 Personal Finance PowerPoint Presentation, Bond Funds. Prepare to get financially fit by practicing personal finance. Most of this information can be found at the Vanguard website, which you can find online at investor.vanguard.com. In prior presentations, we've been taking a look at investment goals, strategies, tools, keeping in mind the two major categories of investments, that being the fixed income, typically the bonds, and the equities, typically the common stock. Also, keeping in mind other tools we might be using such as mutual funds and ETFs, possibly so that we can diversify our portfolio with less investment upfront, as opposed to investing in individual stocks and individual bonds. We've been diving into mutual funds in a bit more detail in prior presentations. Let's give a quick overcap of different types of mutual funds. We've been discussing that being money market funds. We've got the bond funds. That's what we'll dive into in a bit more depth here. You've got the balanced funds. We've got the stock funds. We've got the international funds and sector and specialty funds. Now, when we're thinking about investing in general, remember that you might be saying, well, I can invest in individual stocks, individual bonds, or I can use tools such as mutual funds or ETFs. If I use mutual funds or ETFs, then, which is often the case for many individual investors, then the question is, do I want to have multiple different mutual funds that kind of are going to be part of different sectors, or do I want to try to have as little mutual funds as possible, make it as easy as possible, having some kind of fund that possibly is balanced in and of itself throughout the different sectors. One has less control if you just have one fund, but it's easier to do, and you might still be able to get a good diversification for it. The other gives you a little bit more control, although less control than buying individual stocks, but that might be something still more manageable for an individual investor. Also, always keep in mind that you also want to think about, should I be investing in index funds, which are like averaging types of funds as opposed to active managed funds, and the index funds might be a little bit cheaper than the active managed funds. The active managed funds might be able to get a higher return depending on the management of those funds within this different sectors. Keep in mind that we're going now into the bond funds. So what are fixed income or bond funds? So we're on the fixed income types of things. When we're doing our individual investing, we're typically trying to get some balance between the fixed income like bonds and the equities like the common stocks in general. And then we can get into more detail within those categories, because you could have more standard almost like fixed income stocks, which would be the stocks that are very established that might have dividends that are fairly routine, and you could look at bonds, which are a lot more risky but might have potential returns for them. But in general, you got your bonds, your standard bonds are going to be more fixed income. They're not as exciting as the stocks. You don't expect a lot of volatility as much as you do with stocks, but they should be solid and hopefully counterbalance if there's a downturn on the market. And that's your hedging kind of perspective on the bonds typically. So bond funds and bond ETFs offer greater diversification than individual securities as well as other benefits. Bond funds are similar to stock funds because they invest in a diverse selection of investments, but they hold fixed income securities instead of stocks. Now when you think about the stocks and the mutual funds related to stocks, it kind of makes a little bit more sense like they're more similar in nature in some ways because you're thinking, okay, if I invest in stock like for one company, then that stock may go up, it may go down, and it's going to be volatile. I get that and then if I invest in like a mutual fund which pools money together and invest in stocks in some way, possibly in a particular sector of the market or possibly in the market in general, I would expect that whole mutual fund to be somewhat volatile in a similar fashion as with the stocks, although hopefully less volatile because we're diversified in the stocks. On the bonds, it's a little bit different because when we buy an individual bond, if I bought one bond, that would be kind of like us buying a loan or loaning money to the issuer of the bond, either a corporation or a government. And then we're going to get a fixed income, which is basically set. It doesn't change unless the entity that issued the bond basically goes bankrupt and that's going to be the interest that we're going to be getting. And then we've got the principle that we're going to get at maturity. We're going to get the amount at maturity, but it's a little bit different when we convert that into say a bond fund because now within a bond fund, we're not holding on to one individual bond with that fixed income. The bond fund is now going to be investing in multiple different types of funds, which makes it a little bit more abstract to think about a fixed income type of investment when they're all pooled together in a mutual fund and we're buying the mutual fund, which is a bunch of those bonds kind of put together. So it's a little bit different than the stocks in my opinion. In any case, benefits of