Your Questions About How To Invest In Bonds

Nancy asks…

Do you think it’s ok to start investing in stocks and bonds? I want to plan for retirement.?

I am 32 years old. I want to start planning for retirement. I hear all the bad news about the stock market. What do you think about investing in stocks, bonds or mutual funds for retirement? What about annuities? I’m very green with investing terminology and concepts so I’m open to suggestions. Thanks.

John answers:

If you’re not retired and you’re working then it’s a good time to be investing in stocks and bonds. As long as you have a balanced portfolio, you can gain from the declines in the market by rebalancing so a market downturn is no reason to stop investing. Indeed when people stop during the difficult times, they make their recovery all the more difficult.

An example of rebalancing would be if you had a $1,000 portfolio and you had a balance target of 50% in stocks and 50% in cash therefore you have $500 stocks and $500 cash. Let’s say the stocks dropped in half, you now have $250 stocks and $500 cash so you rebalance by purchasing $125 in stocks giving you $375 stocks and $375 cash. Let’s say the stocks goes back to it’s original price, you then have $750 stocks and $375 cash for a portfolio value of $1,125 all while the stock price is essentially unchanged. Similarly had the stock doubled and then halved, you would’ve gone from $500/$500 to $1,000/$500 rebalanced to $750/$750 and dropped to $375/$750 for a portfolio of $1,125. Frequent rebalancing results in buying low and selling high but due to the commission costs, you often only rebalance once a year.

Now Ben Graham said to invest 45% in equity ( stock ) and 55% in bonds. Markowitz said the lowest risk is 25% equity, 75% bonds which is safer than 100% bonds and that 50/50 has the same risks as 100% bonds but much better returns. Claude Shannon at MIT did a mathematical proof that 50/50 was the optimal so why do they say to be aggressive when young and offer aggressive funds of 80% equity or more? Ben Graham said to never go below 25% equity and never above 80% equity so many people follow the advice of investing 100 – their age in percent in equity thereby moving from 80% to 25% equity in a straight line but why? Your continued contribution is why, you are contributing a set sum from your paycheck each and every month, this cash flow is like the payments from a bond so you in fact already have a bond investment as secure as your job for as long as you contribute to your investment. You can even calculate it’s value if you have a suitable discount rate; as you can’t trade in your job for cash, that discount rate should at least be equivalent to the return of your investments, currently we would expect a return of 5.4% per annum from stock market investments so using that as a discount rate, putting $466.66 per month ( maxing out your IRA or TFSA if you’re Canadian ) from the age of 32 till you’re 60 would be the same as having $466.66 * ( 1 – 1 / 1.054^28 ) / ( 1 – 1 / 1.054^( 1 / 12 ) ) = $82,238.96 so you can invest more aggressively in equity before you reach the 50% equity and 50% bonds mark if you consider your continued contributions as money invested in a bond. However your rebalancing would be limited to the contributions themselves so you can only take so much advantage of a down market which normally isn’t bad as you would achieve the ideal 50/50 market faster by investing all equity but these are times when a downturn is quite possible so it may be better to go with Ben Graham’s 80% equity till you’re balanced.

You can achieve a balanced portfolio by investing in an appropriate mutual fund, investing in a combination of a low fee index fund ( all equity ) and a low fee bond fund, or selecting your own investments. Annuities are often offered by insurance companies and have an insurance premium involved so you are paying for a benefit you hope never to collect. It is wise to have an emergency fund against the unknown so as not to make a bad financial decision but an insurance policy is an expensive and qualified way to do it.

Mary asks…

Is it better to pay as much as we can when buying a house?

Me and my wife are thinking about buying a house in London…
We have more than 100k in the bank invested in Bonds and ISAs (from which we get roughly £4500 net a year)…
We are planning to buy a house for around £200k..
Is it better for us to use all our cash, or most of it (and lose out on the interest earned) just so we don’t need a big mortgage?
What would you do?
Thanks in advance for all the advices!

John answers:

Yes, the larger the deposit, the better, as interest is accumulated and calculated on the balance you owe, at the end of a period, whether it be monthly or yearly. So the lesser the amount, for them to calculate interest on, the better, cos then effectively you pay less of what you have not borrowed. Also, its best to take it over a shorter period in years, than the maximum period, as the shorter period means less interest, fees. Etc.

Laura asks…

How much interest on I bond accounts this November?

I have a few thousand invested in I bonds. Where do you think the intrest will be on I bonds next month? Should I buy more?

John answers:

4.25%

I would invest in CDs. The rates of return on I-bond will not out pace them over the next few years.

Sharon asks…

How much US Treasury mark-up fee Scottrade and TD Ameritrade charging?

Hi,
I want to start investing in bond market, however, I am new to this market with basic knowledge of bond valuation. After I read the Fees and Commission from most popular brokers, I can see they are charging mark-up and down fee for bond trading. Anyone know how much % they are actually charging ?

John answers:

There are no set mark up/down schedules, each firm establishes their own charges, but by regulations they can not charge you 5% or more.

Mark up/downs are charged since the firm is usually acting as a principal in your transaction and not as an agent. When acting as an agent, the brokerage firm charges a commission, when acting as principal they are prohibited from charging a commission (in most cases) and therefore must charge a mark up/.down.

The charges are based on the market prices at the time of your purchase/sale or their cost at the time of your purchase/sale.

All charges are noted on the confirmations of trades so you will then be made aware of the mark up/down.

Thomas asks…

How much does a guy like me need to worry about taxes when holding this fund outside of a tax advantaged acct?

I’m referring to Vanguard’s Wellesley Income Fund (VWINX). This balanced fund is about 2/3 invested in bonds.
I’m a simple cabbie in California and my income is less than $30K/annually. I have about $180K conservatively invested.
Thank you.
Yes! I have maxed out my tax advantaged accounts!
I’ve been maxing out the Roth IRA’S for years.

John answers:

Outside of a tax-advantaged account you’re going to pay taxes every year at your normal tax rate on the interest. It has a about a 3.5 percent yield. Its generally better to put income-producing investments into a tax-advantaged account.

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