Author Topic: Bond mutual fund as a savings account?  (Read 5218 times)

gebraset

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Bond mutual fund as a savings account?
« on: March 10, 2014, 04:10:56 PM »
I tried doing a quick search on the Internet, as well as on the forums, and couldn't find too much in regards to the direct comparison of bonds and saving accounts.

I'm trying to figure out if it is smart to cash out a savings account in order to make more more within a US based bond mutual fund. Here are the numbers I am using as an example of earning potential:

Savings account - Ally
Investment: $10,000
APY: 0.87%
Estimated earnings before tax over one year (if APY does not go up or down): $88.38

Bond - VBTLX
Investment: $10,000
Shares (at current price of $10.67): 937.2071227741331
Dividend (last payout, we will assume the price stays the same all year): $0.02234/month
Estimated earnings before tax over one year (not taking into consideration market fluctuations, assuming dividend payout to reduce complexity of calculations): $251.2464854732896

What would be the reasoning not to do this? I understand that bonds can fluctuate a bit, give or take a few percentages, so that could be a potential risk. Additionally, bonds are not FDIC insured like savings accounts are, as far as I am aware. So yet again, another risk, though small in my opinion.

Thoughts?

Abe

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Re: Bond mutual fund as a savings account?
« Reply #1 on: March 10, 2014, 05:58:50 PM »
You have the main points: bond funds are more risky than savings accounts since they are not insured and can lose value if the currently held bonds have lower interest rate than new bond issues. Thus there is a risk that you may have less money than you started out with. Savings accounts will either have the same or more monetary value (though inflation may decrease what you can buy in either case).

warfreak2

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Re: Bond mutual fund as a savings account?
« Reply #2 on: March 10, 2014, 06:09:16 PM »
I understand that bonds can fluctuate a bit, give or take a few percentages
"A bit" is relative. VBTLX has had several 6-8% dips over the last decade. If you might need the money in the short term, a savings account or money market fund (e.g. VMMXX) is better.
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the fixer

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Re: Bond mutual fund as a savings account?
« Reply #3 on: March 10, 2014, 07:28:12 PM »
If you're looking for safe yield, look at promotional rates on CDs that come up every now and then, and do the math to figure out how the early withdrawal penalty would affect the effective return at some hypothetical future date. You should be able to do better than a savings account this way. In December, PenFed offered a 3% rate on a 5-year CD.

Another option is a rewards checking account from a credit union. There are several out there that will pay about 3% APY on up to ~$20k provided you jump through various hoops: use online bill pay, make so many debit card transactions per month, etc.

Both of these options are FDIC insured but still contain "risk." The risk in a CD is that you need the money early (or: market rates improve to the point that you're better off withdrawing early and getting a new CD), so that adds some variability to the return depending on how early you cash it out. The risk of a rewards checking account is more of a personal performance risk: that you'll mess up how many debit card transactions you need, you forget to pay a bill online one month, etc and lose out on a month's interest here or there. You should consider these, but I think they're way lower than the risk of interest rates rising.

gebraset

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Re: Bond mutual fund as a savings account?
« Reply #4 on: March 10, 2014, 08:05:14 PM »
Thank you all for your responses. As far as the money that will be invested, I do not need to access it for roughly 2.5 to 3 years. Nonetheless, getting the money within a few business days would be preferable if something were to arise.

In terms of CDs, I have already gone that route in the past. I was lucky enough to find an institution that only charged a 60-day interest penalty to close any CD early, no matter the length. That has now risen to, if I am correct, 12 months interest for a 3-5 year CD. I have never found a promotional CD offer with the financial institutions that I currently am affiliated with, and I certainly would not like to add any more forms to my tax filings.

The money market account seems like a waste to be honest. VMMXX for example has an expense ratio of 0.17%, but in the last year has brought in 0.03% and in three years has brought in 0.14%. Additionally, the distribution is $0.00001. On a $10,000 investment, distribution would give me $1.20 in one year, with very minimal growth. Would you not lose money just having it sit in the account due to the expense ratio?

