Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
Advice on Bond Index Funds
Old 03-22-2012, 07:05 PM   #1
Dryer sheet wannabe
 
Join Date: Mar 2011
Posts: 12
Advice on Bond Index Funds

I retired in 2005 and am currently living on savings. I am 58 years old and will begin drawing on my retirement IRA with Vanguard at age 59 1/2. My concern is about my lack of understanding on how the Total Bond Index funds actually work. The concern being that if we get into a rising rate environment it seems that the bond fund would shrivel up similar to the way things went in the early 80's. Is this a valid concern or am I missing something and if that is the case what should I do? My AA is about 50/50 in index funds and I have enough cash on hand to coast approx. five years.

Thanks for your thoughts on this.

PG
__________________

__________________
poorgeezer is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Old 03-22-2012, 07:29 PM   #2
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jun 2005
Posts: 8,615
How much did total bond index funds shrivel up in the early 80s? Do you actually know?

See also: Wiki article link: Bond Basics
__________________

__________________
LOL! is offline   Reply With Quote
Old 03-22-2012, 08:22 PM   #3
Full time employment: Posting here.
 
Join Date: Mar 2012
Location: seattle
Posts: 643
Here's a chart you can set per year and see actual price changes[treasuries] back to 1977.

Treasury Bonds Year Historical Prices Charts - Historical Commodity Futures Charts'

Find similar for libor or your favorite interest rate and compare.
__________________
bld999 is offline   Reply With Quote
Old 03-22-2012, 08:26 PM   #4
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jun 2005
Posts: 8,615
That chart does not show total bond index funds, so it really does not apply here.
__________________
LOL! is offline   Reply With Quote
Old 03-22-2012, 08:47 PM   #5
Dryer sheet aficionado
 
Join Date: Mar 2012
Location: Flagstaff
Posts: 30
Bond basis moves inverse to the interest rate. If you are concerned with loss of basis perhaps individual bonds held to maturity using bond ladders might be a better? I may be blurring the IRA/Taxable account line...
__________________
If the above message contains any tax related matters, then the following applies:
IRS CIRCULAR 230 DISCLOSURE: Tax advice contained in this communication (including any attachments) is neither intended nor written to be used, and cannot be used, to avoid penalties under the Internal Revenue Code or to promote, market or recommend to anyone a transaction or matter addressed in this communication.
pfleming is offline   Reply With Quote
Old 03-22-2012, 09:01 PM   #6
Full time employment: Posting here.
 
Join Date: Mar 2012
Location: seattle
Posts: 643
Did total bond index funds exist in 1980?
__________________
bld999 is offline   Reply With Quote
Old 03-22-2012, 09:08 PM   #7
Thinks s/he gets paid by the post
walkinwood's Avatar
 
Join Date: Jul 2006
Location: Denver
Posts: 2,675
If you are worried about interest rate risk, choose a short or intermediate term bond index fund. However, if rates go up, price of bonds go down - you can't get away from that.
__________________
walkinwood is offline   Reply With Quote
Old 03-22-2012, 09:08 PM   #8
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jun 2005
Posts: 8,615
@bld99, If they did, then they had a different duration than 30-year Treasury bonds. Several Vanguard funds were around in the early 1980s. The Vanguard GNMA fund (VFIIX) was around and might be a decent proxy for other bond funds of that time. Hint: It did not shrivel up. See also VWESX.

1986 is when Total Bond Index was started.
__________________
LOL! is offline   Reply With Quote
Old 03-22-2012, 09:56 PM   #9
Full time employment: Posting here.
 
Join Date: Mar 2012
Location: seattle
Posts: 643
Quote:
Originally Posted by LOL! View Post
@bld99, If they did, then they had a different duration than 30-year Treasury bonds. Several Vanguard funds were around in the early 1980s. The Vanguard GNMA fund (VFIIX) was around and might be a decent proxy for other bond funds of that time. Hint: It did not shrivel up. See also VWESX.

1986 is when Total Bond Index was started.
I see; I looked around and read someplace that average duration for total bond funds ~3.7 years, 30year treasuries ~ 16, so my chart is bunk as you say. I was looking for a proxy, maybe VFIIX works well enough.


