Bond Funds or Bonds?

[Montecfo]

With the recent rise in interest rates, investors have renewed interest in investing in bond funds, ETF's and bonds. This is the thread to discuss the pros and cons of owning bonds indirectly through funds, ETFs etc. versus owning them directly.

While acknowledging there is no single approach is right for everyone this is the place to discuss the advantages and disadvantages of each.

Feel free to recount personal experiences or discuss individual strategies.

I will start with Open-End Bond funds, which are the most common type of bond mutual funds. This is not all advantages or disadvantages, add your own.

Open End Bond Funds:

Advantages:

-Can start small
-Diversified portfolio which reduces risk at first dollar invested
-highly liquid so easy to buy and sell, ready market. Easy to use to rebalance
-Managers of large funds have buying power to minimize transaction costs
-Easy to research fund strategy and holdings
-Investors may choose from a wide range of durations, strategies and types of holdings

Disadvantages:

-In a changing interest rate market, investors may flee funds, which may add selling pressure to bond markets and affect performance
-In a changing interest rate market, investors may rush into funds, making it tough for managers to invest new funds efficiently
-No fixed maturity, so no way to mitigate losses by holding securities to maturity (but Invesco "Bullet Shares" and similar products may address this)
-Fee structure may be a drag on returns (but low cost funds may mitigate this)
-In times of rapid rate changes, fund results may trail market due to fund structure
-if fund holdings are illiquid fund values may be challenged in times of rapid change in underlying bond values

That is a start, probably many more.

Most folks probably make their first bond investments through funds or ETFs, mainly I suspect because of the convenience of doing so.

Did you take this path, and if so what attracted you to bond funds?

 

[Happyras]

My first bond fund was sold to me by my Dean Whitter rep, it was early 1980's and I had a lot to learn, later I invested in them with Vanguard in my 401k and did some more learning. Since those early days, I grew up and was sold derivative bonds, and some even so called advisors managed the hell out of all my investments with individual stocks, but never bonds. I always argued that bond funds, such as the open end type were not bond investing, but more like a derivative of buying bonds with higher risk. I hold a few bonds and preferreds, and would not consider a fund or even using a managed bond account as suggested by Schwab and Fido. Just buy and hold my own.

 

[pb4uski]

There is a middle ground to be considered also... target maturity bond ETFs have attributes of both bond funds/ETFs and individual bonds.

For those who prefer the control that one gets from individual bonds but dislike the idea of having to research and select individual bonds, target maturity bond ETFs might be attractive.

 

[Happyras]

I do have to argue with myself, as I held Vanguard Wellesley and Wellington in the past. Very well managed bond exposure which I can't explain. If you look at stock charts for BND SPY and VWINX for the lost decade, Wellesley somehow had double the CAGR of either a 60/40 or 40/60 index blend of SPY and BND

 

[audreyh1]

I still have my beloved bond index funds, ha ha.

I am a total return investor not looking for a dividend or interest income stream. I prefer bond funds because their liquidity makes it easy to rebalance. Mark to market is just fine with me. When they get hammered I buy more, when they appreciate I sell some. Fleeing investors? Great! (also true with equity mutual funds and stocks). Right now their low distribution yield is an advantage since it is reduced taxable income.

I don’t care about holding to maturity either. I prefer the more or less constant maturity of a bond fund. I manage my fixed income overall duration by having some in cash equivalents, some in short-term bond index funds and some in intermediate bond index funds.

And most of all I like not buying individual bonds. I play around some in my cash allocation buying some new issue CDs or T-bills or IBonds when they are attractive, but this is generally for durations of 6 months or less for T-bills and under 18 months for CDs. I can always parks these funds only in MM funds and high yield savings instead.

 

[Montecfo]

I do have to argue with myself, as I held Vanguard Wellesley and Wellington in the past. Very well managed bond exposure which I can't explain. If you look at stock charts for BND SPY and VWINX for the lost decade, Wellesley somehow had double the CAGR of either a 60/40 or 40/60 index blend of SPY and BND

They have done remarkably well. A good choice I think for small investors especially.

