Rising rates: "What - Me Worry?"

[Lsbcal]

Shown below is a famous American who said that.

I was looking at previous rising rate periods and have convinced myself that things will not be that bad with intermediate bond funds. As Alfred once said "life is no fun if you don't stick your neck out once in awhile".

Below shows how things went in some rising rate periods for (1) an intermediate Treasury fund, (2) Vanguard Total Bond Mkt VBTLX, (3) Pimco Total Return PTTRX, and (4) Dodge and Cox Income DODIX. All numbers are percentages.

For example, starting Nov 2010 there was a 1.0% rise in the 5 year Treasury (from 1.2% going up to 2.2%). Even though the durations were around 3 to 5 years for the funds, they didn't do as bad as the Treasury rise might imply (5 year duration x 1.0% might imply -5% return). Those active funds PTTRX and DODIX held up pretty well. The green shows the winner for the rising rate period (DODIX in the first line).

I know, "this is just history" one might say -- but that is all we have to go on.

Full disclosure: I own the active bond funds PTTRX and DODIX. Most of my equities are indexed.

 

[GrayHare]

"The last time interest rates were near current levels, in the 1950s, Treasury bonds lost 40% of their inflation-adjusted value over the following three decades."

http://www.fool.com/investing/gener...st-threat-to-your-portfolio-its-not-what.aspx

 

[LOL!]

Thanks for that. I feel better already.

Maybe post your table over at Bogleheads since lots of folks their are about to crap in their pants because their bond funds are not going up anymore.

 

[panacea]

I'm thinking this period may be a bit different with all the QE 1,2... And the fed keeping rates artificially low for so long. That could result in a faster increase in rates than what history shows. That said I have a fair amount of intermediate term bonds as well!

 

[audreyh1]

Hey - the 10 year treasury went from 1.5% 6 months ago to over 2% today. That's a 33% rise in interest rates. How are we doing? Looks like the intermediate bond funds have done just fine over that time period - slightly up.

Who knows what the future will bring. If rate rises are gradual, thing may not be so bad. If they are sudden and sharp, then there might be some real pain.

 

[W2R]

There are times when I am glad that I am not a trader. I just stick with my financial plan and rebalance as needed to maintain my asset allocation.

Last time I looked, worry was not a required action listed in my financial plan. I think I did all that when I was going through the "what if"s. I have SS yet to claim, just in case.

 

[Lsbcal]

Thanks for that. I feel better already.

Maybe post your table over at Bogleheads since lots of folks their are about to crap in their pants because their bond funds are not going up anymore.

I'm not that brave posting about active bond funds even with Vanguard Total Bond Fund in that mix.

 

[brewer12345]

Hmmm...

The problem with these comparisons to the past is that in most of the past cases rates were nowhere near the current extremely low rate environment. We are a bunch of standard deviations out on the curve. As a result, I choose to be more careful regardless of what the past sggests.

 

[Gatordoc50]

These rates aren't due to market forces but rather actions of the Fed. The Fed will raise rates eventually, maybe even in the next decade or two. Everyone is worried about bonds when the real risk from financial repression is to equities.

 

[Lsbcal]

Hmmm...

The problem with these comparisons to the past is that in most of the past cases rates were nowhere near the current extremely low rate environment. We are a bunch of standard deviations out on the curve. As a result, I choose to be more careful regardless of what the past sggests.

Yes, one should not place one's entire bet on the past repeating. I do have some intermediate bonds for the long haul. And so I'm just referring to an isolated slice of my own portfolio.

The current 5 year Treasury is at 0.9% so that first line in the table (starting low rate = 1.2%) is not too far off of the current rate. I'd expect that when rates go up they would perhaps (big perhaps) go up at a slower rate but go up more. Perhaps 2 or 3% over 3 years. Just a wild guess. It's interesting and comforting that funds that have a broader bond profile like the ones shown did better then the straight Treasury fund shown.

 

[walkinwood]

I'm thinking this period may be a bit different with all the QE 1,2... And the fed keeping rates artificially low for so long. That could result in a faster increase in rates than what history shows. ....

.... I'd expect that when rates go up they would perhaps (big perhaps) go up at a slower rate but go up more. Perhaps 2 or 3% over 3 years. Just a wild guess. .....

I'd like to understand what is behind your thinking / wild guess. What intermediate conclusions did you reach before getting to this?

I read the news & know a bit of the history, but can't figure out how to reach a conclusion.

 

[ERhoosier]

0.9% is 33% lower than lowest rate in the Table. In this market small absolute rate changes are much larger in relative terms.
Personally- I'd rather sit on the sidelines until rates drift back towards historical norms (whenever that might be ??)

 

[brewer12345]

I'd like to understand what is behind your thinking / wild guess. What intermediate conclusions did you reach before getting to this?

I read the news & know a bit of the history, but can't figure out how to reach a conclusion.

What you'd like to do is run the Barclays Agg index through a rate shock model and look at the impact of 100 to 600BP shocks over a 1 year period. I would be amazed if nobody has done this.

 

[Lsbcal]

I'd like to understand what is behind your thinking / wild guess. What intermediate conclusions did you reach before getting to this?

I read the news & know a bit of the history, but can't figure out how to reach a conclusion.

The real rate of return for 5 year bonds over about the last 80 years has been about 2.3%. If we add maybe 3% for inflation then maybe the nominal rate could climb to 5.3% when the dust settles. From 0.9% today that is a 3.4% rate change. Maybe it could occur at the rate of 1% rise per year with a very jagged rise over 3 years or so.