the bond funds. So get higher income potential. Bond mutual funds and ETFs get your portfolio the opportunity to earn income unlike money market funds, which focus on maintaining the value of cash and stock funds, which aim for long-term growth. So when we're thinking about our investment strategy, we want the stocks, which are looking for that growth kind of potential but possibly not earning you actual money at this point in time, although you could invest in stocks that have a dividend that are given out, which would be the more established like utility companies and that kind of stuff. And when you're just holding on to cash, you might put money into the money market fund, but that's really just maintained. It might give you some income possibly to lower the impact of inflation, which is the decline in the value of the dollar, but it's probably not going to give you much income over and above that for actually growth. The bond fund is somewhere in the middle, right? So that's where you can kind of put your money and hopefully get a return higher than the money market funds but possibly not a long-term return as high as you could get with the stocks. However, less volatility on bonds than with stocks, more volatility on bond funds than on the money market funds typically. So add stability to your portfolio when included in a well-balanced portfolio. Bond funds can help balance the risk associated with stock funds. We're always thinking about this kind of balancing concept, and if you're always as an individual investor looking at your kind of portfolio, this balancing concept, this concept of diversification, which you're going to hear if you look at the Bloomberg channels, for example, or the stock analysts, they got like a hundred words that basically mean diversification, right? But it's actually harder to do in practice than you would think because if you're talking about a time where things are going pretty good, then the stocks are going to be doing quite well. And especially at a time that we've had prior to this recording where the interest rates were quite low, you're looking at your bond fund and saying, I'm not earning anything on the bond fund and you're looking at your equity funds and saying, you know, they keep going up. So you're going to be saying, hey, everything that I put in the bond fund is just wasted money. I mean, it's like putting it in the bank account. I'm just losing money on it. So you're going to want at that time to shift the money to the stocks oftentimes. But the idea would be you should kind of not do that because you're trying to diversify over the long run if you're looking at the long run type of investment. And on the other side of things, when the market goes down, you're looking at the stocks going, I'm getting killed on the stock market, right? And that's when people typically pull the money out and they put it all into bonds, fixed income, or possibly just put it into their bank account or into the money market account, which, again, is not usually the good thing to do because you could see what happens here. People are making their decisions based on fear rather than a diversified portfolio which should hedge those things out because when the bonds are low, when the bonds aren't making a lot of money and the stocks are going up, you still want the money in the bond fund because you don't know when the stock market's going to crash and the bond fund should hedge against it and that's the kind of the idea. When the stock market does go down, that's not when you want to take your money out usually. That's when you want to rely on the fact that you already have some money in the stable bond funds that are hedging against the inevitable outcome that stocks will decline at some point in time. So it's more difficult to do and practice even though it's the bedrock foundation of any financial planner that you'll talk to, diversification generally. So inflation-protected bond funds can also help you keep pace with inflation. So these funds invest in government bonds and are routinely adjusted for inflation. So you can actually put your money in bond funds that are adjusted for inflation, which is an interesting tool that's a more recent kind of tool, help reduce your investment risk. Fixed-income mutual funds and ETFs can contain hundreds, sometimes thousands of bonds in a single fund. You get more diversification than owning just a handful of individual bonds. So how to choose a bond fund you might ask. There are a few questions to ask yourself when considering bond funds for your portfolio. Am I investing outside of an IRA or other retirement account? This is always going to be a component. Look at what we're saying here when we see this because many people have a big misconception with these retirement accounts, an IRA, a 401k plan. They think that the IRA is like its own thing. It's like its own investment. It's not like these other investment tools like bond funds, mutual funds. But no, they're saying right here, look, it's the same kind of investment tool, which is the bond fund. If you choose to put money into a bond fund, you could put it under the umbrella if you have the capacity to do so of a retirement type of plan like an IRA or a mutual or a 401k, for example. The investment tool, the bond fund, the mutual fund, is the same kind of thing. It's now that you have this tax component because it's under this umbrella of this retirement account kind of thing, which you