Bond Investing vs Bond Funds

MercyMe

MercyMe

Recycles dryer sheets
Joined
May 7, 2022
Messages
227
It appears that many intermediate bond fund yields are lower than YTM's on individual bonds. Like some others, I've become quite interested in Freedom56's thread "Golden Period on Fixed Income Investing", but I'm afraid of getting too deep into something which I know little about. And to get that extra bit of yield, you have to buy callable bonds which brings up the topic of reinvestment risk.

After much research, I did make a few new issue bond purchases recently. However, my AA is still too heavy in cash and I'd like to move most of it into fixed income. It would seem easier to just drop the cash into Fidelity's FLTMX fund versus buying new bonds and dealing with reinvesting of dividends and called bonds. It's not that I'm lazy, but I don't enjoy the searching and analysis process for each bond.

So... What is the overall consensus on buying intermediate bond funds today? Good idea? Why?

I guess this question for me is more specifically about tax-exempt bond funds since purchases now would be in my taxable account (my tax deferred account is already mostly bond funds).
 
I run a tax free muni ladder in my taxable account and have since begun to add taxable bonds as well because of the higher yield.
I am not a fan of funds since they not only have expenses, mark to market timing issues if you want to withdraw - buying high, selling low, but also redemption drag due to other investors pulling money out forcing managers to sell at market price.
Buy a fund if you must, but be willing to accept lower overall returns.
 
Buying individual bonds is too much work for me, just as buying individual stocks is too much work for me. I generally use very low expense broadly diversified index funds. Keep it simple is my motto.

I don’t care about maturity or fund volatility due to investors piling in or fleeing because I rebalance. I structure my fixed income duration by having some in cash, some in short term, and the remainder in intermediate.

I don’t care about overall yield either because I’m a total return investor and don’t count on the investments generating cash flow. In fact I’d rather they didn’t as for me it’s taxable or counts against the IRMAA thresholds.

I make an exception for very short-term treasuries and CDs for holding my cash allocation as that’s just a matter of comparing yields against money market funds and high yield savings and no credit risk.
 
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You need to embrace the "golden period". Money market funds like FZDXX are earning 3.07% today and is a 100% risk free investment. YTM in bond funds have no meaning whatsoever since most funds are faced with the prospect of selling bonds at a loss and most don't hold securities to maturity. You have to look at distribution yields. Right now money market funds are yielding more that most bond fund distributions. Just buy treasuries or CDs if you don't want to buy individual bonds. My order for Goldman Sachs 6.75% shows "execution pending". Sure it's a callable bond. But I will earn 6.75% for at least one year and 100% return of capital in the worst case. The callable bonds that I bought earlier at yields from 4.5% to 6.25% now have a lower risk of being called.
 
Freedom56 said:
You need to embrace the "golden period". Money market funds like FZDXX are earning 3.07% today and is a 100% risk free investment. YTM in bond funds have no meaning whatsoever since most funds are faced with the prospect of selling bonds at a loss and most don't hold securities to maturity. You have to look at distribution yields. Right now money market funds are yielding more that most bond fund distributions. Just buy treasuries or CDs if you don't want to buy individual bonds. My order for Goldman Sachs 6.75% shows "execution pending". Sure it's a callable bond. But I will earn 6.75% for at least one year and 100% return of capital in the worst case. The callable bonds that I bought earlier at yields from 4.5% to 6.25% now have a lower risk of being called.
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Made me look. Both of my orders for GS 6.75% say pending as well.

Sorry for the thread drift.
 
MercyMe said:
So... What is the overall consensus on buying intermediate bond funds today? Good idea? Why?
Click to expand...

I'm pretty sure there is no consensus on bonds vs. bond funds. If rates go down as much as they've gone up, your NAV will likely go back up. If they go up again as much as they have already, your NAV will likely go down either further.

Funds are more volatile than individual bonds. You may get more or less than your original principal back. If you buy individual bonds your principal gets redeemed, if you hold the bond to maturity.

