Vanguard's Managed Payout funds, which are currently in registration with the Securities and Exchange Commission, are also designed to generate monthly cash payouts without consuming principal.

I see a major difference between the new Vanguard and Fidelity retirement funds.

The article states this about the Fidelity funds,

The distributions, which seek to keep pace with inflation, are expected to come from dividends, fund appreciation and a portion of principal. Meanwhile, the remaining assets stay invested.  

I'm not sure how the second difference listed below will affect the payouts on these funds. 

(Vanguard funds) Monthly payouts are adjusted each year based on the fund's performance over the three previous years (Fidelity's payouts are based on the annual account balance.)  

helmut

Add Schwab to the list.  It's also coming out with one

Roberta 

"without consuming principal"

That's a joke 

One will own less shares of their mutual fund after each distribution!

Marshall

Of course, the number of shares you own is not affected by a distribution, but the NAV does decrease by the amount of the distribution. I expect that their goal is to use asset allocation to keep the NAV fairly level and make distributions from investment income and realized capital gains.

OK, that makes sense.

Personally I could see the most conservative version of these managed distribution funds as simply a really well diversified balanced fund for an accumulator, or a retiree who wants to set aside a percentage of his assets for diversified growth.

Marshall

From what I have read so far, I have not seen anything stating Vanguard intends to sell shareholders individual shares in the retirement funds to satisfy their managed distribution policy. CEF's with similar policies certainly do not do that.

There are several ways Vanguard can accomplish their objective without selling the shareholder's individual shares. Along with dividends, they can do what many CEF's do with managed distribution policies, they can sell shares in their holdings in individual companies then pay the remaining distribution with either the increase in realized capital gains or return of capital in the case of capital losses.  

If I'm not mistaken any return of capital is not a taxable event. This is an advantage over converting capital gains or losses into dividends using dividend capture.

helmut 

Income Builder Funds are a much better option for all the reasons this forum has come to know.

Marshall

Avalon:

Income Builder Funds are a much better option for all the reasons this forum has come to know.

Marshall

 
"... thinking beyond what you are allowing yourself to acknowledge as understanding would require you making a change that would affect your personal self esteem as an investor...."

Someone else might as well take your advice because you are not using it.

helmut 

Good to see you weighing my every word.

M

And that's a QUALITY 3 or 5 or 7%........not JUNK!

(I'm not sure why Fidelity is advertising consumption of principal unless their funds are intentionally targeted for people who want a zero balance upon death. Maybe their referring to selling growthy stock shares?)

These 2 funds should make it clear that investors need not take inordinate risks to get income as high as 7%/yr and still have the portfolio grow and the income keep up with inflation.

Running around like a chicken-without-a-head chasing yield is never a good option. 

Good Luck, Ken. 

The Vanguard funds were discussed here several weeks ago.

The Vanguard does not guarantee to provide a real, inflation adjusted distribution.  It seeks to provide one, which is not a guarantee.  Provided the fund NAVs rise, over time, by inflation, so will the distributions.  If they fall, the distributions will be cut.

It seems that the 3% fund is a waste of time.  I could put my whole portfolio in individual TIPS and receive that, forever.

The 5% fund might provide some value to retirees.  After all, the long term rate of return of the stock market has been 10%, with 4% of that coming from yield and 6% from growth.  To provide 5% means that the fund has to average 2% yield, and 3% growth, over time.  I don't think it too difficult a task.

If I wanted, or needed, 7%, I'd go with Vanguard's other seasoned fund, VWEHX, rather than the new, untested one.  After all, a 7.34% yield in the hand is worth more than some 7% yield/growth combo in the bush.

ElLobo:

It seems that the 3% fund is a waste of time.  I could put my whole portfolio in individual TIPS and receive that, forever.

Where are you buying TIPS with a current yield of 3%?  The market data printed in today's Wall Street Journal lists a yield to maturity of 2.3% for most of the issues.  The one maturing in Jan 2008 has a yield to maturity of 4.0%, but that yield disappears in three months.

In addition, the Vanguard Managed Payout fund that expects to sustain a 3% payout has an investment objective of inflation protection and capital appreciation (not only the inflation protection provided by TIPS).

The biggest advantage of these funds may well be having both your assets and your withdrawals professionally managed at the same time and place for .35% of AUM.

Then there is the issue of traditional withdrawal studies that says 7% withdrawals won't work over 25 or 30 years.  In my view, most retirees who go for the 7% will be investing at far lower levels of fixed income than they would do on their own.  Because the rest of the  mix is not just traditional equity funds, the excess risk MAY  be somewhat mitigated.  A couple of really bad market scenarios showing up and it doesn't seem likely this will work. 

But then that is true for any investment strategy, other than individual tips, IMO.

Very few retirees that I have talked to really expect to die with more than they go into retirement with.  If they begin to build assets considerably greater than their initial nest egg, the normal reaction would be to spend more, or gift to children or grandchildren.

So the prospect of losing some principal over time perhaps is not that big a deal to me.

best,

Bill

mean to imply the income was guaranteed to grow with inflation, nobody can guarantee that, not even income builder funds.

VWEHX by itself would be too risky for me, besides there's not much growth potential.

Good Luck, Ken. 

Pat,

You're obviously right.  I didn't check current TIPS yields.  I recalled they were somewhere between 2 and 3 percent.

Nevertheless, to provide a 3% safe rate of withdrawal, a portfolio need only have a yield greater than 3%.  I believe that the Vanguard fund is useful for those who have no clue how much they can safely withdraw from their portfolio during retirement, and rely on Vanguard.

Bill,

I DO agree that the 7% fund will be a Godsend for those REQUIRING such a withdrwal during retirement.  I predict that, of the 3, this will be the most successfull, in terms of assets under management.

In fact, had these funds been available back in 2003, I may have use the 7% fund for most of my portfolio.  After all, at that time, I used VWEHX for 50% of it!  I still might!  Maybe take half of our VWEHX holdings and convert to the new fund.  See what happens.

"Very few retirees that I have talked to really expect to die with more than they go into retirement with.  If they begin to build assets considerably greater than their initial nest egg, the normal reaction would be to spend more, or gift to children or grandchildren."

Absolutely.  The difference, perhaps, between you and I (and a minor one at that!) is that we prefer to spend that principle rather than loose it to the market.  Much more control.

http://www.marketwatch.com/news/story/retirement-income-products-reduce-guesswork/story.aspx?guid=%7B00FBB2C1%2DA77E%2D48D0%2D96B4%2D8D09F961ECEA%7D

Another country heard from.......

best,

Bill

Well, after posting the following over 9 and one-half hours ago on the Investing during Retirement forum and the link from CBS MarketWatch but not getting any replies there, I've finally arrived at the right place.

Good job, Denny!

I said:

In the case of the Vanguard Payout product, I'm interested to see how far back historically Vanguard's backtesting will go and how many asset classes it will include in order to "fudge" the monthly distribution rate. Also, I'm wondering how much time it will take for this product to get all of its legs, that is, to use allocations such as absolute return, commodity ingredients, and the other features as given in the N1-A. Finally, what is the likelihood that the Real Growth Payout option can outperform the S&P 500 if the investor reinvests distributions? Can Real Growth, as an asset allocator, be a total return product that exceeds the S&P?
 

Bill,

Thanks for the Marketwatch reference.  It was a good summary, of both the products as well as the problems they are trying to solve.

From the MarketWatch article: 

"Until the funds have three years under their collective belts the payouts will be fudged, and most likely based on back-tested strategies,"

From the preliminary prospectus Vanguard filed with the SEC: 

"The hypothetical account value is averaged over the prior three years in order to increase the relative predictability and relative stability of distributions to shareholders from year to year. A modified version of the formula will be used until the Fund has established three calendar years of history. In the first calendar year of the Fund, the monthly per-share distribution will be based on the initial per share value of the hypothetical account. In the second calendar year, the average daily balance of the hypothetical account over the prior calendar year (or the portion of the prior calendar year for which the Fund was in existence) will be used to determine the monthly distribution per share. In the third calendar year, the average daily balance of the hypothetical account over the prior two calendar years will be used to determine the monthly distribution per share."

"The hypothetical account value is averaged over the prior three years in order to increase the relative predictability and relative stability of distributions to shareholders from year to year. A modified version of the formula will be used until the Fund has established three calendar years of history. In the first calendar year of the Fund, the monthly per-share distribution will be based on the initial per share value of the hypothetical account. In the second calendar year, the average daily balance of the hypothetical account over the prior calendar year (or the portion of the prior calendar year for which the Fund was in existence) will be used to determine the monthly distribution per share. In the third calendar year, the average daily balance of the hypothetical account over the prior two calendar years will be used to determine the monthly distribution per share."

Finally, what is the likelihood that the Real Growth Payout option can outperform the S&P 500 if the investor reinvests distributions?

You're attempting to compare a retirement income product with an accumulator growth product???

I can only guess you haven't supplied sufficient background information as to why you'd be considering these two very different funds for the same slot in your portfolio.

Considering the difference in yield vs the difference in risk, why would you put anything more than a much smaller percentage than 50% into VWEHX?

ken250:

Considering the difference in yield vs the difference in risk, why would you put anything more than a much smaller percentage than 50% into VWEHX?

 

Ken...I agree that 7% withdrawal from a much more diversified portfolio would have a much greater chance of success. If a retiree had invested in VWEHX in 1997 expecting a 7% dividend withdrawal it would have been a disaster. 

I think that if I were to invest in HY bonds (I'm not) I would jump in all the way and go for PREMX, but no more than about 5%. Although it is a EM bond fund, the majority of the bonds are sovereign debt.

PREMX has had only one losing year out of eleven, but it was a big one at -23%. The ten year annual average total return is 9.39% and a lifetime total return of 13.75%. It appeared to be a great diversifier during the last correction too.

PREMX IMO would be a good way to play EM. Total returns equal to stock total returns with a lot less volatility, with a current dividend yield of 7.62% 

helmut 

Hi Ken.

First, as an asset allocation product, I view the Real Growth portfolio as an opportunity for growth from non-correlated assets and one that allows reinvestment rather than spending of distributions. If Vanguard is correct in stating that this fund has a higher probability of generating growth in both capital and payouts that exceeds inflation, resulting in long-term capital appreciation, then I am interested in using it as a growth product complemented by other non-correlated holdings to produce a total return objective. Because Vanguard is combining percentages of various non-correlated assets classes at an ER of .34 -- assets that can produce higher returns than those from a 100 % equity class alone-- the fund deserves consideration.

From the S&P website:

"From January 1926 through September 2007 the annualized total return for the S&P 500 was 10.51% per year vs. 10.51% for June 2007 (unchanged)."

Using the 10.51% figure for this period, I am attempting to evaluate hypothetically what total returns the Real Growth product may produce based on studies I've seen using using non-correlated assets and my own holdings. The potential of using Real Growth with other portfolio holdings to achieve total returns that meet or exceed the S&P has merit.

Cheers 

Ken,

"Considering the difference in yield vs the difference in risk, why would you put anything more than a much smaller percentage than 50% into VWEHX?"

I assume this question is for me.  The answer?  VWEHX is considerably less risky than the new fund.

helmut,

"I agree that 7% withdrawal from a much more diversified portfolio would have a much greater chance of success."

So, a 7% withdrawal from a risky stock fund has a much greater chance of success than a 7% withdrawal from a safer bond fund?  Please explain!

"If a retiree had invested in VWEHX in 1997 expecting a 7% dividend withdrawal it would have been a disaster."

VWEHX yield in 1997 was 7.7%.  Withdrawing 7%, reinvesting 0.7%, would have worked just fine.  Principle would NOT have been withdrawn.

VFINX total return, since 1997, was 6.49%.  Withdrawing 7% would not have been a disaster either, even though, on average, 0.5% of principle would have been withdrawn over those same 10 years.