Also: poorgeezer, there is a discussion of bonds going on right now at:
Any good ideas for Bond funds?
__________________
bld999 is offline   Reply With Quote
Old 03-22-2012, 10:03 PM   #10
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
Gone4Good's Avatar
 
Join Date: Sep 2005
Posts: 5,381
Here is a rough estimate of what a bond fund with a duration and average maturity similar to the Total Bond Market Index would have returned:
Attached Images
File Type: png Capture.PNG (31.0 KB, 27 views)
__________________
Retired early, traveling perpetually.
Gone4Good is offline   Reply With Quote
Old 03-23-2012, 04:35 AM   #11
Dryer sheet wannabe
 
Join Date: Mar 2011
Posts: 12
Quote:
Originally Posted by Gone4Good View Post
Here is a rough estimate of what a bond fund with a duration and average maturity similar to the Total Bond Market Index would have returned:
This is helpful, for me, to see the yield/price fluctuations side by side.

If this is in fact the case then I am somewhat relieved.

Thanks, PG
__________________
poorgeezer is offline   Reply With Quote
Old 03-23-2012, 05:32 AM   #12
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
clifp's Avatar
 
Join Date: Oct 2006
Posts: 7,450
Quote:
Originally Posted by poorgeezer View Post
This is helpful, for me, to see the yield/price fluctuations side by side.

If this is in fact the case then I am somewhat relieved.

Thanks, PG
Remember these are nominal returns pre tax. You really want to look at real after tax returns. Top Marginal tax rates back in the late 70s and early 80s (Pre Reagan Tax cut) were 70% and 50% was pretty common. If we assume a 50% marginal tax rate.

The real returns for the total bond market fund holder.

YearPortfolio YieldAfter TaxPrice ChangeInflationReal Return
19787.23%3.61%-5.38%7.62%-9.4%
19797.64%3.82%-5.55%11.22%-12.95%
19808.3%4.15%-10.04%13.58%-19.47%
19819.2%4.6%-13.88%10.35%-19.63%
This means that the end of 1981 the purchasing power $10,000 investment with interest reinvested would be worth ~$5,160 every bit as painful as the 2008/9 crisis for equity investors.

Needless to say trying to withdraw 3% or 4% adjusted for inflation from bond heavy portfolio would make a 30 year retirement virtually impossible.

During this time 1978 to 1981 10 year T-bill went from 8% to 15%. I am not sure if the impact of rise of T-bill from 2% to 9% would be more or less devastating (although taxes hopefully would be lower) . My guess is more.
__________________
clifp is offline   Reply With Quote
Old 03-23-2012, 07:43 AM   #13
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
Gone4Good's Avatar
 
Join Date: Sep 2005
Posts: 5,381
Quote:
Originally Posted by clifp View Post
During this time 1978 to 1981 10 year T-bill went from 8% to 15%. I am not sure if the impact of rise of T-bill from 2% to 9% would be more or less devastating (although taxes hopefully would be lower) . My guess is more.
The biggest difference today is that the starting portfolio is only earning 2%, versus 7% in 1970. That extra 500bp of yield is an extra 500bp of cushion to help absorb the volatility in principal. To get a sense of how a similar change in interest rates would impact today's Total Bond Index fund, subtract 500bp from each year of the total return column.

Also, lower coupon bonds have higher duration - so today's TBMF is more sensitive to interest rates than the same fund would have been in the 80's. For example, a 10yr bond yielding 8% has a duration of 7 whereas a 2% bond has a duration of 9. Although the calculation above assume a constant duration similar to the one of today's fund.
__________________
Retired early, traveling perpetually.
Gone4Good is offline   Reply With Quote
Old 03-23-2012, 09:30 AM   #14
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
audreyh1's Avatar
 
Join Date: Jan 2006
Location: Rio Grande Valley
Posts: 16,454
Quote:
Originally Posted by clifp View Post
Remember these are nominal returns pre tax. You really want to look at real after tax returns. Top Marginal tax rates back in the late 70s and early 80s (Pre Reagan Tax cut) were 70% and 50% was pretty common. If we assume a 50% marginal tax rate.
If someone's portfolio is in a tax-deferred account, then the tax hit is not going to be there until money is withdrawn. I don't know if such accounts beyond pensions and annuities were available back then, but the point is moot since things have changed so much.

