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Posted by
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Suggestions on Corporate Bonds?
Posted by fasdit on 9/4/11 at 5:59 pm00
I am relatively new to the vast world of investing. One topic that I am almost completely in the dark on is corporate bonds.
Let us supposed I have extra $5000 sitting around that I would like to earn interest on while maintaining low risk. At a glance it would make more sense to buy an investment grade corporate bond than a certificate of deposit.
It seems like investment grade corporate, while technically not as safe as a CD, is still far above what anyone would consider risky. In other words, the chance of default in practice is non existent and you get more interest!
Does anyone on MT have experience or protips for corporate bonds?
Let us supposed I have extra $5000 sitting around that I would like to earn interest on while maintaining low risk. At a glance it would make more sense to buy an investment grade corporate bond than a certificate of deposit.
It seems like investment grade corporate, while technically not as safe as a CD, is still far above what anyone would consider risky. In other words, the chance of default in practice is non existent and you get more interest!
Does anyone on MT have experience or protips for corporate bonds?
re: Suggestions on Corporate Bonds?Posted by TheHiddenFlask on 9/4/11 at 10:39 pm to Athanatos
quote:
the chance of default in practice is non existent and you get more interest!
Signed,
Lehman Brothers circa 2007
Short term investment grade, maybe. IT to LT, probably not. $5k into a STIG fund, maybe, one off corporate bond is not worth the risk. This will give you a good idea of various corporate fixed income risks:
Reasons to avoid corporate bonds
For $5k ibonds might be a better alternative, tax deferred and paying 4.6%, will reset at a different rate in November, plus you can cash it out after 12-months with no principal risk but will forgo 3-months of interest.
Reasons to avoid corporate bonds
For $5k ibonds might be a better alternative, tax deferred and paying 4.6%, will reset at a different rate in November, plus you can cash it out after 12-months with no principal risk but will forgo 3-months of interest.
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I'm will try to keep this simple. ST investment grade bonds are the only corporate bonds over time that have reasonably kept up with similar maturity treasuries. The longer a corp bond's maturity, the less liklihood of accurate return predictions. What may be investment grade today, may not be in 3-5 years depending on what happens to the company and economy over that span, Treasury ratings are much more stable. Corporate bonds will always have an equity risk components, whereas T's do not. The longer the bond maturity, the greater the equity risk component becomes, even with IG corp bonds.
As a proxy, if you look at the Vanguard ST investment grade fund, the SEC yield = 1.65% as of 9/2, the ST Treasury fund is .17%, the durations of the funds are close enough for this convo. Personally, I would accept the STIG yield spread of 1.48% as adequate compensation to buy the STIG over the STT fund, but all bonds/funds are selling at a premium, ie higher cost than face/par value unless you are buying a new issue bond, this is a significant risk and why I said look at the Ibonds, you can't lose principal and you are receiving adequate inflation protection for holding them, and the earnings are tax deferred until you cash them out.
Hopefully this link will take you to a 4-fund comparison, the GNMA fund is a likely good alternative for the short run, but you will encounter a similar situation when/if mtg rates increase, but the 3.22% yield is much more attractive than STIG/STT funds. None of these alternatives are beating inflation, much less inflation plus taxes if held in a taxable account.
VGD fund comparison
Bond investing is not risk free, in fact it is far from it when factoring in inflation and shitty yields in a horrible rate environment, which is why I keep bitching about the Fed destroying savers/retirees purchasing power through its crappy "save the banks" policy. Combine this with the liklihood of a high spread if buying individual corporate bonds via a brokerage account against experienced professionals you would be better off buying a low cost fund.
As a proxy, if you look at the Vanguard ST investment grade fund, the SEC yield = 1.65% as of 9/2, the ST Treasury fund is .17%, the durations of the funds are close enough for this convo. Personally, I would accept the STIG yield spread of 1.48% as adequate compensation to buy the STIG over the STT fund, but all bonds/funds are selling at a premium, ie higher cost than face/par value unless you are buying a new issue bond, this is a significant risk and why I said look at the Ibonds, you can't lose principal and you are receiving adequate inflation protection for holding them, and the earnings are tax deferred until you cash them out.