Here is a plot of TR for VWEHX since 1997:  Add VFINX to see a comparison.

"I think that if I were to invest in HY bonds (I'm not) I would jump in all the way and go for PREMX, but no more than about 5%."

So, are you saying PREMX is less risky than VWEHX, or at least as risky?  Otherwise, this statement makes absolutely no sense.  VWEHX and PREMX are NOT the same asset class!  One is emerging market debt, the other is domestic high yield debt.  Would you say that, rather than investing in domestic value stocks, you would jump all the way to foreign growth stocks?

"Total returns equal to stock total returns with a lot less volatility, with a current dividend yield of 7.62%"

VWEHX has had total returns, over it's 29 year lifetime, equal to stock total returns (a bit over 9%), with a lot less volatility (8.54% SD).  Numbers for VFINX (S&P 500 Index fund) are 32 year lifetime, 12.2% total return, unknown volatility, probably near market average of 18%, certainly greater than 8.5%.

Or are you looking at EM debt, versus EM equity?

Bottom line is that, although you and Ken throw the 'risk' word around quite a bit, you both seem to fail to grasp the application of the concept of risk!

Here's all three of them - total return.  Volality is interesting.  Unfortunately we've lost are only web resource that does total return on custom dates or longer than 10 years.

TR 

Roberta 

So, a 7% withdrawal from a risky stock fund has a much greater chance of success than a 7% withdrawal from a safer bond fund?  Please explain!

This is not a presidential debate so let's not take things out of context to prove a point. I said nothing about a risky stock fund (I remember when Al Gore used the term "risky scheme" to label his opponents view on the privatization of SS in the 2000 election).

I said, "a much more diversified portfolio" would have a better chance of successfully delivering a 7% withdrawal than VWEHX. Apparently Vanguard agrees with me too.

VWEHX yield in 1997 was 7.7%.  Withdrawing 7%, reinvesting 0.7%, would have worked just fine.  Principle would NOT have been withdrawn.

VFINX total return, since 1997, was 6.49%.  Withdrawing 7% would not have been a disaster either, even though, on average, 0.5% of principle would have been withdrawn over those same 10 years.

You are going to have to paint by the numbers so I can understand these statements. First the annual total return for VWEHX for the last ten years has been 5.31%. At a 7% withdrawal how does that not equate to a return of principle?

As to your second statement concerning VFINX, who was talking about the S&P 500? How would a 0.5% loss of principle X 10 years = 5% loss of principle come anywhere close to keeping up with inflation (3%x10 = 30%)?

So, are you saying PREMX is less risky than VWEHX, or at least as risky? 

No, I do not consider PREMX less risky than VWEHX, but when I made the statement, "I would jump in all the way and go for PREMX." "Jump in all the way", was just my little euphemism for saying it does carry more risk, but I believe the greater risk in this case is warranted because I believe the potential reward could be greater.

Now when I said, " but no more than about 5%" I was not ignoring risk, I was just taking your advice by controlling risk through diversification.

When you quoted my statement, "Total returns equal to stock total returns with a lot less volatility, with a current dividend yield of 7.62%", again you are taking me out of context as to label my conclusion as a "risky scheme".

Had you quoted my previous sentence, "PREMX IMO would be a good way to play EM", you would have seen that I was comparing PREMX's volatility to an EM stock fund, not to VWEHX's volatility.

Bottom line is that, although you and Ken throw the 'risk' word around quite a bit, you both seem to fail to grasp the application of the concept of risk!

If you compare a 5% position of PREMX to a 40% position in VWEHX as failing to grasp the concept of risk then that is your opinion and you are welcome to it, but I'll stick to mine.

helmut 

"This is not a presidential debate so let's not take things out of context to prove a point."

So, by the numbers:

1)  Title of Ken's post is: "VG HY vs new fund" 

VWEHX is all bond, new fund will contain stocks.  According to Vanguard.  So Ken has to talk risks and rewards with that in mind.  That is, the differences, in risks and rewards, for bond funds versus stock, or balanced, funds.

2) Ken said: "Considering the difference in yield vs the difference in risk"

VWEHX yield is slightly lower than new fund, but considerably less risky.  So, risk/reward tradeoff isn't there.  That is, what 'considerations' were taken into account?

3)  You said: "I agree"

So you agree with Ken.  In context.  Then you brought in the 7% rate of withdrawal, not I, or Ken, where Ken only talked yield, not withdrawal rates.  I assumed that was your primary consideration

4)  I didn't even bother to ask you how you arrived at the same risk/reward tradeoff that Ken came up with, to which you agreed.  In context.  So I ask now.  What is the risk/reward tradeoff that you make, which agrees with Ken?  What considerations do YOU take into account?

So, let's get these questions out of the way first, before we discuss safe withdrawal rates.

Remember, this is a thread discussing a new fund from Vanguard.  Contextually, how this new fund compares to other Vanguard funds.

1)WEHX is all bond, new fund will contain stocks.  According to Vanguard.  So Ken has to talk risks and rewards with that in mind.  That is, the differences, in risks and rewards, for bond funds versus stock, or balanced, funds.

How does my statement that a diversified portfolio (new payout fund) has a better chance of surviving a 7% withdrawal than VWEHX differ from Ken's statement?

2) "Considering the difference in yield vs the difference in risk"
VWEHX yield is slightly lower than new fund, but considerably less risky.  So, risk/reward tradeoff isn't there.  That is, what 'considerations' were taken into account?

When you make the statement that VWEHX is considerably less risky, you are making a statement from facts not in evidence. There are no facts to lead you to a logical conclusion that VWEHX is less risky than any of the new payout funds.

You said,

VWEHX has had total returns, over it's 29 year lifetime, equal to stock total returns (a bit over 9%), with a lot less volatility (8.54% SD). 

Don't you think it would be a more meaningful comparison to judge past performance of VWEHX since you have personally owned it? If you would have taken a 7% withdrawal from the time you invested in 1999, I don't see how you can make this statement.

VWEHX yield in 1997 was 7.7%.  Withdrawing 7%, reinvesting 0.7%, would have worked just fine.  Principle would NOT have been withdrawn.

If you had started with a $10,000 investment in VWEHX in 1997 and taken a 7% annual withdrawal, your first year you would have withdrawn $700, the last withdrawal in 2007 would have been $580 for total withdrawals of $6385. Your remaining balance would have been $8119.43. You would have had a 2.06% return of capital per year. At an annual inflation rate of 3% your remaining balance would be equivalent to $6041.

Disclaimer: This example does not take into account the uneven volatility of VWEHX's NAV, but assumes a 5.31% annual average total return. Taking that into account, your spreadsheets might be able to give us a more accurate picture, but that aside I don't think it would be much different.

Now, do you think that is what Vanguard is shooting for?

3) So you agree with Ken.  In context.  Then you brought in the 7% rate of withdrawal, not I, or Ken, where Ken only talked yield, not withdrawal rates.  I assumed that was your primary consideration.

If you did not bring up a 7% rate of withdrawal, what do you mean when you said in an earlier reply,

 If I wanted, or needed, 7%, I'd go with Vanguard's other seasoned fund, VWEHX, rather than the new, untested one. After all, a 7.34% yield in the hand is worth more than some 7% yield/growth combo in the bush.

#4 has already been answered.

Finally, my side note that if I were going to invest in HY bonds I think I would go for 5% of PREMX rather than 50% of VWEHX, was just my opinion, and has nothing to do with the viability of your possible allocation of VWEHX paired with the new payout fund that you mentioned in an earlier post that inspired Kens reply in the first place.

In fact, had these funds been available back in 2003, I may have use the 7% fund for most of my portfolio.  After all, at that time, I used VWEHX for 50% of it!  I still might!  Maybe take half of our VWEHX holdings and convert to the new fund.  See what happens.

helmut 

"Considering the difference in yield vs the difference in risk, . . . . ."

This was Ken's statement.  You agreed with it.  So, your statement is: "Considering the difference in yield vs the difference in risk, why would I, ElLobo, put any more than a small portion of my portfolio in VWEHX?

Ken asked a question, you, and I, answered it!  Your statement was an answer, not a question.  That's how it differed.

If you meant your statement to be the same as Ken's, then it would read, "Considering the difference in yield vs the difference in risk (between VWEHX and the new fund), why would I, ElLobo, put anything more than a much smaller percentage than 50% into VWEHX?"  This implies I would put 50% into the new fund, but only a few percent into VWEHX.

My answer, to your question, is the same.  VWEHX is less risky then the new fund.  My question back to you is why do you feel it's MORE risky?

Until YOU answer this question, we can't go on!  IOW, I'm waiting for the next pitch!

Your metaphors are as misplaced as your position. You're not playing baseball, your playing dodge ball. I've given you enough rope to hang me if you could, but all you do is obfuscate your in indefensible position by repeatedly demanding answers to your questions, then moving the target by claiming your questions have not been answered. Yet, all the while you refuse to defend your position with any real facts.

The reason this debate can not go on has nothing to do with me not being able to supply answers to your questions, it has everything to do with the fact that you cannot support your theory.

Asking me to prove to you why a junk bond fund that has managed to lose 20% of its NAV and 40% of the NAV's buying power over the last ten years is less risky than a broad diversified portfolio of most of the major asset classes is like asking me to prove to you that NASA did not fake the moon landings in a Hollywood studio.

You don't have to go to a diversified portfolio to disprove your theory, VWEHX has the worse 10 year total return (well below the target 7%) of any Vanguard intermediate or long term taxable bond fund, and has only beat two of the Vanguard stock funds and none of the Vanguard balance funds, and unless we re-elect Jimmy Carter I suspect it will pretty much stay that way. But yet you say it would be fine and even less risky for a retiree needing a 7% withdrawal to invest in VWEHX rather than a specially designed broad base portfolio of virtually all the different major asset classes to produce a safe 7% withdrawal.

Well, I will ask you one more time, "Where is the beef in your position?" Or will this just be another case of me not being able to stimulate your intellect enough to make it worthwhile for you to give a meaningful reply?

helmut 

You are yield-focused.

Risk is less of a concern for you, except to expose yourself to several high yield "classes".

Good Luck, Ken.

Why do YOU consider investing in stocks, and stock funds, to be less risky than investing in bonds, and bond funds?  That's the question.

I consider that to be more risky, not less.  Therefore, an ALL bond fund, VWEHX, is less risky than a stock, or balanced fund, in general.

Now, answer that question, and we will go on.

"You are yield-focused."

Yes, I am.

"Risk is less of a concern for you, except to expose yourself to several high yield "classes"

First, risk is all encompassing  in my investment strategy.  I know, and fully understand, the risks in every investment I make.  I understand how to quantify risks, how to mitigate them, and how to do a risk/reward tradeoff.  I understand the relative 'riskiness' of two different investments.  That is to determine, if one asset is riskier than another.

Therefore, whenever you write that:

"And that's a QUALITY 3 or 5 or 7%........not JUNK!"

or:

"These 2 funds should make it clear that investors need not take inordinate risks to get income as high as 7%/yr and still have the portfolio grow and the income keep up with inflation.  Running around like a chicken-without-a-head chasing yield is never a good option."

or:

"VWEHX by itself would be too risky for me, besides there's not much growth potential."

Then ask the question:

"Considering the difference in yield vs the difference in risk, why would you put anything more than a much smaller percentage than 50% into VWEHX?"

I simply am asking you to discuss those (YOUR) considerations.

It appears, first of all, that you believe an all bond, no growth (income type) fund is riskier than a balanced fund, which has some income, some growth characteristics.  I'd like you, as well as helmut, to discuss how investing in stocks is less riskier than investing in bonds!

I've said that the current yield of VWEHX is 7.34%, while the new fund attempts to make a 7% distribution without touching principle.  I'd like you, and helmut, to discuss how investing in a bond fund, which generates 0.34% more yield than another, without touching principle, is more risky than one that may have to touch principle.

