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This is the follow up to my introduction to laddered bond portfolios. As with the first installment I am going to assume that I am speaking to the experienced bond investor, so I will not go into any great detail the basics of bonds or bond investing.
The first question that generally comes to mind is why go to all this trouble to put together a bond portfolio? Why not invest in a bond fund? Good questions both, and a do-it-yourself bond portfolio is not necessarily better or worse than a bond fund. It has more to do with an individuals objectives, risk tolerance, etc...
I will just touch on bond funds, assuming that you are reading this because you have decided to build your own laddered bond portfolio and wish to know how to go about doing so.
There are some advantages to bond funds, but it is now without expense or risk. T Rowe Price has a number of good California Tax Free Bond Funds. When I first started out in the business one had to subscribe to Morningstar to get the kind of information I got in ten minutes from T Rowe Price's website. They have a nice set up where you can move a little pointer along a horizontal spectrum and choose your level of risk reward. When you stop your pointer as I did in the area of lower to moderate risk reward it then brings up a number of bond funds for you to click on. I brought up a Tax Free California Muni Bond fund. There is a lot of good information at your finger tips and for some, a good way to go.
That is all I am going to say as far as bond funds go. I will leave it to you do the foot work if that is the route you want to take.
There are some drawbacks to creating your own laddered portfolio. While some relish the idea of rolling up their sleeves and putting together their own 'bond fund', others will not have the desire or the gumption to do the necessary work. If you do not have the time or desire to put together your own portfolio simply call your financial advisor and go over in detail what it is you are trying to accomplish and let them do the work and get back to you with a proposal.
For those of you who like to get down and dirty, the Internet is a wonderful place to do so. There are many on-line brokerages one can go to or you can simply do as I have done and go to a place likewww.investinginbonds.com and follow these steps:
Your job is to search through the issues to find the bonds to create your portfolio. Here is a sample portfolio. I would suggest you buy them in lots of 10 bonds which at par is ten thousand dollars a lot. There a couple things to note that I will point out. If your an experienced investor you will know this, but it is so important I will point it out anyhow. When you are looking through the different issues you will notice in, say a two year bond, a coupon of 6%. Now before you go wow, I have got to buy that, look over at the tab called price yield, or as they use to call it, current yield. The price yield is the actual yield you are getting when you factor in the price which could be 108, or one thousand eighty dollars per bond. You will only get the coupon rate if you purchase your bonds at par, or 100 (1,000.00). The coupon will tell you the payment you will receive and nothing more. The yield will change with the price fluctuations of the issue. If you go under the trades tab and the history you can see just how volatile these bonds can be. You will also notice how much the trader pays for an issue and how much a customer like yourself pays. Just like a stock, there is a spread in bonds as well.
A note on call features. A great majority of bonds issued come with one or more call features. For your added uncertainty and risk you are paid a little higher yield. The risk is that bond prices soar, yields tank, and the issuer of your bonds calls in the bond. The call price is usually at a premium, however you will not be able to reinvest in another bond issue at that rate. So how do you know an issuer will call the bonds? You cannot not know for sure as there are many determining factors. However if I had an issue with a coupon of 6% but the current yields today are in the 3.5% range it is a good bet the issuer is going to call the bonds and borrow again at a much lower rate of three and a half percent.
There are a few other important things to note. The more risk you are willing to take, the greater you are rewarded. If you are willing to buy a BBB bond over a AAA bond that is insured your going to find, in most cases a nice difference in yield. How risky is a BBB bond? Who in here thinks that Los Angeles California is going to default on a school bond? I don't think so. The percent of BBB bonds that have ever defaulted is minuscule. You do have to sleep at night so if your bond portfolio is keeping you awake nights you need to look at making some changes.
Are you willing to buy bonds that are not insured? Are you okay with a bond that is only rated by Fitch and not Moody's or Standard and Poors? If you do the research and find that the difference in price yield between insured bonds and uninsured BBB bonds is negligible then you may choose to stay with the insured issue. If the spread is a lot wider it may be worth putting a few BBB bonds in your portfolio. If you could only buy one bond issue I say buy the AAA bonds. If you have ten issues you can probably sleep fine at night with a couple uninsured bond issues. Only you know your risk tolerance.
Hopefully this second part to the laddered portfolio has not muddied the waters for you and you can now go out and put your bond money to work for you in a way that better suits your needs. I am a firm believer that you as an informed investor will be able to create your own portfolio without having to pay someone to do it for you. For those of you who feel you do not have the time or the expertise to do this call your broker and pick his brain. Just remember the decision is yours and you are the one who has to live with your investment choices.