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Are You Paying Way Too Much in Bond Fund Fees?

Interest rates are at all-time lows, but you wouldn't know it by looking at mutual funds. Investment-grade corporate bonds with 10-year maturities yield in the 2% range. Yes, many bond mutual funds charge 1%. Evidentially, bond investors have not figured this out. Some folks must think it's 1983 and Ronald Reagan is still president with the fees they're paying (rates were really high back then).


We'll start by looking at individual bonds. Today, I had to bite the bullet and buy a bond issued by Jim Beam, whose parent company is Suntory (STBFY), that matures in nine years and yields a little over 3.5%. I say "bite the bullet" because I hate going out that far in maturity. If interest rates rise, that 3.5% won't be so attractive and the bond will have to drop in value for the yield to be 4% or whatever rates are. However, rates probably aren't going to rise for a while and even if they do, we need to get paid while we wait.

We bought a handful of other bonds today. They are all BBB-rated, which is the bottom rung of investment-grade. We look for bonds that mature between one and six years. For higher-graded bonds, the yields are about 1% to 2% for that maturity.

You can find some other bonds, but they usually have some type of problem. General Electric (NYSE:GE) has several series of bonds, but the problem is the company may get broken up and your bonds may be part of another company. That other company could be a private equity fund or privately held company with tons of debt. You don't know. Other bonds are in risky industries like oil drilling. Oil drillers are under pressure with new drilling techniques that make it easier to find energy. Still, other bonds are part of financial companies that are difficult to evaluate.

When we search for bonds that yield 3% to 5% with maturities of one to six years, names like Continental Energy (CPPXF), Quest Communications and EQM Midstream Partners (EQM) come up. Either they have way too much debt or are in risky industries that are difficult to understand and predict. It doesn't matter if you have $10,000 to invest or $10 billion. All investors are looking at the same bonds.

Let's look at American Funds Corporate Bond Fund. The average maturity is 9.2 years and the 30-day Securities and Exchange Commission yield is 1.68%. Roughtly 90% of the portfolio is in investment-grade bonds. The fees of the fund are 0.9%. Yikes! If the fees were 0%, your fund would earn about 2.58%.

Now let's look at the Pimco Total Return Fund. The SEC yield is 2.58% and the fees are 0.71%. Yikes! You'd be earning 3.29% if the fees were zero.

I get emails from mutual fund wholesalers who have bond funds that still charge 1.5%. I kid you not. Where are the customers' yachts?

There are some good mutual funds and exchange-traded funds out there. The Vanguard Intermediate Term Bond Fund yields 2.75% and the fee is only 0.07%. Now we're talking.

What's sad is that huge amount of risk the baby boomers take. Fidelity came up with a study and found that half of baby boomers invested in 401(k)s had way too much risk. Fidelity recommended 54% in stocks and the rest in bonds.

So it's like this. Anyone over the age of 55 should have bonds. Either you have individual bonds or you own a fund. If you own a fund, it needs to be a super low fee fund.

I remember 2008-09. I would meet with someone who had just lost half their money or more. I would recommend they leave their financial advisor because they were in investments that were far too risky for their age, risk tolerance or wealth. The people would get angry and tell me they were going to hang on. Actually, that worked because the markets did rebound. Unfortunately, markets don't always quickly rebound. Some of these folks may be 100 years old before their investments get made whole.

Disclosure: We own none of the securities mentioned.

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This article first appeared on GuruFocus.