One thing I would point out is that some posters here told me at the beginning of the year when I would say why I was selling my bond funds is that they are holding their bonds for 7 - 8 years and then they will come out ahead. Now you can look back at your bond funds' 5, 10, years and since inception performance stats and see if they have lost NAV during the last 7 to 8 years. Or in the case of TIPS funds, see if they have kept up with inflation. Some have not only not kept up with inflation, but they have lost money over the last 5 years, while cumulative inflation has been 20%, which individual TIPS or I bonds would have increased by in their inflation adjustments.
 
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I see at least 3 main questions. Before I address that, a disclaimer. In general, I would not recommend anyone changing their bond approach at this time. That is, I'm not a buyer for now.

1st question -- are munis the right choice? You didn't say your tax bracket or location, but will assume you are going the muni route. Muni world is different in terms of buying, future expectations, etc. If you've never bought individual munis before, you have some work ahead.

2nd, is intermediate the best time frame? Is your personal time horizon as long or longer than the duration? If so, you are probably ok (especially if reinvesting). If not, might want to consider shorter term, particularly while rates rising as now. (Saw your tag line indicating possible change at end of next year?)

Lastly, individual vs fund. Lots of disagreement on the board clearly. If you are reinvesting dividends, wanting to rebalance, have low effort, I'd say funds will be much better -- especially in munis. Not enough info to say if the fund you mentioned is good fit for you.

Good luck!
 
FLTMX is a loser fund. If you want to play the Muni market without buying individual Muni bonds, buy Muni bond CEFs when they trade well below asset values. The leverage funds (California) are returning distributions of 5.7% versus 2.2% for FLTMX. The non-leveraged CEFs are returning 3.8% currently. Keep an eye on them in December during tax loss selling season.
 
audreyh1 said:
Buying individual bonds is too much work for me, just as buying individual stocks is too much work for me. I generally use very low expense broadly diversified index funds. Keep it simple is my motto.

I don’t care about maturity or fund volatility due to investors piling in or fleeing because I rebalance. I structure my fixed income duration by having some in cash, some in short term, and the remainder in intermediate.

I don’t care about overall yield either because I’m a total return investor and don’t count on the investments generating cash flow. In fact I’d rather they didn’t as for me it’s taxable or counts against the IRMAA thresholds.

I make an exception for very short-term treasuries and CDs for holding my cash allocation as that’s just a matter of comparing yields against money market funds and high yield savings and no credit risk.
Click to expand...

+1. No sense over thinking things for me :popcorn:. Keep it simple.
 
audreyh1 said:
I generally use very low expense broadly diversified index funds. .
Click to expand...

Do you ever use actively managed bond funds or always index bond funds?
 
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youbet said:
Do you ever use actively managed bond funds or always index bond funds?
Click to expand...
Pretty much moved over to bond index funds from active because:
a) they tend to have the highest credit quality, and
b) they are way way lower cost.
 
MercyMe said:
Very helpful. Thank you Freedom.

Newbie here... Even with the "help" link on that page, I'm having a hard time understanding the difference between the distribution yield and the 30-day yield. Is there a place you recommend where I can better understand this?
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See the link below. There is a lot of misinformation about SEC yields. Most financial advisors don't even understand that it is just a benchmark for comparing funds and has nothing to do with what you will earn from the fund. This is the summary:

The SEC yield is a standardized yield computation that allows a comparative measure for bond funds that fall under the jurisdiction of the Securities and Exchange Commission (SEC).

The SEC yield is not a measure of returns to be expected from a fund, but rather a benchmark for yield performance comparison. It does not account for the fact that most funds do not mature, nor do they always hold bonds until maturity, but rather trade them actively.

A majority of funds tend to compute a 30-Day SEC yield on the last day of every month; however, a 7-day SEC yield is also computed and reported by funds in the United States. The 7-Day SEC yield indicates the potential yield of a fund, had it paid an income similar to the preceding 7 days for an entire year.


https://corporatefinanceinstitute.com/resources/wealth-management/sec-yield/
 
Index funds here but I am doing what is often called "duration matching". Meaning I'm emulating a bond ladder by holding 2 different index bond funds at a time, each with a different effective duration, and adjusting their relative ratios over time. Lots of details beyond that which I'm not going to get into, but plenty of discussion over on bogleheads about it.

