Bonds - Short Term or Longer

[mathjak107]

2.50% average return from an investment paying 5.58% is not a good return , maybe to you , not to most . your rate of return as of 2007 is 1/2 of what a new bond buyer is getting. that is the price you paid for hanging in there.


i own 60% bond funds at this point , but i am watching them carefully and slowly starting to shift some out as investors bid rates higher which they did the last month.

is it a bump in the road? don'tt know but it certainly bears watching .

 

[mathjak107]

Here's another example of what happened to total bond over a 4 year period where rates increased:

https://www.bogleheads.org/forum/viewtopic.php?f=1&t=151665#p2273379

the other issue with this chart is it is not accurate . we had an inverted yield curve in 2007 where shorter term rates were higher than long term rates . it was a rare fluke when bond investors disagree with poppa fed and bid interest rates the opposite the fed wants them to go .

the 5 year bond illustrated is part of the short term rate curve and not illustrative at all at what longer term bonds did .

they show rates going from 2.08 to 5,16% . that is a huge jump right?

but it is not reflecting the correct thing.

the 10 year treasury bond actually went from 4.03% in 2003 to 4.76% in 2007 ,hardly an increase at all. someone should notify who ever put that example up that they are illustrating what happend to short term rates which run out to 5 years as well as 5 year cd rates. these do not reflect actual longer term rates that are controlled by investors loike the the 10 year bond or longer.


that is why the 5 year bond shows a jump from 2.08 to 5.16 while an actual 10 year bond merely went from 4.03 in 2003 to 4.76% in 2007 . hardley a 3/4 point move .

 

[karluk]

2.50% average eturn from an investment paying 5.58% is not a good return , maybe to you , not to most . your rate of return as of 2007 is 1/2 of what a new bond buyer is getting. that is the price you paid for hanging in there.

This is sheer nonsense. A bond purchased in 2007 doesn't retroactively generate 5.58% interest going back to 2003. Your choices for fixed income investments from 2003-2007 were the choices available in 2003, 2004, 2005, and 2006 Among those choices were money market funds and a total bond market fund. The graph in the Bogleheads forum clearly shows that the total bond market fund beats the money market fund, unless you're clairvoyant enought to exercise perfect market timing in exactly the right time frame. Even then you're worse off over longer time frames.

So your concern over rising interest rates would most likely have caused you to make a poor investment choice in 2003. How about 2015? We'll see how holding short term cash compares with sticking with a total bond fund in the future. The bonds may not win every year, but if you compare over a period equalling the bond fund's average duration, it should easily be the winner.

 

[Mulligan]

Interesting debate and good viewpoints. I remember reading a similar debate in Bogleheads and the conclusion of graphs indicted over the long term, rising rates ultimately did improve total performance over lower current rates. Of course the amount, sequence, and some assumptions did factor in to these results which could make the conclusions disagreeable. Plus, remember these people were never selling or changing their allocation amounts. Mathjak appears to be considering looking to move money around for optimal capital performance which is a bit different than setting the allocation and riding it out.


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[mathjak107]

look at that chart posted , it does not reflect what happened to intermediate term bonds at all.

they picked a five year bond which is like a 5 year cd . it moved very different from the longer term intermediate term bonds we are discussing.

the 10 year moved less than .75% over the 4 years.

 

[mathjak107]

This is sheer nonsense. A bond purchased in 2007 doesn't retroactively generate 5.58% interest going back to 2003. Your choices for fixed income investments from 2003-2007 were the choices available in 2003, 2004, 2005, and 2006 Among those choices were money market funds and a total bond market fund. The graph in the Bogleheads forum clearly shows that the total bond market fund beats the money market fund, unless you're clairvoyant enought to exercise perfect market timing in exactly the right time frame. Even then you're worse off over longer time frames.

