Predictor for returns in bonds: accurate?

[tulak]

I see no upside to Vanguard Total Bond Market when PenFed is paying a guaranteed rate of 3% for 5 or 7 years and only charges a flat one year penalty for early withdrawal. TBM is only paying 2% right now, and for the rate to rise the NAV has to drop.

+1

I sold my TBM fund at Vanguard earlier this week and sent PenFed my application for an IRA. At this point, I hope they get the funds before they drop the rate.

I've been thinking about this for a while and decided to pull the trigger after reading the bond fund threads here and at bogleheads. I really didn't want the extra hassle, but that's a lame reason - at least for me.

The following analysis also helped me decide on the move: http://thefinancebuff.com/bond-fund-vs-cd-2014.html

 

[NameTaken2]

the size of likely intermediate term losses in reasonable 3-6 year bond funds is tiny relative to equity volatility. No place for the rent money, but for anything with a 3 or so year horizon it is low risk. There are also good political reasons to think that all developed country central banks and governments will move mountains to avoid steep rate increases in their bonds, bills, and notes.

Ha, thanks for your reply.
Understanding that a long-term perspective is best, I'm still interested in the short-term perspective on bonds many investors wiser than me seem to have. Many with SV funds are placing 50% of their bond allocation there to hedge against short-term downside risk in bonds. This got my attention and interest in the logic behind it.

An investment in VBMFX today will be OK long-term. The short-term strategy allocating 50% to a SV fund earning the same yield must be with the intent/hope that in a few years VBMFX may be at a 10-15% discount to today's price. The people doing this seem savvy, so this strategy is interesting and if I can earn a comparable yield holding back 50% of my bond allocation in the SV fund then a better LT return is possible if that 10-15% discount becomes available.

Unlike with this Q on bonds, I must accept equity volatility because I'm aware of no alternative investment.

NT2

 

[NameTaken2]

I see no upside to Vanguard Total Bond Market when PenFed is paying a guaranteed rate of 3% for 5 or 7 years and only charges a flat one year penalty for early withdrawal. TBM is only paying 2% right now, and for the rate to rise the NAV has to drop. So until it begins to pay at least 3% I would rather have my money in CDs. If rates rise, I can always cash in the CD and buy into the bond fund at a lower NAV and higher yield. It seems like a no brainer to me on this one. I've dumped all my TBM funds at this point.

Ready, thanks for your reply.
Would a risk in the 5yr CD at 3% be that rates rise above 3% within 3 years? The one year penalty could cost approx 1/3 of the interest earned?
Just wondering how the thinking goes with the 5 year CD's at 3%.
Thanks-
NT2

 

[Spanky]

I'm also at Vanguard, approx 2/3 tax-deferred. Not moving into CD's for the same reason, and because I've realized I'm fortunate to have the SV in my 401k to take advantage of.

NT2

I have tax-deferred (IRA, Roth IRA & 401K) and taxable accounts at Vanguard. For 401K, fixed-income are all in SV fund. For IRA/Roth IRA, all bond holdings are in short-term index fund. For taxable account, 1/2 of fixed income is limited-term tax-exempt fund and the rest to PenFed 5 yr CDs.

 

[golfnut]

I know Vanguard's tip fund (vipsx) had a bad 2013 return. Is this a good hedge going forward for the Total Bond fund ? I have both funds in my 401k.

 

[Ready]

Ready, thanks for your reply.
Would a risk in the 5yr CD at 3% be that rates rise above 3% within 3 years? The one year penalty could cost approx 1/3 of the interest earned?
Just wondering how the thinking goes with the 5 year CD's at 3%.
Thanks-
NT2

If you keep the funds in place for three years you would earn 9%. If you the pull out at the end of the third year, you lose one year interest, so you've earned 6% now over 3 years, or about 2% per year. Since the 3 year rate is only 2% anyway, you're at break-even if you terminate early at three years on a five year CD. So I see no upside to a 3 year CD at only 2%. If you think you may only keep the money in the CD for a year or two, then a shorter term CD might be more appropriate.

 

[Ready]

+1

I sold my TBM fund at Vanguard earlier this week and sent PenFed my application for an IRA. At this point, I hope they get the funds before they drop the rate.

I've been thinking about this for a while and decided to pull the trigger after reading the bond fund threads here and at bogleheads. I really didn't want the extra hassle, but that's a lame reason - at least for me.

The following analysis also helped me decide on the move: Bond Fund vs CD In the Next Five Years

Nice short article that summarizes why you can't win with these bond funds compared to a 3% CD. It's disappointing that the best thing we can do with the fixed income portion of our portfolio is lock in a 3% return, but it's the price we pay for enjoying several decades of declining interest rates to the point where there's just no room left for them to decline any further.

Thanks for posting that!

 

[galeno]

We use the SEC Yield and project forward for the bond fund's duration. We assume unchanging interest rates.

 

[Spanky]

I know Vanguard's tip fund (vipsx) had a bad 2013 return. Is this a good hedge going forward for the Total Bond fund ? I have both funds in my 401k.

In general, a TIPS fund can be used to hedge against inflation but is susceptible to changes in interest rates. VIPSX has a duration of about 6.4%. That means that a hypothetical 100-basis-point rise in interest rates would result in a 6.4% drop. If you are concerned with inflation, a short TIPS fund is also available at Vanguard.