Finally, I'd like you, and helmut, to comment on the relative riskiness of investing in two different types of funds, today, based on their history.  That is, VWEHX has been around for 29 years, the new fund isn't even in existance.  Tell me how a PROVEN fund is more risky than a proposed fund.

If you can discuss these three simple risk concepts, and show how YOU considered them in YOUR consideration of the relative risks and returns, between VWEHX and the new fund, then I'll listen!

Then, and only then, can we go on to discuss the risks of either fund supporting a 7% rate of withdrawal, going forward.

Interesting discussion. Here are some facts to move it along. 

$100,000 invested on 12/31/78. Cap gain distributions reinvested in additional shares at year-end NAV.

High Yield Corporate vs Long-Term Investment Grade vs Wellesley Income.

To summarize:

High Yield Corporate   Income 222,717    Mkt Value   60,716

Long-Term Inv Grade   Income 223,503    Mkt Value 118,642

Wellesley Income       Income 315,478    Mkt Value 286,861

 A significant portion (2% to 3% average historically) of junk bond interest rates are compensation for default risk. When the defaults inevitably occur, the fund's NAV takes a hit. The $100,000 invested in 1978 now has a market value of $60,716. While the current yield remains fairly high (relative to the $6 NAV) your "personal yield" is 4.33% ($4,330 income distribution in 2005 from your $100,000 investment).

I can try to post the per share fund data that underlies this if anyone is interested.

Mathguy,

Three points:

1) "Here are some facts to move it along."

helmut has to answer the ultimate question of the universe, before we move on.  That is, why he considers a 28 year old all bond fund to be riskier than a brand new all stock, or a stock/bond fund, especially if the yield distribution from the first is about the same as the yield (might include some principle!) distribution that might be made by the second!

2) Your data, although interesting, doesn't include historical data for the new fund!  Remember, we're comparing the risks associated with a fund that's been around for 29 years with another fund that hasn't been born yet.  So, unless you can show that the new fund will have risk/return characteristics similar to one of the two you have shown, that data isn't usefull to this discussion.

3) To accurately compare even these three existing funds, you need to model the distribution calculations Vanguard will make on the new fund.  That is, calculate the avereage fund NAV for the previous 3 years, then take 7% (on a monthly basis) of that average NAV out of the fund, as a distribution.  And remember, if you take out 7%, you gotta put the excess yield back into the fund!

Now, the purpose of doing any of this is to try to figure out what helmut meant whenever he said that, using VWEHX instead of the new fund, which wasn't around, for retirement withdrawal purposes was DISASTEROUS.  To me, even based on YOUR numbers, it doesn't look disasterous to me.

If YOU are interested, I have the complete monthly distributions made by VWEHX, from 1978 up until 2000, whenever I stopped looking at this stuff.  Included is the monthly reinvestment NAV, along with yearly inflation data.  So, you can model any withdrawal strategy that you want.  I've tried several.  Your numbers above is the 'Withdraw ALL of the yield" strategy, which isn't optimal.

Try withdrawing 70% of the yield, reinvesting the excess 30% with your numbers.  See how close that comes to a real, inflation adjusted 7% (of the starting value, similar to Trinity, Jarrett, et al).

Try a straight 7% of the portfolio value withdrawal strategy each year.  See how that looks.

As I say, we can discuss all of this later if you want.  Suffice it to say, I need helmut to step up to the plate first, so to speak!

BTW, as to defaults, do you know how many default 'hits' VWEHX has taken over it's lifetime?  Can you see them in the fund NAV?  I know (up through 2000), and I can't!

As far as answering any more of your questions, you are the only poster here that refuses to back up your position with any real facts then demands anyone that does not agree with you give song and verse.

If only it could be as easy, as capturing risk in some algebraic formula, but you can not. According to David Dreman, "The original betas constructed by Sharpe, Lintner, and Mossin were shown to have no predictive power, that is, the volatility in one period had little or no correlation with that of the next." 

For me there are two major risks in investing. First there is financial risk, and the second risk is the loss of purchasing power through taxes and inflation. The second being the most insidious especially to fixed income with junk bonds on the bottom of the food chain.

HY bonds are the most susceptible to financial risk which in turn makes HY less effective as a diversifier than higher quality bonds in a correction. If a retiree is using the yield from HY bonds as a major contributor to his or her income then financial risk becomes even more pronounced. 

For an investor that is so myopic that yield is the ultimate goal he would have found that in the 2000-2002 correction VWEHX at the time the investor needed it most, would have averaged a whopping 1.24% annual average total return during those three years. That was the worse three year period for VWEHX which by no coincidence was also the worse bear market since the inception of VWEHX. On the other hand VRITX (Vanguard's intermediate Treasury bond market) had an average total return of 11.87% during that same time period.

Now, as I know it, El Lobo's argument is that the actual NAV or share price does not matter, but I would argue that dividend yield, total return and financial health are not somehow mutually exclusive events living is some sort of vacuum in and by themselves. Rather for long term investments they are interdependent of each other. VWEHX is the poster child proving El Lobo theory does not hold water with HY debt. (Thanks to Mathguy2 for his contribution)

On the equity side El Lobo has never produced any compelling evidence that his theory has any legs either. Use  RAS for an example. Taking El Lobo's theory into account the   -70% YTD total return of RAS should not effect the dividend yield, and while the dividend yield has actually climbed to 31% the actual dividend paid has dropped from $0.61 in January to $0.46 (-25%) in September. But according to El Lobo's hypothesis RAS with a yield of 31% would be less risky than SPG with a yield of 3.14% because the dividend would be unaffected by market volatility.  

An even more disturbing fact is that many retirees look to dividends as a key indicator to keep them out of over valuations, economic bubbles and financially unhealthy stocks in general. RAS's dividend did not help its investors in that regard.  Just because the sub-prime lending bubble as been identified it does not mean there is not another bubble lurking on the horizon. If energy tanks (pun intended)  El Lobo argues that NAT is the less risky investment simply because of the size of the yield which is an assumption that is so absurd that  it is unworthy of any debate.

As far as VWEHX  vs. the new Vanguard payout funds, HY has been on a long term decline since the HY bubble burst in the late 80's. If you go back to any shorter  more recent period in time the results would be even worse. Now if that is what you consider a proven fund worthy of investing your entire retirement then I think you owe it to the rest of the forum, even the lurkers to explain why you think so. By the way, how many retirees do you know have their entire retirement portfolio in VWEHX? If an investor had purchased VWEHX in 1999, and taken a 5% withdrawal and re-invested the rest of the dividend, he would not have even been able to even keep up with inflation. The only thing that proves is VWEHX does not work in the manor El Lobo recommends.

El Lobo, if you want to be taken seriously, don't write anything that you can't back up. 

After all, the NEXT time you write something like this

If I wanted, or needed, 7%, I'd go with Vanguard's other seasoned fund, VWEHX, rather than the new, untested one.  After all, a 7.34% yield in the hand is worth more than some 7% yield/growth combo in the bush.

unless people take you seriously, you will be wasting your time doing so!

helmut 

El Lobo,

You've made the following statements in this thread:

"VWEHX yield in 1997 was 7.7%. Withdrawing 7%, reinvesting 0.7%, would have worked just fine. Principle would NOT have been withdrawn.

VWEHX has had total returns, over it's 29 year lifetime, equal to stock total returns (a bit over 9%), with a lot less volatility (8.54% SD). Numbers for VFINX (S&P 500 Index fund) are 32 year lifetime, 12.2% total return, unknown volatility, probably near market average of 18%, certainly greater than 8.5%.

Why do YOU consider investing in stocks, and stock funds, to be less risky than investing in bonds, and bond funds? That's the question.

I consider that to be more risky, not less. Therefore, an ALL bond fund, VWEHX, is less risky than a stock, or balanced fund, in general.

It appears, first of all, that you believe an all bond, no growth (income type) fund is riskier than a balanced fund, which has some income, some growth characteristics. I'd like you, as well as helmut, to discuss how investing in stocks is less riskier than investing in bonds!

I've said that the current yield of VWEHX is 7.34%, while the new fund attempts to make a 7% distribution without touching principle. I'd like you, and helmut, to discuss how investing in a bond fund, which generates 0.34% more yield than another, without touching principle, is more risky than one that may have to touch principle.

Finally, I'd like you, and helmut, to comment on the relative riskiness of investing in two different types of funds, today, based on their history. That is, VWEHX has been around for 29 years, the new fund isn't even in existance. Tell me how a PROVEN fund is more risky than a proposed fund.

If you can discuss these three simple risk concepts, and show how YOU considered them in YOUR consideration of the relative risks and returns, between VWEHX and the new fund, then I'll listen!"

To summarize (1979-2005):

It looks like both LT Inv Grade and Wellesley have produced higher returns with less risk.

"BTW, as to defaults, do you know how many default 'hits' VWEHX has taken over it's lifetime? Can you see them in the fund NAV? I know (up through 2000), and I can't!"

No, I don't know of any specific default hits suffered by VWEHX. The VWEHX NAV bounces around due to changes in the general level of interest rates and the appetite for credit risk -- but NAV erosion is averages 1.8% per year over 27 years, about what you'd expect based on the historical average default rates and the fact that VWEHX tends to hold more bonds at the higher quality end of the speculative rating categories. But these bonds are speculative as to the payment of interest and repayment of principal, and you should expect some of them will loss value either through defaults or rating downgrades. Compare VWEHX to the results for the long-term bond fund where principal is even more sensitive to changes in interest rates, but the principal is intact after 27 years.

"Your numbers above is the 'Withdraw ALL of the yield" strategy, which isn't optimal."

Your earlier comments suggest that VWEHX is superior to the new fund because its current yield is over 7%. Isn't this a "withdraw all the yield" strategy? I agree that a "withdraw all the yield" strategy is not optimal -- it's not even sustainable (due to the NAV erosion). But why reach for yield if you have to reinvest 30% of it in order to keep your principal intact? Wouldn't that lower VWEHX's current optimal payment ratio to 5% (70% of 7.34%)?

Unfortunately, I can't provide you with any historical data for the new fund. But if a plain vanilla 35/65 income-producing stock / long-term investment grade bond fund like Wellesley can beat VWEHX, I don't see why the new fund (which will also invest in assets that do well in an inflationary environment) shouldn't have even less volatility than Wellesley while producing similar long-term returns. Time will tell.

Unfortunately, I can't provide you with any historical data for the new fund. But if a plain vanilla 35/65 income-producing stock / long-term investment grade bond fund like Wellesley can beat VWEHX, I don't see why the new fund (which will also invest in assets that do well in an inflationary environment) shouldn't have even less volatility than Wellesley while producing similar long-term returns. Time will tell.

If an investor had purchased VWEHX in 1999, and taken a 5% withdrawal and re-invested the rest of the dividend, he would not have even been able to even keep up with inflation. The only thing that proves is VWEHX does not work in the manor El Lobo recommends.

Let's not use a single point extreme position that has nothing to do with El Lobo's recommendations.

Year 1999 was near the peak of the bubble. The stock market Safe Withdrawal Rate was around 2%.

Have fun.

John Walter Russell 

JWR1945a:

If an investor had purchased VWEHX in 1999, and taken a 5% withdrawal and re-invested the rest of the dividend, he would not have even been able to even keep up with inflation. The only thing that proves is VWEHX does not work in the manor El Lobo recommends.

Let's not use a single point extreme position that has nothing to do with El Lobo's recommendations.

Year 1999 was near the peak of the bubble. The stock market Safe Withdrawal Rate was around 2%.

Have fun.

John Walter Russell 

John...The only reason I used 1999 is because it does have a significant meaning to El Lobo. Dispute the numbers if you will, but I will let El Lobo explain the significance of the year 1999 and VWEHX.

helmut 

helmut, 

1)  Investing in stocks is riskier than investing in bonds, simply because you expect higher returns, that is, growth of share prices.  Ball 1.

