Bond Index Funds-a Synopsis                         Page 11

Some Investors Don't Like Having Treasuries in Bond Index Funds

Some mutual fund customers complain that they don't need or want to pay a management fee to hold treasury bonds in a portfolio, since they can buy treasury bonds commission-free from the government. And some say they would prefer to hold only corporate bonds or GNMAs in a high-quality index fund, but that such funds don't exist at present. (Morningstar.com)

Disadvantages of Bond Index Funds vs. Other Investment Instruments: Some Compelling Arguments for Holding Individual Bonds

As John J. Brennan, CEO at Vanguard said, "1999 was a useful reminder that you can lose money in Bond Funds." During that year investors learned not to "count on regular capital appreciation in a bond fund investment." In some bear market years, like 1994 and 1999, bond funds can carry considerably greater downside risk. So even though many bondholders saw the value of their investments plummet on the secondary market, and even though these bonds occasionally lost money after inflation, bond mutual fund investors reportedly lost even more money during these years.

Bond Holders Can Control Timing of Buying and Selling

By holding individual bonds, the investor chooses when to buy or sell-thus retaining control over the timing of any taxable capital gains or losses. With treasuries or investment grade corporate bonds, investors also have the assurance that they will almost certainly be paid at a certain time and at a set interest rate.

Investors Can Buy Treasuries Commission-Free Directly from the Government

Recently, the Treasury has made bonds available with no fee when investors buy them online or over the phone. Click here or here for the relevant government websites. The minimum investment through Treasury Direct is $1,000, although one would probably need about $50k to achieve a decent degree of diversification.

Five Year Treasury Study

Scott Burns, a syndicated financial editor who writes for the Dallas Morning News, among other periodicals, recently (5/2/00) published a study comparing the returns of five-year treasury bonds with the returns of various bond funds. He found that in each of the five-year periods ending in the previous six months, a five year treasury bond has yielded greater returns than an index of 20 major government securities funds. Moreover, of the 1290 bond funds with five year track records, only 282, or 22%, produced a higher load-adjusted return than a five year treasury note, and almost all of these 282 bond funds contained riskier issues from emerging markets, international bonds, junk bonds, or long-term treasuries.
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