When it comes to income investments, just as with conventional investing, too many people feel too insecure.
They're way too quick to throw their money at anybody who pretends to be a professional, with the willingness and ability to make their choices for them. Once they accept the desirability of owning bonds for income, they soon discover the difficulties faced by small bond buyers, and immediately punt to bond mutual funds.
Unfortunately, this costs them a lot of money.
Peter Lynch is No Fan of Bond Mutual Funds Either
Famous Fidelity Magellan Fund manager Peter Lynch said in a 1990 interview with Barron's: "Since one U.S. Treasury bond or Ginnie Mae certificate is the same as the next, there is little a manager of one of these funds can do to distinguish himself from competitors."
Lynch also said, regarding mutual funds devoted to bonds: "Their purpose in life eludes me."
Strong words from the spokesperson for the biggest family of mutual funds, including, I'm sure many bond funds.
And we should thank him.
Too Many People Use Mutual Funds to Evade Responsibility for Their Portfolios
I believe Lynch doesn't perceive their usefulness, however, because he's lost touch with ordinary people who don't understand investments and mutual funds as well as he does. Their purpose is to make people think they're getting financial guidance, portfolio selection and diversification -- even for financial instruments that these things don't apply to.
As a dedicated income investor, I realized bond mutual funds are a bad thing because, by owning lots of bonds with various maturity dates, they force you to pay attention to price changes (which are primarily due to changes in interest rates, which you can't control or predict.)
When you buy an individual bond, its market value changes with prevailing interest rates, but you don't have to care. You just hold it, collect your interest checks, and then receive your money back upon maturity.
However, with a bond mutual fund, you don't have that choice. The interest is just one part of the total return.
Bond Mutual Funds Cost Too Much for Nothing
However, thanks to reading John Bogle, I've discovered even more reasons to oppose bond mutual funds.
They cost too much.
Many of them charge a load. Don't ever pay a load. Many of them have high management expense fees. Those come out of your pocket. Because all bonds of one kind are so similar, as Peter Lynch points out, bond mutual fund managers can't really outperform each other through selecting superior bonds.
So why do some mutual funds for bonds outperform others? Because they have lower expenses. The lower a mutual fund's expenses, the better its performance.
As Lynch also said, "The benefits of expert management were exceeded by the expenses that were extracted from the funds to support the experts."
Try Individual Bonds or Exchange Traded Funds
Fortunately, there is another way to obtain some diversification in your bond portfolio. Exchange Traded Funds. They hold a bond portfolio designed to replicate the market for that type of bond. This eliminates the constant buying and selling that drains money from mutual funds.
ETFs still have management experts. While generally a lot lower than mutual funds, they still affect overall performance, so shop around.
To give Bogle his due, his company Vanguard usually offers the lowest available management expense ratios for both its mutual funds and Exchange Traded Funds.
Vanguard is an important company for your income investments.
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