2) For the SAME yield, dividends are riskier than interest.  After all, corporate debt is higher on the foodchain.  That is, bond holders have more rights than stockholders.  Ball 2.

3)  A 29 year old fund is less risky than one that hasn't been born yet.  How do you EVER evaluate risks or expected returns unless you can look at the securities actually held by the fund, and watch the fund managers money management style.  This is the standard active versus passive/index fund management argument, applied to the two funds in question.  Ball 3.

4) If you even think any of the above is not true, please reply specifically.  Otherwise, you can kiss it goodby, the ball's 'outa here.

 Mathguy,

"VWEHX is a bond fund that does not touch principal"

You 'touch principle' whenever you sell shares, and withdraw the proceeds.  Principle value changes always occur, as fund NAVs rise and fall.  Whenever the fund yields 7.34%, that represents a certain number of dollars.  If you withdraw 7% (a certain smaller number of dollars), you reinvest 0.34%, a considerably smaller number of dollars.  You don't withdraw principle, you actually add ot it, by buying more shares.  Sell shares, you touch principle, buy shares, you add to it.

"that a balanced fund (just because it holds stocks) is riskier (defined as standard deviation of total returns?) than a fund that holds all bonds (regardless of quality?)."

SD of share price changes is higher than SD of yield changes, simply because share prices are more uncertain.  SD data for VWEHX over it's lifetime is TR - 8.54%, Y - 2.63%, G - 7.99%, BTW.  That is, almost ALL of the SD for VWEHX TR comes from the volatility of the fund NAV, and NOT the volatility of it's yield.  And VWEHX is a bond fund, not stock fund.

Now, you might argue that, because of correlation coefficients, the TR of a balanced fund might be lower in risk than either an all stock or all bond fund.  But, since we don't know the asset classes that will be in the new fund, nor their percentages, we really can't make this determination.  Absent ANY knowledge of the new fund, and infinite knowledge of VWEHX, I consider the new fund much riskier.

"The 1978-1994 data for the bond funds is actually fiscal year Feb-Jan from Vanguard's annual reports."

I have the same data, through 2000.  I also have the actual monthly information, which is much more useful to show monthly withdrawals from the fund.  As I say, I stopped at 2000, and used the results to develop my investment and withdrawal strategy.

"It looks like both LT Inv Grade and Wellesley have produced higher returns with less risk."

Looks like returns were higher.  What about SDs?  Finally, will the new fund behave like either?  And how do you quantify THAT risk of uncertainty?

"No, I don't know of any specific default hits suffered by VWEHX."

The answer is 2, and I don't know whether it was a complete loss of principle or not.  I forget when they occurred, but there was no discernable  drop in fund NAV at those times, which were a few years apart.

"The VWEHX NAV bounces around . . . . ."

It's SD was a bit under 8% over it's lifetime.  The SD of a typical stock fund is at least double that.  Average annualized TR for VWEHX over it's lifetime is 9.77%, average yield was 11%, average capital loss (drop in fund NAV) was -1.23%.  None of this behavior can be explained by historic default rates, credit quality, whatever, as your paragraph implies.  The fund behavior was what it was.  Nothing more, nothing less.  And you can expect it to behave in a similar manner, going forward.  What do you expect the behavior of the new fund is going to be, going forward?

"Isn't this a "withdraw all the yield" strategy?"

No.  Withdrawing 7.34% is the withdraw all the yield strategy.  If you withdraw 7%, you reinvest 0.34%, buying more shares.  If you withdraw 8%, you are withdrawing more than the yield, touching principle.  Withdrawing 70% of the yield strategy would withdraw 5.14%, reinvesting 2.2% of the yield.

I would now argue that using VWEHX, instead of the new 5% fund is considerably less risky, for all of the same arguments in this post!

"it's not even sustainable (due to the NAV erosion). "

Actually, withdrawing any part of, including ALL of the yield, is sustainable.  That is, the income will last forever.  What doesn't sustain is whether or not that income adjusts for inflation, nor the value you have in the fund.  With a bond fund, the ONLY way to have the yield adjust for inflation is if the fund itself is a fund of TIPS, or if you withdraw only a portion of the yield and reinvest the rest of the yield.

You CAN have a stock fund the produces income (dividend yields) that grow with inflation.  The dividends themselves have to grow by that amount.  In addition, if you withdraw a portion of the dividend yield, you have a second mechanism that might grow the real withdraw amount.

In summary, I was asked why I considered an investment, today, in VWEHX to be considerably less risky than an investment in a new, untested fund.  I've given the reasons.  Then the conversatiion turned to discussing those risks in terms of a 7% rate of withdrawal.  It's still considerably less risky, based either on past performance (of which the new fund has none!) or expectations.  Withdrawing 7% from VWEHX over it's lifetime would not have been disasterous.  Withdrawing 7% from a fund that yields 7.34% won't be disasterous, going forward.

It's as simple as that.

I'm discussing this with you, since you understand the numbers.  helmut doesn't.  For example, rather than looking at the complete history for VWEHX, as you have done, he chooses the last 10 years, and tries to make some point.  But why 10?  Why not 5?  Turns out that the all time LOW for VWEHX was almost exactly 5 years ago, and it's been uphill ever since!  How would that affect things (higher, rather than lower, fund NAV).

Just something thrown out, by the relief pitcher!

JWR,

"If an investor had purchased VWEHX in 1999, and taken a 5% withdrawal and re-invested the rest of the dividend, he would not have even been able to even keep up with inflation."

The yield for VWEHX in 1999 was 7.15%.  Withdrawing 5%, in 1999 dollars, means that 2.15% was reinvested back into the fund, buying more shares.  That 2.15% yield reinvestment more than kept up with inflation.

What does VWEHX invest in.........below investment grade bonds.

What does that mean................lot's of credit risk. When that credit risk shows up that extra 0.34% in yield won't be there.

Junk bonds do well in strong markets, not distressed markets. But why would you settle for junk bond returns in a strong market when you could invest in a solid dividend-paying stock fund?

VWEHX is supposed to be better junk, so I guess that's worth something. But to invest 100% in VWEHX is irrational.

Ball 1) Wrong, expecting higher return is based on TR not NAV growth. Bonds can NEVER promise positive real TR over any time period, stocks do it in 17 years.

Ball 2) Wrong, interest doesn't keep pace with inflation, many dividends do keep pace.

Ball 3) What part of junk don't you understand?

Ball 4) Don't start your home run jaunt, it's foul.

El Lobo,,,

1)  Investing in stocks is riskier than investing in bonds, simply because you expect higher returns, that is, growth of share prices.  Ball 1.

2) For the SAME yield, dividends are riskier than interest.  After all, corporate debt is higher on the foodchain.  That is, bond holders have more rights than stockholders.  Ball

 
Both of these statements are fairly sweeping generalities which have no specific substance. True, bond holders are higher on the food chain, and if you your choice was buying either a HY bond from Ford or investing in Ford stock, then indeed the Ford HY bond would have less risk than owning stock in Ford, but as a practical matter, I think most investors would feel the risk would be less owning stock in TM rather than investing in a Ford bond.

Now if you are going to argue that a HY Ford bond is safer than stock in Toyota because bondholders get paid interest before stock holders dividends, or, in the case of both Ford and Toyota going bankrupt bond holders get paid first, I will not argue a technical point that you are so fond of doing to rationalize your position. But if you use the analysis of a company's financial strength, earning power, outstanding debt, dividend payout ratio, and dividend growth as a measure of risk instead of short term share price volatility then your perspective on risk changes dramatically. Show me one case of a stock with substantial dividend growth history that resulted in a -70% drop in total return or a 25% cut in dividends in 10 months as in RAS.

As Ken has already pointed out interest on investment grade bonds cannot support a 7% or even a 5% withdrawal without succumbing to inflation. Obviously both the NAV and the interest dividend paid on HY bonds is volatile enough, as you have pointed out, to make the income from HY bonds unstable enough to require long term re-investment of at least part of the dividend. How do you determine the SWR when re-investment of the dividend is required? You either cannot, or will not explain or do not recognize the risk involved in trying to determine this.

 3)  A 29 year old fund is less risky than one that hasn't been born yet.  How do you EVER evaluate risks or expected returns unless you can look at the securities actually held by the fund, and watch the fund managers money management style.  This is the standard active versus passive/index fund management argument, applied to the two funds in question.  Ball 3.

 Funny a significant history was not important to you when determining the risk on ADVDX, NAT or other investments you have made.

Now, concerning VWEHX and the new payout funds, only the fund of funds itself housing the individual funds will be new. Most of the underlying funds will be proven establish funds, most of which have better long term returns than VWEHX. Even if I don't understand the numbers as well as you, Vanguard, I'm pretty sure, does.

 As I told you at the beginning of this thread, if you consider this as failing to grasp the concept of risk then that is your opinion and you are welcome to it, but I'll stick to mine. I'll just take comfort in the fact that the vast majority of the investing community fail to grasp your upside down concept of risk either.    

helmut 

Ken, helmut,

I suggest you BOTH take a basic bond primer.  Here is what you will learn.

ALL risks for debt show up in current interest rates for the investment.  The ONLY risk free investment is 30 day T bills.  Everything else, including cash in a Mason, jar, is riskier, and the relative riskiness of any DEBT investment is given by their interest yields.  The BOND market is absolutely and completely efficient.  The two primary debt risks are quality, and time/inflation.  Finally, the total return you expect from investing in debt is the interest yield you expect to receive.  You don't expect to receive a higher price for a bond than what you paid for it.

The risk you take on with bond funds is that you will probably receive some return from fund NAV changes, from the time you buy into the fund until you sell out, in addition to the fund yield.  That's why bond FUNDS are riskier than individual bonds, bought at issue and held to maturity!

Stock dividends are riskier than bond interest, and the relative riskiness of dividends isn't related to the size, or magnitude, of that yield.  Furthermore, the riskiness of dividend yield doesn't compare to the riskiness of interest yield.  If it did, a stock, paying any dividend yield less than the 30 day T bill rate, including NO dividend, would be less risky than the only risk free investment!  The total return you expect from investing in stocks is the dividend yield you expect to receive and the growth in share prices you also expect.

The risk you take on with stock funds is that you will probably receive some return from fund NAV changes, from the time you buy into the fund until you sell out, in addition to the fund yield.

Stock fund NAV changes are more volatile than bond fund NAV changes, because bond prices are less volatile than stock prices.  That's why you hold more bond funds in your portfolio - they reduce volatility.

So, you have one BOND fund, with an interest yield of 7.34%, with a 29 year history, and you are comparing it to another fund, of which you know nothing except that it will be a stock/bond fund, which will have some yield, perhaps some capital change (growth) in share and bond prices within it's portfolio, whatever that portfolio happens to be, managed by some unknown Vanguard fund manager, that will pay a 7% distribution that may, or may not, increase over time, let alone keep pace with inflation, and which may include some return of principle.

By the way, Earl McEvoy has been at the helm of VWEHX since 1984.  I think he knows junk!

Now, you can both talk about investment grade versus junk, or fund of funds versus fund, or management skills, or past performance, whatever, and do it until the cows come home.  Or compare VWEHX with any OTHER fund, and try to draw conclusions.  But until you acknowledge the above SIMPLE risk/return characteristics of stocks, compared with bonds, you are both flapping your gums.

That is, you can talk risk/return tradeoffs, but you're not walking the walk.

El Lobo -

Three things.

#1

"I suggest you BOTH take a basic bond primer.  Here is what you will learn."

I don't like the condescending tone you take with helmut and Ken -- especially when your primer is oversimplifed nonsense.

#2

"Finally, the total return you expect from investing in debt is the interest yield you expect to receive.  You don't expect to receive a higher price for a bond than what you paid for it."