So your concern over rising interest rates would most likely have caused you to make a poor investment choice in 2003. How about 2015? We'll see how holding short term cash compares with sticking with a total bond fund in the future. The bonds may not win every year, but if you compare over a period equalling the bond fund's average duration, it should easily be the winner.

your data is flawed , since those were not the results of the intermediate term bonds of that time frame and were just reflective of short term moves by the fed. same as 5 year cd's.

whoever posted that as representative of what to expect from intermediate term bond funds like total bond fund or intermediate term bond funds better lay off the boglehead koolaid.


if you want to use that chart then you bought a 5 year bond in 2003 that payed 2.16% with 10k according to your chart.

in 2007 they had a bit over 11k giving an average return of about 2.50%. or just about the deal they signed on for.

on the other hand if you had a one year t-bill and flipped it each year you would have gone from 2% to 5% over the time frame.

you clearly would have made alot more had you been able to increase each year with the trend.

thinking that rising rates will help you in a bond fund is rediculious. you will never see any better than the deal you signed on for as the fund value will fall with each up tick in rates and even though you see a portion eventually it is never enough to get you out from behind the curve.

it is just math. if you stay the duration value of the fund it gives you back the origonal deal you signed on for ,in this case around 2.50% .

that is dispite the fact rates went from 2.16% to 5.58% and you got no where near that average no matter how you do the math.

 

[karluk]

your data is flawed , since those were not the results of the intermediate term bonds of that time frame and were just reflective of short term moves by the fed. same as 5 year cd's.

I am not sure what you are referring to, but I was talking about the chart that does a side by side comparison of VBMFX and VMMXX. Those are two real mutual funds that were both available in 2003. The chart shows that investors were better off sticking with a diversified bond fund with an intermediate length duration than panicking and moving into a money market fund from fear of higher interest rates.

https://www.bogleheads.org/forum/viewtopic.php?f=1&t=151665#p2273379

if you want to use that chart then you bought a 5 year bond in 2003 that payed 2.16% with 10k according to your chart.

in 2007 they had a bit over 11k giving an average return of about 2.50%. or just about the deal they signed on for.

What do you mean, "just about the deal they signed on for"? I say that they got a much better deal than they signed up for. The 34 BPs of extra return is the bonus investors got from being lucky enough to be invested in intermediate term bonds in a rising interest rate environment. If interest rates had stayed completely flat, the return would have been 2.16%, not 2.5%.

We may not be talking about the same chart, since you don't seem to think my example is comparing a money market fund to a total bond market fund, but even your example shows that rising yields are good for bond investors, not bad.

on the other hand if you had a one year t-bill and flipped it each year you would have gone from 2% to 5% over the time frame.

you clearly would have made alot more had you been able to increase each year with the trend.

No, you clearly would have made less, as the chart shows. VMMXX invested in just such short term securities and underperformed the total bond fund over this time period.

it is just math.

It is just math - math that favors the intermediate term bond fund. You are waving your hands and making claims that contradict the historical record. You are entitled to your opinion, but don't expect me to follow such flawed reasoning when the math clearly favors intermediate term bonds.

 

[mathjak107]

the problem is the chart is flawed. a move from 2.08% on the 5 year bond is very different from the scenario that vbmfx or barclays saw.

over the 4 year period vbmfx saw intermediate term rates only rise less than 1% going from 4.03 to 4.76% not the 3.08% jump up in rates the short end took as it went from 2.06 to 5.62% . that is hardley an example of a soaring bond rate time frame for the intermediate term bond .

basically your comparisaon is looking at what happened when rates on intermediate term bonds rose ,76% over that time frame. there was little to be effected by a move like that.

the money market produced 11,702 and total bond 11,523.

had there been a real 3.06% rate increase in the intermediate term range the difference between the money market would have been pretty great.

the point is vbmfx hardly fell because there was less that a 1% change in 10 year rates,.

the chart is not illustrating the fact that that soaring bond rates had little effect . all it is showing is that when short term rates rise they can have little to do with where bond investors bid the intermediate term and longer bonds.

that we already know. the fed raising the short end by more than 1% has produced only 1 year the last 44 years where bonds lost money.


had the intermediate term bond actually seen a jump from 2.06 to 5.62 with a duration of 5.6 totay vbmfx would have fallen more than 16% in value .

back then its duration was closer to 7 which would have been a 25% drop with a 3 point increase. some of that would be offset by a increase in interest over time but no where near enough to make you get much more than whatever the rate was the day you bought vbmfx..

the discussion is what happens to intermediate term and longer bonds when investors bid them higher and higher like the last 2 weeks.

