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Short term vs Long term Bonds
Old 03-19-2009, 10:11 AM   #1
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Short term vs Long term Bonds

I'm 28 years old and going to allocate 10% of my portfolio with Bonds. I'm trying to decide between Vanguard's Short Term Bond Index (VBISX) vs Vanguard Total Bond Market Index (VBMFX). Is there a reason to choose one over the other?
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Old 03-19-2009, 10:26 AM   #2
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Shorter term will give you less interest rate volatility, and the Total Bond mkt fund is basically an intermediate bond fund with a bit more volatility. Vanguard is showing both funds as "high" credit quality, and it looks like each has around 1/3 or less of their assets in corporate bonds.

The Total Bond Mkt has about 40% in govt mortgage backed securities which I believe are a little riskier than normal bonds because these are more likely to get paid off early if rates drop (meaning you reinvest at a lower rate) and they are held till maturity if rates rise.

In terms of straight yield, you are getting almost 2% more interest (4.4% vs 2.5%) for the total bond mkt fund. If you are a buy and hold investor, most of the long term return from bond funds comes from the coupons or current yields.

The 2% additional yield makes me slightly prefer the total bond mkt fund, but I think "the experts" typically recommend the shorter bond funds because they are less volatile (which is what you want with the bond portion of your portfolio).
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Old 03-19-2009, 05:54 PM   #3
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If you fear a significant and rapid rise in inflation, you should stick to shorter duration bond funds. The turn-over (maturation of older bonds and purchases of newer replacements) in a short-duration fund is rapid enough that the yield will not lag by too much.

Otherwise, if inflation climbs rapidly, the NAV (price) of a longer-term fund (whose composition will be stuck at a lower yield for a longer time) will drop dramatically.

I'm not saying there will be serious inflation in the future, but there are certainly signs that it may appear down the road.

Another potential issue is that the Total Bond fund is heavy in Treasuries, which many people would say are essentially in a bubble. Should this collapse, the price of the fund will decline as well.

Personally, my highly fallible sense is to stay out of long-term treasuries (including indirectly such as via the Total Bond fund) and on the short end of maturities.

You didn't mention if this money is taxable or not. If it's taxable, does Vanguard have a municipal bond fund for your state? If not, perhaps you will want to prefer a high-quality short term corporate bond fund in a tax-free account.
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Old 03-19-2009, 08:27 PM   #4
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If you fear a significant and rapid rise in inflation, you should stick to shorter duration bond funds. The turn-over (maturation of older bonds and purchases of newer replacements) in a short-duration fund is rapid enough that the yield will not lag by too much.

Otherwise, if inflation climbs rapidly, the NAV (price) of a longer-term fund (whose composition will be stuck at a lower yield for a longer time) will drop dramatically.

I'm not saying there will be serious inflation in the future, but there are certainly signs that it may appear down the road.

Another potential issue is that the Total Bond fund is heavy in Treasuries, which many people would say are essentially in a bubble. Should this collapse, the price of the fund will decline as well.
You have raised some good points.

However I believe the total bond mkt fund is technically less invested in treasuries (only about 1/3 of assets, with another 40% in govt mortgage backed). The short bond index is 70% treasury. All per vanguard.

The difference in duration is 2.6 for short and 4.1 years for total bond mkt. That would suggest about 60% more price volatility when interest rates change for the total bond mkt index. However the average maturity is much higher on the total bond mkt fund vs. the short bond index. Maybe it is the slug of govt mortgage backed bonds that are skewing the duration down?

Bank5, google bond duration vs. bond maturity for an explanation of what each means if you aren't familiar.

I actually like the yields on investment grade funds better (short or intermediate) and I think it presents a good risk/reward trade off at this point. Which also ties in to the fear that treasuries are in a bubble right now. And the short bond index is 70% treasuries. Although the short index is also not very sensitive to interest rate fluctuations.

I think there are downsides to whichever bond fund you pick, but at least you are at a low cost provider (Vanguard) so you won't lose all your yield to fees.
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Old 03-19-2009, 08:29 PM   #5
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One more thing: you are in a state with high state income tax. So the more treasuries, the more state tax exempt income you have, if you are holding bonds in a taxable account. Which you generally shouldn't if you can put those guys somewhere else.
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Old 03-20-2009, 10:50 PM   #6
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You have raised some good points.
So have you. I'll have to review these options again.

Thanks.
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Old 03-21-2009, 12:07 AM   #7
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You should also note that most Vanguard's bond fund managers have already lowered their funds' average duration to reflect the current interest rate environment. VBMFX has a duration of 4.1 which is quite low for an intermediate term bond fund. Other Vanguard intermediate bond funds have a mandate to keep their average duration at a minimum of 5-6 years.