would only do if they give you a tax benefit, which they do. That's why you do it because they also restrict your capacity to get access to that fund, right? You're supposed to put it in there and leave it. So you wouldn't do that. You wouldn't put your bond fund under a retirement account. It's not like the IRA has any special magic other than the tax benefit. That's why you put the bond fund under the umbrella. That's why you restrict yourself to accessing it because the government's going to give you tax benefit. So in any case, you're going to have tax implications that you've got to think about with regards to interest because, remember, bonds are going to give you interest. So they're a fixed income type of a thing. So unlike growth stocks, which may not pay dividends because they might be putting the money back into the company, for example, and that means you expect the value of the stock to go up, and so you're not actually realizing the gains there until you actually sell the stock. But with the bond funds, they're going to be paying interest. So you will typically be earning interest and having to pay income when you earn the interest. But if it's under the umbrella of an IRA, then it might have different. You might be able to defer the interest. So that's going to be the idea. So if you're in one of the highest tax brackets in investing outside of your retirement account, you may be able to reduce your tax exposure with tax-exempt bond funds. So we've talked a little bit about tax-exempt investments. Bonds are going to be a kind of interest that you're going to get. If you're a low-income individual or you're not a really high-income individual, you might not get as much benefit putting your money in a tax-exempt area even if you're outside of an IRA because the real benefit comes for those who are paying higher tax brackets, right? So wealthy individuals who are paying a really high income tax rate then are the ones that often benefit from taking a tax-exempt kind of bond fund oftentimes. We talked about that in a little bit more detail in prior presentation. I won't dive into it too much here. So find out if tax-exempt mutual funds are right for you. Cut your federal tax bill with a national tax-exempt fund. Get added state tax savings if you live in California. So obviously high cost of living. Massachusetts, New York, New Jersey, New York, Ohio, Pennsylvania. So do I want domestic or international bonds? Once we start thinking, okay, now I'm breaking out between bonds and stocks, then the question is, well, what kind of bonds do I want? We probably want some very safe bonds. Those are usually like government bonds, for example. But we also might want corporate bonds to diversify, and we also might want to go outside of the United States. What if the whole United States falls apart and we can have some bonds that are in other countries, which an idea, the general idea would also be that the United States hopefully will not fall apart. It's usually the safe haven, so that's what people usually think. And then the other, which I would agree with, and then the other countries, then because they're not quite as safe, you would think you'd get higher returns and the other country possibly as well, because that's just the way bond investing works. If I can get the same return for less risk, then I'll put my money in the government bonds, because the government can always print money, so they shouldn't default on the bonds. And then that means the corporations are going to have to pay a little bit more, even though they're very stable corporations in order for me to invest in there. And that means that people that are outside of the U.S. are usually going to have to pay a little bit more if people think that U.S. bonds, especially government bonds, are the safe haven. So in any case, you can diversify in that way as well. Start thinking about, okay, can I get a mutual fund possibly in bonds that diversifies outside of just bonds in the United States, for example. So investing in both U.S. and international bond funds can add another level of diversification to an already well-balanced portfolio. How much risk am I comfortable with? Knowing the general traits used to identify the different bonds within a bond fund can help you select bonds that are compatible with your overall tolerance for risk. So they love this kind of tolerance, risk-level tolerance type of thing. Remember, don't get stuck in the idea that, well, if you can't tolerate, it sounds like tolerating risk is a virtue the way they kind of phrase this type of stuff. And I'm not sure that's exactly the case. You shouldn't make movements out of fear either way, whether you're taking risky risks or whether you're doing more conservative type of investments. So I don't really always like that the way they kind of phrase the risk-tolerance type of thing. But in any case, we got the average maturity. So bond funds come with short-term, short-intermediate and long-term maturities. So the longer the maturity, the more sensitive the fund is to changes in interest rates. So you can start to think about, okay, when I'm investing and you could look at the market and try to determine whether it'd be better to put your money in the short, intermediate, or long-term maturity types of bond funds. Credit quality bonds that are backed by the government or one of its agencies have the best credit worthiness and a lower chance of default than most corporate bonds. So