Rosy future for bonds?

[cooch96]

So bonds aren't doing well at the moment, and they'll likely do poorly in the near future since interest rates have nowhere to go but up. Am I missing something? Shouldn't a contrarian investor go heavy into bonds right now because they look so terrible? Is there another reason to have bonds other than to help balance out the ride of stocks?

 

[mathjak107]

bonds are important if volatility is a concern.

while bonds may not rise every stock downturn they stand a good chance of it.

if i sell my bonds and switch to cash and equities because i fear bonds may fall if things get better i need to allocate a whole lot more to cash just to maintain the same volatility since cash has no chance of going up in a downturn. in other words i have to cut my equity exposure and increase cash exposure over what i had in bonds.

by having bonds the additional money i would have to allocate to cash to get that protection can stay in equities.

when markets bounce back the extra you had in equities will easily offset a drop in bonds .

sometimes less is more! taking the slight chance you may have your bonds fall in a downturn at this stage is far offet by not having to maintain as big a cash allocation to keep volatility in the same range.

this is something few realize when they think about the roll bonds play. bonds fly fighter cover.

 

[Which Roger]

We had several similar threads around this time last year, insisting that rates had nowhere to go but up, when the 10-year treasury rate was 2.61%. Yesterday is was 2.43%.

 

[jerome len]

Bonds are risky when rates are low; the question is are they better than MM funds or stocks? I like muni bonds since I pay taxes and the after tax rate is better than the avg bond rate I get at Vanguard. I split my money between long term and shorter terms....I can't tell you that this is the right thing to do but I've done it for years and its done fairly well for me......I do have a portion of my assets in stock.....not as high as others on this blog. rates will go up in the next year or two BUT.....will the stock market go down, can you live on low MM or CD rates? Tough questions, no one I know has the answer.

 

[aja8888]

Why not just buy into a municipal bond fund for now and wait it out? Something like VWITX makes a good, tax free dividend and doesn't get punished as much as a regular bond fund or individual bonds.

Woops Jerome, looks like we posted at the same time and mention Munis.

 

[karluk]

So bonds aren't doing well at the moment

This statement is not accurate. Being a numbers guy myself, it is quite surprising to me to see a thread started based on an incorrect premise. Bonds have been doing extremely well recently, being one of the best performing asset classes this year. In general, all bonds have been doing well, with long maturities outperforming shorter maturities. I started a thread early this year pointing out the unexpected, but very strong, bond rally. The trend has continued into early August, so perhaps it's time for an update. The three Vanguard funds I was tracking are now all up by double digits YTD. According to Vanguard's web site, VUSTX is up 14.84% through July 31, VLGSX is up 14.80%, and VWESX is up 12.51%.

http://www.early-retirement.org/forums/f28/how-long-can-the-bond-rally-continue-70280.html

Shouldn't a contrarian investor go heavy into bonds right now because they look so terrible?

The right time for a contrarian investor to make a big bond purchase was around this time last year. A purchase back then would have been handsomely rewarded. Now that bonds have been rallying for many months, it is hardly a "contrarian" stance to buy bonds. You might even be accused of chasing recent performance rather than acting like a contrarian.

 

[mrfeh]

So bonds aren't doing well at the moment, and they'll likely do poorly in the near future since interest rates have nowhere to go but up. Am I missing something? Shouldn't a contrarian investor go heavy into bonds right now because they look so terrible? Is there another reason to have bonds other than to help balance out the ride of stocks?

Don't try to time the market. Set your asset allocation, rebalance when necessary, and tune out the financial pundits.

Assuming you won't be selling (other than rebalancing) your bond funds for 5+ years, choose a low cost intermediate term bond fund and ignore the daily/weekly/monthly NAV changes.

 

[Gearhead Jim]

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.

 

[karluk]

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.

I don't necessarily agree that the volatility of a bond fund doesn't help to increase wealth. I personally made sizable purchases of bond funds last year while rates were rising. So far this year I have done a sizable amount of selling. I made a big profit from last year's purchases, but it's still too soon to know whether my selling this year will pay off or not.

My view is that it's impossible to make informed rebalancing decisions if you own individual bonds and carry them on the books at par with the intention of holding them to maturity. If you did this last year you were fooling yourself that you didn't "really" suffer a loss in your bond portfolio and needed to make new purchases to reestablish your target allocations. The opposite is true this year. If you are carrying individual bonds at par, you now have substantial gains and should be rebalancing out of bonds. But carrying the bonds at par more than likely leaves you unaware of your gains.

I know that a lot of investors swear by individual bonds, but to me it has never made sense. I like the immediate feedback of knowing what my investments are worth (either good or bad), and don't need to play mental tricks on myself to avoid selling bonds during periods of rising interest rates.

 

[robnplunder]

This statement is not accurate. Being a numbers guy myself, it is quite surprising to me to see a thread started based on an incorrect premise. Bonds have been doing extremely well recently, being one of the best performing asset classes this year.

Bingo. They are doing better or holding well against stocks this year which make this a good year for bond. My international bond is even doing better at 8% return YTD.

 

[mickeyd]

Pick an AA and stay the course. Why the fuss about bonds?

 

[daylatedollarshort]

Pick an AA and stay the course. Why the fuss about bonds?

