You Should Still Beware of A Bond Bubble
As interest rates go down and down, people have raised warnings for a possible bond bubble. Vanguard, being a major provider of bond mutual funds, has published several white papers and articles trying assure investors they should stick to bond funds and not worry about a bond bubble.
Unfortunately the arguments put forward by Vanguard are not 100% logical. The short story is that investors should still beware of a bond bubble.
Before I continue, I should define what a bond bubble is. I see the bursting of a bond bubble as "substantial rise in interest rate causing losses in bonds." As you must know, bond values are mathematically determined by the prevailing interest rate. If interest rates go up, bond values go down.
Index Funds Or ETFs? How About Both?
Investors should thank Schwab for pioneering free trades on its in-house ETFs. With the pressure Schwab put on the competitors, now both Fidelity and Vanguard offer free trades on select ETFs. The free ETF trades are a gift to investors.
Free ETF trades make it really easy for small investors to put together a diversified portfolio at extremely low cost because the minimum investment in a ETF is just one share, usually less than $100. See previous post Low-Minimum Index Funds and Commission-Free ETFs for Small Investors.
If you don’t have a problem with meeting the minimum initial investment requirement and you are already investing in traditional open-end mutual funds, should you switch to ETFs?
Luck, Hard Work, and Retiring Overseas
Not too long ago I took a vacation in Costa Rica. I stayed at a Bed & Breakfast. A single mother was running it with her 19-year-old daughter. The mother doesn’t speak much English and I don’t speak Spanish. With hand gestures, we were able to communicate — I suspect she understands English more than she speaks.
I was feeling pretty good about having my tourist dollars help a minority-owned small business until Friday evening when the real owners showed up. They arrived in two separate cars; one of them was a Lexus LX470 full-size luxury SUV. They also brought a maid, who cooked for them.
Although their arrival totally blew my fantasy of helping a struggling single mother, I was able to talk to the owners, who speak English. It turned out that they were a hardworking couple before they became capitalists who earn their living from their money as opposed from their labor.
Is It a Buying Opportunity Yet?
The stock market is having a correction. A month ago the Dow fell 1,000 points in day before recovering most of the loss at the close. Last Friday the S&P 500 index closed at a lower level than the lowest point reached during the so-called "flash crash."
Whenever the stock market gets a hiccup, there are always two schools of thought. Some worry a crash lies ahead. Some say it’s a buying opportunity. Fear and greed have been living with the stock market forever.
What should an investor do? If you believe a crash lies ahead, you should get out of the market, let it crash and get back in at a lower point. If you believe it’s a buying opportunity, you should buy more when stocks are on sale. If you believe neither or if you don’t know, you keep doing what you always do. Investing would be really easy if you know which way the market will go.
Tax Cost Calculator
I usually include a spreadsheet when I post something about numbers and calculation. That way you can play with your own assumptions. I didn’t do one in my post last week Dividend Tax Going Up, Moving to Munis. My bad.
Reader Random Poster asked:
"If you did not hold any value stock funds in your taxable account, but rather only, say, a total stock market index fund, would you still make the investment changes?"
Dividend Tax Going Up, Moving to Munis
When an investor invests in value stock funds and bonds in both a tax deferred account and a taxable account, there are basically two choices:
(A) Put taxable bonds in the tax deferred account and put value stock funds in the taxable account; OR
(B) Put value stock funds in the tax deferred account and buy tax-exempt muni bond funds in the taxable account.
A Case Study On An Index Linked CD
An index linked CD, aka market linked CD or equity linked CD, is a bank CD with an interest crediting formula tied to a market index. The main attraction of an index linked CD is that the value of the CD can go up with the market index but it can’t go down. The principal of the index linked CD is guaranteed both by the bank and by the FDIC.
The no-loss guarantee usually comes at the price of capping the upside. The chart below shows what a market linked CD will do versus a straight-up ETF that tracks the index. The horizontal axis is the average annual (not cumulative) return of the index.
Taxes Going Up, Reset Cost Basis?
Reader Kevin asked:
"I have several mutual funds with large unrealized capital gains. I expect tax rates will go up in the future. Does it make sense to sell them now while the capital gains tax rate is still low, repurchase them immediately after, and reset my cost basis?"
The answer, as usual, is "it depends."
It depends on when one expects to eventually sell these funds, to what extent the tax rates will go up, and how fast these funds will grow.
Flexibility and Retirement Planning
This is a guest post by Mike Piper.
Imagine this scenario: An investor (we’ll call her Susan) retires with a $700,000 portfolio. She plans to withdraw $28,000 in the first year of retirement and adjust that amount upward each year in keeping with inflation. In other words, Susan is using a 4% withdrawal rate–typically considered to be sustainable over a 30-year retirement.
Susan’s not looking to get rich, so she uses a moderate asset allocation for a new retiree: 40% stocks, 60% bonds.
In short, Susan is doing everything right — playing it "by the book" in every way.
Opportunity Cost and Paper Loss
Is an opportunity cost a real cost? That’s the question I have been pondering.
I was deciding whether to buy an air ticket a few weeks ago. I saw a good price when I did the search in the morning. I was at work at that time and I decided to make the purchase that evening. When I searched again in the evening, the good fare was gone. The price had gone up by $70. I paid $70 more than I could have.
According to Wikipedia, an opportunity cost is "the next-best choice available to someone who has picked between several mutually exclusive choices." The opportunity cost of waiting until the evening is locking in the low fare right then and there. Its economic value turned out to be $70. This example shows an opportunity cost is every bit real. It cost me real money out of pocket.
In the world of investing, opportunity cost is present at all times. The opportunity cost of investing in bonds is investing in stocks that turn out better, or vice versa. The opportunity cost of investing today is investing on a different day when the price is lower. The opportunity cost of holding on to an investment is selling it before the price goes down.
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Making the Most of Your Money Now by Jane Bryant Quinn
