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Old 08-11-2014, 09:36 AM   #21
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If you buy actual bonds and hold them to maturity, you don't lose actual money when rates rise, just some opportunity. But buying a diversified group of appropriate bonds is more complicated than most folks can or should do.

If you buy a typical bond fund, that will have a constantly changing NAV. During a period of rising rates for several years, that can really hurt. Sure, you'll catch up some day as the fund buys newer bonds with higher rates. But it won't help to reduce your volatility or increase your wealth during that wait.
Won't inflation typically go hand in hand with a significant increase in rates?

Not always I guess but a lot of the time?
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Old 08-11-2014, 12:03 PM   #22
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Here is a discussion at bogleheads.org on this very subject for those still interested:

Bogleheads • View topic - Bond Funds - Higher Rates - Point of Indifference
There seems to be a lot of misunderstanding of bonds and the meaning of duration.

This chart tells the whole story, clearly and cleanly. It proves that given time, rate rises are the bondholders friend. How much time is a function of the holdings duration. About 3 years ago I bought a few bond funds, their duration has varied between ~3.3 and 4.5. If I look only at the broker's summary of my basis, I am still in a loss position. But if I tally what have been my cash investments, not including the monthly dividend re-investments, I am way ahead in terms of total return. I am particularly way ahead when I compare what I would have if I had invested in very short term paper with lower rates, but which did not go down in price per unit when interest rates rose.

When this topic is discussed, we always get the same range of opinions. My guess is that we will still be getting the same range of opinions five years from now. I guess that is what is meant by ymmv. But really, this is pretty much cut and dried, how can one's mileage reasonably vary from the simple reality? You look at the chart, you see the lines crossing. What part of the story does this not address?

Ha
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Old 08-11-2014, 12:07 PM   #23
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There seems to be a lot of misunderstanding of bonds and the meaning of duration.

This chart tells the whole story, clearly and cleanly. It proves that given time, rate rises are the bondholders friend.
Bingo!
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Old 08-11-2014, 12:22 PM   #24
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I guess each person's "answer" lies in what they are trying to do, and what range of future events they reasonably expect.

In my own case, I'm well into retirement and would be using bonds/bond funds; to provide some return above Money Market funds but with minimal volatility. To prevent having to sell equities for living expenses during a down market. Right now, bond funds don't look like they are the best answer to that problem.

I still have some bond funds, but have been using a CD ladder (thank you, PenFed) as my "keep eating during a stock market downturn" money. An individual bond ladder could do the same thing, if I had the knowledge/inclination to buy individual bonds; but I don't think a bond fund would be right for that; since a market downturn today could be coincidental with, or even be caused by, a rise in rates.

Dissenting opinions?
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Old 08-11-2014, 01:00 PM   #25
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We have basically had a bond bull market for 32 years, with long Treasuries declining from 15% to the current 3+%.

Rates can stay down for a long time, but looking at bond performance since 1982 is not a good way to access your risk. A better time would be to look at mid 1970's thru 1982.

Not saying that's going to reoccur, but losses to purchasing power as well as NAV erosion took a mighty toll on bond holders during that period, as inflation was significant.


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Old 08-11-2014, 01:27 PM   #26
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Originally Posted by Gearhead Jim View Post
If you buy actual bonds and hold them to maturity, you don't lose actual money when rates rise, just some opportunity. But buying a diversified group of appropriate bonds is more complicated than most folks can or should do.

If you buy a typical bond fund, that will have a constantly changing NAV. During a period of rising rates for several years, that can really hurt. Sure, you'll catch up some day as the fund buys newer bonds with higher rates. But it won't help to reduce your volatility or increase your wealth during that wait.
Since rates don't have too far to fall to get to zero but rates could rise an unlimited amount, I think the odds highly favor not being in long term bond funds for at least the next year or two. There is unlimited downside risk and very little upside potential any more.
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Old 08-11-2014, 01:33 PM   #27
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Since rates don't have to far to fall to get to zero but rates could rise an unlimited amount, I think the odds highly favor not being in long term bond funds for at least the next year or two. There is unlimited downside risk and very little upside potential any more.
Or you could look at it another way - rates can go down by half, then down by half again, etc. Likewise they can double, then double again. No limit to either one.
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Old 08-11-2014, 02:01 PM   #28
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Or you could look at it another way - rates can go down by half, then down by half again, etc. Likewise they can double, then double again. No limit to either one.
Rates can go to 15%+ as in gcgang's post but they cannot drop that far. I prefer not risking a possible big loss of principal at my age. YMMV.
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Old 08-12-2014, 05:51 PM   #29
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Exactly.