 

[pb4uski]

I do have to argue with myself, as I held Vanguard Wellesley and Wellington in the past. Very well managed bond exposure which I can't explain. If you look at stock charts for BND SPY and VWINX for the lost decade, Wellesley somehow had double the CAGR of either a 60/40 or 40/60 index blend of SPY and BND

I don't see double CAGR at all. https://www.portfoliovisualizer.com...Inv+(VBMFX)&allocation3_2=40&allocation3_3=60

Portfolio	Initial Balance	Final Balance	CAGR	Stdev	Best Year	Worst Year	Max. Drawdown	Sharpe Ratio	Sortino Ratio	Market Correlation
Portfolio 1	$10,000	$92,879	7.69%	6.51%	28.91%	-9.84%	-18.82%	0.83	1.31	0.72
Portfolio 2	$10,000	$100,642	7.98%	9.39%	28.74%	-20.20%	-30.72%	0.63	0.92	0.98
Portfolio 3	$10,000	$75,082	6.93%	6.71%	25.22%	-15.79%	-19.36%	0.70	1.04	0.93

Portfolio 1 is 100% VWINX, postfolio 2 is 60/40 Total Stock/Total Bond and portfolio 3 is 40/60 Total Stock/Total Bond.

 

[HawkOwl]

Bond funds make reinvesting dividends easy.
They make record keeping easy.
If you want to invest in bonds that require special expertise, like junk bonds/international/emerging market/munis, this is covered for you.

Individual bonds have a fixed end date when you know you will get 100% of your principal back.
Baring default, and if you hold the bond to maturity, there is no risk to the principle of individual corporate bonds.
Some bond fund managers may try to tweak yields by slipping in a few junk bonds or derivatives to an otherwise more conservative fund-I count this need for diligence as a disadvantage to the bond fund category.

As a not so knowledgeable bond investor, I prefer low expense bond funds for everything but the most straight forward bond holdings (Uber safe bonds like treasury bills or treasury notes).

 

[GravitySucks]

I laddered iShare target date funds. This years was down a little bit when it redeemed 12/15/22. It didn’t behave exactly as planned but was a decent investment. I’m keeping my 2023 through 2024 iShare funds but extending the ladder with bonds. TIPS out on the 5 year and 10 year. I’ll fill year 4 with a quality corporate.

2018 I went sold all my AGG and moved to shorter duration funds. I’ve also been buying one and two year corporates since then as rates were so crappy I was just punting down the road with the rebalancing dollars. Quite a bit is maturing in the next two years that i will probably reinvest in individual bonds.
Still have my FUAMX and think I’ll keep most of it for now.

Bonds have been a pain. I don’t think negative real yields is the norm but it has been the case since I retired in 2013.

 

[Happyras]

I don't see double CAGR at all. .

I think you missed my point that the period of time measured was the lost decade. ( If you look at stock charts for BND SPY and VWINX for the lost decade....) The period from Jan 2000 to Dec 2010. Else it would be comparable, but MY point was to pick a period of time which I believe to be similar to todays investing enviro.


Portfolio performance statistics
Portfolio Initial Balance Final Balance CAGR Stdev Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio Market Correlation
Portfolio 1 $10,000 $21,670 7.28% 6.51% 16.17% -9.84% -18.82% 0.73 1.12 0.66
Portfolio 2 $10,000 $15,030 3.77% 9.78% 20.40% -20.20% -30.72% 0.17 0.23 0.99
Portfolio 3 $10,000 $16,634 4.73% 6.69% 15.04% -11.78% -19.36% 0.35 0.49 0.93

 

[Happyras]

For that time frame, VWINX is 7.28% the others avg 4.25 so not quite double, for avg, but double for 60/40.

