates.
If you own municipal bond funds to lower your taxes, then Brinker says you can buy tax exempt Municipal Bonds directly from your broker. Buy NEW ISSUES to get the lowest fees. If you were worried about the quality of municipal bonds, then Brinker says you could purchase high quality state general obligations (GO Bonds) which have had no failures in over a century.  (As a Californian, I find little relief in that fact given the circus we have in Sacramento giving huge raises and pension benefits to unions that support the people in government that keep spending while the state circles the drain of insolvency.  End of digression.)

My Warning: You need to be careful with Muni bonds because some cities, struggling with the recession, have missed payments and could default. Harrisburg, the capital of of Pennsylvania, is the latest to miss a payment and potentially default.
Pennsylvania capital, Harrisburg, skips payment, may move closer to bankruptcy
Harrisburg Mayor Linda D. Thompson has adamantly opposed declaring bankruptcy, while the move has been been advocated by the city controller and a growing bloc on the City Council. 
The city's bond insurance company is expected to cover its upcoming $3.3 million bond payment. But some analysts say relying on that backstop could add to the mounting pressure on firms that provide insurance for the $2.8 trillion municipal bond market.
The good news for investors is the insurance company will make the payments but if enough cities and states like California (even with with insurance) miss payments, it could get nasty.
Seeking Yield for Income Is Risky 
Currently, if you need yield, it means you are taking significant interest rate risk.  Buying bonds directly is fine if your goal is to not lose money but if there is high inflation, then you will lose purchasing power to inflation whereas someone in money funds, TIPS, Ibonds or savings accounts will do much better since we will get higher returns as rates normalize (go up.)  Everyone should be aware that the Federal Reserve is again buying US Treasuries to help keep rates low and nudge investors to take more risk to help the economy grow again.  Rates could surge again when (not if) the Fed stops buying US Treasuries.

Vanguard's GNMA fund, VFIIX, currently has an average duration of 1.7%.  That means if interest rates were to jump 1% overnight, you could expect VFIIX to lose 1.7% in net asset value, NAV.  If they jump 3%, expect NAV to fall by 5.1%, 3 times 1.7%.
I am lucky. I have enough cash flow from my Two Investment Letters, people clicking ads on my blogs and websites plus commissions for products I recommend that I don't need yield to live on.  Thus, I take very little interest rate risk.  I've sold all my bonds and bond funds not indexed to inflation with my own money and in  "Kirk Lindstrom's Investment Letter." 

My personal iBond portfolio currently yields 5.43% (Majority are from Oct. 2001) but of course, I only get the interest at maturity, a great way to defer taxes.  The TIPS fund I got for my Vanguard ROTH by selling the GNMA fund is up 18.4% in under 2 years.  I also hold individual TIPS and a significant holding in the TIPS fund at Fidelity, FINPX, that is up 25.8%.  I suspect those TIPS funds will give back some when rates normalize, but rates probably won't normalize without a significant inflation component so I expect they will do better than bond funds not indexed to inflation.

Many of the stocks in "Kirk's Newsletter Explore Portfolio" are paying a great dividend while selling at very low price to earnings multiples.  My portfolios are up significantly over the past 10 years while the index funds are down.   I expect equities to significantly out perform bonds and probably CDs over the next decade and my "core plus explore" portfolio approach should do even better.
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  1. Hi Kirk,

    What's the history and some background on times interest rates jumped 1% or more overnight?


  2. Hi Marie
    Go to US Treasury Rates - Quotes at a Glance. Wait for "10-YEAR TREASURY NOTE TNX" to load. You can see what it has done back to 1963. If you want to calculate specific percentage change, you'll probably have to download the data from a source like Yahoo! and do it with a spreadsheet yourself. Remember that rates have not been this low since the early 1960s, 50 years ago. The next decade, the 1970s, was notable for massive inflation. The Fed says it is determined to not repeat that mistake so I expect them to raise rates quicker than they have in the past. In 1994, a period very much like today for stock valuation, they increased the Fed Funds rate 0.75% overnight on Nov. 15. (1994 Rate History) There are many who think retired people will start spending again when they get 4% on their savings, especially 1-yr CDs... This could happen if/when the Fed normalizes rates. Some think they should kick them up 2% right away.

    Remember, just because something hasn't happened in the past doesn't mean it won't happen in the future. I don't remember any time before Mr Obama when the president of the US took money from GM Bond holders and gave it to unions after calling the bond holders greedy for wanting to be first in line for payment per the law. Who would buy a bond after that? I also do not remember a time when note holders for mortgages were pressured from the White House to "forgive" debt they are legally entitled to.

  3. August Consumer Price Index up 1.1% (Press Release

    The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3 percent in August on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. (Before seasonal adjustment, the all items index increased 0.1 percent for the month.) Over the last 12 months, the all items index increased 1.1 percent before seasonal adjustment.

    The energy index rose in August and, as in July, was the primary factor in the seasonally adjusted all items increase. All major energy components posted increases, with the gasoline index being the main factor. The food index, which declined in July, rose in August. The food at home index was unchanged while the index for food away from home increased.

    The index for all items less food and energy was unchanged in August after increasing in each of the previous three months. This pattern mirrors the shelter index, which also was unchanged in August after rising in recent months. Posting increases in August were the indexes for medical care, used cars, and new vehicles, while the indexes for recreation and apparel declined.

    Over the last 12 months, the index for all items less food and energy rose 0.9 percent, though the shelter component posted a 0.7 percent decline. The food index increased at a similar rate, rising 1.0 percent, with grocery store food prices up 0.8 percent. The energy index posted a somewhat larger increase, rising 3.8 percent with gasoline up 4.4 percent.

  4. Fixed Income Update

    In 2009 Vanguard's TIPS fund, VIPSX, gained 10.8%
    In 2009 Vanguard's GNMA fund, VFIIX, gained 5.3%

    As of yesterday (10/5/10)
    VIPSX is up 8.00% YTD
    VFIIX is up 6.78% YTD

    I dumped my Vanguard GNMA (VFIIX) fund almost 2 yrs ago in my Vanguard ROTH and bought the TIPS fund VIPSX. Total gain as of yesterday was 21.3%!


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