 

[karluk]

over the 4 year period vbmfx saw intermediate term rates only rise less than 1% going from 4.03 to 4.76% not the 3.08% jump up in rates the short end took as it went from 2.06 to 5.62% . that is hardley an example of a soaring bond rate time frame for the intermediate term bond .

Uh, so what? If intermediate term rates had risen as much as short term rates, the net result would have been to INCREASE the advantage of holding the intermediate term bond fund compared to the money market fund, assuming of course that the holding period is at least equal to the bond fund's duration. The period from 2003-2007 saw a situation where investors in the money market fund could get sharply higher interest rates quickly without risking principal. In comparison, the intermediate term bond fund could get only modestly higher yields from interest rates that hardly budged. The net result is that the money market fund almost kept pace with the bond fund instead of losing to it decisively, as it would have done if short and intermediate term interest rates had risen by the same amount.

So we are discussing a period 2003-2007 where investors would have paid only a small penalty to sit in a money market fund instead of bonds. If you want to hypothesize a period where the money market investment would have gotten trounced, please feel free to be my guest. I don't care. I'll just stick with the investment that promises the better returns.

 

[mathjak107]

you are way out in left field. if the intermediate bond rate was 2.06 when you bought in as you are hypothetically saying and rose to 5.62% then if you stayed for the duration figure of the fund currently 5.06 years you would simply get around the 2.06% rate you origonally got the day you bought in as a total return 5 years later on average per year..

that is what the duration of a fund means. it means for every point rates go up if you stay the duration you will get whole again back to the number you had the day you bought in.

however any downgrades in credit throw that number out the window in a fund like total bond and you may never get back to that 2.06%.

if rates are going higher and higher over those 4 years i doubt many would just sit and get 2.06% when rates are 3,4 and eventually 5% elsewherel


you could but not many will. last year when nbonds took a hit did you see the billions that fled the bond funds ?

 

[karluk]

you are way out in left field. if the intermediate bond rate was 2.06 when you bought in as you are hypothetically saying and rose to 5.62% then if you stayed for the duration figure of the fund currently 5.06 years you would simply get around the 2.06% rate you origonally got the day you bought in.

that is what the duration of a fund means. it means for every point rates go up if you stay the duration you will get whole again back to the number you had the day you bought in.

however any downgrades in credit throw that number out the window in a fund like total bond and you may never get back to that 2.06%.

if rates are going higher and higher over those 4 years i doubt many would just sit and get 2.06% when rates are 3,4 and eventually 5% elsewherel


you could but not many will. last year when nbonds took a hit did you see the billions that fled the bond funds ?

I guess my basic reaction is that for someone whose handle is "mathjak" you do an awfully lot of hand waving and hardly any concrete mathematical analysis. The math favors the intermediate bond fund, so vague claims to the contrary don't carry a lot of weight.

As far as investors real life behavior, I can't speak for others, but I definitely can speak for myself. I was a big net buyer of bond funds in 2013, when interest rates were rising, and a big net seller in 2014 and January of this year, when interest rates were falling. This was all in the name of rebalancing, but I know I made a substantial profit on these transactions over and above a simple buy and hold strategy. To me this is a huge advantage of the intermediate term bond funds on top of their in-built advantage over cash. It's possible to realistically implement a "buy low, sell high" strategy that isn't available with cash and CD investments.

 

[mathjak107]

believe what you want but rember i did try to correct your logic which is wrong. watch what happens to total bond fund if bond rates take a 3% jump

i am done .

