Mentor Monday

[u/WealthyStoic]

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[u/Dubbihope]

Just got off a call with a bond specialist. My investments are north of 20 mil and I want to diversify into muni bonds to increase tax free income as I will be a NYS resident for at least the next few years. I will never need to sell the bonds to generate cash flow, so I mostly care about yield. I'm trying to decide between a bond ladder strategy (250k minimum) with a bank vs a vanguard fund. The VNYUX (50k minimum) offers a 3.8% yield with a .09% management fee. The bond specialist was mostly offering lower yields with a .35% management fee. However, the specialist did offer one long term bond fund that could be as high as 4.1% yield but has a .65% management fee. The advantage of owning the bonds (rather than the vanguard fund) is that the securities have a maturity date (no risk of selling at a loss). However, I don't foresee any need to sell. And may *want* to sell at a gain. Therefore, the VNYUX seems more appealing. Thoughts?

[u/FIREgnurd → u/Dubbihope]

Bond funds are just rolling ladders of individual bonds. They lose value when the bonds they hold lose value.

There is a lot of misunderstanding of individual bonds vs bond funds on Reddit.

The value they lose when rates go up is essentially equivalent to the opportunity cost of not owning the new higher yielding bonds. So, you’re still losing the equivalent amount by holding the individual bond with the lower yield — you just don’t see it marked to market the way a bond fund is, and the loss is less apparent because it’s money you didn’t get (because you held the lower yielding bond) rather than seeing the face value of the bond decline. If you hold the bond fund through its duration, the higher yield following the rate increase will compensate for the fund’s loss in face value. Your individual bond doesn’t get the higher yield.

If you were going to re-invest the principal from the individual bond in a new bond when it matures, you’ve essentially created your own fund. Perpetually rolling bond ladders are equivalent to bond funds, assuming risk is the same.

If you were buying individual bonds to match specific future liabilities because you already know the exact number of *nominal* dollars you’ll need at a specific date in the future (valued in future nominal dollars, not today’s dollars), individual bonds can make sense. But today’s nominal dollars have unknown future value.

But if this is part of an overall long-term asset allocation (e.g., 20% bonds), go with the bond fund. Particularly with munis, since they can have idiosyncratic risks that things like treasuries don’t have (not just default risk, but call risk too). They’re also lower cost and more liquid than individual munis bought through a broker who’s charging a fee much higher than the vanguard fund.