Not true. The total return you expect from investment in debt is the interest yield plus the expected credit loss. The expected credit loss on investment grade bonds is essentially zero. Here is a link to a Moody's primer on default rates and credit ratings. Look at page 20 where they discuss speculative grade bonds and average yearly credit loss. For speculative grade bonds you expect to receive 3% less per year than what you paid for it.

http://www.moodyskmv.com/research/whitepaper/52453.pdf

When I attributed the severe NAV erosion of VWEHX (as compared to the long-term investment grade fund for the same 27-year time period) to this credit loss, you replied,

"None of this behavior can be explained by historic default rates, credit quality, whatever, as your paragraph implies.  The fund behavior was what it was.  Nothing more, nothing less."

You either refuse to acknowledge the obvious or are in denial.

#3

"The risk you take on with bond funds is that you will probably receive some return from fund NAV changes, from the time you buy into the fund until you sell out, in addition to the fund yield.  That's why bond FUNDS are riskier than individual bonds, bought at issue and held to maturity!"

Some people take comfort in the fact that they will get their principal back at maturity, but there is no financial risk difference between a bond fund and individual bonds with the same credit/duration characteristics. Each has its own advantages. You do have more control over maturity dates and other portfolio characteristics with individual bonds. However, if you are forced to sell an individual bond before maturity, you are subject to the same price fluctuations as a bond fund.

Thanks for the bond primer.

A few comments on your post....

re  That's why bond FUNDS are riskier than individual bonds, bought at issue and held to maturity!

All holding to maturity does is guarantee you get face-value upon maturity, in addtion to fixed interest payments along the way. There is no opportunity to increase the interest rate as there is with a fund, which is convenient if there is increased inflation. Individual bonds are ok if inflation is stable over the life of the bond.

Moving on....

VWEHX has an average maturity of 7.6 years, not exactly nimble. So there is some concern when it comes to higher rates and inflation. However, possibly more important in an inflationary environment is not the ability of the FUND MANAGER to sell and buy in timely fashion to capitalize on new higher rates and fight inflation. The ISSUERS' credit rating becomes a big factor, and therefore the probability of the issuers DEFAULTING on their lower-than-investment-grade bonds becomes a major problem. Inflation puts an inordinate burden on low quality issuers, so does deflation. Expectations for all these bad things may be built-in on issuance, but expectations are nothing more than educated guesses. You've heard the expression "Flight to Quality" haven't you? If the credit floor becomes unstable the HY market will be one of the first victims...those big juicy yields won't be worth the paper their printed on.

Interest rates only reflect EXPECTED risks based on forward-looking analyses, once the bond is issued you're on your own.

Good Luck, Ken. 

BTW, this should give you some idea about why high-yield (ie, high payout ratio) stocks are GENERALLY viewed as risky........unless the business model warrants a high yield.

Helmut, I tried.

Mathguy,

"I don't like the condescending tone you take with helmut and Ken -- especially when your primer is oversimplifed nonsense."

I'm offended!  I wasn't being condescending to Ken and helmut.  I was having a battle of wits with them, and I considered them well armed!

I AM condescending to someone who calls a 2 paragraph primer on yields nonsense, given that they consider a better primer to be a refence to page 20 of an 84 page white paper, entitled, "Historical Default Rates of Corporate Bond Issuers, 1920-1999" instead!

So, to wit:

From the ***, Jane, & Spot, LLC white paper, entitled "We Look and See"

1) Investing in stocks is riskier than investing in bonds.

2) Investing in high yield bonds is riskier than investing in lower yielding bonds

3) Investing in low yield stocks is riskier than investing in higher yielding stocks.

"The total return you expect from investment in debt is the interest yield plus the expected credit loss."

Not true.  The total return you expect from an investment in debt is the risk free interest yield plus a credit risk premium.  That sum IS the current interest yield of the investment.  That's what the bond market expects to receive from that bond.  They don't expect to take a loss.

"The fund behavior was what it was.  Nothing more, nothing less."

That behavior (fund NAV changes, as well as changes in the yield distribution) was the result of the fund manager buying, holding, and selling a portfolio of bonds over the last 29 years.  The CURRENT yield of a bond fund is a complete measure of the risks associated with it, GOING FORWARD.

But the current yield says nothing about past risks.  There is no risk in past performance.  Whenever those two bonds defaulted, the NAV for VWEHX, as well as the dollar amount of it's monthly distribution, changed a bit.  After all, the value of those bonds may have gone to zero (affecting NAV), or the bonds may have skipped an interest payment (affecting monthly distribution from the fund).

But those effects are IN the historical NAV and distribution for the fund.  And they were negligible.

Now, the fact that those two bonds default says NOTHING about whether any other bonds will default, going forward.  That is, those two defaults added NOTHING to the risk, hence yield, characteristics of the fund.

Your implication has been that the 1.9% average decrease in fund NAV over it's lifetime was due primarily to the effects of defaults.  That's what I got out of your explanations, and it's nonesense.  My point is that those two defaults had almost zero effect on either the NAV or the distribution.  That's why I asked you if you knew how many defaults occurred, and when.  You can't see them in the historical record for the fund.

Now, what you say (about credit risk) is probably all true.  I know the bond market takes all of this into account, as well as a slew of other information.  But the end result is that the bond market sets a price on each bond, and that price determines it CURRENT yield, not it's yield some time in the past.

"Some people take comfort in . . . . . .."

My point was only that people invest in bonds for the interest that they expect to receive, but they invest in stocks not only for the dividends but also for expected growth in share prices.  In general.  And that any investment, for growth, is riskier than an investment for yield.

"Primers"

Here's a chalange for your math skills and investment knowledge:

1) Provide a one paragraph description on why a stock/bond mixture can be less risky than either an all stock, or all bond, portfolio.

2) Provide a one paragraph description of the convexity attribute of bonds, that is, how and why a positive convexity bond differs from a negative convexity.

For both descriptions, use no math terms!  It's too easy to use terms like maxima, minima, and first derivitives.

I found this article by William Bernstein very enlightening conderning the risk envolved with HY debt.

Credit Risk: How Much? When?

El Lobo....VWEHX according to Vanguard has had 16 defaults since its inception. The benchmark Vanguard judges VWEHX by has had 452 defaluts during the same time period. 

All of that said, I still cannot see the wisdom or the reward in putting 40% or more of your retirement into HY bonds. Obviously you can and have put your money where your mouth, is and I wish you the best of luck.

helmut 

helmut,

I'm quite familiar with Dr. Bill's article.  It deals with whether or not it makes sense, from a credit risk premium standpoint, to put new money into junk versus quality.  The Moody's white paper dealt with the same subject.

"VWEHX according to Vanguard has had 16 defaults since its inception"

Not to doubt you, but did you find that somewhere online?  If so, I'd be interested.  I contacted them back in 1998, and got the two default number.  I haven't checked since.  Regardless, I'd be interested in seeing actual default dates, the percentage of the portfolio involved, and the overall effect on fund NAV and monthly distribution.

The basic assumption people make (including Dr. Bill, whom I once met and discussed this with him) is that the 1.9% loss of fund NAV for VWEHX was due to default risks coming home to roost.  That just wasn't the case, through 2000.

"All of that said, I still cannot see the wisdom or the reward in putting 40% or more of your retirement into HY bonds."

Back in 1998, whenever LaLoba retired, I was still working, and I wanted a 50/50 stock/bond portfolio.  All of her money went into VWEHX, mine was still in equity funds.  I had to decide which bond fund to use.

By that time, I had already developed the yield based withdrawal strategy.  For all of the reasons discussed on this forum.  I knew that an all VWEHX portfolio would support a 4% real inflation adjusted withdrawal hands down.  It would have done so at any time period of it's history.  It would have also supported a 6% withdrawal strategy over it's lifetime.  Believe me, I ran all of those scenarios through my spreadsheets.

Anyhow, the point was that I wasn't using bonds to reduce volatility, although VWEHX certainly does do that.  I was using it to produce income.  In fact, since the expected TR of VWEHX is 9%, which is close to the expected TR of the stock market, I was able to show that, using VWEHX instead of the S&P 500 index fund, mixed 50/50 with a bond index fund, was actually a less volatile mixture, at nearly the same TR.  This was from an efficient frontier standpoint.

Remember, junk is more like equity than debt, but less volatile.

The way I look at it, 100% in VWEHX would support a withdrawal strategy that was 50% greater than the standard, traditional rate of withdrawal (6% versus 4%), do it with no risk of touching principle (6% is less than the yield of the fund), and was diversified (a few hundred bonds in the portfolio).

The way I look at it, the OTHER 50% of my portfolio (at that time) was in the risky world of individual stock investing, where I'm not comfortable putting more than 3% or so in any individual high yield asset.

Anyhow, that's the story, and I'm sticking with it! 8-)

Remember, this whole thread deals with a discussion of a new Vanguard fund.  My point, in introducing VWEHX, was that it was the ONLY high yield fund available to me back then.  And I know it intimately (or knew it, back in 2000)

Quite frankly, I think Vanguard will be quite successfull with their new fund.  I know I could be, if I were the fund manager.  I'd just use my current portfolio!

And that's a big 8-)))

ElLobo.....I called Vanguard and ask their rep for the default rate or the loss rate for VWEHX. The Vanguard Rep very professionally stated he did not have that information, but he knew who to ask. After being on hold for about ten minutes he informed me he did not have that information, but he then told me the fund had 16 defaults since its inception which average about 1/2 a default per year, and the benchmark for that fund had 452 defaults during the same time period.

Of course the devil is in the details, as we would have to have the dollar amounts to see if the default rate was significant. My instinct tells me it probably was not. 

Knowing your nature ElLobo you will, as would I, call to verify this information so if you get a different story I would like to know.

helmut

You wrote

Then there is the issue of traditional withdrawal studies that says 7% withdrawals won't work over 25 or 30 years.  In my view, most retirees who go for the 7% will be investing at far lower levels of fixed income than they would do on their own.

Vanguard (and Fidelity too) is skirting the issue of safe withdrawal rates.  Recall a safe withdrawal rate of 4% is guaranteed and also is guaranteed to increase with inflation.  I would be shocked if Vanguard's 7% rate was able to rise with the pace of inflation. For that reason, I would not use any of these funds for my whole portfolio.

Luckily we have two more years until retirement... maybe these funds will have a track record of some sort by the time we need them.  Heck I think I would prefer the 7% fund over say investing in high yielding individual stocks with very low chance of increasing dividend rate (say KMR, EEQ, DHT, etc...).

Stats 

statsguy:

...  I would be shocked if Vanguard's 7% rate was able to rise with the pace of inflation.  ...

Neither does Vanguard expect the account value or payout of its Managed Payout Capital Preservation Fund to keep pace with inflation.  According to the Preliminary Prospectus of the Vanguard Managed Payout Funds, the Capital Preservation Fund "is likely to appeal to investors who require a greater payout level to satisfy current spending needs. This Fund is expected to sustain a managed distribution policy with a 7% annual distribution rate.  Although the Fund's payouts and capital are not expected to grow at a rate that keeps pace with inflation, the Fund does seek to preserve the 'nominal' (or original) value of invested capital over the long term."

Statsguy, et. al.,

The way Vanguard is going to calculate that 7% distribution guarantees that the fund will last forever.  It will take something like the average fund NAV over the previous 3 years, which is in dollars, take 7% of that number (actually divided by 12, to get a monthly withdrawal), then reduce the fund NAV by that amount and pay the distribution.  At least that's the way I understand it will work.

Anyhow, that 7% withdrawal is exactly the same as taking 7%/12 of the current fund NAV each month.  That's NOT taking the standard 7% of the initial value, adjusted for inflation type of traditional withdrawal.

The difference is Zeno's paradox, his first, 'ifn I remember.  That is, if you take out 7% of the value of the portfolio, you still have 93% of it left in the fund.

Now, that distribution will rise and fall as the 'last 3 year average fund NAV' rises and falls.  Whether it keeps up with inflation depends upon whether or not the fund NAV keeps pace.