 

[audreyh1]

believe what you want but rember i did try to correct your logic which is wrong. watch what happens to total bond fund if bond rates take a 3% jump

i am done .

Exactly which rate do you think is going to jump 3%??

You can't lump all interest rates together. There is the Fed Funds rate, and then there are the rates for each duration of Treasury, then there are rates for various durations of different bond asset classes - muni, corporate, high yield etc.

IMO it's useless to paint them with a broad brush. The rates at different durations and among different bond asset classes operate quite differently.

 

[mathjak107]

When discussing bond funds the rate that matters is the rates that apply. Generally the 10 year treasury is the bench mark for intermediate term bonds.

What has a corrolation no better than a coin toss to intermediate bonds or long term bonds are the feds action on short term rates.

the chart posted above shows how a big 3.08% move over 4 years didn't effect intermediate bond funds like total bond much . but that chart fails to point out the 5 year bond was reflecting the feds short term moves which were huge.

the fact is the 10 year treasury went only from 4.06 to i think it was 4.76%. that is hardly an abnormal move in any year and over 4 years it is nothing to speak of and is quite tame so of course total bond reflects little change . see what happens if the 10 year increases over 4 years by 3.08% to a fund like total bond or corporate bond. you can look at the funds duration number and do your own math. .

all bonds are moved by rate changes and the catalyst is usually equivelant maturity treasury bonds. corporates ,muni's and high yield just add other parameters in such as credit rating. interest rates can stay the same but a rash of credit down grades will see corporate bonds fall.

we saw that in 2008-2009 when treasury bonds soared and corporates ranged from down 8-9% to up slightly.

 

[audreyh1]

When discussing bond funds the rate that matters is the rates that apply. Generally the 10 year treasury is the bench mark for intermediate term bonds.

What has a corrolation no better than a coin toss to intermediate term and longer are the feds action on short term rates.

The 5 year treasury would be the appropriate rate to track for intermediate bond funds. Intermediate bond funds are usually around 5 years in duration. 5 year interest rates and 10 year interest rates can behave differently, and often do.

 

[mathjak107]

The 5 year treasury would be the appropriate rate to track for intermediate bond funds. Intermediate bond funds are usually around 5 years in duration. 5 year interest rates and 10 year interest rates can behave differently, and often do.

Just because a bond fund has an "average duration" of 5 years does not mean all the bonds in the fund have a duration of 5 years - a portion of the fund could have much longer duration. Take for instance the Intermediate Bond Category index -- the category average is that these bonds have about 20% in the 20-30 year bond category.

maybe the rest are in the 10 year and 3 year.

it is the weighted average of all these bonds that alone move to different bond rates that produce a duration figure and the funds return..

if you had 30 year bonds , some 15 year and some 3 year depending on how much of each you have you could have a 5 year average but in no way would your mix track a 5 year bond.

some will move with the 30 some with the 15 and some with the 3 year note. a 5 year bonds movement may have very little correlation to your actual moves since they all move differently.

but if whatever rates changed enough to move your fund 3% in 4 years will have a big effect on your total returns.

don't forget once you get away from treasuries greed ,fear and perception play a part too in a bonds price.

 

[audreyh1]

Just because a bond fund has an "average duration" of 5 years does not mean all the bonds in the fund have a duration of 5 years - a portion of the fund could have much longer duration. Take for instance the Intermediate Bond Category index -- the category average is that these bonds have about 20% in the 20-30 year bond category.

maybe the rest are in the 10 year and 3 year.

it is the weighted average of all these bonds that alone move to different bond rates that produce a duration figure and the funds return..

if you had 30 year bonds , some 15 year and some 3 year depending on how much of each you have you could have a 5 year average but in no way would your mix track a 5 year bond.

some will move with the 30 some with the 15 and some with the 3 year note. a 5 year bonds movement may have very little correlation to your actuual moves since they all move differently.

And yet the 10 year Treasury is somehow magically the benchmark?

There is a reason that average duration is useful for modeling/predictive purposes.

Oh, never mind!

