Suze Orman says NO,.....to Bond Mutual Funds, and to only by Individual BONDS, WHY? I think just the opposite, what if? the bond... bankruput??

January 04, 2008

Posted by TonyLiu

( 0 ratings )

Here is why:

A Bonding Moment
Earlier I mentioned that I am not a big fan of bond funds. Here's why: The beauty of owning bonds directly is that if you choose a high-quality bond you are pretty assured that when the bond matures you will be repaid your entire initial investment, or "principal." So not only do you get the periodic interest payments from the bond, but there's an extremely high probability you will get your principal back. In fact, if you invest in a U.S. Treasury bond, you are guaranteed to get your principal back at maturity. And when you buy a bond directly, you lock in the interest rate for the entire length of the bond. If you buy a 10-year bond with a 5 percent yield, you will get 5 percent for the next 10 years.

But a bond fund is different. That's because there's a manager at the helm who is actively buying and selling bonds rather than buying and holding them until maturity. So you lose the certainty of getting your principal back. And by the way, you have to pay that manager; the typical expense ratio on a bond fund is about 1 percent. You're lucky to get a yield of 4 percent on a high-quality Treasury bond fund and you're going to give back one quarter of that performance in a fee? That just doesn't make sense to me.

Granted, with a talented manager all that buying and selling can produce returns that exceed the buy-and-hold strategy of owning a bond directly. But there's no guarantee of that. Moreover, there is no locked-in interest rate. The yield on the fund will fluctuate based on what the manager happens to own at any particular time. When rates are falling, a bond fund's yield is going to fall too. Whereas if you owned a bond directly, your higher rate would still be locked in for as long as you owned the bond. Back in the days when I was a financial advisor, I had clients buy 30-year Treasury bonds in 1980 yielding more than 14 percent. I guarantee that no long-term bond fund today has a 14 percent yield -- you're lucky to get 5 percent -- but anyone who bought one of those 30-year bonds is still getting their 14 percent!

- I agree with Suze on this one....

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