Personal Investment Notes

I saw a question: why did my bond fund lose money? In other words, why did the bond fund price drop?

A seemingly simple question.

I also wondered if the prospectus was read; if not, what was the person told? Oh, it won’t vary much…or at all…or not told a thing about volatility.

Bonds, when held to maturity, give you your money back plus interest. Bond funds, on the other hand, do not have a maturity date. They have to evaluate their portfolio every day, after market close, to see how much it is worth if it sold all its holdings. However, if you priced an individual bond every day as to what it would sell for, most likely it will vary from its issue price (normally $1,000 per bond)…but you will get your principal back at maturity date (or call date, if that occurs) as long as the company does not go bankrupt.

Depending on the risk of the bonds bought, the price of the bond fund can vary quite a bit (measured by standard deviation). Short-term bond funds will vary much less that high-yield junk bond funds.

In reality, holding a bond to maturity can cause losses…to inflation, taxes, and reinvestment. The purchasing power of $1000 thirty years ago was much more than it is today thus the interest the bond generates needs to make up for inflation and taxes just to stay even. Also, with an individual bond, unless you use it to generate monthly consumable income, the interest needs to be reinvested. The bond fund makes this easy but an individual must either save the money to buy another bond or reinvest it in something else such as a money market which probably pays less than the bond’s interest.

For bond funds, look at the standard deviation and compare it to other funds such as short-term bond funds (VFSTX, Vanguard short-term investment grade fund has a SD of about 3. FAGIX, Fidelity’s Capital & Income fund, a junk bond fund, has a SD of about 12.) and long-term or junk bond funds. You will get an idea of how much the price will vary.

Another source of information is the monthly prices of a fund. Scan them over to see how much they vary.

The standard deviation and monthly prices can be found on finance.yahoo.com under risk and historical prices.

Bottom line: the riskier the bond fund the higher the standard deviation and the more the prices vary. Choose your funds wisely.

If there needs to be a tie-breaker, then choose the fund with the lowest expense ratio. This is especially important in the bond world.