Replies to post #28720 on A.I.M. Users Bulletin Board (AIMUSERS)

[Toofuzzy]

Hi Bud

>>>>>All...Please forgive my ignorance..I have never owned an income producing instrument. I have some limited understanding, but not much...I hope I don't sound too dumb to be answered. Thanks.

1. Take HYG for instance. I note that it has paid about $.60 per share over it's lifetime..and holds so-called junk bonds. I am also interested in similar junk or investment grade bond etfs's..the latter pay a bit less, of course.

My questions:

A. If I hold HGY and the price goes down, my net worth goes down...but doesn't the dividend stay about the same? If not, what happens? If the price goes up in say two or more years from now, my net worth will be more..but doesn't the dividend stay about the same??

B. I think the risk of holding the etf is the composite risk of one or more of the companies going bankrupt. That would mean they would no longer pay their portion of the dividend. Would that only mean that the total dividend paid monthly by HYG would drop by a small amount..and NAV drop a bit..or would there be more serious consequences to the holders of HYG?

C. In your opinion, if the amount to be invested in these junk bonds was what you would call pretty large..how would you reccomend reducing the risk of failures? Would you split your pot into 4 segments, for instance, and buy equal amounts of four etfs?....say, HYG, LQD, ACG, and PHB? Or, what other method would you use?

D. What other income producing instruments would you use in place of the ones I have mentioned?

Sorry for the lengthy questions. All replies will be gratefully received. Thanks again.<<<<

Hi Bud

I am assuming you are thinking you are going to put everything you own in these assets.

1) They are called JUNK for a reason!

2) Do not chase yield

3) Different funds that buy all the same thing or the same asset class is not diversification. In fact I own 10 ETF in 10 completely industries and they are ALL down on average 50% in the last 6 months! Cash is the only asset class that is diversifying everything else.

4) You want to diversify by either STYLE (large, small, foreign, Real Estate, Bond, cash) or by industry (oil, consumer goods, technology, materials, health, etc, etc and cash)

Check out the ETF board here and also Tom's website to see what he did in his retirement account www.aim-users.com

I hope this sends you on a different track.
Toofuzzy

[OldAIMGuy]

Hi Husk, Re: your questions...............

A) If the bond fund is "unleveraged" (a rarity in the last half dozen years) the NAV will represent the average general value of the bonds they own. The yield will be a composite of the yields of the bonds. A lot of funds try to smooth out the dividend being paid so that investors see a steady stream. Then near year's end they will make a distribution that makes up for the difference between what they've paid and what they've taken in.

Leveraged bond funds have the peculiarity of having to service their own debt. If the leverage is used wisely, it can enhance yield. If, during tight credit times like now, the funds can't "borrow" they lose the ability to enhance earnings. This is being anticipated in many of the ETFs and closed end funds right now. Some may need to cut their current payouts temporarily because of this loss of a source of income. Some expect dividends to be cut 1/3 to 1/2. Less leveraged funds will show a smaller drop.

So, if bonds are depressed, the NAV drops and your "net worth" goes down, too. The distribution, if all the bonds continue to pay and don't default, stays the same. But one must understand that the only reason bonds go down in the first place is if investors "feel" there's a greater risk of default. An economy entering recession, for instance, will see corporate earnings drop. That may mean that some companies will be unable to continue paying their debt service and default. The likelihood of ALL companies doing this is rather small. So, the diversification does help.

In govt bonds it's a bit different. Usually default is less of a concern to bond valuation. It usually has more to do with competition for the dollars being invested. If one believes there's better chance of return in common stocks, then one might sell govt bonds to buy stocks. If this is the prevailing mentality (Herd Effect) then govt bonds can be depressed.

Real Estate income funds follow more closely with corporate bond funds in how they are priced and evaluated.

B) In general a highly diversified collection of income producing investments (either indivual bonds or bond funds) should spread the risk of default.

C) As I mentioned before, one effective way to diversify on the Income side is by source of income. 1) govt bond funds, 2) corporate bond/preferred funds, 3) REIT and real estate funds. Subcategories could be U.S. and International funds in these categories.

D) Head to http://www.etfconnect.com and click on their "Find a Fund" heading. There you can select by category the type of fund in which you're interested. There's lots of choices. You will get a long list of appropriate funds. You can then sort them by clicking on the various column headings. Further, you can select funds from the list for side-by-side comparison. Then you can cull out the ones that don't please you.

Best regards, Tom