Great info though - thanks!

Audrey
__________________
Well, I thought I was retired. But it seems that now I'm working as a travel agent instead!
audreyh1 is online now   Reply With Quote
Old 03-23-2012, 04:11 PM   #15
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
pb4uski's Avatar
 
Join Date: Nov 2010
Location: Vermont & Sarasota, FL
Posts: 16,403
When you say your AA is about 50/50 I presume that you mean 50 fixed and 50 equity?

You are right that when interest rates increase then the fair value of the bond fund will decline, but the nominal income the bond fund generates will take a long time to change dramatically as proceeds from maturing bonds will be reinvested in new bonds that have higher yields. The fund's historical trading range has been $9-11/share and it is currently towards the upper end of that range.

My thinking is that if interest rates increase it will likely be because the economy is doing better, so any loss in value of my Total Bond holdings are likely to be offset by increases in value of my equity holdings. That's the whole reason behind holding both fixed income and equities. As we saw in 2008, it doesn't always work that way.

I think it is important to look at the whole portfolio rather than just the fixed side.

YMMV
__________________
pb4uski is online now   Reply With Quote
Old 03-26-2012, 09:05 AM   #16
Thinks s/he gets paid by the post
nun's Avatar
 
Join Date: Feb 2006
Posts: 4,835
Rising interest rates will probably indicate an improving economy, unless the US is about to default. If interest rates go up bond prices will fall, but yields will go up and your equity assets will probably be doing well (ingoring the default possibility). You are spreading your risk by owning the Total Bond Index so think of it in just the same way you think of a Total Stock Market Index. If you are doing this passive style it's all about AA and rebalancing, so don't try to guess what interest rates are going to do. You'll be tempted to do exactly that every time the Fed makes a statement, but unless you want to look at yield curves, slice and dice your fixed income and time the market just stay 50/50 with a bond index and maybe some cash and short term bonds to ride out down turns. Take income from winners and rebalance.......you won't maximize your returns, but you'll be well placed to do OK in most scenarios.
__________________
“So we beat on, boats against the current, borne back ceaselessly into the past.”

Current AA: 65% Equity Funds / 20% Bonds / 7% Stable Value /3% Cash / 5% TIAA Traditional
Retired Mar 2014 at age 52, target WR: 0.0%,
Income from pension and rent
nun is offline   Reply With Quote
Old 03-26-2012, 01:39 PM   #17
Dryer sheet wannabe
 
Join Date: Apr 2011
Location: Macedon
Posts: 24
I suggest short term corporate instead of total bond market. Lower yields but less risk if rates increase.
__________________
Bdroc is offline   Reply With Quote
Old 03-26-2012, 02:20 PM   #18
Thinks s/he gets paid by the post
nun's Avatar
 
Join Date: Feb 2006
Posts: 4,835
The OP is in index funds and has 5 years in cash. I'd first decide on an AA and general philosophy. If they are a passive investor I'd dollar cost average over a few years into Total Bond Index and maybe a more "sectorly" and or duration biased index as a nod to your active inclinations and to massage your ego that you can read the indicators. Once the AA is achieved take out gains and rebalance.
__________________

__________________
“So we beat on, boats against the current, borne back ceaselessly into the past.”

Current AA: 65% Equity Funds / 20% Bonds / 7% Stable Value /3% Cash / 5% TIAA Traditional
Retired Mar 2014 at age 52, target WR: 0.0%,
Income from pension and rent
nun is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
Advice you'd give your 25 year old self EvrClrx311 FIRE and Money 110 06-06-2012 10:54 AM
Any good ideas for Bond funds? Birchwood FIRE and Money 8 03-22-2012 05:43 PM
Wanted Opinions on RE Strategy why1942 FIRE and Money 29 03-22-2012 04:32 PM
Thoughts on unemployment and age MichaelB FIRE and Money 94 03-22-2012 02:20 PM

 

 
All times are GMT -6. The time now is 03:20 PM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.