Do Bonds still make sense?

[Focus]

I have a stable value fund ready and waiting in case rates actually start to move higher. But I have no intention of making that move in anticipation of a rate increase that nobody really knows when or if it will occur.

I hear ya. For a while there, I kept my fixed income portion split between the stable value fund in my Vanguard 401(k) and the total bond fund. But when it became clear the consensus regarding an interest rate rise was wrong and the stable value fund (which has a higher expense ratio) dropped below a 2% return, I went back to 100% in the total bond fund.

 

[Cobra9777]

I hear ya. For a while there, I kept my fixed income portion split between the stable value fund in my Vanguard 401(k) and the total bond fund. But when it became clear the consensus regarding an interest rate rise was wrong and the stable value fund (which has a higher expense ratio) dropped below a 2% return, I went back to 100% in the total bond fund.

My stable value fund yields 1.8% with an ER of 0.83%, so I'll continue avoiding it until I need a refuge. Right now, there are too many cross-currents affecting interest rates to warrant making a bet on rising rates (or getting overly defensive). Just looking at the US, there's a decent case for rising rates, especially with the labor market continuing to improve and increased likelihood of a Fed rate hike later this year. But I think the weakness in Europe, Russia and elsewhere, the strengthening dollar, insatiable global demand for treasuries, lack of inflation, slumping commodity prices, deflation fears, etc, could just as easily keep rates in a sideways mode for an extended period. So for now, I'll stick with my diversified mix of bond index ETFs and wait to see how and when this all plays out. That same inaction served me well in 2014.

 

[bad_LNIP]

I own both REITs and Bond Funds, but REITs are not a substitute for Bonds.

I'm curious why you think REITs aren't a substitute for bonds or regular income.

Everyone is talking about the great performance of bonds, which is to be expected as rataes fall to multi-decade lows, but I wonder what you guys are going to do when the blood bath starts and bond prices get slammed as rates rise...and people realize they are getting paid peanuts to hold that kind of risk.

 

[mathjak107]

reits do not have a tendency to rise in a recession , they offer no protection in a depression and generally what is bad for stocks is bad for reits.

reits are stocks.

 

[Letj]

@Wolf - check out Trowe Price Mutual fund for Virginia bonds - PRVAX.


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[audreyh1]

I own both REITs and Bond Funds, but REITs are not a substitute for Bonds.

I'm curious why you think REITs aren't a substitute for bonds or regular income.

Everyone is talking about the great performance of bonds, which is to be expected as rataes fall to multi-decade lows, but I wonder what you guys are going to do when the blood bath starts and bond prices get slammed as rates rise...and people realize they are getting paid peanuts to hold that kind of risk.

Wake us up when that actually happens.

On a more serious note,

If we don't endure a few years of deflation first, long-term rate rises are likely to be very, very gradual taking years if not decades. It took 40 years to go from the lows of 1940 to the highs of 1980. Intermediate bond funds will do OK in that scenario. No one here expects them to be super stars even though they certainly were at times during the 2000s. The portfolio diversification role bonds play is still valid even during periods of gradually rising rates.

 

[ArkTinkerer]

I use TGLMX...TCW Total Return Bond Fund
1yr..4.85%
3 yr..6.20%
5 yr..6.82%
10 yr..7.01%

Look at the return after tax from Morningstar and it looks like slightly above inflation...

TCW Total Return Bond I (TGLMX) Fund Tax Analysis

Someone here mentioned comparing to CPI. How it is calculated has changed several times in my lifetime. My family has leased property tied to the CPI based on how it was calculated in the 1970's. The newer numbers downplay food and energy. These items are what I expect the biggest factors to be for me in retirement. Not sure how it treats medical care. Food was pretty flat from the 90's until maybe 2005? Since then its gone up but the new calculations reduce the input of food into the CPI number.

 

[audreyh1]

Look at the return after tax from Morningstar and it looks like slightly above inflation...

TCW Total Return Bond I (TGLMX) Fund Tax Analysis

Someone here mentioned comparing to CPI. How it is calculated has changed several times in my lifetime. My family has leased property tied to the CPI based on how it was calculated in the 1970's. The newer numbers downplay food and energy. These items are what I expect the biggest factors to be for me in retirement. Not sure how it treats medical care. Food was pretty flat from the 90's until maybe 2005? Since then its gone up but the new calculations reduce the input of food into the CPI number.

Why are you looking at tax adjusted return? What if someone kept their bond funds in their IRA, as many do for tax efficiency reasons, - then it doesn't matter.

Regardless average annual inflation rates have averaged about 2.6% for the 2000s, and under 2% this decade so far. Average Annual Inflation Rate by Decade

So I don't see how you can beef about a 5+% real return for the past 15 years, or even a ~3% "after tax" real return on TGLMX. That is NOT "slightly above inflation".

The 10-year Treasury on average only will only give a provide a small real return. Only very occasionally do returns exceed 5%. Some periods you'll average around 2%, and occasionally the real return is negative. 2% is the expected long-term return going forward based on the current yield. Inflation right now is running under 1% and who knows it might keep dropping.

You need to look at why people own various asset classes as part of a diversified portfolio, not the real or after-tax returns of each component. It's important to understand how they work together as a whole and why people choose to own them.

 

[ArkTinkerer]

I will admit, I really should look at bonds in a tax sheltered account. Its only reasonable since the majority of my funds are in such accounts. Just a dumb oversight on my part.

