When Bond Funds Make Sense

[ZMAN]

This thread is confusing me. My AA is 70% Vanguard intermediate bond funds and 30% Vanguard stock index funds. That allows me to sleep at night after 2001 and 2008. I was a 50/50 guy before then. I know if I hold an individual bond to maturity, market fluctuations do not matter. As such I thought that over the average duration of the bonds within a fund, the loss of principal is recaptured. So if interest rates go up, and if the average duration is say 5 years, I would recapture the capital loss by the end of those 5 years. Is that wrong?

 

[Al in Ohio]

I hope rates do go up..That means over time my dividends will go up..Why should I care what the share price is if I have no plans to sell..

You need to realize how bond funds work. If an intermediate bond fund has an average duration of bonds that is 7 years and interest rates rise one percent this year, your bond fund will lose 7 percent. If you have a large portion in another fund of long term bonds with say a 20 year average duration period, that same one percent rise will cause that fund to lose 20 percent. While a 20 percent correction in equities might be made up in the next few years, the time for a long term bond fund to recover might be 5-10 years.

 

[cooch96]

And what if inflation goes up by 5%? Would recovery take 25-50 years?!

 

[lawman]

I know if I hold an individual bond to maturity, market fluctuations do not matter. As such I thought that over the average duration of the bonds within a fund, the loss of principal is recaptured. So if interest rates go up, and if the average duration is say 5 years, I would recapture the capital loss by the end of those 5 years. Is that wrong?

That's the way I see it too..That doesn't address inflation risk but I 'm not convinced that the market risk that goes with equities is worth the trade off..

 

[pb4uski]

I was mostly in equities in 2008...I'm no number guru but if there has ever been a 9 year period when Intermediate Bonds faired worse than equities did from Jan. 1, 2000 through Dec. 31 2008 ( -3.7% annualized return) I missed it thank goodness..I would be interested in a chart that gave history of intermediate bond returns over various time periods..Here is one I found for equities..
CAGR of the Stock Market: Annualized Returns of the S&P 500

You say that you are no numbers guru, but you are definitely a cherry-picking guru

How about you do the same comparison for 1/1/2009 to 12/31/2016. Or for the most recent 1, 3, 5 or 10 year periods?

Or since you claim to be a long term investor, let's go back as far as possible....from 1/1/94 to now... a $10k investment in VTSAX is now worth MORE than DOUBLE what a $10k investment in VFIDX is now worth.

http://quotes.morningstar.com/chart...dDay":"02/16/2017","chartWidth":955,"SMA":[]}

So to answer your question, all of the above (1/1/2009-12/31/2016, teh 1, 3, 5 and 10 year periods ended 2/16/2017 and 1/1/94 -2/16/2017) are all periods where intermediate corporate bonds fared worse than equities.

 

[mathjak107]

since the 1980's every year the fed raised short term rates more than 1% in a year intermediate term bonds went up in value , except 1994 .

but today we are seeing something different . short term rates are moving very little and it is the expectation of higher inflation driving longer term rates .

the end result is bond values are falling far more than just short term interest rate movements would reflect .

we rolled back up a bit off the lows but we can resume the downward trend at any point in time again .

if trumps growth expectations do not pan out bonds ,especially long term treasury's can do very well . but if inflation expectations remain high than bonds are not going to be adding a whole lot to the growth of a portfolio and will likely be taking away . cash and equity's may be the better choice as the cash acts as stock options for stocks at lower prices with no expiration while benefiting from rising rates .

 

[lawman]

You guys may all be right and you make the same arguments that my financial advisor makes..I hope to one day feel like equities are once again a good value and perhaps maybe I'll live long enough to get the 2008 type correction I think we may get...To be honest, the advisor I most respect is John Hussman even though most of his stuff is way over my head but you can bet that if and when he turns positive on equities again I will be all in..

 

[audreyh1]

You guys may all be right and you make the same arguments that my financial advisor makes..I hope to one day feel like equities are once again a good value and perhaps maybe I'll live long enough to get the 2008 type correction I think we may get...To be honest, the advisor I most respect is John Hussman even though most of his stuff is way over my head but you can bet that if and when he turns positive on equities again I will be all in..

Well it was much better that you be in 100% bonds than in Hussman's funds over the past decade.....

 

[mrfeh]

OP - if you are unwilling to put 20-30% of your portfolio in equities, then I suggest a healthy dose of your bonds be in TIPS.

 

[lawman]

OP - if you are unwilling to put 20-30% of your portfolio in equities, then I suggest a healthy dose of your bonds be in TIPS.

Presently I'm about 10% equities and 20% I - Bonds..

 

[Totoro]

If the primary goal is capital preservation equal to inflation, and minimum volatility next, getting a little bit in equities is advisable if your time horizon is still relatively long (>20 years). Efficient frontier is one reason.

My grandmother is fully in fixed interest. She's 85. My mother is around 30% and I intend to shift it up to 50% at most.

To reduce volatility further I'd go for the broadest index there is: the MSCI world. Alternatively the S&P 500.

