Bond funds: continuing to get hosed

[Gone4Good]

But you want your NAV to be going down.  It means that the bonds that are being bought in the fund now will be getting higher interest rates.

This article shows how rising rates will give you a better return in the long run.

When interest rates fall, rising bond prices boost short-term returns, but the lower interest rates translate into lower returns on future investments, as your reinvested income compounds at lower yields. When interest rates rise, the short-term pain of falling prices can eventually be salved by higher returns on reinvested income.

This is one of the most under appreciated aspects of investing.  In every other aspect of life people get upset when prices go up.  But in investing, people only get excited when they have to pay more for a stream of future cash flows (or earnings) and conversely get dejected when that same series of cash flows becomes less expensive.  

Personally, I couldn't be happier with the higher interest rates.  As a net lender I'm tired of giving away money at negative real returns.  I only wish the long bond rate would go up some more and that the real yield on TIPS would go back above 3% - then we'd be talking!  

 

[Gone4Good]

Minor quibble: the break-even inflation rate isn't the same as the embedded inflation prediction if you believe that nominal bonds also include an "inflation guess" risk premium in the yield.

In any case, I think the market is wrong, so TIPS look better to me.   And even if the market is right, the upside for nominal bonds is dismal unless we suddenly hit a protracted stretch of deflation, in which case you'll look like a genius. 

I'm not sure I understand the distinction between the break-even inflation rate between TIPS and treasuries and the inflation rate imbedded in treasuries - if there is only one "real rate" shouldn't they be the same?

I think Bill Gross is of the view that rates are coming back down so regular treasuries would be the way to go if he's right. I have no idea, so I own both.

 

[Mr._johngalt]

This is one of the most under appreciated aspects of investing.  In every other aspect of life people get upset when prices go up.  But in investing, people only get excited when they have to pay more for a stream of future cash flows (or earnings) and conversely get dejected when that same series of cash flows becomes less expensive.  

Personally, I couldn't be happier with the higher interest rates.  As a net lender I'm tired of giving away money at negative real returns.  I only wish the long bond rate would go up some more and that the real yield on TIPS would go back above 3% - then we'd be talking!  

Excellent post!

JG

 

[wabmester]

I'm not sure I understand the distinction between the break-even inflation rate between TIPS and treasuries and the inflation rate imbedded in treasuries - if there is only one "real rate" shouldn't they be the same?

BIR = Nominal - TIPS(real), but Nominal = real + inflation prediction + risk premium, so BIR = inflation prediction + risk premium.

 

[Gone4Good]

BIR = Nominal - TIPS(real), but Nominal = real + inflation prediction + risk premium, so BIR = inflation prediction + risk premium.

Makes sense that regular treasuries should include a risk premium above TIPS to compensate for the uncertainty of future inflation. Meaning that the 10-year inflation expectation as expressed by the bond market is less than 2.6% - which seems a little light to me (which I think was also your point).

 

[cute fuzzy bunny]

TH, I think you're Gross...

Its plausible. Bet you've never seen us both together in the same place at the same time.

All the talking heads and newsbits i've seen are pointing to bernankes one potential achilles heel; that he's perceived as an inflation dove. Further predictions are that he'll have to do a few rate hikes to dispell that. I've been waiting for this credit card economy to hit a wall and higher rates will sure as shootin' do that.

I'm enjoying the potential for higher rates myself. With no debt and plenty of cash still sticking to my fingers, I'd like an improved return. But I think i'll wait for the other five shoes to drop in the bond market before buying in and reaping the benefits of those higher yields without the loss of capital.

 

[Gone4Good]

But I think i'll wait for the other five shoes to drop in the bond market before buying in and reaping the benefits of those higher yields without the loss of capital.

Rates could be heading higher but the economy could also be heading for an '06 cliff dug by the Fed and high energy prices. I have no idea. But the 6.5% taxable equivalent yield I can get on intermediate term muni bonds is looking pretty tasty right about now.