we've talked about this in prior presentations. The government, when you have government backed bonds, that means the government's responsible for them. If the government defaulted, that would look really bad for the government. So they're not going to do that because they could print money if they wanted to if it's the United States government. So you would think that there's very little risk, or at least as low a risk as possible on the government bonds. And again, that means that when you invest in corporate bonds, the corporate bonds are going to have to pay higher interest rates, you would think, because if I can put my money into an almost, no risk of default government bond at the same rate of interest, that's where I would put my money. So even really well-established companies that want to generate some cash flow through the issuance of bonds are going to have to hire or have a higher interest rate, you would think. So corporate bonds with higher credit quality are considered investment-grade bonds, and those below investment-grade are considered high-yield junk bonds. Do I specifically want to keep pace with inflation? We have inflation-protected bond, ETS, invest in government bonds, and routinely adjust for inflation. So that's kind of a newer kind of component. We've talked a bit about that more detail in prior presentation, so I won't go into it in a lot more detail here. Get broad exposure to the bond markets. You can use just a few funds to complete the bond portion of your portfolio. Each of these ETS and index funds gives you access to a wide variety of bonds and a single diversified fund. So this is going to be your strategy. Usually you're saying I want diversification in my portfolio. So what am I going to do? Maybe I'm going to go with mutual funds or ETS, which are going to be those tools that pool my investments together with other investments allowing me to diversify in that way. Then the question is, do I want to have different mutual funds or possibly different index funds, which are averages of specific sectors, for example, or specific areas, or do I want to have one mutual fund that tries to diversify over bonds and stocks, for example, or do I want to then have separate funds for bonds, separate funds for stocks so I have a little bit more capacity to differentiate between just one standard bond fund because obviously if I choose one fund, I've got to make my diversification with whatever that bond fund or whatever that diverse fund is doing. So maybe I then want a separate bond fund and a separate stock fund. If that's the case, then on the bond side, do I want to have one bond fund which is just diversified over all the different bonds like corporate bonds and the government bonds and possibly international bonds or do I want to have multiple bond funds or possibly index funds within bond funds that are going to be specialized in basically different areas so I have again a little bit more capacity to be able to wait differently than say just one diversified bond fund, for example. So those are the things you got to go into and remember that if you get really detailed on a lot of different funds then you have more control but that also means you've got a lot more management that you're going to have to look at and rebalance your portfolio from time to time and so on and so forth. So in any case, so you can view the Vanguard Total Bond Market ETF so if you're looking for just one place to put your bonds, funds that has some diversification, then you might look at the Total Bond Fund which holds about 10,157 domestic investment grade bonds once again domestic investment grade bonds you got the view the Vanguard Total International Bond Fund so which holds more than 6,427 bonds from both developed and emerging markets so that's the one that's going to give you some exposure so these two, if you have these two, you're going to say, well, if I had two bond funds then this one's giving the exposure to a bunch of different domestic and this one's going to give me the exposure to international so that's the strategy. View the Vanguard Total Bond Market Fund Index which holds more than 10,557 domestic investment grade bonds the keyword here being an index fund so note that the indexes are going to be kind of like averages we're trying to take a sample of the population to give us an idea of the overall activity so if you're choosing an index you're kind of betting on the growth of the overall or the average kind of of that particular sector also note that if you have not an index then you would expect more active management active management within the particular area of the bond funds so now you've got someone trying to beat the average in essence you would think that's how you can kind of visualize it and the question would be can they beat the average over the long term because if that's the case you're going to be paying more for the active manager you would expect there'd be fairly well-paid people if they think they're going to beat the market by investing in particular different types of bonds as opposed to the index fund where you're just going to say hey look just tie it to the index and you would think that the cost for them to manage that fund would be a lot less because they have their hands tied to just tie the thing to the index so you got the view of the Vanguard Total International Bond Index Fund so once again index which holds about 6427 same kind of concept with the index