If I remember correctly, Swedroe advocates a 1-5 year average duration as it seems to be the sweet spot for bond investing. But I think he doesn't like VBMFX because that fund owns too many MBSs.
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Old 03-21-2009, 09:45 AM   #8
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really depends on what you are hoping to accomplish with the bonds.... income sucks on all off them ... for portfolio protection nothing works better than long term treasuries .... while all the taking heads said stay away from bonds in 2008 because they were doomed to drop they were all sooooo wrong.

long term bonds soared 28% last year offestting much of the crash in equities.. short and intermediate term bonds dont have enough power to protect well... they serve more as a storage place for money thats not in stock then they do flying fighter cover for your porfolio

long term bonds soard with the fed announcement the other day over 8% before settling down.

if you think deflation is in the cards long term treasuries are the place to be, if you think its inflation they are the place not to be..
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Old 03-21-2009, 09:48 AM   #9
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I recall Bill Bernstein studying the question of duration, and his conclusions were that long maturities don't adequately compensate you for the extra risk. I think they returned less than 0.5% more than shorter term bonds with something like three times the volatility.

Now over a very long period of time you may be okay with that volatility, but at least where Treasuries are concerned, the long end seems scary to me because of how low it already is.
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Old 03-21-2009, 09:50 AM   #10
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from an income standpoint yes, bill is right,,, but its not just about income these days and thats where the power of the long term bonds lie


the move is almost double on long term treasuries vs intermediate when its time to do its job

big difference being up 13% for intermediate treasures vs 28% last year for long term

a 50/50 mix of stocks and long term treasuries would have left you only slightly down last year.... thats why i like harry browns permanent portfolio idea.. throw in equal amounts of gold and short term treasuries and leave it alone.....
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Old 03-21-2009, 09:58 AM   #11
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the move is almost double on long term treasuries vs intermediate when its time to do its job

big difference being up 13% for intermediate treasures vs 28% last year for long term
Agreed -- but the moves are on the upside AND on the downside. So if inflation and/or interest rates start rising again, suddenly the long bonds get slammed much harder.

I guess another question for OP would be whether or not they are looking for a "permanent" duration for their portfolio or if they are looking for what to do now based on current and expected economic conditions.

For a long term allocation, I stick to shorter maturities. But if one is going to try to choose based on where they think we're going from here economically, it depends on whether they buy the deflation argument. If so, long maturities would still outperform (at least for Treasuries) and if not, a return of inflationary pressures would maul the long end of the curve.

My personal belief is that all this debt and money printing has to be ultimately inflationary, so I don't want to be overweight the long end. (In reality, though, no matter how much extra cash they print, it won't be inflationary as long as it's hoarded and not spent or lent out.) My personal bond allocation is about half in individual TIPS (mostly 2016s and 2025s) and about half in VBMFX.
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Old 03-21-2009, 10:02 AM   #12
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its funny your thought are my exact feeling as to how we play out....truth is something not even on the radar makes things play out differently then it looks like its a given ..


right now im 25% each gld gold
tlt long term treasuries
vti total market index
cash

no matter what the strong trend im covered,, not a barn burner in a bull market but never a big looser... was actually up 1% last year... gold was up almost 5% and tlt 28%

for a portfolio that bets on no outcome it does quite well , now averaging over 9% over the last few decades


reason i dont use tips is tips can take a beating when inflation rises as the base rate on new tips goes up making the older lower tips drop in value with their lower base rate. the new tips have a higher base rate and then get the inflation kicker added to it. tips dont have the power either in deflation or severe turmoil like last year... for a porfolio that bets on nothing you need maximum ooomph from each catagory.....


tips are also a fairly new producted never really tested in high inflation.....
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Old 03-21-2009, 10:50 AM   #13
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reason i dont use tips is tips can take a beating when inflation rises as the base rate on new tips goes up making the older lower tips drop in value with their lower base rate. the new tips have a higher base rate and then get the inflation kicker added to it. tips dont have the power either in deflation or severe turmoil like last year... for a porfolio that bets on nothing you need maximum ooomph from each catagory.....
Actually, so far every time the market has sensed inflation, TIPS have rallied. Look at the Treasury's action a few days ago when they said they'd start buying back a huge amount of long-term Treasuries and presumably print money to do it. The market read inflation and everything that's an inflation hedge and/or an anti-dollar bet was up: gold, oil, other commodities, foreign currencies, and yes, TIPS. My 2025s were up 6% on that day. The evidence to date (what there is of it) suggests that TIPS will rally in periods of high inflation.

Like anything, people will pay more for security when they sense they need it most. People are paying a LOT for Treasuries now because they are willing to pay a high price for security. When investors fear inflation, they pay a high price for inflation protection.

