Long time FW Finance reader here, first time poster.
So earlier this year my father passed away unexpectedly and I have been dealing with the finances associated with the estate (I am in my 20's). I moved some money around into the market from my inheritance and so far I have done pretty good with multiple diversified portfolios.
Currently my asset allocation is: 42% Liquid Stocks (AVG return ~16%) 53% Liquid Cash (AVG return ~2%) 5% Other (Lending Club, etc) (AVG return ~13%)
My current belief is that the market will more slowly grow and may detract within the next year so I was looking to diversify my portfolio with a bond. My current financial advisor recommended a S&P index tied bond (I will not give specifics since that is against rules) of Senior Unsecured Debt to a major bank (Rated A1). It is a medium term bond which matures between 1 and 2 years. The return is such that should the S&P be up or even over a 12 month term the bond is called at a 10% coupon per year. The risks are bank associated credit risk and the S&P index declining over a 2 year period. This seemed so attractive to me that I decided that I would move some of my cash into this position. I figure that since this is a senior note that a total loss is almost impossible, and such a decline over 2 years is almost even more impossible IMO.
After this investment I would then be at: 42% Stocks 12% Bond A1 40% Cash 5% Other
Is it stupid to allocate 12% to one bond no matter how safe? The way I see it the CDS price of this bank puts it at a 5 year default insurance rate of around 6% and this bond will be for only 1-2 yrs. The chances of the biggest bank in America defaulting is so low that if such an event were to happen we would all be eating out of tin cans anyway.
NewToFatWalletUser said: tripleB said: Then take the rest (75?)% split it in two between Total Stock Market Index Fund and Total International Index Fund.
Why not just use the Vanguard Total World fund?
Higher ER. You can use it if you want. Just do Age in TBM and Rest in Total World Fund.
NewToFatWalletUser said: tripleB said: Then take the rest (75?)% split it in two between Total Stock Market Index Fund and Total International Index Fund.
Why not just use the Vanguard Total World fund?
it's new. it was created in 2008, thus no track record. it has a .25% purchase fee expense ratio is .50% maybe you dont want 40% USA/60% intl
FinanceJunkie said: Long time FW Finance reader here, first time poster.
So earlier this year my father passed away unexpectedly and I have been dealing with the finances associated with the estate (I am in my 20's). I moved some money around into the market from my inheritance and so far I have done pretty good with multiple diversified portfolios.
Currently my asset allocation is: 42% Liquid Stocks (AVG return ~16%) 53% Liquid Cash (AVG return ~2%) 5% Other (Lending Club, etc) (AVG return ~13%)
My current belief is that the market will more slowly grow and may detract within the next year so I was looking to diversify my portfolio with a bond. My current financial advisor recommended a S&P index tied bond (I will not give specifics since that is against rules) of Senior Unsecured Debt to a major bank (Rated A1). It is a medium term bond which matures between 1 and 2 years. The return is such that should the S&P be up or even over a 12 month term the bond is called at a 10% coupon per year. The risks are bank associated credit risk and the S&P index declining over a 2 year period. This seemed so attractive to me that I decided that I would move some of my cash into this position. I figure that since this is a senior note that a total loss is almost impossible, and such a decline over 2 years is almost even more impossible IMO.
After this investment I would then be at: 42% Stocks 12% Bond A1 40% Cash 5% Other
Is it stupid to allocate 12% to one bond no matter how safe? The way I see it the CDS price of this bank puts it at a 5 year default insurance rate of around 6% and this bond will be for only 1-2 yrs. The chances of the biggest bank in America defaulting is so low that if such an event were to happen we would all be eating out of tin cans anyway.
So what do you think FWF?
against the rules? what do you mean?
my belief is that everyone's portoflio should have bonds. they cushion when the market declines. it's not how fast your portfolio grows, it's how little it shrinks.
AVG: bonds = age conservative: bonds = age+10 aggressive: bonds = age - 10
so if you're 25 and an AVG risk taker: bonds = 25% (Total bond market) intl = 30% (total intl index) -> see my above post as to why intl = 30% US = 45% (Total stock market -> vtsax)
but you're young. you should be more aggressive since you have more time: bonds = 15% intl = 30% Us = 55%
tolamapS
Senior Member - 2K
posted: Nov. 20, 2009 @ 10:05p
1. What is a liquid stock? You mean large caps?
2. Don't buy bonds of single names. Worst idea ever.
3. Fire your financial advisor and move your assets to vanguard.
4. For the asset classes you have chosen, find the lowest cost funds. No front / back loads, no restrictions on buying / selling, and sub 10 basis point expense ratio.
