How to avoid the #1 mistake made by bond fund investors

bond fund investingMany bond investors top priority is income, which leads them to place a heavy emphasis on a fund’s yield when making investment decisions.  To show you why that’s a mistake, and why you should focus on total return instead, lets take a look at an example.
  To see a list of high yielding CDs go here.  
For this example, I am going to use the 12 month trailing yield of two bond funds, the PIMCO Total Return Fund and the Great-West Bond Index L Fund.  The 12 month trailing yield is a backward looking number which represents the average yield the fund has paid out over the last 12 months.

12 Month Trailing Yield for PTTRX and MXBJX

Fund 12 Month Trailing Yield
PIMCO Total Return Fund (PTTRX) 3.71%
Great-West Bond Index L Fund (MXBJX) 6.13%

Had you invested $100,000 in the PIMCO Total Return Fund at the beginning of 2012, you would have received a check for around $264 per month on average, for a total of around $3710 for the year.  If you  had put that same $100,000 into the Great-West Bond Index L Fund, you would have received a check for around $510.83 per month on average, for a total of around $6130 for the year.

Many investors looking at these numbers would say without hesitation that the Great-West Fund would have been the clear best choice.  When looking at things from a total return standpoint however, things look a little different.

 

What is Total Return?

Total return is the total amount that the fund earned or lost, including all interest payments (its yield), capital appreciation or losses (gains or losses in the value of the bonds the fund holds) and any fees like loads or commissions.  For the purpose of this example we are going to assume that you did not pay a commission or load to buy either fund.

Total Return for for PTTRX and MXBJX

Fund 2012 Total Return
PIMCO Total Return Fund 10.16%
Great-West Bond Index L Fund 3.15%

When you take into account both the yield the funds earned and the capital gains and losses on the bonds they hold, the picture looks very different.  If you had invested $100,000 in the PIMCO Total Return Fund at the beginning of 2012, you would have earned a total of $10,160.  That same $100,000 invested in the Great West Bond Index L fund would have earned you a total of $3,150.  That’s a difference of $7010.

How can that be?

At the same time the Great-West fund was sending you a nice interest check every month, it was losing money on the value of the bonds held by the fund.  In this situation the interest payments generated by those bonds was enough to partially offset the losses the fund took on the value of the bonds it held.

The situation for the PIMCO Total Return Fund was the exact opposite.  While the interest checks you would have received from this fund were not as big, it was also making money from the increase in the value of the bonds the fund held.

 

What’s the Bottom Line?

Often times the biggest mistake that bond fund investors make is focusing on yield instead of Total Return.  If you think about it, its easy to understand why.  Investors think that if they just take the interest check that comes from the fund, then they are not “dipping” into their principal (the original money they invested in the fund).  However if the fund loses the money you have invested in the fund, then it doesn’t matter that you have not dipped into your principal, it has been reduced all the same.

For more advice on how to generated a consistent stream of income in retirement go here.

Fore more on funds which can help you do that go here.
    Want to learn how to generate more income from your portfolio so you can live better?  Get our free guide to income investing here.

Print Friendly


                                   

Leave a Reply

Your email address will not be published. Required fields are marked *