- The Washington Times - Wednesday, January 4, 2006

Mix best bonds,

stocks instead

QI invest in corporate bonds using a “laddered” approach. Are corporate bonds

considered too risky to be recommended? What do you think of my approach?

A: Regular readers of my columns know that I’m an advocate of a diversified portfolio that includes investing some money in bonds, including corporate bonds. Holding a diversified portfolio of high-quality corporate bonds actually helps to reduce the volatility and risk of a stock portfolio. Over the long haul, bonds historically have produced lower returns than stocks. Thus, a bond-and-stock portfolio should produce lower overall returns than an all-stock portfolio.

As for creating a bond “ladder” — that is, your own portfolio of individual bonds of varying maturities — I think you can do better by investing in the best bond funds. When you take on the role of portfolio manager — which is what you are doing by selecting your own corporate bonds — I think you are taking on a responsibility that you are likely not up to handling as well as a professional bond fund manager.

Do you have the proper training to be evaluating the credit risk of larger corporations? Do you have the necessary time to research and monitor companies’ financial statements over time? Do you have sufficient capital and training to cost-effectively build a truly diversified portfolio?

You can invest in the leading bond funds for less than 0.5 percent per year (many of Vanguard’s bond funds have fees around 0.2 percent). Then, you can spend your time doing the things you are best at, which likely does not include bond investing.

Q: Some of the mutual funds I own report their yields as “30-Day SEC Yield.” These figures tend to be higher than the yields reported in some publications, which use yearly data. Which is the truer or more useful number?

A: Fund companies are supposed to report the SEC yield, which is a standard yield calculation that allows for fairer comparisons among bond funds. The SEC yield reflects the bond fund’s so-called yield to maturity. This is the best yield to use when you compare funds, because it captures the effective rate of interest an investor will receive looking forward.

Funds also calculate a current yield, which only looks at the recently distributed dividends relative to the share price of the fund. Funds can pump up this number by purchasing particular types of bonds. For just that reason, current yield is not nearly as useful a yield number to look at (although some brokers who sell bond funds love to use it because it can be utilized to make particular funds look better than they really are).

Yearly data isn’t terribly useful for the simple reason that such a yield measures how much a fund has distributed over the past year. Going forward, the SEC yield offers you a much better indication of what a fund may pay out in yield.

Finally, as you already seem to know, when you ask a mutual fund company for a bond fund’s current yield, make sure that you understand the time period the yield covers.

Write to Eric Tyson at eric@erictyson.com.


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