Finally, the Vanguard fund managers need only keep the current yield of the fund greater than 7% to avoid touching principle.

"but he then told me the fund had 16 defaults since its inception"

Then we know that it's had 14 defaults since 2000!

"benchmark for that fund had 452 defaults during the same time period."

To me, that's a measure of the quality of the fund manager, Earl McEvoy, and the conservativeness of the fund itself.  It doesn't shine whenever junk shines, but doesn't tank when things go south.  After all, the fund itself was begat in the last period of hyperinflation in this country, the late 70s.  The fund also survived the Mike Miliken junk bond scandle of the late 80s.

"Knowing your nature ElLobo you will, as would I, call to verify this information"

Actually, I have no further need to analyze the behavior of VWEHX.  So far, I've held this fund almost 10 years now.  I'm spending much more of my time looking at the risky, equity part of my portfolio!

And trying to figure our Medicare!

"All holding to maturity does is guarantee you get face-value upon maturity"

That 'sez, to me, that there is no risk of loss of principle, save for defaults, whenever you invest in individual bonds.  Whenever you invest in bond funds, you have that volatility of bond fund NAV changes.  Don't get me wrong.  I understand the advantages of investing in bond funds, rather than individual bonds.  You don't see a dozen or two individual junk bonds in MY portfolio! 8-)

Moving on:

"VWEHX has an average maturity of 7.6 years, not exactly nimble."

The average duration is still 5 years and change, considered intermediate term, which is the 'sweet spot' in terms of the risk/return characteristics of all bonds (duration is the first derivitive of the yield curve).  ALL bonds (from quality to junk) with the same duration have similar responses to changing interest rates and inflation.  That's how duration is defined, and used.

Interestingly enough, Bill Bernstein once wrote an article where he considered treating stock dividends in the same manner as bond interest.  He talked about duration of the stock, and other similar stuff.  If I get a chance to root through all of his back articles, I'll provide a link in some posting.

Regarding the rest of your paragraph, I need only point out that VWEHX began in 1979.  Inflation for that year was 13.3%, the highest it's been here in ages.  Inflation fell to 1.1% in 1986, back up to 6.1% in 1990, then lower (with a few wiggles) since then.

In 2000, the the tech bubble burst, and junk interest rates rose.  In fact, if you look at the VWEHX NAV from 1998 to 2003, you see a significant erosion of NAV.  Remember, that period of time included the tech bubble, the dying throws of the clinton years, an economic downturn, and 9/11.  All of which wasn't good for junk.  My point is that you can see how this fund does in different economic climates.

And don't forget Mike Miliken, in the late 80s!

"Interest rates only reflect EXPECTED risks based on forward-looking analyses, once the bond is issued you're on your own."

Absolutely.  While you own a bond, though, it's value changes, as the bond market 'adjusts' the trading price, which in turn raises or lowers the yield.  As I said, current yield reflects future risks.

"BTW, this should give you some idea about why high-yield (ie, high payout ratio)"

High yield and high payout ratios are two different concepts.  A company can pay out 100% of it's earnings and still have a dividend yield of a percent or two. However,

"high-yield stocks are GENERALLY viewed as risky"

I agree, but that doesn't make them more risky!  There has to be some fundamental reason that high yield equity is riskier than low yield equity, like there is for debt, but that reasoning excapes me.  OTOH, the relative risks of growth, versus yield, tells me that the opposite is true.

"........unless the business model warrants a high yield."

Business model (e.g., REITs, BDCs, tankers, royalty trusts) either warrent, or require, a high payout ratio.  That is the dollar amount of the dividend.  It's the market that prices the stock, setting it's percentage yield, not the company.  Remember, earnings determine the dividend and the share price, earnings growth determine dividend growth AND share price growth.  Some companies are perfectly happy to pass along earnings to shareholders, rather than to grow.

El Lobo -

We'll never see eye-to-eye on this. You focus on yield and are willing to chalk up everything else to NAV volatility (which you don't care about since you don't expect to sell any shares.)  I consider some investments that have "above market yields" to be cases where you're robbing Peter to pay to Paul (speculative bonds and ADVDX special one-time dividend capture are two such cases) and it's in those cases where you need to reinvest a higher proportion of your current income to keep your invested asset base intact (above and beyond what you'd need to reinvest to get the income $ to grow.)

Regarding defaults, I don't think the number of defaults in VWEHX is relevant. The fund does tend to hold higher quality speculative bonds, so it probably doesn't have many that are on the brink of default. But it incurs credit losses whenever a company's financial condition deteriorates and the bond's credit rating is lowered and Exhibit 25 in the Moody's whitepaper shows that credit rating downgrades are much more likely than upgrades. I would bet most of these bonds are sold for less than their purchase price before they get to the point where default is imminent. This is a permanent loss of principal, not price fluctuation due to interest rate changes. I know you'll say that there are gains and losses all the time as the fund manager turns over the portfolio, but the NAV losses in VWEHX have been persistent and growing through time. I see the majority of the credit risk yield premium as compensation for this expected loss, not reward for taking the risk -- and it's that portion of the yield that you need to reinvest in order to keep your principal intact.

Look at the difference in yields between VWEHX and the Long-Term Investment Grade fund. The average is around 2.25%, which is largely the credit risk premium. I say that around 1.80%, on average, was compensation for future expected credit loss (which shows up in the long-term differences in NAV between the two funds), and around 0.45% was compensation for taking on the risk that the actual credit loss would vary from the expected loss.

I appreciate your contributions to this thread. Your posts are informative, fundamentally sound, easy to read and concise. Your explanation of the steady long term decline in VWEHX ‘s NAV in your last post makes more sense than any other explanation I have heard so far. 

While it may not be exactly to the point, the article I linked in this post goes to the fact that bond yield (especially junk bonds) is not as black and white as some would think. Even with bond funds return comes from more than just yield.

helmut

helmut,

The article is a good summary. The section on rolling down the yield curve was interesting -- it helps explain why many bond funds have higher turnover than you'd think was necessary to maintain their target durations and maturities.

Of course, there could be several things that contributed to VWEHX's NAV erosion. They could buy bonds with higher than market yield coupons at a premium and then have the amortization of that premium decrease the fund's NAV. Some bond funds systematically do this just to inflate their advertised yield. Or, the fund manager could have made a few bad interest rate bets, lengthening duration just before a spike in interest rates and then shortening it just before interest rates came back down.

But the most logical explanation is the credit loss inherent in speculative grade bonds. Here is a comparison of VWEHX to the T. Rowe Price High Yield fund.

$100,000 invested on 1/1/1985 -- reinvest capital gain distributions

                                                  VWEHX     PRHYX 

Income distributions 1985-2005     184,174     185,972

Market value on 12/31/05                73,615      71,026

PRHYX is not quite as conservative as VWEHX, so you'd expect the income and credit loss to be a little higher. The PRHYX expense ratio is 50 bp higher -- that eats into the income distributions ($500/yr in 1985, only $350/yr now.)

OK, let's continue to talk this out.

"We'll never see eye-to-eye on this, . . . .that have "above market yields" to be cases where you're robbing Peter to pay to Paul . . . ., and so forth."

First, are we talking stocks or bonds, are we talking accumulation or decumulation, and, for risks, are we talking SD or defaults?

"You focus on yield and are willing to chalk up everything else to NAV volatility."

Well, the return you get from a bond fund IS the yield you receive, plus/minus any NAV changes over time.  Just like for stock, or balanced, funds.  helmut's reference discussed why bond prices (for individual bonds) fluctuate, and, since a bond fund is the sum net affect of the yields and all bond price changes for all bonds held in the portfolio, why fund NAVs change.  From an investor in that fund, all returns I see (that is, I can spend) are the yield distributions.  Any capital changes are unrealized, until I sell shares.

"Regarding defaults, I don't think the number of defaults in VWEHX is relevant . . . . ."

I agree. Two defaults in 21 years made absolutely no dent in either the yield, or the fund NAV.  That was my original point!

Regarding the rest of this paragraph, read over it again.  You are trying to explain the 1.2% drop in VWEHX NAV as the 'natural' thing that happens whenever a fund manager invests in below investment grade bonds, versus investment grade bonds.  I invite you to consider the following:

1) Bond funds loose capital and yield whenever individual bonds that it holds default.

2) Bond funds loose capital whenever they sell, or redeem, a bond at a price lower than at purchase.  They gain capital whenever they sell, or redeem, at a higher price.  Your reference talked about this.

3) Bond fund NAVs rise and fall in response to decreases, or increases, in interest rates.

Now, we have eliminated reason #1 as the culprit in the 1.2% fall in VWEHX NAV.  Your theory is that number 2 is the culprit, based upon some assumptions as to what the fund manager does in response to changes in the credit quality of the individual companies he invested in.  Although what you say may well have happened, for specific cases, to attribute ALL of that loss to an effect of which you have no direct knowledge (which bonds, and when, for example) is conjecture and theory, nothing else.

I suggest that the reason the fund lost 1.2% of it's NAV per year over the first 21 years of it's lifetime is the net result of ALL of the activities described in helmut's reference.  Coupled, of course, with the fact that, in 1979, inflation was 13.3%, and the yield of VWEHX was 10%.  Since then, the yield of VWEHX peaked at 15.6%, in 1982, then has been in a fairly steady decline down to it's present level.

So, unless you are willing to look at specific buy and sell transactions for the fund, I simply suggest that the past is what it was.  That is, it makes little sense to conjure up reasons why the fund lost 1.2%, because there is NO way that you, or anyone, for that matter, can take something like the reference helmut gave above and apply those effects to a portfolio of a few hundred bonds and adequately describe that 1.2% loss.

"Look at the difference in yields between VWEHX and the Long-Term Investment Grade fund."

Zero risk debt is 30 day T-bills.  Any other debt of lower quality (investment grade through junk) at short term (out to 3 or 4 years) has a higher coupon.  This is credit risk.  Any other debt, at the same quality, that is higher term also carries a higher coupon, even government debt.  This is inflation risk.

Look at the 9 M* style boxes for debt.  Short, intermediate, long term is the one direction, high, medium, low quality is the other.  If 30 day T-bills are risk free, they carry the lowest coupon.  The highest coupon is long term junk.

(Consider this the normal case, where the yield curve is positive (and has positive convexity).  An inverted curve has higher yields at lower terms.  That is, an intermediate term government bond is less risky than the T bill.)

That 2.25% difference in yield is PARTLY the difference in quality, partly the difference in term.  Not all quality, as your theory suggests.

Hi Stats:

I have been in North Carolina up in the mountains for the last week, so I wasn't ignoring you:)

My only point was that I think many retirees feel comfortable at 40/60 stock/bond mix or maybe even less.  I don't see this fund distributing 7% based on an expected 7% return with only 40% equities. 

So what I'm saying is that retirees will trust Vanguard and invest in this fund and many will never even know that it has far more equities than they would ever hold on their own.

Frankly, I think that is probably a good thing.

best,

Bill

There are a lot of things we don't know about these funds at this point.  On of the big things to me is if they will be three different AAs with three different payouts or if they will have the same AA in all three funds.

 Lets assume that they have the same AA for a minute. 

If you want a 5% distribution where your principal grows with inflation, would you choose the 5% fund and let the NAV rise with inflation or would you choose the 7%, and reinvest 2% to increase shares resulting in the same portfolio value but a lower NAV?

Wouldn't your payouts likely increase with the latter over time, visa vie the 5% fund?

best,

Bill

I suggest that the reason the fund lost 1.2% of it's NAV per year over the first 21 years of it's lifetime is the net result of ALL of the activities described in helmut's reference.  Coupled, of course, with the fact that, in 1979, inflation was 13.3%, and the yield of VWEHX was 10%.  Since then, the yield of VWEHX peaked at 15.6%, in 1982, then has been in a fairly steady decline down to it's present level.

