Smart Saving and Investing

On this blog, Smart Saving and Investing, I concentrate on three financial tasks that many people can do:

1. Save money on a regular basis automatically by opening up an online savings account and linking it to your bank checking account to make sure the online savings account is funded every pay period automatically.
2. Participate in their employer’s retirement plan, which forces you to automatically invest because it most likely comes right out of your paycheck and you’ve been forced in away to live without it.
3. Open and invest in a Roth IRA. This takes some extra effort because you have to try and found out how you’re going to do this by opening up the Roth IRA somewhere and try and automatically fund it. Which also brings up questions like, “How am I going to fund my Roth IRA and where am I going to fund it at?”

Although these three actions sound simple, taking action to get these in place requires effort. It also takes effort to decide what to invest in. Which typically brings confusion and for a lot of folks, no action taken.

Well, depending on your age and your ability to stomach these markets that are going crazy lately, bonds can and do play an important part of your investment portfolio.

We’ve been taught that bonds are a more conservative investment because they are fixed investments and can ride out the markets ups and downs. While you watch your stock mutual funds go up and down, bonds sit there and provide stability. Which is kind of cool to watch when your stock mutual funds start falling.

I would start investing in Bond Funds at 50 depending on what I’ve accumulated in my portfolio over the years. However, I do know that some folks get queasy watching all the money they’ve invested over 10 or 20 years go up and down so dramatically no matter what age they are and Bond Funds would give them a more stable feeling through those times.

Therefore, if you’re going to invest in Bonds, invest in Bond Funds. Why? Because Bond Funds have the following benefits:

• professional management
• diversification of the different types of Bonds can be held in a Bond Fund
• invest in no-load Bond Funds to reduce expenses and transaction costs
• you can Dollar Cost Average* into a Bond Fund to build your Bond position over time
• it’s more convenient to buy Bond Fund than Bond individually
• with any income produced by the Bond Fund it can be automatically reinvested in the fund

* - Dollar Cost Averaging is when you invest the same amount on a regular basis to achieve the best average price. If you invest $50.00 every month and your bond mutual fund goes up, you buy less shares, if the bond fund goes down, your $50.00 involvement buys more. Over time, your average price is lower than if you tried to time the market and buy when you think it is right to buy.

There are a lot of Bond Fund types: U.S. Government Funds, Corporate Bond Fund, Municipal Bond Funds, Bond Index Mutual Funds, Multi-Sector Bond Funds, Convertible Bond Funds, Ultrashort Bond Funds, International Bond Funds, and Emerging Markets Bond Funds to name a few.

How to decide to include Bond Funds in your portfolio:

• Where are you at in life in terms of age and current portfolio holdings
• What is your risk tolerance (what makes you sleep at night)

Vanguard Group, Inc founder John Bogle recommends holding a bond position equal to your age. So if you’re 50, you’d own 50% of your portfolio in a bond index fund. When you turn 60 you’d have 60% in a bond index fund, etc. He also mentions that other investment professionals have called that too conservative. Mr. Bogle mentions you could also use your age minus 10 as well. So if your 50 years old then you’d have 40% in a bonds index fund.

I would suggest that when you’re in the accumulation stages of life, your bond fund exposure be 0% if you are under 50 years of age.

When you hit 50 years old, you might want to include one of the funds below. I’m more on the aggressive side of investing so I would hold something like 20% to 25% in bond funds or a balanced fund that owns a portion of stocks and a portion of bonds.

At 60 years of age I might look at 30% to 40% of my portfolio would be in bond funds. Even at 70 years old, I still would be involved with some aggressive investments but it would be below 40% of my portfolio, with bond funds occupying over 50% to 60% of my portfolio.

With all that out of the way here are the funds we’ve discussed and you can look at for your portfolio.

• Vanguard Total Bond Market Index, symbol VBMFX - A good one for the indexers out there
• T. Rowe Price Capital Appreciation, symbol PRWCX - roughly a 50/50 split of stocks and bonds
• Leuthold Asset Allocation, symbol LAALX - Note: Although this doesn’t have a long track record the manager does have a great track record at another fund he managed.

written by Bill Stevens

In part one of this series on All About Bonds, I covered the three main types of Bonds - U.S. Government Bonds, Municipal Bonds and Corporate Bonds.

I also introduced a fund that holds approximately 50% stocks and 50% bonds, called the T. Rowe Price Capital Appreciation fund, symbol PRWCX. I also included an index bond fund called the Vanguard Total Bond Market Index, symbol VBMFX.

For our purposes at this site, we’ll concentrate on Bond Funds and not purchasing bonds individually just like we’re not focusing on purchasing individual stocks at this site, but investing in Mutual Funds that hold stocks.