 

[mathjak107]

no the benchmark is not the 10 year . think of a bond fund that had equal weighting in 30 year and 1 year paper. hypothetically they may have a duration of 15 or so but they will track a 30 year bond and a 1 year note.. they would have zero to do with tracking a 15 year bond. the 15 year is far to long to track what a 1 year note is doing to even make sense and far to short to track a 30 year bond and what investors are asking for rates to go out that far.

now you should follow why i said the 5 year bond was the wrong benchmark to try to track an intermediate term bond fund with bonds ranging from maturing tuesday to 20 years out.. the weighting of the fund has nothing to do with the benchmarks that trade daily and set the course of each bonds rates.

duration is only the average weighting of the funds effect on the funds value when rates rise or fall by 1%.
duration numbers say hypothetically we can expect the funds value to fall 15% if overall the funds uinderlying bonds move 1%.

perhaps the 1 year moved zero but the 30 year moved 2%. so the funds weighting produced a 15% loss. that is how duration works.

now as far as the amount of years you have to stay that is a different issue. in this case eventually as those 1 year bonds roll over we will get new bonds paying 1% more but we have a crap load of 30 year bonds that are stuck at what they are. getting . the funds value has to drop 15% so anyone buying in now gets the higher rate even on the 30 year bonds which are actually earning the old lower interest rate before newer bonds paid 1% more .

after 15 years collecting that extra 1 % we got back the 15% the fund fell and we are whole again back to the interest rate deal we had the day we bought in.

from this point on you can pocket a little extra interest going forward but that assumes rates didn't move another point up in which case the process starts all over.

that is where the years fit in.

it is a bit trickier in real life since bond funds buy and sell bonds all day trying to capture small differences between years or types but like night follows day you can bet you will fall close to the funds duration number.

 

[karluk]

There are numerous inaccuracies and oversimplifications in Mathjak's explanation of duration. But this is a very complicated subject, so I'll content myself with providing a link that explains some of the basics:

Advanced Bond Concepts: Duration | Investopedia


From the point of view of the current thread, which was started to discuss whether short or intermediate term bonds were preferable, the paragraph on "immunization" is worth looking at. Quoting from the link

Immunization
As we mentioned in the above section, the interrelated factors of duration, coupon rate, term to maturity and price volatility are important for those investors employing duration-based immunization strategies. These strategies aim to match the durations of assets and liabilities within a portfolio for the purpose of minimizing the impact of interest rates on the net worth. To create these strategies, portfolio managers use Macaulay duration.

In my view, this concept of immunization explains quite clearly why so many investors go seriously awry with their bond allocations. They are spending too much time looking into their (rather cloudy) crystal balls trying to determine the future of interest rates, when they should actually be focusing on matching their bond mix with their future financial needs. Failing to do so will work extremely well if you're lucky enough to make good guesses about interest rates, but it can be a true disaster if you're wrong. Pick maturities that are too short and you risk reinvesting money that you won't need for 10-20 years at near zero interest rates. That must be a common regret among investors since 2007. Pick maturities that are too long and you're vulnerable to principal losses when you really need the money to be there. That could easily be a problem in the future.

So the real answer to OP's question is, "It depends." In an ideal world you would structure your fixed income investments to match your expected financial needs in order to protect yourself against interest rates not behaving the way you expect. Unfortunately, it's not always possible to know one's spending needs so many years in advance, which is probably why investors skew towards short term investments, such as setting up an emergency fund that is much bigger than they most likely will need.

 

[OrcasIslandBound]

Yes, bonds are actually a bit trickier to manage then stocks. Lots of good, heated discussion points by passionate people.

My own investment strategy actually uses more long term, 14 year duration, bonds for about a third of all the bonds that I have. One of the best diversifying assets for stocks is long term treasuries. This is from "The Bond Book" by Annette Thau. Will I take a hit in my portfolio because of this decision? Could happen. Did happen to someone in 2013 using the exact same tool I use, Vanguard long term bond index, BLV. Now, when I bought these bonds in September last year, the yield rate was about 4.5%. I'm aiming to retire in 2 years and that yield will hold up in payments for the duration of 14 years and at that time I will roughly get my full principal back as well.