Unless we hire an accounting firm to audit VWEHX the exact reason for the long term decline in VWEHX will probably forever remain a mystery. The bottom line to this debate is that it has, and if you were to use any shorter time period the loss would be even greater. Obviously if you had taken the entire dividend during almost any extended time period your income and share value would have declined. Your premise of re-investing part of the dividend to protect your investment may or may not work depending on future performance and all the different factors mentioned earlier.

A 28 year drop in the NAV (regardless of the reason) and dividend would tell me that VWEHX would only work as a total return type of product with no more than a 5% withdrawal, and unless High yield bonds have a long term substantial turn around, a lower withdrawal may be necessary to insure VWEHX's continued viability. This would mean a higher partial dividend re-investment would be required.

Conceding the generalization that bonds are less risky than stocks, remembering that a big part of risk management of your personal portfolio depends on diversification, it is my belief that a broad base established portfolio of Vanguard stock and bond funds would be much more diversified and carry less long term risk than a single portfolio of high yield bonds.  With that in mind, I will respectfully ask you this question.

Unless you are recommending some sort of market timing in and out of High yield bonds similar to a fund like IMSIX, and as Bernstein recommends, please provide your reasoning, without using share counting, as to how a simple total return withdrawal of a broad diversified established Vanguard portfolio of stock and bond funds ( if not the new payout funds, then Wellington or Wellesley) would be more risky than trying to determine the safe future dividend re-investment amount of a portfolio made up entirely of VWEHX?

helmut

Mathguy2,

With that description of the reasonings, or lack thereof, for fund NAV losses over time, and Vanguard's new fund distribution payout calculation (based on average fund NAV of the last 3 years, upon which the 7% distribution is calculated, on a monthly basis), how would YOU expect a fund, like VWEHX, with it's current yield of 7.34%, to perform, going forward?

That is, for any existing fund, with a yield greater than 7% on current fund NAV, how would increases, or decreases, in fund NAV (against the 3 year average) fare against any fund with a yield LESS than 7%?

That is the topic of this thread.

BTW, I do have the data for the first 21 years of VWEHX.  It would be a simple matter to apply that distribution policy to it, and see how monthly income, and fund value, would have fared.  I can tell you that withdrawing 70% of the monthly yield generated resulted in a monthly withdrawal that was fairly stable in real, 1979 dollars (nice increase in nominal dollars), as was the value of the portfolio.  In fact, the nominal value of the portfolio was 60% higher than at the start.  This was true even though the fund NAV, as well as the dollar amount of the actual distribution fell steadily over that time period.

The reason for the above is the the growth in the number of shares owned, purchased through reinvestment of the yield NOT withdrawn, more than kept up with the drop in NAV and $$$ yield.  That is, fund NAV times the number of shares owned equals the value of the portfolio, the asset base, in your terminology.

"The bottom line to this debate is that it has, and if you were to use any shorter time period the loss would be even greater."

Use the last 5 years data for this fund.

ElLobo:

"The bottom line to this debate is that it has, and if you were to use any shorter time period the loss would be even greater."

Use the last 5 years data for this fund.

Yes, there are short periods of out performance, but I hope this is not the long awaited reversion to the mean you are counting on. 

Does this mean you will not answer my question?

helmut 

Here is an article related to how the new fund will work -- diversify using asset classes with low correlations. I haven't read it closely yet, but it looks like it's on topic.

http://www.indexuniverse.com/index.php?option=com_content&view=article&Itemid=34&issue=121&id=3220&limitstart=0

"So, unless you are willing to look at specific buy and sell transactions for the fund, I simply suggest that the past is what it was."

In other words, "Unless I see all the specific securities transactions and their credit rating histories, I refuse to believe what you are saying about my fund's yield." You still believe that capturing six quarterly dividends adds up to a 13% yield for ADVDX.

Most people will accept a theory when presented with a preponderance of the evidence. I guess you use the "beyond a reasonable doubt" or "beyond a shadow of a doubt" standard. And then, like a good defense attorney, you try to distract the jury with talk about T-Bills, inflation, and style boxes. In this case, there is no contradicting evidence, just bluster.

My theory is simply that a very significant portion of the yield difference between investment grade bonds and junk bonds is compensation for future credit losses that will gradually erode the fund's NAV (and the shareholder's initial investment), and this will have a corresponding muting effect on future $ income distributions.

My evidence is:

1) Your own analysis that you can't take 100% of the VWEHX distributions as withdrawals -- you can only take 70% and reinvest the rest. You say this is necessary to grow the number of shares to support a $ income distribution that keeps pace with inflation. Well, inflation introduces an additional factor -- what percentage could you take if your goal was simply to preserve your initial investment over the 27 year history?

2) I looked at Vanguard investment grade bonds of all types -- short, intermediate, long, corporate taxable and municipal -- and not one, from inception through 12/31/05 with various levels of NAV volatility, failed to preserve your initial investment while withdrawing 100% of the income distributions. The Intermediate Investment Grade fund was the closest call -- it was only $14 ahead on a $100,000 initial investment -- and it opened in late 1993 right before interest rates spiked in 1994 and knocked the NAV down 10%. On the other hand, the T. Rowe Price fund that invests in the same asset class as VWEHX had nearly identical income distributions and pronounced market value loss over a comparable time period. The difference between the preserving principal or not? Investment grade versus junk.

3) The Moody's whitepaper that contains reams of historical data quantifying the risk of loss of principal for junk bonds versus investment grade bonds.

I don't expect any of this to convince you. You need to see to believe.

"future credit losses that will gradually erode  . . . . ."

Well, that MAY gradually erode, not WILL.  The point you are missing is that junk bonds pay this premium, and the risk you take, whenever purchasing these bonds, is that they do default, at some time in the future.  That's why they call it a risk premium.

If they don't default (which all, except two, in VWEHXs portfolio didn't!), you've earned that extra yield.  You seem to be making the argument that the loss of NAV for VWEHX was due to all of the bonds NOT defaulting in the portfolio somehow eating away at that premium.

You have history, and history says only 2 bonds defaulted.  You have a theory that the rise, and fall, of the creditworthiness of the rest somehow magically led to the 1.2% loss.  I say you have no idea why the fund lost that amount, because funds experience losses due to all kinds of activities, that helmut's reference outlined.

As evidence, on YOUR part, simply go to helmut's reference and tell me where YOUR theory fits in!

You have no 'evidence', as you call it, that the funds losses were anything more than the second and third reasons I gave a few posting above.  You can conjecture all you want.

"what percentage could you take if your goal was simply to preserve your initial investment over the 27 year history?"

From 1979 through 2000, taking a real, inflation adjusted 6.7% (of initial starting value) from an all VWEHX portfolio resulted in a portfolio value, in 2000, equal to what you started with, in 1979.  Alternately, if you took 90% of the yield generated, you also ended up with the same portfolio value.  That difference (between 70% and 90%) was what made those numbers real, not nominal.

Look, you, as well as a few others on this forum, seem to think everything is tied up in fund NAV.  You point to portfolio value, you call this 'asset base', but you forget that portfolio value is the number of shares times the fund NAV.  A 1.2% drop in NAV is exactly compensated by a 1.2% rise in the number of shares owned.

El Lobo.....From 1979 through 2000, taking a real, inflation adjusted 6.7% (of initial starting value) from an all VWEHX portfolio resulted in a portfolio value, in 2000, equal to what you started with, in 1979.  Alternately, if you took 90% of the yield generated, you also ended up with the same portfolio value.  That difference (between 70% and 90%) was what made those numbers real, not nominal.

How would you determine in 1979 that a 6.7% (of initial starting value), inflation adjusted (hmmm sounds like a total return withdrawal strategy to me) to be a safe withdrawal strategy going forward?

helmut 

My thoughts on NAV erosion for VWEHX:

"1) Bond funds loose capital and yield whenever individual bonds that it holds default.

2) Bond funds loose capital whenever they sell, or redeem, a bond at a price lower than at purchase.  They gain capital whenever they sell, or redeem, at a higher price.  Your reference talked about this.

3) Bond fund NAVs rise and fall in response to decreases, or increases, in interest rates."

I believe that the NAV erosion is mainly caused from #2 rather than ! or three for this fund.  I think #1 is a bigger factor in lower quality junk bond funds.

My reasoning is mainly logic and process of elimination.  There have not been sufficient defaults for #1 to be a huge factor.

As to #3, I'm not convinced that HIY bonds, especially HIY "lite" would be more interest rate sensitive than investment grade intermediate bonds of similar duration.  That being said, the NAV history of most of Vanguard's bond funds seem to show little NAV erosion from rate changes, with some slightly below their $10 starting price and some slightly above.

This brings me to #2.   A higher quality junk bond fund MAY actually have more credit sensitivity because unlike its junkier counter parts, it MAT BE more likely that the credit rating of the bonds will lowered prior to maturity, the "no where to go but down principle".  This lowering of credit rating lowers the price of the bond from its original purchase price and unless the bond is held to maturity, this NAV loss becomes permanent upon sale.  On the other hand, it seems less likely that the credit rating of these bonds will be improved during their holding because they are already higher quality and it is a big jump from high quality junk to investment grade.  In the event the credit rating does improve, the price would increase, thereby often triggering a call provision where the manager gets back the par price only.

HIY bonds are far more illiquid than investment grade bonds.  When people begin to head for the exits, sellers have to accept a lower price because there are so few buyers.  This lowers the price (NAV) of the issues the manager is holding and has nothing to do with either credit or interest rates.  It is unique to junk.

While defaults don't occur often in this fund, it is impossible to know how often sales of issues are made due to "fear of default".  If company troubles lead the investment community to believe an issue MAY default, the price will decline.  If it DOES default, it will decline much further.  It is not unreasonable then for a manager to sell and take a small loss rather than roll the dice about a much larger loss.  But in doing so, he is indeed taking a permanent loss that erodes NAV. 

 Anticipation of either default or a lower credit rating MAY be significant factors in long term NAV erosion.

No evidence, just an opinion :)

best,

Bill

Bill,

How was the vacation?

"especially HIY "lite" would be more interest rate sensitive than investment grade intermediate bonds of similar duration."

Bond funds of similar average duration have the same sensitivity.  That's what duration means.  However, that sensitivity is to the underlying rate of interest.  That is, HIY funds are sensitive to changes in HIY rates, while investment grade funds are sensitive to investment grade interest rate changes.

Now, that average duration, from a mathamatical standpoint, is the first derivitive of the yield curve, and the HIY curve is above the investment grade curve.  That is, for any given maturity, HIY pays a higher rate than investment grade, because they are riskier.  Therefore, at any given maturity, the duration of the bond is higher, for HIY, than for investment grade.

So, if a HIY fund has the same duration as an investment grade fund, then the average maturity of the HIY fund will be lower than the other.

Anyhow, this probably makes little sense to you, however, I wrote this more for Mathguy, who knows derivitives!

"Anticipation of either default or a lower credit rating MAY be significant factors in long term NAV erosion."

I agree.  That's why one would have to analyze all of the VWEHX holdings over it's 29 year history, to determine if this was a significant factor, or not.  That is, if it caused the 1.2% loss, or 0.1% loss!

However, to assume, as some do on this forum, that a long term drop in NAV for a high yield bond fund is somehow a 'characteristic' of HIY debt is a bit of a stretch, IMHO.

You CAN get some idea on the size of this factor by examining capital gain distributions for the fund.  It has made a few in the past, but hasn't done so since I've owned it.  Anyhow, if the fund realizes a gain on any bonds that it buys, then sells, it's required to pay the gain out to shareholders.  If it realizes a loss, it, obviously, can't distribute a loss.

However, it can 'bank' those losses to offset gains in later years.  I am not an accountant, and I certainly don't know how funds do their taxes, but I would think the VWEHX annual report might contain any losses that it has accumulated/banked.  It would be interesting to see how much, on a per share basis, is in the bank.