Of course, there are many variables so this is a wild guess. Don't bank on it.

 

[timeasterday]

I'm thinking this period may be a bit different with all the QE 1,2... And the fed keeping rates artificially low for so long. That could result in a faster increase in rates than what history shows. That said I have a fair amount of intermediate term bonds as well!

But do you think the Fed would really allow a fast rise in interest rates? They are pulling the strings right now and I doubt they would just cut them all at once and let things go. I think we'll have a very controlled rise in rates that could take years, maybe a decade or more (just my opinion).

 

[enjoyinglife102]

There are times when I am glad that I am not a trader. I just stick with my financial plan and rebalance as needed to maintain my asset allocation.

Last time I looked, worry was not a required action listed in my financial plan. I think I did all that when I was going through the "what if"s. I have SS yet to claim, just in case.

Three years ago rates "were rising" and bonds took off providing outstanding returns. How many missed that? Four or five years ago the "experts" said hold off buying five year cd's at 5-6% (for the few I have, I shed a tear now when each matures). No doubt rates are historically low at this moment but reassuring data provided by the OP and I too will stick to my financial plan which also excludes worry as a required action. It got me this far and I fully expect it to get me through the next 40 years of freedom to do what I want with my time.

 

[eytonxav]

These rates aren't due to market forces but rather actions of the Fed. The Fed will raise rates eventually, maybe even in the next decade or two. Everyone is worried about bonds when the real risk from financial repression is to equities.

+1 although bonds may react to a raising rate environment first, after some period of this going on, equities are not going to like the raising rate environment either.

 

[audreyh1]

There is going to be some pain. We don't know if it's going to be a mild pain, or a horrible pain, or even when the pain will start.....

It doesn't bother me [that much] that my bond funds might be underwater for 5 years. If it's harsh, my stock funds may get hit too for a while, making rebalancing not so easy. I have some cash, some short-term bond funds, a very diverse set of intermediate bond funds - so I'm kind of "laddered".

Part of my "what me worry?" attitude, is that most of my investments in these funds are from early 2000s, so I haven't been adding a lot to them recently except when equities outperform. Ride them up, ride them down.

And we still could go the Japan route (of extended low interest rates)...

Now, when it does happen, and if it is excruciatingly painfully, I might be singing another tune.

 

[REWahoo]

Now, when it does happen, and if it is excruciatingly painfully, I might be singing another tune.

No doubt we'll have enough singers to form one hell of a choir...

 

[haha]

And of course 85% of our complacency comes from one fact: nothing strikingly bad has happened for a while.
Ha

 

[audreyh1]

Just to go back to the last time interest rates were this low (we're actually lower now):

From The outlook for bonds: Are the good times about to end? | Vanguard Blog

 

[BTravlin]

There is going to be some pain. We don't know if it's going to be a mild pain, or a horrible pain, or even when the pain will start.....

It doesn't bother me [that much] that my bond funds might be underwater for 5 years. If it's harsh, my stock funds may get hit too for a while, making rebalancing not so easy. I have some cash, some short-term bond funds, a very diverse set of intermediate bond funds - so I'm kind of "laddered".

Part of my "what me worry?" attitude, is that most of my investments in these funds are from early 2000s, so I haven't been adding a lot to them recently except when equities outperform. Ride them up, ride them down.

And we still could go the Japan route (of extended low interest rates)...

Now, when it does happen, and if it is excruciatingly painfully, I might be singing another tune.

There was an article in the WSJ the other day stating many market pros are having second thoughts on rebalancing this year. They say the recent run up in equities points to the need for rebalancing but many consider bonds too risky right now to carry through with the usual strategy and will therefore stay heavy to equities.

While on the one hand I understand their reasoning, on the other hand it just seems like another version of timing. Thoughts anyone?

 

[audreyh1]

There was an article in the WSJ the other day stating many market pros are having second thoughts on rebalancing this year. They say the recent run up in equities points to the need for rebalancing but many consider bonds too risky right now to carry through with the usual strategy and will therefore stay heavy to equities.

While on the one hand I understand their reasoning, on the other hand it just seems like another version of timing. Thoughts anyone?

IMO it's pretty silly to argue that one shouldn't rebalance because one of the asset classes you might buy is "too rich". That basically disavows the whole idea of maintaining an AA. Yet I see these comments all the time. The fact is, we don't know which asset class will do well over then next year. I don't believe in "anticipatory" not rebalancing.

I rebalanced. I bought some bonds. My equities went up much more than my bonds in 2012, so I ended up buying some bonds. If my bond funds hadn't gone up so much as well, I would have bought a lot more. Because they did go up, I bought less. When they (eventually) go down, I'll buy more - assuming my equities don't go down as much. That's how rebalancing works.

 

[Midpack]

But do you think the Fed would really allow a fast rise in interest rates? They are pulling the strings right now and I doubt they would just cut them all at once and let things go. I think we'll have a very controlled rise in rates that could take years, maybe a decade or more (just my opinion).

+1. Unless the economy takes off, which frankly seems highly unlikely to me anytime soon, I can't imagine a rapid increase in rates. More yes from next to nothing, but rapid no... YMMV

 

[Midpack]

From The outlook for bonds: Are the good times about to end? | Vanguard Blog

+1, another good read IMO, thanks.