Concerning VBTLX, I'm not seeing how it has had any 6-8% dips over the last decade, besides possibly during last year. And even if that is correct, the fund was only down 2.15% for the last year. On $10,000, that would represent $215, which was probably recovered by the distributions paid out during 2013.

In the end, I understand the somewhat minor risk that comes with bonds. I understand that it is higher than a money market account. But even if VBTLX went down 2% over the next two years, dividends would almost certainly cover the loss.

I'm not discrediting what you all have said, but it still seems to me that using a fund like VBTLX would suffice for a savings account, in regards to its potential earning and relatively low risk to capital.

tj

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Re: Bond mutual fund as a savings account?
« Reply #5 on: March 10, 2014, 08:52:28 PM »
Thank you all for your responses. As far as the money that will be invested, I do not need to access it for roughly 2.5 to 3 years. Nonetheless, getting the money within a few business days would be preferable if something were to arise.

In terms of CDs, I have already gone that route in the past. I was lucky enough to find an institution that only charged a 60-day interest penalty to close any CD early, no matter the length. That has now risen to, if I am correct, 12 months interest for a 3-5 year CD. I have never found a promotional CD offer with the financial institutions that I currently am affiliated with, and I certainly would not like to add any more forms to my tax filings.

The money market account seems like a waste to be honest. VMMXX for example has an expense ratio of 0.17%, but in the last year has brought in 0.03% and in three years has brought in 0.14%. Additionally, the distribution is $0.00001. On a $10,000 investment, distribution would give me $1.20 in one year, with very minimal growth. Would you not lose money just having it sit in the account due to the expense ratio?

Concerning VBTLX, I'm not seeing how it has had any 6-8% dips over the last decade, besides possibly during last year. And even if that is correct, the fund was only down 2.15% for the last year. On $10,000, that would represent $215, which was probably recovered by the distributions paid out during 2013.

In the end, I understand the somewhat minor risk that comes with bonds. I understand that it is higher than a money market account. But even if VBTLX went down 2% over the next two years, dividends would almost certainly cover the loss.

I'm not discrediting what you all have said, but it still seems to me that using a fund like VBTLX would suffice for a savings account, in regards to its potential earning and relatively low risk to capital.

I'm not sure that the dividends covered the loss. I think it lost 2% after dividends?
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skyrefuge

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Re: Bond mutual fund as a savings account?
« Reply #6 on: March 10, 2014, 11:05:19 PM »
Heck, why not just move your cash to a randomly chosen mining startup in an emerging market? You'll have the chance of even BIGGER returns there than you would in the bond market!

The reason is because you have a certain risk tolerance, and your asset allocation is based on that. If your Investment Policy Statement shows that you're under-allocated to bonds and over-allocated to cash, then yes, you should definitely move your cash. But moving to bonds simply because you're disappointed with the return on your cash is entirely the wrong way to make investment decisions.

Due to low interest rates, there is "yield chasing" going on all around the investment universe these days. The very people you'd be buying VBTLX from are likely selling it because they're pissed at its low returns, and are buying dividend stocks instead. They're doing it wrong too. You can't just gun for more return without taking on more risk. There's no free lunch.

Bond prices fall when interest rates rise. Do a bit of Googling and see what people think interest rates are going to be doing in the near and continuing future (if you're picking up my tone right, you might even be able to skip the Googling and correctly guess the answer). A holding of VBTLX lost 2.2% in 2013 as interest rates rose, and no, you wouldn't have made it up with dividends, because that number already includes reinvested divdends. Conversely, you don't have to subtract 0.17% from VMMXX, because the expense ratio is already included in its 0.03% return. And in hopefully my last random nitpicky correction, adding a bank name and interest amount from a new CD to your tax form is the smallest burden ever, and certainly no more burdensome than adding the tax-related info from VBTLX distributions.

Make an IPS. The research on risk and asset allocation that you'll need to do to write one means that if/when you move your cash to bonds, you'll truly understand why you're doing what you're doing.

gebraset

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Re: Bond mutual fund as a savings account?
« Reply #7 on: March 11, 2014, 05:13:25 AM »
I appreciate the reply, no matter how nit picky or aggravated you seem to be about your reasoning, lol.