 

[Happyras]

VTSAX Vanguard Total Stock Market Index Fund Admiral Shares Fund VTSAX chart[/url]

So to answer your question, all of the above (1/1/2009-12/31/2016, teh 1, 3, 5 and 10 year periods ended 2/16/2017 and 1/1/94 -2/16/2017) are all periods where intermediate corporate bonds fared worse than equities.

I added VWENX and VWIAX to your MS chart and for some reason Wellington beat VTSAX marginally with a high exposure >35% in bonds. Since 1994 is a good run of years, but not necessarily representative of markets going forward from now or current management for the fund.

 

[pb4uski]

OP, since you're a Hussman fan you might be interested in this thread: http://www.early-retirement.org/for...-that-makes-me-want-to-sell-stocks-85416.html

Personally, I think he is a flake and has a poor record, but to each his own.

 

[Backdraft57]

https://personal.vanguard.com/us/insights/saving-investing/model-portfolio-allocations

OP ck these graphs for historical returns on various asset allocations. I'm pretty conservative as well but have settled on 20-35% equities.

Sent from my SM-G935V using Early Retirement Forum mobile app

 

[razztazz]

https://personal.vanguard.com/us/insights/saving-investing/model-portfolio-allocations

OP ck these graphs for historical returns on various asset allocations. I'm pretty conservative as well but have settled on 20-35% equities.

Sent from my SM-G935V using Early Retirement Forum mobile app

Thanks a'plenny for that page o' pie charts.

 

[lawman]

https://personal.vanguard.com/us/insights/saving-investing/model-portfolio-allocations

OP ck these graphs for historical returns on various asset allocations. I'm pretty conservative as well but have settled on 20-35% equities.

Sent from my SM-G935V using Early Retirement Forum mobile app

That's good stuff! I look forward to adding another 10% - 15% to equities if and when valuations return to historical norms...

 

[lawman]

OP, since you're a Hussman fan you might be interested in this thread: http://www.early-retirement.org/for...-that-makes-me-want-to-sell-stocks-85416.html

Personally, I think he is a flake and has a poor record, but to each his own.

okay thanks!

 

[MrLoco]

since the 1980's every year the fed raised short term rates more than 1% in a year intermediate term bonds went up in value , except 1994 .

but today we are seeing something different . short term rates are moving very little and it is the expectation of higher inflation driving longer term rates .

the end result is bond values are falling far more than just short term interest rate movements would reflect .

we rolled back up a bit off the lows but we can resume the downward trend at any point in time again .

if trumps growth expectations do not pan out bonds ,especially long term treasury's can do very well . but if inflation expectations remain high than bonds are not going to be adding a whole lot to the growth of a portfolio and will likely be taking away . cash and equity's may be the better choice as the cash acts as stock options for stocks at lower prices with no expiration while benefiting from rising rates .

I would disagree....especially those of us with large investment portfolios. So if I have an investment portfolio of $5million and I desire a 50/50 AA equities / fixed income , you are suggesting $2.5M equities/ 2.5M cash? And if stocks do not correct in the near future, how long should we be sitting on all that cash earning a whopping 1% or less?

I would much rather have an AA of 50/40/10 equities/bonds/cash
keeping the bonds at the short duration level (less than 5 years) and at least gain some dividends in the 2-3% range. This also allows for tax loss harvesting in a taxable account if one desires to sell equities that have gained and offsetting these gains with moderate bond losses.

 

[Al in Ohio]

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[REWahoo]

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Hairball?

 

[mathjak107]

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I would disagree....especially those of us with large investment portfolios. So if I have an investment portfolio of $5million and I desire a 50/50 AA equities / fixed income , you are suggesting $2.5M equities/ 2.5M cash? And if stocks do not correct in the near future, how long should we be sitting on all that cash earning a whopping 1% or less?

I would much rather have an AA of 50/40/10 equities/bonds/cash
keeping the bonds at the short duration level (less than 5 years) and at least gain some dividends in the 2-3% range. This also allows for tax loss harvesting in a taxable account if one desires to sell equities that

have gained and offsetting these gains with moderate bond losses.

That would only be true until bond rates continue their rise. Losing 5% in a total bond fund for every point rates rise vs gaining in cash may not be the best strategy

 

[lawman]

That would only be true until bond rates continue their rise. Losing 5% in a total bond fund for every point rates rise vs gaining in cash may not be the best strategy

I too would disagree..Dividends will only go up as interest rates rise..I have nothing I plan to sell at any time period less than the longest term bond held in my bond funds..Again it's my desire that interest rates rise...

 

[pb4uski]

That would only be true until bond rates continue their rise. Losing 5% in a total bond fund for every point rates rise vs gaining in cash may not be the best strategy

I agree with you that interest rate risk is real but IMO 50% in cash is crazy... there are other ways to mitigate interest rate risk. For example, long CDs have no interest rate risk and pay a lot more than cash.... or while short (5 year or less) individual bonds or target maturity bond funds have interest rate risk you will get your par value back within 5 years or less so they are similar to a CD but with some extent of temporary interest rate risk... or even low duration bond funds.