5. Have fun.
tolamapS
Senior Member - 2K
posted: Nov. 20, 2009 @ 10:08p
germanpope said: Dodge and Cox has a World Fund --- it started a couple of years ago at 10 --- went to 4 and now back to 8
FinanceJunkie said: Is it stupid to allocate 12% to one bond no matter how safe?
The way I see it the CDS price of this bank puts it at a 5 year default insurance rate of around 6% and this bond will be for only 1-2 yrs. The chances of the biggest bank in America defaulting is so low that if such an event were to happen we would all be eating out of tin cans anyway.
So what do you think FWF?NEVER put more than 4% of your investment portfolio in ANY single investment or issuer.
I thought the Ginnie Mae bond fund would be less volitile over time. Boy was I wrong? The bond fund principle value dropped 10+% in face value over a short few months. Principle value has recovered some, but now the return on the investment is 2/3rds of what it was. I am NOT putting any more money in bond funds due to the changes in principle value.
Can you get burned in a volcano? YES. We did. We trusted Washington Mutual a few years ago. It's a name we thought we knew. Our $38,000.00 face value of short to medium term bonds are now worthless thanks to the FDIC which closed Washington Mutual just before Congress acted to save several banks in similar situations.
Is it tough to get a fair return on money safely? ABSOLUTELY. We have been blessed to average better than 6% APY on our bond portion. That is coming to a grinding halt with air brakes as a few bond issues mature or get called. Due to the way our bond ladder looks next year, we are just parking much of the matured bonds. The current short term offerings are a joke at less than a half per cent APY.
Whatever you do:
Check for the call feature: Callable when or Non-callable? We bought some taxfree bonds mature dated 2018. It turns out the bonds will be called in 2012 as the money is already set aside. (Pre-funded).
Check for the estate feature. If something happens to you, can your family turn the bonds in at face value? We were blessed to be able to stick it to GM because our GM bonds had the estate feature. We cashed out after my Dad died. We did not have them when the press started to butcher GM. We exercised 7 bonds that due to the market were priced below 90 cents on the Dollar. We collected full face value. Another bad bond market like the past 12 months is possible despite the current apparent recovery in bond prices.
Check for Material Events on the bonds you hold often. The bond rating comapanies just love to surprise. Just when you think they have gone to sleep is when they change the rating.
Fbone
Member
posted: Nov. 21, 2009 @ 12:25a
I've seen charts that state a 70/30 has only a small return above a 50/50 yet significantly more risk.
I'm not sure about your bond. It doesnt seem to match your risk tolerance. You have 40% cash. That to me indicates low risk.
FinanceJunkie
New Member
posted: Nov. 21, 2009 @ 12:48a
Thanks for the responses so far. I appreciate it.
My current age is 24. I have been slowly moving my cash into stocks over the past 7 months, it's alot of cash for me to deal with at my age. The bond is issued by BAC btw. I still want to put something in it because I like what I see, so I should drop it to maybe 5%? I feel like my broker is trying to sell me things rather than give me the guidance I need. I have a meeting with a fidelity advisor on tuesday so I will see what he says. What do you think of me halving my investment in the bond and taking the other half and pick out some other ones I like?
I don't want to do too many index funds, because they are boring and I like to pick and choose my investments. I know I am ripe for flaming for saying that, but honestly this is a side hobby for me which I enjoy.
Getting some other bonds from other issuers that you have researched is a good idea IF you do your homework. We own some BAC bonds which pay monthly too, but not over the 4% guideline I gave you. You need to be watchful as Countrywide bonds are back in the market. They are BAC owned now as is MBNA which has some bonds out under that name still. We use Fidelity for bond purchases at $1.00 commission fee per $1000 bond purchased. We are not that different regarding funds vs individual selection. We do both to some degree. For stocks, I like S&P500 SPY aka spiders. That is one choice we exceed the 4% guideline because of the diveristy.
FinanceJunkie
New Member
posted: Nov. 21, 2009 @ 1:13a
I own SPY and DIA as well, they are alot of my portfolio. I like a mix of the two. These are new issue BAC bonds, they are not resale. This bond will actually be traded on the NYSE in the future as a bond fund, much like what you all recommend it is subject to credit risk of BAC though.
I am thinking 6% is a fair amount of risk to take on it, I will add a few more along the way. I REALLY like the risk/reward on this one, which is why I went so strong with it.