I was not aware of some of the things that you pointed out, such as the loss on VBTLX including the reinvested dividends. Additionally, I was also not aware that with VMMXX, the expense ratio was already included in its 0.03% return. You are additionally correct in terms of adding a CD to my tax forms; emotions played a role into that initial comment since I need to do some consolidating in terms of where my funds are located at. In the end, a CD may be the best option for a better return without any actual risk, besides inflation of course.

Additionally, I looked into a money market account provided by Ally, and the rate is 0.85%, so lower than the savings. Their CDs are decent, with 12 months right now giving you 0.99%, if I remember correctly. 3 years is 1.2% I think, with an early withdrawal fee of 90 or 120 days of interest.

Anyhow, thank you for the information, and I will research further into an Investment Policy Statement.

ncornilsen

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Re: Bond mutual fund as a savings account?
« Reply #8 on: March 11, 2014, 08:09:15 AM »
Smartypig.com.  1.00% APY, 2 day lead time to get your cash back. FDIC insured. PLUS, you can use that money to get discounted gift cards at quite a few useful retailers. For my house addition, I saved nearly $700 using their discounted lowes/HD gift cards.

I'd post my refer a friend link, but I don't have time to pull it from the site :)

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Re: Bond mutual fund as a savings account?
« Reply #9 on: March 11, 2014, 08:15:28 AM »
Thank you all for your responses. As far as the money that will be invested, I do not need to access it for roughly 2.5 to 3 years. Nonetheless, getting the money within a few business days would be preferable if something were to arise.

In terms of CDs, I have already gone that route in the past. I was lucky enough to find an institution that only charged a 60-day interest penalty to close any CD early, no matter the length. That has now risen to, if I am correct, 12 months interest for a 3-5 year CD. I have never found a promotional CD offer with the financial institutions that I currently am affiliated with, and I certainly would not like to add any more forms to my tax filings.

The money market account seems like a waste to be honest. VMMXX for example has an expense ratio of 0.17%, but in the last year has brought in 0.03% and in three years has brought in 0.14%. Additionally, the distribution is $0.00001. On a $10,000 investment, distribution would give me $1.20 in one year, with very minimal growth. Would you not lose money just having it sit in the account due to the expense ratio?

Concerning VBTLX, I'm not seeing how it has had any 6-8% dips over the last decade, besides possibly during last year. And even if that is correct, the fund was only down 2.15% for the last year. On $10,000, that would represent $215, which was probably recovered by the distributions paid out during 2013.

In the end, I understand the somewhat minor risk that comes with bonds. I understand that it is higher than a money market account. But even if VBTLX went down 2% over the next two years, dividends would almost certainly cover the loss.

I'm not discrediting what you all have said, but it still seems to me that using a fund like VBTLX would suffice for a savings account, in regards to its potential earning and relatively low risk to capital.

You are rationalizing away the risk because you think this is a safe play, the reason the bond pays a higher return then the savings account is because it is inherently more risky and that is the return you are paying for by purchasing it.

Albeit a bond fund like this is substantially less risky than other investments, that is why the return is only 2.15% and you think it is safe and a good replacement for a savings account.

Be careful, this is the type of risk that is easy to ignore and burn you, you are trying to make a few extra dollars in dividends over your savings interest at the risk of losing more in capital, the risk vs reward is hardly worth it.

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warfreak2

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Re: Bond mutual fund as a savings account?
« Reply #10 on: March 11, 2014, 09:40:27 AM »
Concerning VBTLX, I'm not seeing how it has had any 6-8% dips over the last decade, besides possibly during last year.
According to Google Finance,
If you bought 2012-07 to 2012-12 and sold in 2013-09, you'd have lost over 6%.
If you bought 2008-02 and sold 2008-10, you'd have lost over 7%.
If you bought 2003-06 and sold 2006-06, you'd have lost over 9%.

The advantage of a savings account is you can't be punished for withdrawing at the "wrong" time.