There are pros and cons with both buying bonds directly and buying bond funds:

"Also -- and this is a key difference -- bond funds never mature, because the fund manager is buying new bonds to replace those that mature, or those he sells. So the fund's share price can go up or down, mostly in response to changes in interest rates, and you can never be sure of getting your principal back when you sell the fund shares."

Sometimes You Should Buy The Bonds Directly - Sun Sentinel

It is probably not a great time to be buying into longer term bond funds as the odds are rates will rise, not to go lower.

 

[mrfeh]

It is probably not a great time to be buying into longer term bond funds as the odds are rates will rise, not to go lower.

If you hold shares of a bond fund (not individual bonds), you want rates to rise. Over time, the primary source of return from bond funds is the dividend, not the NAV change.

If you're looking for capital appreciation, buy stocks.

How to Adjust Bond Mutual Fund Strategies in Face of Rising Interest-Rate Risk

 

[daylatedollarshort]

If you hold shares of a bond fund (not individual bonds), you want rates to rise. Over time, the primary source of return from bond funds is the dividend, not the NAV change.

If you're looking for capital appreciation, buy stocks.

How to Adjust Bond Mutual Fund Strategies in Face of Rising Interest-Rate Risk

From Forbes -

"First, invest in short term bonds. Bonds with longer maturities will be hit harder when interest rates rise. "

Why Rising Interest Rates Are Bad For Bonds And What You Can Do About It - Forbes

 

[mrfeh]

From Forbes -

"First, invest in short term bonds. Bonds with longer maturities will be hit harder when interest rates rise. "

The NAV will be hit harder. If you don't sell, you don't care about the NAV.

 

[pb4uski]

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.

A middle road are target maturity bond ETFs that own a portfolio of bonds that mature in a particular year. In aggregate, they act like individual bonds in that you get the par value at maturity (absent any credit defaults) even if rates rise. You get professional bond picking and more diversification and I suspect better pricing than would be likely in an individual bond portfolio but in exchange for an expense of 10-42 bps depending on the ETF you select.

The problem is that there are relatively few series of these ETFs, mostly from BlackRock (iBonds) and Guggenheim (Bulletshares) and they are relatively new.

 

[daylatedollarshort]

The NAV will be hit harder. If you don't sell, you don't care about the NAV.

If you are not concerned with ever getting your principal back, even after your demise for your estate, then buying or owning long term bond funds in a rising interest rate environment is the right investment choice for you.

 

[mrfeh]

If you are not concerned with ever getting your principal back, even after your demise for your estate, then buying or owning long term bond funds in a rising interest rate environment is the right investment choice for you.

The NAV recovers in time; it doesn't stay at the lower value forever.

Look at the NAV of any intermediate term bond fund over 10+ years. You'll see it meanders, but never very far, or for very long.

As always, the average duration of the bond fund should be appropriate for your investing horizon (aka when you expect to sell).

 

[mathjak107]

rising rates will always leave you behind the curve unless they level off as well as unless you are talking treasury bonds the changinging of credit worthiness and investor sentiment on corporate bonds can make things never catch up when dealing with funds since you have two issues going on and not just an interest rate link..

 

[mrfeh]

Here is a discussion at bogleheads.org on this very subject for those still interested:

Bogleheads • View topic - Bond Funds - Higher Rates - Point of Indifference

 

[Fermion]

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.

Won't inflation typically go hand in hand with a significant increase in rates?

Not always I guess but a lot of the time?

 

[haha]

Here is a discussion at bogleheads.org on this very subject for those still interested:

Bogleheads • View topic - Bond Funds - Higher Rates - Point of Indifference

There seems to be a lot of misunderstanding of bonds and the meaning of duration.

This chart tells the whole story, clearly and cleanly. It proves that given time, rate rises are the bondholders friend. How much time is a function of the holdings duration. About 3 years ago I bought a few bond funds, their duration has varied between ~3.3 and 4.5. If I look only at the broker's summary of my basis, I am still in a loss position. But if I tally what have been my cash investments, not including the monthly dividend re-investments, I am way ahead in terms of total return. I am particularly way ahead when I compare what I would have if I had invested in very short term paper with lower rates, but which did not go down in price per unit when interest rates rose.

When this topic is discussed, we always get the same range of opinions. My guess is that we will still be getting the same range of opinions five years from now. I guess that is what is meant by ymmv. But really, this is pretty much cut and dried, how can one's mileage reasonably vary from the simple reality? You look at the chart, you see the lines crossing. What part of the story does this not address?

Ha

 

[mrfeh]

There seems to be a lot of misunderstanding of bonds and the meaning of duration.

This chart tells the whole story, clearly and cleanly. It proves that given time, rate rises are the bondholders friend.

Bingo!

 

[Gearhead Jim]

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?

 

[gcgang]

We have basically had a bond bull market for 32 years, with long Treasuries declining from 15% to the current 3+%.

Rates can stay down for a long time, but looking at bond performance since 1982 is not a good way to access your risk. A better time would be to look at mid 1970's thru 1982.

Not saying that's going to reoccur, but losses to purchasing power as well as NAV erosion took a mighty toll on bond holders during that period, as inflation was significant.


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