I even went and studied the Default Swap prices of BAC vs my Return and I felt it was a good trade off. Don't get the wrong impression, I do my homework and I know what I am doing.
xerty
Senior Member - 2K
posted: Nov. 21, 2009 @ 3:56a
FinanceJunkie said: I was looking to diversify my portfolio with a bond. My current financial advisor recommended a S&P index tied bond (I will not give specifics since that is against rules) of Senior Unsecured Debt to a major bank (Rated A1). It is a medium term bond which matures between 1 and 2 years. The return is such that should the S&P be up or even over a 12 month term the bond is called at a 10% coupon per year. The risks are bank associated credit risk and the S&P index declining over a 2 year period. This seemed so attractive to me that I decided that I would move some of my cash into this position. I figure that since this is a senior note that a total loss is almost impossible, and such a decline over 2 years is almost even more impossible IMO. You can now talk about specific investments here (they finally scrapped the old rule about specific stocks, etc). If you post the details of what this great "S&P indexed bond" is, I bet you'll find the resident FWF posters will tear it apart. Most of these structured products are pretty much crap, with lots of fine print that amounts to you writing them lots of embedded options at well below market price.
Is it stupid to allocate 12% to one bond no matter how safe? The way I see it the CDS price of this bank puts it at a 5 year default insurance rate of around 6% and this bond will be for only 1-2 yrs. The chances of the biggest bank in America defaulting is so low that if such an event were to happen we would all be eating out of tin cans anyway. Stupid might be too strong, but foolish yes. What were the CDS rates on Lehman Brothers in 2006, 2 years before they declared bankruptcy? Now there are whole businesses devoted to suing them over their structured products similar to the ones you describe.
Don't fool around with this bank-specific nonsense. Do you have any good reason not to buy Vanguard's Total Bond Market (VBMFX) with your bond money? I think this should probably be a default choice, and you can deviate from this only with a good reason. "The nice salesman told me about something new" is not a good reason. If you want something shorter term with less risk, fine, go for a short-term index bond fund instead like Vanguard's (VBISX).
xerty
Senior Member - 2K
posted: Nov. 21, 2009 @ 4:12a
FinanceJunkie said: These are new issue BAC bonds, they are not resale. This bond will actually be traded on the NYSE in the future as a bond fund, much like what you all recommend it is subject to credit risk of BAC though.
I am thinking 6% is a fair amount of risk to take on it, I will add a few more along the way. I REALLY like the risk/reward on this one, which is why I went so strong with it.
I even went and studied the Default Swap prices of BAC vs my Return and I felt it was a good trade off. Don't get the wrong impression, I do my homework and I know what I am doing. Ok, if you really want to trade individual bonds as a hobby, enjoy yourself and good luck. The retail bond market is notorious for high spreads and bad quotes, which are more important than outright commissions for real purchases. If I wanted exposure to bank debt, I'm sure there are plenty of good junk bond funds out there that are very likely cheaper, easier, and far more diversified if what you're looking for is being long credit exposure.
Your downside is equity risk and your upside is fixed income returns. How much you financial advisor gets paid in commissions?
Did you compare that bond to a put option on SPY?
tolamapS
Senior Member - 2K
posted: Nov. 21, 2009 @ 9:45a
FinanceJunkie said: Is it stupid to allocate 12% to one bond no matter how safe? The way I see it the CDS price of this bank puts it at a 5 year default insurance rate of around 6% and this bond will be for only 1-2 yrs. The chances of the biggest bank in America defaulting is so low that if such an event were to happen we would all be eating out of tin cans anyway.
So what do you think FWF?
About 6 before the crisis top (circa Winter / Spring of 2008), a relative of mine was suggested AIG bonds (by e*Trade or TD Ameritrade, or wherever his money was at that time) as a way to park his emergency funds, around $30K. My relative was moving it from bank to bank, from short term CD to another, enjoying 5%+ returns, but obviously those rates went down fast, so at that time the "nearly" riskless bonds sounded good.
I talked him out of it, suggesting instead another CD, maybe using a special deal.
You mentally think that you will only put your money there for only 1-2 years, and that most likely, nothing will happen during those 1-2 years. But then you will continue doing the same thing over and over again, year after year.
That, my friend, is poor investment policy. You essentially have decided that you should not do that, but you go ahead and do that anyway.
Don't get suckered by some BS-talking investment advisors. You want a bond portfolio? Get a diversified portfolio via a cheap mutual fund or an ETF.
It always amazes me how specific some of the advice is in these "what do I do with my money threads". FW Finance contributors are on the whole fearless with other people's money. There's some really good advice here, but weeding it out from the bad advice is the rub.
The old school would suggest the OP is too young for any bonds. I agree. I would advise the OP to stay away from all bonds at his age. The market has done very well this year, and a lot of people exposed to it have done very well and feel smart. Most of them, however, are decidedly not particularly smart, because a "rising tide lifts all boats," etc. Well, not completely, but enough so that anyone who remained somewhat well diversified throughout the year has done OK.
