Expert: Doug Ingram - 9/22/2005

Question
Doug,

Thanks for your answer. Some points are not clear.

1. "Thus, you could invest $10,000 and get less than that if you take it out in a few months and rates have gone up."

I thought that when investing in government bonds it's not possible to loose money (in absolute value, I am not talking about inflation). Please explain why if rates go up (BTW, which rates?) I may loose money?

2. "but more for longer bonds and then even more for higher-yielding lesser-rated issues"

If we take MorningStar risk rating - Vanguard fund indexing long term gov bonds is evaluated as average, while Vanguard fund indexing interm term gov bonds as high - so it seems to be not according to the rule

Please clarify

Thanks in advance

Yuri


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Followup To
Question -
Dear Doug

Please help to understand why MorningStar rates Vanguard funds indexing Intermediate Government bonds as high risky...

I would think Gov bonds are reliable investments

Yours
Yuri
Answer -
You are correct.  Government bonds are as safe as any investment can be.
There is no risk to principal or timely payments of interest if you own them directly.

However, the longer the maturity, the more price sensitivity exists.  Thus, you could invest $10,000 and get less than that if you take it out in a few months and rates have gone up.
Also, they have to allow that some funds are mismanaged.
While I don't think that would be the case with Vanguard, they may just be covereing their tracks by recognizing that there is some inherent management and price risk.
(in almost any fund - but more for longer bonds and then even more for higher-yielding lesser-rated issues)

Answer
Sure.  Any investment other than money markets is subject to market movement.  If I hold my bond to maturity, there is no risk - I'll get my investment back!  However, if I buy bonds at 5%, and then rates go to 5.25% for that sector, my bond is worth less.  Why would anyone pay me 100 cents on the Dollar for my 5% bond when they could buy one for 5.25%.  Thus, you could put $10,000 in a fund and get only $9,788 (or whatever) back if you sell it after rates have risen.  If they fall, you'll get a profit, but you have to know the risk.
Which rates?  The rates on the intermediate part of the curve for that fund.  

2.  There's always the possibility that that fund might have underperformed recently - or even changed managers - I don't know.  I was giving you a few reasons.  It is the case that there is more price-risk sensitivity for longer-term investments.  Event he rules for that fund could be different.  You could even call vanguard and ask them!