Question: I currently use a money manager for half of my portfolio. I manage the balance.

I am 55, retired, have sufficient funds to live comfortably and have a 60/40 asset allocation. My managed account has a 1 percent management fee.

Here's my question. The managed account uses municipal bond mutual funds for the bond side of the account. In good years, the returns have run as high as 12 percent. But the average returns have been about 5 percent over five and 10 years. They currently yield about 4 percent.

I am considering pulling this money away from the manager and investing in a 10-year bond ladder in AAA insured individual bonds. The yield on the ladder would be about 4 percent. I would hold all bonds to maturity.

The fund manager said this was not a good deal for me as I would forgo the opportunity to make the 10 percent to 12 percent when interest rates fall.

The ladder would also lack the diversification of a fund. And I would lose the "tax loss harvesting," where they sell one bond fund at a loss and buy a similar fund.

I say, "Don't ever ask your barber if you need a haircut."

I think I should move into the individual bonds. What do you think?

B.B., Dallas

Answer: When it comes to logical thinking, you beat your money manager hands down. Indeed, his poor quantitative thinking scares me a bit.

Here's the hard data background for your decision

While there can be substantial gains (or losses) in the market value of bonds in any single year, a close look at the historical Ibbotson data shows that the bulk of the long-term return is from interest income, not changes in market value.

Worse, when you have to pay 1 percent a year for the privilege of betting that your manager will garner extra returns from capital gains or "tax loss harvesting," the odds are deeply against you.

If you think of it in terms of gambling, the vig is too high.

Paying 1 percent a year to manage tax-free bonds is like playing the slots rather than sitting at the blackjack table. You're an automatic loser.

You can understand this by examining the distribution of returns over 10 years for intermediate-term municipal bond funds.

The average annualized 10-year return for this group of funds was 4.57 percent at the end of June, according to the Morningstar database. A fund was in the top 25 percent with a return of 4.98 percent.

Even if your manager were capable of selecting funds in the top 25 percent, his annual 1 percent fee would reduce the return you received to only 3.98 percent.

That return would put your net performance in the 94th percentile, only 6 percentage points from the bottom.

Viewed another way, your manager is asking you to pay 1 percent a year for a 50 percent chance of picking a top 50 percent fund.

The average 10-year return of these top 50 percent funds is 5.01 percent, a gain of 44 basis points from the average.

In effect, you're paying $1 for a shot at winning 44 cents. Immediate annuity

Question: How does a retiree determine if an immediate annuity should be included in their retirement program, and how much of the retirement assets should be directed toward the purchase of the annuity?

I have read numerous articles on the merits of an immediate annuity but have never come across specific steps to consider using this financial instrument.

D.H., Dallas

Answer: You've seen little because it's a relatively new idea, first published in the December 2001 issue of the Journal of Financial Planning.

The research showed that if you convert 25 percent to 50 percent of your portfolio to a life income annuity, you would enjoy significantly improved odds that your remaining financial assets will support 30 years of withdrawals.

The survival rate for a typical growth portfolio (60 percent equities, 40 percent bonds and cash) rises to 96.7 percent from 87.4 percent, when half of the original portfolio is annuitized.

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Personal finance writer Scott Burns is syndicated by Universal Press. His twice weekly column appears in newspapers from Boston to Seattle. He is the Chief Investment Strategist for AssetBuilder, Inc. Readers can register at www.scottburns.com. Questions/comments can be posted directly. They can also be sent, without registration, to scott@scottburns.com. Questions of general interest will be answered in future columns and on this blog.

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