My suggestion to the OP is to be careful. We have the Santa Claus rally to look forward to, and historically this has been a reliable indicator of year end performance. So an index fund type of buy right now will *probably* be at least a bit higher at the end of the year.
Taking tax implications out of the equation, in the OPs shoes I would, once again, be careful committing new money to the market now, which may be a bit ahead of itself. I'd normally recommend keeping six months of cash high and dry and investing the rest in higher risk/higher return funds/stocks. No bonds. At least at the OP's age. And assuming this money is invested for the long term.
However, in the present economy, I'd put half in some type of highly diversified stock index instrument, and the rest in the most liquid, safe, and highest APY returning account I could find. And then reevaluating the situation as needed. Of course, knowing when to reevaluate and when/if to act is the really tricky part and what 'separates the men from the boys' .
One of the simplest but historically most reliable rules of thumb is to "sell in May and go away" until November. The simplicity of this method would seem to belie its effectiveness, but over the years it's worked surprisingly well.
FinanceJunkie
New Member
posted: Nov. 21, 2009 @ 12:32p
The bond is called Strategic Accelerated Redemption Securities from Merrill Lynch.
$10 per unit
1-2 year maturity
Auto-call at 1 year if S&P is up or even from observation date, 10% coupon paid. On a $1000 investment a $100 coupon Auto-call at 1.5 year if S&P is up or even from original date. 15% coupon. On $1000 investment $150 coupon. Matures at 2 yr. If s&p is up or even 20% coupon. If s&p is down you take a principle loss minus 10%. So on $1000 if the s&p is down 10% you get full principle $1000.
Max gain is 20% max loss in 90%.
That is a somewhat guaranteed 10% annual return with a 10% downside protection. No fees, no load.
Do you understand this investment? Out of the huge financial universe of possible investments, why would your "current financial advisor" recommend this fairly arcane product? Ask yourself this question, and better still, ask him. Do you have enough money to sufficiently interest a financial adviser? How much money is the adviser going to make if he sells you this product?
I'm not suggesting you're rushing into anything. But just be careful. Never trust a financial adviser with something to gain by selling you a product. At least not until you become much more familiar with investments.
FinanceJunkie said: Well you failed to make any argument why.Since your downside risk is still S&P500, you are not really diversifying. That's why you should fire you FA, not because he makes a commission.
FinanceJunkie said: Well you failed to make any argument why.I don't want to beat up on you too much, because I'm sensing you have a lot to deal with right now.
However, did it ever occur to you that some of us here have more experience than you, and just don't feel like explaining why we're not that crazy about every investment suggested by well-meaning but naive investors, especially somewhat obscure ones like Strategic Accelerated Redemption Securities, which is linked to the DJ and has only been around for a little more than a year. I will say that your current general asset diversification (listed in your first post) is not bad.
We know nothing about your total financial picture: your net worth, what your family's role is/might be in your savings plan, your present and expected futre income, etc. If Strategic Accelerated Redemption Securities is going be your keystone investment, I'll just say don't do it and bow out.
I sincerely wish you the best of luck, whatever you decide.
NewToFatWalletUser
Dismembered Member
posted: Nov. 21, 2009 @ 5:06p
I'm the same age as the OP and my Roth comprises the bulk of my retirement accounts (and net worth).
I only hold three stocks in my Roth IRA -- Altria (MO) 40% / Philip Morris Int. (PM) 40% / Kraft (KFT) 20%.
ftw.
FinanceJunkie
New Member
posted: Nov. 21, 2009 @ 6:49p
Thank you for your explanation.
What do you guys think about a bond index like JNK?
I am thinking about maybe 15% of my portfolio to bonds. With maybe 30% Junk, and 70% investment grade ETF.
What do you think about this breakdown? 5% Cash 5% Other (Lending club etc) 15% Bonds 30% junk 70% investment grade 75% Equities 10% Mid-Small Stocks 20% International 30% Blue Chip 40% Index ETF
xerty
Senior Member - 2K
posted: Nov. 21, 2009 @ 7:27p
FinanceJunkie said: What do you guys think about a bond index like JNK?
I am thinking about maybe 15% of my portfolio to bonds. With maybe 30% Junk, and 70% investment grade ETF. First, junk bonds are really best thought of as "stock" rather than "bonds". Junk bonds are up 40-50% this year. In a bad year, they could be down 40-50%. Does that sound more like a stock or a bond to you? You can hold junk bonds if you want as a bet on a credit recovery, but do yourself a favor and count them as risky assets rather than safe ones.
