Rosy future for bonds?

[daylatedollarshort]

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.

 

[mpeirce]

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.

 

[daylatedollarshort]

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.

 

[Gearhead Jim]

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?

 

[daylatedollarshort]

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.

 

[mrfeh]

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.

 

[gcgang]

Mrfeh
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.


Sent from my iPad using Early Retirement Forum

 

[daylatedollarshort]

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.

 

[mrfeh]

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.

 

[jebmke]

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.