Interest rates play a big role in how bonds perform. So much so, that interest rates drive the bond market. You might have heard before, “When interest rates go up, bond prices go down and when rates go down, bond prices go up.”

As the S&P 500 is used to compare returns of a mutual fund, the 10-year treasury note has become the standard measuring stick for bonds for some folks.

There are many investment “Grades” when it comes to bonds. Grades include the following:

• Highest Grade - AAA - these bonds carry the smallest amount of risk and are the safest
• High Grade - AA - very small amount of risk but not as good as AAA
• Upper Medium Grade - A - still a very small amount of risk but might be sensitive to adverse economic changes
• Medium Grade - B - these are still acceptable bonds but might be sensitive to adverse economic changes

There are many grades but we don’t want to go below “B” grade.

As you compare buying bonds individually to buying stocks individually, you find that you would watch some of the same attributes of stocks as you do bonds. Some of those attributes include:

• Risk - there is some risk with bonds even though they are considered safer than stocks
• Inflation
• Bond Market
• Trading Bonds
• Tax Issues
• Interest Rates
• Capital Gains and Losses
• Economic Indicators

With all the above similarities as stocks, I would pursue Bond Funds instead of owning Bonds outright. There are many different aspects to the three types of bonds that would fill a book, so I’ll defer to, well, books and websites that specialize in bonds.

For a more indepth view on Bonds visit the Investing In Bonds website.

The final Part 3 of this bond series will discuss Bond Funds and Bond Strategies.

written by Bill Stevens

So what are Bonds anyway?

Bonds represent a loan. For example, if you lend the U.S. government some cash in the form of a U.S. Government Bond for the amount of $xxx.xx, they will promise to pay you $x,xxx.xx sometime in the future as determined by the bond.

There are a variety of Bond types that come from various issuers. An issuer is an entity. An entity is a…, well you get the point, I hope. Issuers include the U.S. government, state and local governments, and corporations.

Bonds create a balance in our portfolios and are typically viewed as a conservative investment. Bonds tend to provide you with a steady stream of income and react differently to how stocks react to market conditions.

A lot of investment pros will tell you, “When interest rates go up, the value of bonds go down.” Likewise, “When interest rates go down, the value of bonds go up.” We’ll discuss this in a future article for this series on “All About Bonds.”

Depending on what makes you sleep at night or how you handle watching the markets go sky high one day and fall to earth hell another day, helps you determine if and when you should invest in Bonds.

Through years of investing, I wouldn’t look at bonds until you’re 50 years or older because prior to that age, you should be in the growth stage of investing by way of Mutual Funds, that is, stock mutual funds or what they also call equity mutual funds.

As a reminder, this site promotes three actions, open and contribute monthly and automatically to an online saving account paying 5.05% at the current time, 2007. Participate in your employer’s retirement plan and open and invest in a Roth IRA. See the About page for what context I’m writing in.

Ok, back to bonds. Here’s a quick list of bond types.

U.S. Government Bonds include:

• Treasury Bills
• Treasury Notes
• Treasury Bonds
• Savings Bonds
• Treasury Inflation-Protected Securities
• Agency Securities

Government bonds are considered the lowest risk and safest of bonds because they are backed by the United States government.

Municipal Bonds (”munies”) include:

• General and
• Revenue

They provide for state and local governments to fund projects like building stuff - roads, bridges, etc. These are attractive to high tax bracket folks because they are except from federal income tax on the interest the bonds pay. As an added benefit, if the municipal bond is withing your state, it could be exempt from state and local income tax.

Our good and well respected friend Suze Orman invests in Municipal Bond:

What does Orman do with the rest of her money? Solomon asked, and was told: “Save it and build it in municipal bonds. I buy zero-coupon municipal bonds, and all the bonds I buy are triple-A-rated and insured so that even if the city goes under, I get my money. I take a little lower interest rate to make sure my bonds are 100 percent safe and sound. “ Source

Corporate Bonds include, well:

• Corporate Bonds Companies can finance many different projects by way of Corporate Bonds. These are considered the more higher risk bonds.

That’s it for the types of bonds we’ll discuss in this post.

A great resource for U.S. Government Bonds is the website Treasury Direct. This site is also helpful for folks who might have parents who have passed away and held EE Bonds from years ago. You can find out what they are worth by entering the bond serial number and issue date at the website. This is something I had to do this year.

To end, here is a fund for those folks who can’t stomach or don’t want to stomach the huge swings in the market. The fund is the T. Rowe Price Capital Appreciation fund, symbol PRWCX. It holds approximately 50% stock and 50% bonds. The fund has never had a down year in the last 10 years. It has averaged 12+% the last 5 and 10 years time horizon.