But I don't intend to sell it then. In fact, if the interest rates do rise, I'll also likely have more gains in stocks and will simply buy even more BLV. I expect a much lower volatility with the overall 43% stocks and 57% bonds portfolio because of the long term treasuries component.

Sent from my Nexus 4 using Early Retirement Forum mobile app

 

[mathjak107]

oh it is accurate enough and simplified enough to understand why the info above was wrong.

we have never had an extended bear market in intermediate term bonds yet since 1980.

there is no comparison or data you can use to see what if 's. we had single years where they lost money but we have had zero extended bear markets in bonds in 35 years to compare against.

in fact in every year the fed raised short term rates 1% or more intermediate term bond funds ignored the short term rise and produced positive returns except 1 year 1994 . in that year investors in bonds agreed with the feds acrtion and bid longer term bond rates higher as well so many funds lost money and posted negative returns .

the barclay intermediate term index posted negative returns of 2% after figuring in all the interest .

the issues will come when bond investors want more compensation and bid these longer rates higher. if you think that is a good thing for your existing bond investment you are dreaming and need a math lesson..

 

[HF63]

I decided to keep the money in cash since the dollar keeps rising in value versus the Mexican peso. The dollar is up to almost 15 pesos and this has provided a nice return with no taxes!

 

[karluk]

oh it is accurate enough and simplified enough to understand why the info above was wrong.

No, it is inaccurate enough and oversimplified enought to lead you to erroneous conclusions. You have indulged in a lot of hand waving in this thread in order to come to faulty conclusions about how bonds behave, but I am a numbers guy and ran some typical rising interest rate scenarios yesterday to convince myself that bond fund investors do, indeed profit from rising interest rates. Over time the decline in NAV from the rate increase is fully compensated by reinvesting dividends at a higher yield. The payback period varies depending on the assumptions one makes about the size and frequency of the rate increases, but is highly dependent on duration, as can be expected from basic mathematical analysis.

So, if you want to make a positive contribution to this thread, you should seriously rethink your unwillingness to work through the math and present us with your prediction of how interest rates will change in the future along with some concrete calculations (using your prediction) to determine how long it will take for holders of intermediate bonds to be better off than holders of short term t-bills, or whatever your favorite cash equivalent is. If you think you can present a plausible scenario where cash is permanently better than intermediate term bonds, that's fine. We can critique your calculations and either agree with you or show you where your calculations are wrong.

What isn't productive is all of this hand waving that allows you to present unsupported assertions as fact, and substitute your opinion about how bonds should behave with how they actually do behave.

 

[mathjak107]

time will prove who is right and who is wrong!

fully compensated means you worked your way back over the duration period to the deal you had day one that you bought in. that is likely below what the current interest rate would have payed in shorter term instruments over the same time frame.

the greater the rise the more left behind current rates you will be.

eventually you will be whole again but that is only true if rates stop rising. with historial rates on bonds in the 6-7% range and us at 2% you can be behind the curve for a very long time if rates rise for a very long time.

in a corporate bond fund if credt ratings are cut the duration period can grow longer and longer as nav falls not only from rates rising but bond values falling from down grades like we saw in 2008-2009 and all bets are off as to when that compensated point will be hit.

remember too that funds can shorten durations when rates rise meaning when that 10 year bond matures they buy a 5 year instead . that means lower interest rates than 10 year bonds would get so you can't count to much on those duration numbers making you whole in a specified time period.

my opinion is once bond rates start to rise one would be foolish to sit static in conventional bonds and would do much better in other types of income funds more appropriate.

you wan't to ? be my guest . but it isn't something i would do . i would keep some money in coventional bonds but certainly not 40% of the bond budget the way i would have when rates were falling for 35 years,..

 

[pb4uski]

....i am done .

When is done, done?