by John Darer CLU ChFC CSSC RSP
If your financial adviser is recommending a bond fund over the "ultimate* in predictable income" of a structured settlement you better read this:
"Your bond fund may be riskier than you think.
For years, the fund industry and research firms have assessed the safety of bond funds by analyzing their holdings' underlying credit quality. Now, amid concerns that the measurement could understate the risk that the bonds will blow up, Morningstar has changed its methodology to count lower-rated bonds more heavily". The Wall Street Journal September 25, 2010 "How Safe is Your Bond Fund?"
Research from the Securities Litigation & Consulting Group Inc., a Fairfax, Va., consulting firm that provides expert witnesses to regulators, law firms, banks and brokerages publishe din November 2009, found that the mutual fund industry often reported average credit-quality ratings that were at least one whole letter credit-rating higher than the portfolios' true credit risk.
Under the new Morningstar system
13.85% of domestic taxable bond funds had average credit ratings of AA, or investment grade status (from 36.38%)
13.36% had average credit ratings of BB, or junk bond status
Notes
- Structured settlements are funded by annuities issued by legal reserve life insurance companies or using obligations of the United States government.
- Life insurance companies must certify an asset/liability match annually to each state their are admitted in.
- A bond fund is not a bond
- Since the net asset value of a bond fund may decrease over time it is possible, depending on the date you withdraw, that you may not get your principal back. How will the traditionally inverse relationship between interest rates and bonds affect the bond fund (and your capital) if yields increase in the coming years?
* a recent article in Investment News referred to immediate annuities as the "ultimate in predictable income"
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