Hopefully this link will take you to a 4-fund comparison, the GNMA fund is a likely good alternative for the short run, but you will encounter a similar situation when/if mtg rates increase, but the 3.22% yield is much more attractive than STIG/STT funds. None of these alternatives are beating inflation, much less inflation plus taxes if held in a taxable account.
VGD fund comparison
Bond investing is not risk free, in fact it is far from it when factoring in inflation and shitty yields in a horrible rate environment, which is why I keep bitching about the Fed destroying savers/retirees purchasing power through its crappy "save the banks" policy. Combine this with the liklihood of a high spread if buying individual corporate bonds via a brokerage account against experienced professionals you would be better off buying a low cost fund.
I loooked over the series I bonds.
There are 2 rates.
The fixed rate: Currently 0.00%
The CPI-U inflation indexed rate: Currently 2.30%
Which are manipulated with this equation
(Fixed)+(2 * Semiannual Inflation)+(Fixed * Semiannual Inflation)
to equal a composite rate of 4.60%
I don't fully understand the semiannual rate. Does this 4.60% mean that I am completely break even with inflation? In other words, can I expect the current issue of I Bonds to beat inflation?
On another note, if corporate bonds and treasuries are not even keeping pace with inflation, why the hell would anyone want to buy them?
From your numbers both options look like a terrible place to put your money right now if you hope to have it generate any useful interest after taxes and inflation.
There are 2 rates.
The fixed rate: Currently 0.00%
The CPI-U inflation indexed rate: Currently 2.30%
Which are manipulated with this equation
(Fixed)+(2 * Semiannual Inflation)+(Fixed * Semiannual Inflation)
to equal a composite rate of 4.60%
I don't fully understand the semiannual rate. Does this 4.60% mean that I am completely break even with inflation? In other words, can I expect the current issue of I Bonds to beat inflation?
On another note, if corporate bonds and treasuries are not even keeping pace with inflation, why the hell would anyone want to buy them?
From your numbers both options look like a terrible place to put your money right now if you hope to have it generate any useful interest after taxes and inflation.
quote:
On another note, if corporate bonds and treasuries are not even keeping pace with inflation, why the hell would anyone want to buy them?
That's the primary issue due to current rate policy and demand for "safe" assets by investors, no matter if they lose money in real terms, ie inflation adjusted. Investors choose to take real losses, knowingly or unknowingly, instead of potential large losses in risky assets if the risky assets go down 15-40%, stocks, PM's, etc.
The current I bonds are as you state, zero coupon + 1/2 of the annual inflation rate of 4.6% determined for the 6 month period ending this past April, it resets in November depending on what inflation is for May-Oct. If you look at longer term inflation, CPI-U has done a reasonable job of tracking. The point is without a coupon rate it still is better than other forms of savings accts, CDs, ST-IT bonds selling at a premium to face value, at that starting rate with return of principal guaranteed after 12-months, less 3-months interest surrender charge for early termination. Compare this to some past I bonds that were issued with 3%+ interest rates + semi annual inflation adjustments and they were a no brainer, it's just a much more challenging rate environment now.
I have done very well with individual TIPS and VIPSX, but I can't foretell the future. VIPSX is up ~ 11.3% YTD, with longer term performance of 6.25% - 7% over the past 3-10 years, but would caution on buying now with a negative real yield. Also up 36% on some long dated TIPS since February and have done very well on TIPS bought in late 2008 when the hedge funds were fire selling at significant discounts.
YMMV, I am not saying I bonds will outperform "x" number of other opps, but they have a place in a diversified portfolio and to meet specific retirement goals/plans in the future. Times are tough in investment land, especially when one is already maxed out on all the investment classes he/she wants to own and has a lot of cash, that's all I got.
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