Bond prices fall when interest rates rise. Do a bit of Googling and see what people think interest rates are going to be doing in the near and continuing future
It's not quite so simple; if this is widely believed already, then the market has already reacted to it, so the prices already reflect the expectation that interest rates will rise.
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hodedofome

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Re: Bond mutual fund as a savings account?
« Reply #11 on: March 11, 2014, 09:53:50 AM »
Totally agree with Fancypants. You are trying to eek out a very small extra return for a risk that you can't quantify.

Bonds have been in a 30 year bull market. How much longer do you think it will last? Are you willing to risk your savings/emergency fund on that? What if interest rates rose to 5%, 10% or worse? Do I think that might happen? Personally, no. But can it happen? Yes! VBTLX could lose 20% in an event like that.

If we're only talking about a $10k account, then the small, small amount you might make from the higher dividend is just not worth it IMO. You want your savings account to always go up, not be at risk of going down. Don't fall into the yield chasing trap. That NEVER ends well.

skyrefuge

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Re: Bond mutual fund as a savings account?
« Reply #12 on: March 11, 2014, 10:29:43 AM »
According to Google Finance,
If you bought 2012-07 to 2012-12 and sold in 2013-09, you'd have lost over 6%.

Not quite. Google's charts are price charts, and thus exclude the value of reinvested dividends. And in a bond fund, that makes a big difference. Morningstar's "growth of 10k" charts are much better for understanding historical total returns. http://quote.morningstar.com/fund/chart.aspx?&t=VBTLX That shows that for your 2012-2013 period, the loss was "only" ~3% rather than 6%. 

It's not quite so simple; if this is widely believed already, then the market has already reacted to it, so the prices already reflect the expectation that interest rates will rise.

Agreed. I was just trying to throw an alternate perspective at the OP besides the very rosy past-performance of the bond market. Of course no one knows what will happen in the future, but seeing that there are tons of people screaming about the impending bond market collapse (whether they're right or wrong) might at least make the OP pause a bit and reassess.

warfreak2

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Re: Bond mutual fund as a savings account?
« Reply #13 on: March 11, 2014, 11:44:21 AM »
OK, thanks for the correction.
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gebraset

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Re: Bond mutual fund as a savings account?
« Reply #14 on: March 11, 2014, 05:36:14 PM »
Again, thank you all for the additional insight. I will probably settle on a CD that is relatively short, as the money will be needed in roughly three years. Additionally, you are all correct in regards to me attempting to rationalize it. I thought that it was a good idea, which can be seen from my expressions within my initial post. Chasing the yield would probably hurt me in the end, and choosing a CD will likely be more beneficial than going to a bond fund for short term savings.

I appreciate all of the input on this topic!

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Re: Bond mutual fund as a savings account?
« Reply #15 on: March 11, 2014, 05:37:29 PM »
If you bought 2003-06 and sold 2006-06, you'd have lost over 9%.

Just another data point: over this period with dividends reinvested VBTLX would have returned over 6%.  Fund price alone distorts the real story; I'd recommend using Yahoo Finance "Adjusted Price" for more realistic assessments.

Your point stands, of course, and leads me to another point: VBLTX is a rather shitty choice for a bond fund to serve as a savings-like account.  Something like VSGBX would probably be more appropriate--much lower risk (with lower reward, of course).  Across your three time window examples VSGBX would have returned

0.3% (2012-07 to 2013-09)
1.0% (2008-02 to 2008-10)
4.4% (2003-06 to 2006-06)

That said, the last year it's only returned ~0.1% and thus you'd have been better off with CapitalOne 360/Ally/whomever at ~.75%

hodedofome

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Re: Bond mutual fund as a savings account?
« Reply #16 on: March 12, 2014, 08:50:54 AM »
I'd go back a whole lot more than 10 years to find out how a fund did. Try going back 100 years to see what bonds did each year. Last year the Barclays Aggregate was down -2%. It was also down over 2% in 1994, down almost 1% in 1999 as well. If I look at 10 year treasuries between 1929 and 1972, I count 9 years with negative performance.