Not all of us are looking to hit home runs with fixed income. I think my TIPS+VBMFX mix hits a lot of singles but rarely strikes out. And at this point in my "investing career," I'm content with singles out of my bonds. I bought my TIPS when their worst-case *real* YTM was over 2.5% (held to maturity), and I see nothing at all wrong with a safe, CPI+2.5% return out of fixed income.

So again, to the OP, it really depends on what you're trying to accomplish with your bond holdings: a "single set it and forget it" allocation or trying to move in and out of various types of bonds depending on perceived economic conditions. For me it's the latter. YMMV, naturally.
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Old 03-21-2009, 10:53 AM   #14
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Actually, so far every time the market has sensed inflation, TIPS have rallied. Look at the Treasury's action a few days ago when they said they'd start buying back a huge amount of long-term Treasuries and presumably print money to do it. The market read inflation and everything that's an inflation hedge and/or an anti-dollar bet was up: gold, oil, other commodities, foreign currencies, and yes, TIPS. My 2025s were up 6% on that day. The evidence to date (what there is of it) suggests that TIPS will rally in periods of high inflation.

Like anything, people will pay more for security when they sense they need it most. People are paying a LOT for Treasuries now because they are willing to pay a high price for security. When investors fear inflation, they pay a high price for inflation protection.

Not all of us are looking to hit home runs with fixed income. I think my TIPS+VBMFX mix hits a lot of singles but rarely strikes out. And at this point in my "investing career," I'm content with singles out of my bonds. I bought my TIPS when their worst-case *real* YTM was over 2.5% (held to maturity), and I see nothing at all wrong with a safe, CPI+2.5% return out of fixed income.

So again, to the OP, it really depends on what you're trying to accomplish with your bond holdings: a "single set it and forget it" allocation or trying to move in and out of various types of bonds depending on perceived economic conditions. For me it's the latter. YMMV, naturally.

dont forget the long term treasury ralleyed up 8% the other day and we all know inflation is hell for that, so the other day really wasnt much of an inflation performance indicator
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Old 03-21-2009, 10:55 AM   #15
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dont forget the long term treasury ralleyed up 8% the other day and we all know inflation is hell for that, so the other day really wasnt much of an inflation performance indicator
That was an anomaly, IMO. The reason was that because the Treasury was going to buy back its long bonds, the supply of them shrinks, the demand is artificially induced and leads to at least a short-term spike in price. But all the other stuff that usually rallies in an inflationary environment spiked up.

Look, I know I'm not going to convince you and that's fine. I just don't like long-term Treasuries right now as my primary permanent bond holding. Maybe in the context of the Permanent Portfolio it works, but I think if you're not following that, long Treasuries are just way too risky if inflation returns and/or the economy recovers.
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Old 03-21-2009, 12:12 PM   #16
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your right , without the confines of the permanent portfolio long term bonds are very risky.

i realized a few years ago that the conventional 60/40 50/50 mix was great when we typically followed the traditional 2/3 of the time up and 1/3rd down format... we are now over a decade and down in equities.... the traditional short, and medium bonds dont offer enough pull to fly that fighter cover for my portfolio.... while they do offer a holding place for some cash and potentially a higher yield they may not even pull that off as anyone holding a bond fund that wasnt treasuries found out last year.....

my days of getting richer from stocks are over, now i just dont want to get poorer, im tired of trying to time the markets buying only the asset classes i think will go up or lightning up on what i think is headed down

i find lately just bet on it all and let it ride, good or bad.....

im not convinced in high inflation tips will have any oomph compared to gold as i said new tips offer a higher base rate so my older ones would have to drop.... that would hardly give me the gains i would want in that area.... ill stick to gold for that part

while equities dropped 50% the last 10 years, gold and long term treasuries did very well..... when stocks come back the treasuries will drop but the equities should offest that by a bit.....
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Old 03-24-2009, 04:34 PM   #17
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IMHO, Vanguard's Intermediate Term Investment Grade bond fund is
the best overall compromise now for your tax sheltered bond money.

It was hammered last year and is currently paying about 6%. There
may even be a modest NAV gain when the economy recovers.

I own some in my IRA.

Cheers,

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Old 03-24-2009, 04:40 PM   #18
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IMHO, Vanguard's Intermediate Term Investment Grade bond fund is
the best overall compromise now for your tax sheltered bond money.

It was hammered last year and is currently paying about 6%. There
may even be a modest NAV gain when the economy recovers.
I definitely concur on this one. And the short term investment grade fund pays a nice coupon too, a few hundred basis points above the comparable duration treasury bond fund. Pretty good for primarily A or better rated debt.
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