For the indexers out there here is an index bond fund.  The Vanguard Total Bond Market Index, symbol VBMFX.

written by Bill Stevens

If you’re one of the many folks who invests in index funds or are thinking about investing in them, then here’s a portfolio for you to own or to compare your current portfolio to. We’ll keep the following allocation that we’ve been talking about in other posts:

Large Growth - 35% (1 fund)

Large Value - 20% (1 fund)

Small Growth - 20% (1 fund)

Small Value - 15% (1 fund)

International - 10% (1 fund)

The 2007 Index Portfolio

This is an allocation with suggested index funds you could use when signing up for your employer’s retirement plan. However, your employer’s retirement plan would have to offer the Vanguard family of funds. I would use this allocation for anyone under 50 before looking at adding Bond funds to this portfolio.

Index funds track the market performance and their category’s performance. In this case, categories would include our allocation types - Large Growth, Large Value, Small Growth, Small Value, and International.

Here’s a table of the returns on these funds. Returns are what you would make on your money when invested in these funds. So if you invested $10,000.00 over a long period of time, your money would “make money”.

Let’s say 10 years later you decided to cash out (sell) your funds and received $20,000.00 back after you sold them, then that’s the return on your money. You made $10,000.00 over that time period, 10 years.

The table below expresses those returns in percentages, which is the typical way most investments report their return.

So there you go. These are set and forget (almost) group of index funds that will perform excellently for you over a long period of time making investing in these funds automatically simple in your employer’s retirement plan if Vanguard funds are available or in your Roth IRA.

In a Roth IRA you would have to pay a required minimum deposit and anytime you want to deposit more money into these funds there would be a minimum as well, typically $100.00.

Note: This is a portfolio I would use for myself if I was under 50 years of age and consider myself an indexer. I would look at adding a bond fund for anyone 50 and over.

The great John Bogle claims a general rule of 20% in bonds if your 20 years old and 70% bonds if you’re 70 years old. He says, others call that very conservative and so he mentions maybe your age minus 10 to give for a bond allocation. So if you’re 20, that would be 10% of your portfolio in bonds.

Of course for indexers, you’d want to have that percentage or some percentage you feel comfortable with in the Vanguard Total Bond Market Index, symbol VBMFX. Bonds make us feel more secure because they’re less volatile than the stock funds that we’ve been talking about.

We’ll revisit bonds at a later date.

written by Bill Stevens

To describe an Index Fund I’ll use the classic Vanguard 500 Index fund, symbol VFINX.

The VFINX fund is made up of stock in the 500 companies that the S&P 500 tracks. You would own a piece of all the 500 companies in the S&P 500.

The S&P stands for Standard and Poor’s. Standard and Poor’s is the leading provider of financial market information.

The S&P 500 is a leading benchmark for how the markets are doing. Many funds are compared to the S&P 500 performance. The 500 companies performance.

So if we take a look at the chart from Morningstar below, we can see that red, orange and green lines are stacked on top of one another. How in the heck can you see that if they’re stacked on one another!! Well, trust me.

The red line indicates the VFINX fund and its performance. The orange line indicates the category’s performance that the VFINX is in and the green line indicates the S&P 500 and its performance.

This is a great fund that a lot of folks invest in and it resembles the latest talk amongst those folks who want to make their lives simple by investing in index funds.

Some reasons include:

• The VFINX tracks the market, and we’ve been told that historically the market goes up. So if a person can hold the VFINX fund in their portfolio or as their only holding in their portfolio, and if they can stomach the downs of the market that we’ve been experiencing lately, then that is the promise. This fund will go up with the market and go down with the market. It will never do better than the market. In other words, it will NOT beat the market when the market goes up and it won’t try and lose less than the market when the market goes down. WOW!! What a mouth full.
• The expenses related to the VFINX are extremely low. The fund manager basically doesn’t have to do too much. At Morningstar it’s listed as 0.18%. We’ll talk through the “Express Ratio” in another post. But that is one indicator to look at that will tell you how much it costs to run a fund and the VFINX is good and low.
• The VFINX is considered tax efficient. Why? Because the fund manager doesn’t have to trade in and out of different investments that would cause a taxable event like selling a stock. There would be very little selling since the “makeup” of the fund doesn’t change often.

There is great power and trouble-free worry when it comes to owning the Vanguard 500 Index fund. Through the power of compounding over a long period of time this fund would do good for a lot of folks.

Of course, according to Morningstar it would cost you a minimum of $3,000.00 to get into this fund.

If it’s available to you in your employer’s retirement plan, you would most likely be able to get into this fund without the minimum. Check with your employer.

If you’re interested in holding the VFINX in your Roth IRA, you’re brokerage firm will list the minimum to get into this fund.

Disclaimer: Past performance is not a guarantee for future performance. Even owning this fund you are taking a bit of risk. The risk of the market.

written by Bill Stevens