The market has movedsideways for quite sometime, and navigating thisstatic plane is becomingincreasingly difficult. Forthose physician-investors who are nearingretirement and have adopted amore conservative investment postureconsisting of fixed-income securities asopposed to equities, I want to brieflydiscuss one such vehicle, bonds.
For the purpose of illustration, Iwent into the Morningstar Principia(Morningstar, Inc, Chicago, Illinois)database for the 12 months endingDecember 31, 2005 and conducted thefollowing search. I performed a filter ofall fixed-income (ie, bond) mutualfunds that had met certain investmentcriteria. The funds selected had to be atleast investment-grade quality or better.In other words, the average credit qualityof the bonds in the underlyingmutual fund portfolio had to be at leastBBB or better as rated by Standard &Poor's. Next, the average effectivematurity had to be less than 7 years andthe average duration had to be less than4 years—the purpose of which is toreduce interest rate risk in a flat to risinginterest rate environment. From theuniverse of available mutual funds, thissearch yielded a database of 1152funds with an average 12-month yield(through December 31, 2005) of 3.4%,a 12-month return of 1.7%, and a 3-year annualized return of 2.4% with anaverage expense ratio of 1%. Assumingyou held the "average" fund in yourtaxable portfolio, the after-tax returnswould have been pretty dismal andwould not have kept pace with inflation.Even in a tax-deferred investmentaccount, the returns are nothing to getexcited about.
As you can infer from the returnsabove, the decline in the value of thebonds in the underlying "average" portfolio was offset by the yield on thatportfolio. As a matter of fact, going toyour local bank and acquiring a 6-month or 1-year CD would have, in alllikelihood, given you as good or bettera rate of return. So, what are youroptions if you are a conservative investorinterested in bonds?
Avoid the bond funds anduse a laddered portfolio of individualbonds. In other words, purchasing individualbonds of varying maturities thatare of investment-grade quality or betterwill, in all cases, eliminate the internalexpenses associated with a mutualfund. A 1% expense ratio may notsound like much to be concerned about,but for a $1-million investment portfolio,1% translates into $10,000 annually,or $100,000 over a decade.
I went into another financial databaseand performed a filter of the availablebonds that are rated at least BBBand better and had maturities under 4years as opposed to 7 years. The searchyielded many taxable corporate andagency securities that yielded in therange of 4.7% to 5.4%. The returns aregoing to be a function of the length oftime until the note matures and thequality of the credit. Granted, uponmaturity, or if and when the bonds arecalled by the issuer prior to maturity,you will receive only the par or statedface value of the note. As such, there isreally no potential for capital appreciationif you hold the note until such timeas it is redeemed.
The only costs you will incur byadapting this strategy are transactioncosts and possibly commissions ormanagement fees charged by the financialadvisor who is managing youraccount, which you would also haveincurred with mutual funds.
If you are seeking to investin such instruments and want to do sowith less than, say, $50,000, you aregoing to have a difficult time constructinga portfolio of bonds with varyingmaturity dates. In order to get competitivepricing on notes, you generallyhave to deal in lots of $25,000 (25notes) or more. Hence, with $50,000you will not be able to obtain adequatediversification. Therefore, with smallamounts to invest, mutual funds orbank CDs are going to prove the moreviable option.
Thomas R. Kosky and his partner, Harris L.
Kerker, are principals of the Asset Planning,
Group, Inc, in Miami, Fla. The company
specializes in investment, retirement, and
estate planning. Mr. Kosky also teaches corporate
finance in the Saturday Executive and Health Care
Executive MBA Programs at the University of Miami in Coral
Gables, Fla. Mr. Kosky and Mr. Kerker welcome questions or
comments at 800-953-5508 or e-mail Mr. Kosky directly at