 

[pb4uski]

I think you missed my point that the period of time measured was the lost decade. ( If you look at stock charts for BND SPY and VWINX for the lost decade....) The period from Jan 2000 to Dec 2010. Else it would be comparable, but MY point was to pick a period of time which I believe to be similar to todays investing enviro.


Portfolio performance statistics
Portfolio Initial Balance Final Balance CAGR Stdev Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio Market Correlation
Portfolio 1 $10,000 $21,670 7.28% 6.51% 16.17% -9.84% -18.82% 0.73 1.12 0.66
Portfolio 2 $10,000 $15,030 3.77% 9.78% 20.40% -20.20% -30.72% 0.17 0.23 0.99
Portfolio 3 $10,000 $16,634 4.73% 6.69% 15.04% -11.78% -19.36% 0.35 0.49 0.93

You are correct... I read past your cherypicking of the time period... I'm not sure why anyone would do that.

I don't necessarily agree that 2010 was similar to today's investing environment either.

 

[Happyras]

You are correct... I read over your cherypicking of the time period... I'm not sure if I agree that 2010 was similar to today's investing environment either.

Me either, I think its more like 2000, the start of a lost decade for equities. Or maybe 2002. If I could get similar data, I would choose post WWII decade. Just my thoughts.

 

[MichaelB]

<mod note> This thread was moved to “Fire and Money”, which is a more appropriate forum to debate this topic.

 

[Peter]

I held VCADX for 20+ years, and saw substantial capital appreciation and decent monthly income. Sold it all at the start of 2022, to bridge between buying and selling houses. As it turns out, that was a wise move! Can't claim it was the result of any great financial expertise, though!

I keep looking at getting back into that fund. But even allowing for tax free CA income, the interest rate just isn't competitive with treasuries. But I'll keep watching.

 

[latexman]

This is the thread to discuss the pros and cons of owning bonds in directly through funds, ETFs etc. versus owning them directly.

Out of 33 choices, my company’s 401k (Fidelity) has several bond funds and a money market fund. We got a brokerage link the last 1-2 years, but I’ve never used it because I also have an IRA (Fidelity), and I do not know if we can buy bonds directly.

Is this the right place for my questions? Is there a better place? Should I start a separate thread?

 

[Montecfo]

Out of 33 choices, my company’s 401k (Fidelity) has several bond funds and a money market fund. We got a brokerage link the last 1-2 years, but I’ve never used it because I also have an IRA (Fidelity), and I do not know if we can buy bonds directly.



Is this the right place for my questions? Is there a better place? Should I start a separate thread?

Questions about bond funds? Sure.

 

[latexman]

Questions about bond funds? Sure.

And a MM fund.

They don’t really fit perfectly in any of the threads that are going now, like “Treasury Bills, Notes, and Bonds Discussion” and “We are entering a ’Golden Period’ for fixed income investing” or this one.

 

[Graybeard]

Back in the early 80's I bought a MBT Discount 5 IIRC from some well known brokerage whose name I can't recall. I don't know how much I invested but I do remember that it was a municipal bond trust that paid a tax free 11.5% interest! By the end of the 80's all the bonds were being called as the rates were dropping. I knew nothing back then, the money was going into something from all the calls. I sold it, probably was a huge mistake.

I always owned bond funds cuz you know they are like bonds but with diversification! That worked until early 2022 when rates shot up and even though I was in an ultra short term, a short term and an intermediate term funds, I lost a ton of money. 6 months later, reading the great posts by Freedom56 et al, I dumped them, tax loss harvesting the taxable account that was a tax free bond fund. I've been buying treasuries ever since. There isn't much room for rates to drop so capital appreciation in a bond fund may not happen to any extent, certainly not like over the prior 40 years. I don't think I would want to hold bond funds again.

 

[Montecfo]

Back in the early 80's I bought a MBT Discount 5 IIRC from some well known brokerage whose name I can't recall. I don't know how much I invested but I do remember that it was a municipal bond trust that paid a tax free 11.5% interest! By the end of the 80's all the bonds were being called as the rates were dropping. I knew nothing back then, the money was going into something from all the calls. I sold it, probably was a huge mistake.