For my purposes, if it's available, then there is one more yield number to look at: YTM (yield to maturity). Not every fund posts this, but it's a decent number to use. If that's not available, then SEC yield is the next best choice.

Cheers,
Big-Papa
 
YTM or yield to maturity only has meaning if bond are held to maturity. Bond funds do something called duration stripping. To maintain an average duration, a bond fund will sell securities at the shortest duration and replace them with bonds at a longer duration. With rising rates they are selling the short duration bond at a loss and replacing them with a longer duration bond. The YTM or SEC calculation does account for these losses. SEC yield or YTM has no meaning a perpetual bond fund. As long as rates continue to rise, passive bond funds will remain in a "buy high/sell low" mode.
 
I just don’t see bond funds or some sort of convoluted use of bond funds as a replacement for a ladder. They are so different: no par, no set maturity date, expenses and redemption drag. It’s apples and oranges.
 
It's very simple today. Just buy CDs and lock in your yield. You will receive a steady monthly, quarterly, or semi-annual interest payment, depending on the CD and 100% of your money back when it matures. Why bother making it so complicated. Bond funds can't compete with CD or money market yields nor preserve 100% of your capital. That is a fact of life today.
 
audreyh1 said:
Pretty much moved over to bond index funds from active because:
a) they tend to have the highest credit quality, and
b) they are way way lower cost.
Click to expand...

Would you mind throwing out a few names that have been useful to you?
 
Freedom56 said:
YTM or yield to maturity only has meaning if bond are held to maturity. Bond funds do something called duration stripping. To maintain an average duration, a bond fund will sell securities at the shortest duration and replace them with bonds at a longer duration. With rising rates they are selling the short duration bond at a loss and replacing them with a longer duration bond. The YTM or SEC calculation does account for these losses. SEC yield or YTM has no meaning a perpetual bond fund. As long as rates continue to rise, passive bond funds will remain in a "buy high/sell low" mode.
Click to expand...
Holding to maturity is in effect what you're doing when duration matching using bond funds. Well described on bogleheads by vineviz, bobcat2 and others and was first described in an article by Merton years ago. It's definitely not a set and forget like a bond ladder is and does require maintenance as you're adjusting the relative holdings of two bonds at any given time over time to emulate a ladder. The results are very similar to a ladder but not 100% so. But for my purposes it's close enough. Some will simply choose a ladder and be done with it.

Cheers
 
I really don't understand how duration matching works compared to holding a ladder. To keep it simple, let say you have a ladder with one rung. Over the last ten years from the stats I see most bond funds would have lost NAV. TIPS funds would either have lost NAV in the 5 year period or been way behind inflation for the 10 year period. Individual bonds would have kept their principal if bought and redeemed at par. TIPS bought at par and held to maturity would have kept up with inflation.

I don't understand how having one fund or more is going to change the basic math of funds losing NAV in a rising rate environment, individual bonds retaining principal and individual TIPS increasing in value like I bonds with inflation (bought at par and held to maturity). Maybe someone can explain it to me how this would work because I really don't get it.

Everything I have read about bond funds says they have market risk and you never know if you will get more or less of your principal back when you need to redeem your shares. I don't see how having more than one fund changes this math. Two bond funds will still have variable future outcomes, unknown at the time of shares purchase.
 
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In an environment of rising interest rates like in 2022, bond funds can lose money. There is risk there. Buying an individual bond eliminates that risk because you know exactly what you are going to get if you hold it to maturity. When holding an individual bond and interest rates go up, there is an opportunity cost for holding that bond because you are missing out on potentially higher returns but you still get your principal back. Another thing is that you can actually lose money in a bond fund if its management decides to sell out some of its bonds for cheap if they aren't doing well..
 
youbet said:
Would you mind throwing out a few names that have been useful to you?
Click to expand...

I just use the Fidelity bond index funds - Fidelity US Bond Index and Fidelity Short-Term Bond Index funds. These are extremely low cost index funds with expense ratios of only 0.025%. There are additional Fidelity low cost bond index funds available with narrower focus such as intermediate treasury index fund etc.
 
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