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Pastimes : The Justa and Lars Honors Bob Brinker Investment Club Thread
VTI 342.29-0.2%Jan 29 4:00 PM EST
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To: Boca_PETE who wrote (5697)10/17/2010 2:00:54 AM
From: marc ultra2 Recommendations  Read Replies (1) of 10065
 
<What are your thoughts about hedging a long position in VFIIX by owning a position in a fund like TBT?

Pete, assuming we're talking about the same person in both questions then no, I don't think TBT is a good idea. It's a volatile high expense ratio leveraged ETF that is more appropriate for speculation IMO than for hedging a conservative low cost AAA bond fund with a government guarantee.

If we had a shock to the system which we've had in the past like a financial crisis, successful terrorist attack, assassination or other horror you could dream up, something like TBT would lose a lot of money so it's not consistent with preservation of capital. VFIIX in a major shock would go up with it's government guaranteed safety. There's reason to be concerned if you find an ant in the house but buying a bazooka to protect your house is not the best use of money.

<For someone who is almost age 70 trying to preserve capital in uncertain times, do you have any better (from your viewpoint) suggestions on how to protect oneself from rising rates while continuing to own and get that premium interest income from VFIIX?

Before we talk about alternatives I think we need to quantify the risk so when you hear about bond fund risk from me or others you know what kind of exposure you have and don't panic and do something counter-productive.

VFIIX I believe now has an interest rate of about 3% and a duration they've gotten down to about 2.

So that means for every 1% rise in interest rates you could expect VFIIX's NAV to go down about 2%. So let's say interest rates rise 2%. So in that case VFIIX would lose about 4% of it's NAV but if we're talking about a one year time period you'd get 3% in interest for the year so your loss would be 1%. If interest rates continue to trend up the NAV will continue to trend down.

So there are good reasons in terms of interest rate risk for not liking a GNMA fund at this moment but you have to keep things in perspective. Now in terms of alternatives it again comes down to how risk averse you are at this point.

Things I use like floating rate note funds have more credit risk and are more expensive. Bob is often mentioning laddered CDs as an alternative lately. If we forget about the ladder a one year CD yields a little over 1% For someone who's mainly interested in preservation of capital that may not be that bad because you get some interest and then in a year interest rates may be more attractive for your money at that point. So it really does come down to what you're comfortable with in an environment when everything is working against someone wanting decent yield with a high degree of safety.

It also doesn't need to be all or nothing but you could use an alternative for part of the money.

I've mentioned alternatives like FFRHX in the floating rate note fund area and SDY in the equity area. When you use words though like "preserve capital in uncertain times" I'd forget about all the riskier options and consider something like hanging out in a CD for 6 months or a year or staying in the GNMA fund where you may start losing some of the big gains its had lately but you're not going to get clobbered.
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