I always owned bond funds cuz you know they are like bonds but with diversification! That worked until early 2022 when rates shot up and even though I was in an ultra short term, a short term and an intermediate term funds, I lost a ton of money. 6 months later, reading the great posts by Freedom56 et al, I dumped them, tax loss harvesting the taxable account that was a tax free bond fund. I've been buying treasuries ever since. There isn't much room for rates to drop so capital appreciation in a bond fund may not happen to any extent, certainly not like over the prior 40 years. I don't think I would want to hold bond funds again.

Here is what worked last year in bond world: floating rate securities. Individual fixed coupon bonds were down sharply just like the funds. TIPS were just about the worst as they have longer durations due to low coupon rates. Anything reflecting duration was not good.

Funds that hold floating rate securities also did pretty well.

Buying individual bonds has its own set of pros and cons. I may do a list to continue that side of the discussion.

 

[perez99]

I had only have bond funds for maybe 4 years prior to the Feds increasing the rates, while I have equities for ~35 years. Until the rates increase, my bonds funds always gained. Everything seemed "good and as expected" in relation to bonds vs equities volatilities and risk.
Of course, I have not yet internalized the concept of "don't fight the fed".
After experiencing the loss of value/volatility of both bonds and equities and the same time, I realized I really didn't understand bonds and that the concept of "buy and hold" may not apply the same to equities and bonds.

So I learned just enough to be able to buy individual bonds (thanks a lot to this forum).

For me the jury is still out, but so far my perspective is:

• Bonds funds is an easy way to meet your fixed income allocation. Not hard to pick a fund based on a few factors
• Coupled with the belief (right or wrong) that the success in the long term via "buy and hold" applies equally whether is for equities or bonds, makes the bond fund kind of the default for someone who want to apply the Bogleheads principles
• However bonds math based on interests rate direction seems a clear predominant factor that will impacts the long term safety of the investment.

Suddenly bond funds don't look safe nor like the could recover their value even if you hold them as a long term investment

I really have no real interest in becoming an active individual bond investor, but at the same time I want to take my risk in equities, not on the fixed income side. I don't really see any other choice that will limit my risk on the fixed income side. So for know I have a portfolio of 18 individual treasuries, municipals and CD with maturities close to my needs based on bridging to social security @ 70. Let me see how that goes.

 

[VanWinkle]

I don't understand this change in holding bond funds due to a bad 2022. How is this different from stopping holding equities due to 2022? You have a long term plan that makes simplicity and long term gains the priority. One year changes the results, and scraps the whole plan? Recency bias is pervasive and makes us all feel safer. If you like to buy individual bonds, by all means keep doing that. But don't let one year change your long term plan of simplicity.
YMMV.

VW

 

[Montecfo]

We experienced the steepest interest rate increase in history, and from the lowest levels in history.

That this was a bad environment for both stocks and bonds is the expected outcome.

It is a good time to re-evaluate strategy, but that is always good to do.

Buying individuals bonds brings new challenges as noted

 

[dmpi]

My story is almost identical to perez99. Four years ago I turned stable value money and maturing CDs into a bond fund. It wasn't chump change, it was a hefty seven figure amount. I really didn't fully understand what I was doing. I gave it 30 minutes of though thinking 60/40 allocation. What can go wrong? Apparently a lot can go wrong. I don't mind losing money in stocks but losing money in bonds that were suppose to hedge against stock lost kind of hurts. The past is the past... going forward I'm at a quandy what to do. I no longer want to micromanage my investments but I think I'm going to slowly sell out of the bond fund and buy individual bonds and CDs and manage this thing myself.

 

[Montecfo]

CDs and i-bonds, for example, are not subject to changes in principal value. Instead you forfeit part of your interest if you close out early.

Bonds and funds of bonds generally are subject to losses of principal. If you notice, virtually all classes of bonds and bond funds lost money last year.

Invesco Bullet Shares could be a middle ground.