The idea behind these lists is to show the major stocks in an industry, some examples of low-cost funds and ETFs, and the relevant indexes. These are not investment recommendations.

Subsidies to municipal bonds so issuers can offer them at a lower rate…good for the issuer, bad for the bond holder. The worst part is they are taxable bonds. The BABs can generate an unpleasant surprise if you are holding a municipal bond fund as they will generate a tax liability.

The description of the bonds are:

The Economic Recovery and Reinvestment Act (the “Act”) created a new form of bonds known as Build America Bonds (“BABs”).  Build America Bonds are taxable and, through Federal subsidies or tax credits, are intended to reduce municipal borrowing costs.

There are two kinds of bonds:

1. The first type of BABs provide a Federal subsidy to investors equal to 35% of the interest payable by the issuer (“Tax Credit BABs”).
2. The second type of BABs provide a direct Federal subsidy that will be paid to state and local governments in an amount equal to 35% of the interest (“Direct Payment BABs”).

Both types of BABs must be issued before January 1, 2011.

Potential investors of BABs include investors in low income tax brackets, individual retirement accounts, public pension funds and foreign investors.

Part of the American Recovery and Reinvestment Act, Build America Bonds offer a 35% rebate from the Federal government to issuers on their interest payments. This means that issuers can offer higher rates on their debt than they typically would be able to afford, and so take their offerings into the taxable bond market.

Guess where the 35% subsidy comes from? The taxpayers.

What is it costing the taxpayers?

Congress’s Joint Tax Committee estimated in February that the Treasury would spend $9.8 billion through 2019 subsidizing the bonds. Matt Fabian, a managing director at Municipal Market Advisors in Westport, Connecticut, said in a June 22 report that the program’s price tag may reach $27.3 billion by the time all such securities mature in 2044.

What does this mean to me?

If you can get a hold of a BAB it will pay a decent interest rate but note it is taxed as ordinary income.

Standard & Poors released its semiannual study on index funds vs. managed funds (SPIVA). It covers 1, 3, and 5 years.

The study found that on an asset-weighted basis — measuring returns by the invested dollar rather than percentage of funds — index returns beat actively-managed fund returns in all 13 fixed-income categories over one and three years, and in 11 of 13 categories over five years.

One surprise was mortgage-backed securities. The index won around 98% of the time for 1, 3, and 5 year periods.

Index funds generally have much lower costs than managed funds, often 1% or more.

For index bond funds, there is usually less than 0.1% difference in cost between the index bond fund and the index it tracks.

What does this mean for me?

For mortgage-backed securities, the answer is easy: the index fund won 98% of the time.

Since bond index funds have low expenses, they have a much better advantage than managed bond funds, especially long term.

Managed REIT funds have an advantage over corresponding index funds.

For the most part, equity index funds beat managed funds.

Resources

View the full S&P SPIVA study

Fixed rate = 0.10%
Semiannual inflation rate = -2.78%

which gives a composite rate of -5.46%. Since I-bonds are guaranteed not to give negative returns, the interest rate from May 1,2009 to Nov 1, 2009 is 0.0%. In other words, nothing is earned. This anomaly is due to the fact that deflation occurred as measured by the consumer price index (CPI).

Currently (May, 2009) Series EE bonds are issued at a fixed 0.70% interest rate. Pathetic.

But, the U.S. Treasury guarantees the Series EE bond will double in value in 20 years. Using the rule of 72, 72/20 = 3.6 which means in 20 years the investment will return 3.6% annually in order to double in value. The U.S. Treasury will make a one-time adjustment to insure that the return is doubled in 20 years.

DtI – Doug the investor

Individual Bonds

Individual bonds, when held to maturity, give you the principal, not necessarily the purchase price, back plus interest. Typically, a bond is initially sold for $1,000 which is the principal amount. Existing bonds can be purchased through brokers in the secondary market. The purchase price of these bonds can be higher or lower than the principal amount. If you priced an individual bond every day as to what it would sell for, most likely it will vary from its issue price, but you will get your principal back at maturity date (or call date, if that occurs) as long as the company does not go bankrupt.

Bond Funds

Bond funds do not have a maturity date. The portfolio is priced every day, after market close, to see how much it is worth if it sold all its holdings. Depending on the risk of the bonds bought, the price of the bond fund can vary quite a bit (measured by standard deviation). Short-term bond funds will vary much less than long-term bond funds.

To give you a feel for standard deviation, a short-term bond fund such as VFSTX (Vanguard short-term investment grade fund) has a SD about 3. FAGIX (Fidelity’s Capital & Income fund), a junk bond fund, has a SD around12.

Standard deviation and monthly prices can be found on finance.yahoo.com under risk and historical prices.

The riskier the bond fund the higher the standard deviation and the more the prices vary.