I don't particularly care what that number is, but I assume the fund manager knows full well, and manages the portfolio in a tax efficient manner.

By the way, if the 1.2% loss was explained by this change in credit quality, than any gains, like that over the last 5 years, would also be explained!

Again my point is that one needn't know what caused the erosion, just be aware of things that you can do, to guard against further erosion.  That is, what you can do to minimize this particular risk.  The primary, safest, thing is to make up for it with some of the yield.

El,

I had a great time in NC mountains.  Fall colors a little off this year due to hot weather and drought (they say), but still a lot cooler than the 90 degrees we continue to have in SW Florida.

 I agree with your points above.  We can't know with the data available, which is why I was careful not to make any declarative statements.

As you know, I also own HIY fund, but I do so for that " different assets with the same expected return that are not perfectly correlated" thing.  I'm in the Rick Ferri camp that says bond holdings should be diversified just like equity holdings, as opposed to the Swedroe camp that eschews hybrid holdings and prefers to take his equity risks on the equity side and keep his bonds short.

I also like the extra income, and will look for opportunities to purchase more when the yields get up near 8% or above.

The bottom line for me is that the fund has a 9+% total return over almost 30 years and to me the best predictor of future bond fund returns is past bond fund returns.  If I can get 9% over the next 30 years, I won't complain.

By the way, have you given any though to my question above:

Take the 5% fund and let the NAV rise or take the 7% fund and reinvest 2% back and get more shares at a lower NAV?

best,

Bill

bilperk:

There are a lot of things we don't know about these funds at this point.  On of the big things to me is if they will be three different AAs with three different payouts or if they will have the same AA in all three funds.

 Lets assume that they have the same AA for a minute. 

If you want a 5% distribution where your principal grows with inflation, would you choose the 5% fund and let the NAV rise with inflation or would you choose the 7%, and reinvest 2% to increase shares resulting in the same portfolio value but a lower NAV?

Wouldn't your payouts likely increase with the latter over time, visa vie the 5% fund?

best,

Bill

Bill...good to hear from you again. El Lobo has been ask this question in several different forms, several different times, but continues to ignore it.

One answer would make no sense unless you can predict the future using past performance, and the other answer would be an admission that there is no difference in risk between a total return type of distribution and a dividend distribution of an investment that requires a partial dividend re-investment. 

Neither answer  would square with his high yield hypothesis.

helmut  

"Take the 5% fund and let the NAV rise or take the 7% fund and reinvest 2% back and get more shares at a lower NAV?"

I would ALWAYS take the one with the higher yield.  If the specific investments held by the two funds were the same, as was the AA, then the TR would be the same.  My gut feel is that either method (in your question) would lead to exactly the same result, withdrawal wise and portfolio value wise.

"You have no 'evidence', as you call it, that the funds losses were anything more than the second and third reasons I gave a few posting above.  You can conjecture all you want."

Gee, where have I heard that before? Oh yeah, El Lobo said it after I posted the details of two special one-time dividend capture investments that accounted for something like 15% of that year's ADVDX income distributions (except he said "BS" instead of "conjecture".)

I'm not a high yield disciple and won't go to the lengths that those who are do to defend their beliefs. I'm not against high yield investing either -- I just want to understand it -- and if it doesn't hold up, it doesn't hold up. My conjecture is consistent with all the data that I've presented. As you may recall from the ADVDX threads, I lose interest in these arguments after all my outstanding questions have been answered. So, I'm going to go read the article I linked to earlier to see what bearing it has on the new managed payout fund.

One last thing -- helmut wondered if my "conjecture" about VWEHX had any implications on the equity side. I have begun to look at the Ken French 1927-2006 portfolio data by dividend yield deciles that I brought to JWR's attention last spring. I'll start a new thread on this if I find anything interesting -- even if it supports El Lobo's theories!

"You have history, and history says only 2 bonds defaulted.  You have a theory that the rise, and fall, of the creditworthiness of the rest somehow magically led to the 1.2% loss.  I say you have no idea why the fund lost that amount, because funds experience losses due to all kinds of activities, that helmut's reference outlined."

That's why I pointed out that the six investment grade bond funds had not suffered any loss of initial investment made at inception (while withdrawing 100% of the income distributions) -- these funds experienced all the activities outlined in helmut's reference and didn't lose principal. It is only the two funds where creditworthiness is an issue (VWEHX and PRHYX) that had pronounced losses of the initial investment while withdrawing 100% of income.

Are you suggesting that VWEHX systematically purchased high coupon bonds at a premium, and the amortization of this premium drove down the NAV? That's even worse in my opinion. It's a dishonest attempt to fool people who focus solely on current yield.

Sometimes you need to look at the facts and apply a little deductive reasoning.

ElLobo:

"Take the 5% fund and let the NAV rise or take the 7% fund and reinvest 2% back and get more shares at a lower NAV?"

I would ALWAYS take the one with the higher yield.  If the specific investments held by the two funds were the same, as was the AA, then the TR would be the same.  My gut feel is that either method (in your question) would lead to exactly the same result, withdrawal wise and portfolio value wise.

I understand you would always take the higher yield, but we aren't talking about yield here we are talking about distribution of a small amount of yield and capital gains, and perhaps even some principal.

So I'm asking if you see any advantage ( perhaps mathematically) in taking more of the capital gains as they are generated and reinvesting them at a lower NAV, as opposed to keeping more of the CGs in the fund.

It would seem to me the 7% fund will have to "realize" more CGs and  that would amount to 2% more shares if reinvested. Even though the shares are at a lower NAV, the yield of the underlying equities will not change, so by owning more shares wouldn't you be generating a larger and larger portion of the future distribution from yield?

And if yes, wouldn't a decline in equities of 10% for both funds result in a higher value for the 7% portfolio due to a higher positive yield as opposed to a negative capital gain for the 5% fund?

If not, then isn't this whole "seed corn" thing just an illusion?

best,

Bill

Bill,

It's really hard to theorize whether one fund, and a particular withdrawal strategy for that fund, will be better than, or worse than, another fund and strategy, existing or otherwise.  That was why I qualified my answer to say that BOTH funds (5% and 7%) used exactly the same invidicual assets, in exactly the same proportions.  Even under this assumption, it's difficult to just think about these effects.

For example, in your followup, you talked about the importance of realized, and unrealized, capital gains, and I recognize that we both tend to think of capital gains as another source of income from a fund, similar to yield.  But, as I understand both of the Vanguard funds, the way they are going to operate (calculate their distributions) is quite a bit different then I do it.

Remember, I simply gather all yield distributions in a money market, take my withdrawal from it, then reinvest what's left.  As I understand it, Vanguard will, figuratively, reinvest all yield and realized gains back into individual fund assets, then, once a month, take 5%, or 7%, of the average of the last 3 fund NAVs, divide by 12 months in a year, and reduce the current fund NAV by the result, and make their distribution to each shareholder.

Some shareholders will automatically reinvest all of their distribution back into the fund, some won't.  Those that do will see absolutely no drop in the VALUE they hold in the fund.  This is the 1% drop in NAV (for a capital gain distribution) resulting in 1% more shares being owned philosophy.

Now, if both funds had the same asset mix in the same proportion, then it seems reasonable that reinvesting all of the distribution for both funds would lead to exactly the same result (portfolio value wise) over time.  True, the 5% fund would have a higher fund NAV than the 7% fund, but you would own more shares of the 7%.

If that's true, then taking out 5% from both funds (your original question) would also be a wash.

Now, in addition to not knowing the asset mix of each fund (BIG uncertainty), there is another unknown.  Whenever VWEHX makes a monthly interest distribution, the fund NAV doesn't drop by that amount, like it does whenever it, or any other fund, makes a CG distribution.  What that means is that the fund 'accrues' interest it receives during the month, then first divides the monthly total interest received into daily amounts, in order to correctly apportion that interest to those who buy and sell shares during the month.

More importantly to your question, the fund NAV doesn't drop by that amount.  So, if Vanguard uses this method of accounting in both of their new funds, not only would the asset mix and proportion of each be the same for both funds (my first assumption), the NAV behavior over time would also be the same!  And if THAT were true, you would be better ahead to take 5% from the 7% fund and reinvest the difference, to take advantage of the compounding effect.

Anyhow, these were the thoughts running through my head.  That is, without knowing anything about the mix of assets each fund will use (other than generalities), and without knowing anything more about how Vanguard will calculate those distributions, I couldn't really say one way or another whether one fund and strategy would be different than another.

If I were the fund manager, I would manage the fund to keep the yield of each above the rate of distribution.  That would allow both funds to avoid touching principle, a goal of each.

"That was why I qualified my answer to say that BOTH funds (5% and 7%) used exactly the same invidicual assets, in exactly the same proportions"

I called yesterday and each of those three fund allocations will be 'different'.

Marshall

Now, in addition to not knowing the asset mix of each fund (BIG uncertainty), there is another unknown.  Whenever VWEHX makes a monthly interest distribution, the fund NAV doesn't drop by that amount, like it does whenever it, or any other fund, makes a CG distribution.  What that means is that the fund 'accrues' interest it receives during the month, then first divides the monthly total interest received into daily amounts, in order to correctly apportion that interest to those who buy and sell shares during the month.

Your description of daily dividend declarations is pretty close, but if VWEHX works the same way most bond funds do, they declare and credit the dividends daily. The declared dividend is subtracted from the NAV on a daily basis and put into an interest bearing account until the monthly dividend is distributed (some funds that declare dividends daily like CAIBX distribute quarterly) so you would need a microscope to measure the actual daily reduction in the NAV.

helmut 

helmut,

"The declared dividend is subtracted from the NAV on a daily basis . . . ."

I may be mistaken, but I don't think this part is true.  The NAV is the sum total value of all bonds held by the fund.  Whenever a bond makes a coupon payment, the value of the bond doesn't change.

I do know that, if you buy or sell shares during the month, at the end of the month (for purchases) and on the day you sell, you receive your part of the total interest earned during that month.

I also don't know if the fund keeps track of the day, during the month, whenever interest is received.  For example, if all of the bonds paid their interest on the 25th day of the month, but you sold your shares on the 20th, would you receive any of that interest?

My guess is that they divide the total interest earned during the month by the number of days, so they smooth it out.

El Lobo...

Straight from the VWEHX prospectus

"Fund Distributions

The Fund distributes to shareholders virtually all of its net income (interest lessexpenses) as well as any net capital gains realized from the sale of its holdings. The Fund's income dividends accrue daily and are distributed on the first business day of every month; capital gains distributions generally occur annually in December. In addition, the Fund may occasionally be required to make supplemental distributions at some other time during the year. You can receive distributions of income or capital gains in cash, or you can have them automatically reinvested in more shares of the Fund."

helmut 

"The Fund's income dividends accrue daily and are distributed on the first business day of every month."

I understand.  I don't think 'accrueral' means subtraction from the NAV.  That was my only quibble, with your trivia! 8-)

I have never sold shares of this fund since I've owned it.  I have only purchased shares, and at different times during the month.  I remember receiving only part of the interest distribution, and a quick check, with Vanguard, said that was due to holding those shares for a part of the month, not the whole month.

ElLobo...

We had the same argument on the AF forum concerning CAIBX because someone said that the dividend paid by CAIBX was not reflected by a drop in the NAV and assumed that the dividend was never part of the NAV. IT took five men and a fifth of whiskey to find someone high enough on the food chain to give us the right answer.

The way mutual funds are constructed collected dividends are part of the NAV until they are declared.When they are declared they are subtracted from the NAV. Whether you use the word declared or accrued I would be willing to bet a dollar to a donut (not as meaningful a bet as it once was) that the accrued daily dividend is subtracted from the NAV daily.

By the way I called Vanguard again to ask them about the default rate of VWEHX. This time I got someone that no idea what I was talking about and after some hesitation was told that VWEHX had never had a default.

helmut