Still, the more I read the less I think bonds are reasonable. Again, maybe I'm only getting what I look for. But as an example, why would someone buy corporate bonds that are negative return. I mean, buying Gov bonds that are negative seems backwards to me but a corporate bond is even worse. A safe deposit box is cheaper than paying negative rates on a large sum of cash.

Very weird: Corporate bond rates go negative - Feb. 5, 2015

 

[mathjak107]

why negative rates ? two reasons :

capital appreciation selling it to someone who thinks rates will go more negative .

countries can't go to bank and buy a 10 billion dollar cd. countries need a place to keep their money with a healthy currency and stable gov't..

where is greece going to keep their money ? taking a slightly negative rate in german bonds is a whole lot better than greek bonds or greek banks.

 

[pb4uski]

My 0.9% online bank account is growing on me after reading this.

This was the part that I don't get:

"You've got over $1 trillion of euros that will be created. All of that new money needs to find a home," said Thomas Urano, a managing director at fixed-income manager Sage Advisory. "I could park it in the bank and lose money for certain or I could put it into a corporate bond and maybe only lose one basis point."

Why would parking it in the bank be a loss for certain? Or is he referring to on a real basis? If the latter, I don't see where the corporate bond is much better unless interest rates decline further which would mean get more negative. Doesn't make sense to me.

 

[ArkTinkerer]

why negative rates ? two reasons :

capital appreciation selling it to someone who thinks rates will go more negative .

countries can't go to bank and buy a 10 billion dollar cd. countries need a place to keep their money with a healthy currency and stable gov't..

where is greece going to keep their money ? taking a slightly negative rate in german bonds is a whole lot better than greek bonds or greek banks.

OK, so educate me please. Assumptions--Governments (or their reserve banks) can print currency at will. Other than funds actually in paper currency, those funds are just numbers on a balance sheet. Greece doesn't have to have them listed as being in their own bonds, they can consider it "cash" without it being in currency that can be stolen. Why move the funds to an account knowing another country will reduce the amount? Its worth paying someone else to keep those numbers on their balance sheet? I didn't think computer hackers were THAT good! Something is obviously missing in my understanding.

For most individuals, a safe deposit box is cheaper once you hit about $1K. That would secure you against even most of the financial confiscations that took place last year as in Portugal. "Capital appreciation" would be higher under this path than purchasing a negative return bond.

 

[OrcasIslandBound]

Bonds are by far the trickier slice of our investments. The cycle of stocks is usually less than 10 years, so a 20 year history is sufficient to understand their ups and downs. Bonds, on the other hand, have a cycle that started in the late 40's going up then started back down around 1982. This is a 65'ish year cycle. This means that looking at 1, 5, or 10 year returns is a very incomplete picture. Do we expect another 65 year cycle just because interest rates happen to be bottoming right now?

I personally don't think a long cycle of steady increases in interest rates is likely as the fundamentals of our whole market seems to be trending in a poorer direction than this. Hence, we are hedging our stock investments through a portion of long term treasuries in the form of Vanguard long term bond index, BLV. 43% stocks and 57% bonds.

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[friar1610]

Reading the title of the original post made me think of the Time cover article many years ago:
The End of Stocks? (or some such thing).

Investments come into favor and go out of favor.

 

[dallas27]

I dont see bonds as having a cycle, what i see is rates asymptotically approaching zero as a result of a fractional banking system reaching its final equilibrium after decades of slow change.

What comes after zero is the BIG question. Do we hover here forever? I hope so, because now both up and down are a problem.


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[audreyh1]

Seems like when they get really low, they stay there a looong while before very gradually moving up.

from 222 Years Of Long-Term Interest Rates | The Big Picture

 

[Loving Life]

With declining commodity prices, very low core inflation, a government that has 18 T. debt - the government will not raise rates - With Germany 10 year at .34 and Japan at .41 the US at 2.14
The US 10 year has a lot to fall - looking for the 10 year to fall below 1 percent by the end of the year.

 

[Mulligan]

With declining commodity prices, very low core inflation, a government that has 18 T. debt - the government will not raise rates - With Germany 10 year at .34 and Japan at .41 the US at 2.14
The US 10 year has a lot to fall - looking for the 10 year to fall below 1 percent by the end of the year.

I certainly don't know the future, but I agree with you. I have been hesitant to invest fully in this market, but going the route of buying preferred's has helped me. The spread between them and corporates/treasuries has been on the high side. I can live with price fluctuations grabbing 6.5%-7% yield on my money. In fact I hope they drop as it will give me a reason to cash my IBonds and plow it all in on them. Most of the ones I have bought have been around for a long time, and except for the 2008 terror, they have historically stayed pretty tight to par.


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[mathjak107]

bonds have been taking it on the chin the last few weeks. the long treasury bond has lost 8% in not even 3 weeks. corporate bond funds 2% which means most are now running at a zero interest rate as the 2% loss in nav offsets the interest unless rates fall back.

 

[audreyh1]

bonds have been taking it on the chin the last few weeks. the long treasury bond has lost 8% in not even 3 weeks. corporate bond funds 2% which means most are now running at a zero interest rate as the 2% loss in nav offsets the interest unless rates fall back.

Yet not quite back to where we started the year. Just gave back most of Jan's dramatic gains, not counting the dividends paid YTD. <yawn>