Second, bond ETFs still have some issues. I don't personally like JNK much - they have half the diversification of a typical high yield bond fund like Vanguard's VWEHX. Maybe in time bond ETFs will become more popular, larger, and more diversified, but that hasn't happened yet. JNK has 20% of its assets in the top 10 holdings and only 140 total bonds, while the Vanguard fund as half that (10%) in its top 10 and over 300 individual bonds.
What do you think about this breakdown? 5% Cash 5% Other (Lending club etc) 15% Bonds 30% junk 70% investment grade 75% Equities 10% Mid-Small Stocks 20% International 30% Blue Chip 40% Index ETF Inflation protected bonds are reasonable - you might split 1/2 or 1/3 of your bond allocation to those (TIP or VIPSX). I wouldn't split "Blue Chip" vs "Index" in your stock holdings as they're pretty much the same. I would usually go a little higher than 80-20 foreign stocks, maybe 70-30 on diversification grounds.
xerty
Senior Member - 2K
posted: Nov. 21, 2009 @ 7:36p
FinanceJunkie said: The bond is called Strategic Accelerated Redemption Securities from Merrill Lynch.
Auto-call at 1 year if S&P is up or even from observation date, 10% coupon paid. On a $1000 investment a $100 coupon Auto-call at 1.5 year if S&P is up or even from original date. 15% coupon. On $1000 investment $150 coupon. Matures at 2 yr. If s&p is up or even 20% coupon. If s&p is down you take a principle loss minus 10%. So on $1000 if the s&p is down 10% you get full principle $1000.
Max gain is 20% max loss in 90%.
That is a somewhat guaranteed 10% annual return with a 10% downside protection. No fees, no load. This SARS thing sounds like some sort of bad disease. I'm still not entirely clear from your explanation what happens if the market goes down. If the market is -1% over 2 years, do you still lose 10% of your principle? Is that loss in addition to not getting the 10% coupon (since the coupons only happen if the market is up)?
Since you're the finance junkie, I invite you to figure out what combination of put and call options replicate the performance of this product. Then go price those options in the marketplace. I'm sure you'll find that you could accomplish this esoteric combination of options with much better terms (more downside protection or higher coupons, or both) than the bank is offering. Remember that the bank isn't in the business of "giving out great deals", they're in the business of making money and that's coming from you.
FinanceJunkie
New Member
posted: Nov. 21, 2009 @ 8:13p
You have loss protection up to 10% so you will get 100% of your principle.
Fbone
Member
posted: Nov. 22, 2009 @ 1:40a
With 75% equity I dont think you need 5% junk bonds. Maybe put the 5% in TIPS.
While everyone's risk aversion is different I find 80/20 (I'm including Lending club) high for anyone.
P3R3
Member
posted: Nov. 23, 2009 @ 1:43a
You mean I have too much or too little risk?
FinanceJunkie
New Member
posted: Nov. 23, 2009 @ 11:55a
I am leaning towards not doing it right now and sticking with maybe a bond index and some TIPs.
I want to thank everyone who's given a response to OP. This thread has been very helpful to me since I'm 24 and just received an inheritance - similar situation to OP. One of the very first things I did was transfer the assets from Bear Stearns(Chase) over to Vanguard. My father's old broker was charging a minimum of $75/trade plus has the money in all these really high Exp Ratio and load funds.
It always amazes me how the financial industry preys on people.
Fbone
Member
posted: Dec. 8, 2009 @ 1:07a
LtWaldo said: I want to thank everyone who's given a response to OP. This thread has been very helpful to me since I'm 24 and just received an inheritance - similar situation to OP. One of the very first things I did was transfer the assets from Bear Stearns(Chase) over to Vanguard. My father's old broker was charging a minimum of $75/trade plus has the money in all these really high Exp Ratio and load funds.
It always amazes me how the financial industry preys on people.
It's how the brokers earn their living. Problem is that their advice isnt always in your best interest.
Great choice switching to Vanguard. Lots of excellent advice on bogleheads.org Good info and books to read there. Forum to ask questions and well supported.
Skipping 2 Messages...
BetterBrainBureau
Member
posted: Dec. 9, 2009 @ 12:28a
NewToFatWalletUser said: I'm the same age as the OP and my Roth comprises the bulk of my retirement accounts (and net worth).
I only hold three stocks in my Roth IRA -- Altria (MO) 40% / Philip Morris Int. (PM) 40% / Kraft (KFT) 20%.
ftw.
I would change your lifestyle choices by recommending you smoke 2 packs of cigarettes a day. It will be good for your portfolio companies, and it will match your non-diversified portfolio well.
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