 

[Spanky]

Ready, thanks for your reply.
Would a risk in the 5yr CD at 3% be that rates rise above 3% within 3 years? The one year penalty could cost approx 1/3 of the interest earned?
Just wondering how the thinking goes with the 5 year CD's at 3%.
Thanks-
NT2

If you pulled the 5 year CD at the end of

1 year = 0%
2 year = 1.51%
3 year = 2.02%
4 year = 2.27%
5 year = 3.04%

 

[Lsbcal]

+1

I sold my TBM fund at Vanguard earlier this week and sent PenFed my application for an IRA. At this point, I hope they get the funds before they drop the rate.

I've been thinking about this for a while and decided to pull the trigger after reading the bond fund threads here and at bogleheads. I really didn't want the extra hassle, but that's a lame reason - at least for me.

The following analysis also helped me decide on the move: Bond Fund vs CD In the Next Five Years

That is an interesting article. I wish he had followed that math through with a table to completely compare the options.

There may be some scenarios that are not covered in going the 5yr CD route. I'm not sure I can come up with a good one though. If real rates go up and I can now get 10yr TIPS at 2.2%, I might want my money available for the purchase. But the CD could be broken in that case I suppose.

My intermediate money is in DODIX and BOND (etf version of Total Return Fund PTTRX). Hoping they do better then the Total Bond Mkt as they have over many rolling 5 year periods in the past. See 5 year rolling returns graph from M* :

 

[NameTaken2]

If you pulled the 5 year CD at the end of

1 year = 0%
2 year = 1.51%
3 year = 2.02%
4 year = 2.27%
5 year = 3.04%

Thanks Spanky (and Ready also) for confirming 3 years is the approx break even point for early termination of the 5yr CD.

NT2

 

[Chuckanut]

I've been thinking about this for a while and decided to pull the trigger after reading the bond fund threads here and at bogleheads. I really didn't want the extra hassle, but that's a lame reason - at least for me.

The following analysis also helped me decide on the move: Bond Fund vs CD In the Next Five Years

I've been reading similar material also. It brings out the contrarian in me.

 

[pb4uski]

If I had a 2.1% SV fund available to me, I think i would put my entire fixed income allocation there (or between there and PenFEd 3% 5 year CDs up to the FDIC limit).

You would be getting a competitive income return, likely will keep up with inflation and minimal interest rate risk compared to bond funds.

 

[NameTaken2]

If I had a 2.1% SV fund available to me, I think i would put my entire fixed income allocation there (or between there and PenFEd 3% 5 year CDs up to the FDIC limit).

You would be getting a competitive income return, likely will keep up with inflation and minimal interest rate risk compared to bond funds.

pb4uski, thanks for your reply-
Your perspective is similar to a couple other posters, and makes sense.
Others have endorsed the 50:50 with the SV fund and I'm still leaning that way though your strategy could easily end up better.
Keeping SV at 50% is a result of reading some cautions that although SV is "safe" a full bond allocation into SV does have risk dependent on the insurance co's providing the guarantees. Maybe I read to much into that risk.

I'm prone to paralysis by analysis -trying to avoid that but may be going there!

NT2

 

[pb4uski]

....SV does have risk dependent on the insurance co's providing the guarantees. Maybe I read to much into that risk....

I think that you have read way to much into that risk (and others do as well).

While there is theoretically a risk that the wrapper will be unable to perform, IMO the risk is so low it can be ignored for all practical purposes. I have never heard of an insurer providing the wrap defaulting ever, so the risk is truly minimal and certainly much lower than the credit risk associated with the typical corporate bond fund.

 

[clifp]

lsbcal and brewer12345, thanks for your replies.

I understand the duration/rate rise calculation to project the change in bond price. Interested to know if there's any consensus regarding an estimate for how much rates will rise?


NT2

To be flip the consensus prediction is reflected in the bond market pricing.

Now my personal prediction is that the 10 year T bond rate will rise 3-4% over the next two to four year (i.e. pretty steep.) This last year we saw a ~1% rise in the 10 year from 2% to 3%. So my new prediction is 2-3% increase over the next one to three year. This would put the 10 year at slightly above the historical average, which I believe is justified due to the challenges of reversing 5+ years of unprecedented expansion of monetary supply.

I should quickly add that I've be confidently making this prediction since the end of 2009 and 2013 is the first year I've been close to being right. The other years I was dead wrong. But like a broken clock I should be right once a decade (I hope).

My fixed income is Pen Fed CD, and 3 small legacy bond positions, and decent chunk of now short-term corporate inflation protected bond and 75-80% equities.

I remain often wrong but seldom in doubt..

 

[NameTaken2]

my personal prediction is that the 10 year T bond rate will rise 3-4% over the next two to four year (i.e. pretty steep.)....

I should quickly add that I've be confidently making this prediction since the end of 2009 and 2013 is the first year I've been close to being right. The other years I was dead wrong. But like a broken clock I should be right once a decade (I hope).

I remain often wrong but seldom in doubt..

clifp, thanks for your reply-
I remain often in doubt!
At least the 50:50 allocation with SV should make me half-right however this plays out.

NT2

 

[Spanky]

My fixed income is Pen Fed CD, and 3 small legacy bond positions, and decent chunk of now short-term corporate inflation protected bond and 75-80% equities.

Is it short-term inflation protection bond? That's a big allocation to equity!