My understanding:
If you have a bond fund with 3% rates and a five year duration, the most you could gain if rates went to 0 would be 15%.

If rates doubled to 6%, you would instead lose 15%. But especially over a period of years, rates could increase a lot more than that. A bond fund today has limited upside but an almost unlimited downside. Those of us who remember the 1970's and 1980's remain cautious about bond funds.

My math is approximate, but I think the concept is correct.

Discussion?
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Old 08-12-2014, 06:01 PM   #30
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Exactly.

My understanding:
If you have a bond fund with 3% rates and a five year duration, the most you could gain if rates went to 0 would be 15%.

If rates doubled to 6%, you would instead lose 15%. But especially over a period of years, rates could increase a lot more than that. A bond fund today has limited upside but an almost unlimited downside. Those of us who remember the 1970's and 1980's remain cautious about bond funds.

My math is approximate, but I think the concept is correct.

Discussion?
I think our first mortgage was 12%. The second one would have been even higher but the company DH went to work for bought it down as a part of his relocation package.
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Old 08-12-2014, 07:22 PM   #31
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Exactly.

My understanding:
If you have a bond fund with 3% rates and a five year duration, the most you could gain if rates went to 0 would be 15%.

If rates doubled to 6%, you would instead lose 15%. But especially over a period of years, rates could increase a lot more than that. A bond fund today has limited upside but an almost unlimited downside. Those of us who remember the 1970's and 1980's remain cautious about bond funds.

My math is approximate, but I think the concept is correct.

Discussion?
You may not understand that bond fund prices recover in time, even after rates increase. Also, the vast, vast majority of a bond fund's total return comes from dividends, not the change in NAV.

Read the boglehead thread I posted upstream for more information.
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Old 08-12-2014, 07:43 PM   #32
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The article you reference makes no mention of NAV, it is an analysis of how long it takes to breakeven after a rate increase. Even only a 1% rise takes 5.5 years for the extra interest to make up for the principal (NAV) loss, given their assumptions.
If rates are higher, I cannot imagine how NAV could ever go up. Dividends, yes. NAV, no.

Still , bonds may do better than cash, and won't go down like stocks. So if moderate, gradual, erosion of purchasing power still gets you to your finish line, that's OK.


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Old 08-12-2014, 07:50 PM   #33
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If you Google "bond funds never mature" in Google web and Google books, you will get a variety of different ideas about the pros and cons of bond funds, perhaps from a wider variety of sources than the Boglehead forum, where most of the members are very strong mutual fund advocates.

Perhaps longer term bond mutual funds will do fine, but statistically the downside potential at this point is much greater than the upside potential, and all signs from the Fed point to a rise in rates.
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Old 08-12-2014, 09:39 PM   #34
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Perhaps longer term bond mutual funds will do fine, but statistically the downside potential at this point is much greater than the upside potential, and all signs from the Fed point to a rise in rates.
I am not advocating long term bond funds. I am suggesting that people not try to time the market (bonds or equities). If you don't anticipate selling bond fund shares in the next 5-7 years, there's no reason to not be invested in an intermediate bond fund.

Regarding Fed policy - the inevitable increase in rates has already been priced in. The drop in bond prices occurred in the summer of 2013. The 10 year yield has dropped from 3.0 to 2.5 this year, despite the fact that QE will be ending in a couple months.
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Old 08-13-2014, 09:28 AM   #35
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I guess each person's "answer" lies in what they are trying to do, and what range of future events they reasonably expect.

In my own case, I'm well into retirement and would be using bonds/bond funds; to provide some return above Money Market funds but with minimal volatility. To prevent having to sell equities for living expenses during a down market. Right now, bond funds don't look like they are the best answer to that problem.

I still have some bond funds, but have been using a CD ladder (thank you, PenFed) as my "keep eating during a stock market downturn" money. An individual bond ladder could do the same thing, if I had the knowledge/inclination to buy individual bonds; but I don't think a bond fund would be right for that; since a market downturn today could be coincidental with, or even be caused by, a rise in rates.

Dissenting opinions?
I think you are right. Individual bonds can make sense if you are holding treasuries but I use funds for everything else. CDs can be attractive but they are inconvenient for other than small holdings.

I keep my duration low with nominals, long with TIPS (individual bonds). That provides cushion for withdrawal and buying equity when the market is down. Lately I've been going the other way though - selling equity to maintain my allocation.

IMO the issue of "selling equity in down markets" is only relevant for people who hold 100% equity - not for balanced allocations.
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