Are You Worried About Your Bond Index Fund?

[Ready]

Would holding individual bonds in a “ladder” where you have equal amounts maturing in, say, 1 year, 2 years, 3 years, etc. be a reasonable alternative to holding a bond fund? It would eliminate a lot of interest rate risk for the bonds closest to maturity, so if you need to sell, some (hopefully all or most) of your principal would not be at risk; if you did not need the cash, you could reinvest at the long end of the ladder and have a portfolio of bonds that mature on a regular schedule. I guess I was thinking with a bond fund, if your fellow investor panic, the fund might have to sell at a loss even if you were content to stand pat.

There is certainly nothing wrong with this strategy. But I don’t see it as a way to eliminate interest rate risk. It may feel better psychologically to know that you can hold the bonds to maturity without losing any value. But all of the studies I’ve read suggest that the interest rate risk is no different between individual bonds and bond funds. They just handle the risk differently.

With an individual bond you can hold on to it until maturity but if rates rise you are holding a substandard investment. Or you can sell it at a loss but reinvest the money in higher yielding bonds.

With bond funds, the NAV will go down as rates rise, but over time the fund manager will replace the lower yielding bonds as they mature with higher yielding bonds in their place. And that will eventually bring the NAV back up.

The advantage to bond funds is that you can buy them in any denomination. So if you want to buy $200 worth you can do that. With individual bonds you have to go into the market place and buy whatever is available. And in small quantities you will not negotiate as good of a price as a fund manager buying millions of dollars worth.

So over the long term you will do roughly equal with either strategy. It just comes down to which one is more comfortable for you and a better fit for your overall portfolio.

 

[ProGolferWannabe]

With an individual bond you can hold on to it until maturity but if rates rise you are holding a substandard investment. Or you can sell it at a loss but reinvest the money in higher yielding bonds..

This makes sense. My only comment would be that if you held a bond fund to date X, and an individual bond to the same date, you would know with certainty what you would have in your pocket with the individual bond on date X, not so much with the bond fund. Maybe that is different than interest rate risk?

 

[Ready]

This makes sense. My only comment would be that if you held a bond fund to date X, and an individual bond to the same date, you would know with certainty what you would have in your pocket with the individual bond on date X, not so much with the bond fund. Maybe that is different than interest rate risk?

Correct. But from a practical standpoint how useful is this? You generally buy bonds or bond funds as part of a long term investment strategy, and then gradually sell a small portion at a time to cover your living expenses once retired. I suppose if you knew for sure that you would need all of the money on an exact date, and could line that date up with the maturity of an individual bond, you could get more certainty. I just don’t know how much that applies in the real world of investing.

 

[disneysteve]

You generally buy bonds or bond funds as part of a long term investment strategy, and then gradually sell a small portion at a time to cover your living expenses once retired.

I don't agree with the bolded part. People purchase bonds and collect the monthly interest payments to use toward their living expenses. When the bond matures, they take the principal and buy another bond to continue that monthly income stream. My 90-year-old mother has been doing that for 30 years. She has never sold bonds to access the principal.


The problem in recent years has been that as older bonds matured, the interest rate available on new bonds has been very low making it hard to replace the income unless you ventured into higher risk issues.

 

[pb4uski]

According to Christine Benz the formula is bond fund avg duration minus SEC yield.
Part 6: What Kinds of Bonds Should I Hold?

"...to estimate how much an investor could lose during a 12-month period if Treasury yields increased by 1 percentage point during that same 12 months, subtract a fund's SEC yield from its current duration."

Agreed.... I was referring to solely the change in value and not total return for the year... but the point was that all else being equal it'll take about 6 years to get back to where you started and that doesn't sound very good to me.

 

[Markola]

I’ve got to push back on this old axiom. Stocks have drifted higher over decades because earnings increased due to innovation and rising population. What would even be the theoretical reasoning behind bonds doing well over long periods of time when starting at near record low yields?

Fine to push back. My personal answers, as someone with a globally-diversified, 50/50 allocation, include:

1) The value of my bond index funds for rebalancing ballast with my stock funds has not changed.
2) What is the alternative? Even with low returns, I like my bond index funds over gold, real estate or crypto. And I prefer my dollars be working hard every day rather than sitting around in cash. A CD ladder makes sense but I’m lazy and retired.
3) Despite years and years of experts’ predictions for certain bond decimation, my Vanguard Total U.S. Bond Index Fund returned 7.2% in 2020, which beats a sharp stick, and then some. It’s been that way for years and years, except 2018, I think, after which, bonds bounced back strongly.
4) I have not lived through a period of rising interest rates in my investing life but I figure my bond index funds will rotate out the old and rotate in the new. The fund’s Weighted Average Maturity is 8.5 years, so that’s a good-enough bond ladder for me, without lifting a finger.
5) What happens if we get deflation rather than the inflation that the media is so freaked out and certain about? (Speaking of axioms, one of mine is, whatever the cover of Money Magazine is worried about is usually the opposite of what will happen.) With interest rates near zero or even negative, there’s a case that the primary risk is deflation, in which case, I will love my bonds as a hedge.

Maybe I’m wrong and YMMV, of course.

 

[Ready]

I don't agree with the bolded part. People purchase bonds and collect the monthly interest payments to use toward their living expenses. When the bond matures, they take the principal and buy another bond to continue that monthly income stream. My 90-year-old mother has been doing that for 30 years. She has never sold bonds to access the principal.


The problem in recent years has been that as older bonds matured, the interest rate available on new bonds has been very low making it hard to replace the income unless you ventured into higher risk issues.

What is the ultimate goal here? If you want your heirs to inherit all of your bond fund shares I suppose that can work. But if your goal is to enjoy your money while you are alive then living off bond interest payments but never actually selling any of the bonds virtually guarantees you die with substantial assets left over.

If you are planning on a 4% withdrawal rate, there may be some years where the bond payments cover your expenses. When yields are lower you may need to sell some of the bond fund shares.

A 90 year old who is living exclusively off bond interest payments clearly is going to be leaving a large inheritance to someone. That’s fine if it’s her plan to do so. I have no desire to do that.

 

[pb4uski]

+1 I saved this money to enjoy my retirement, not to hoard it for the benefit of my heirs.

 

[audreyh1]

@Audreyh1 I agree with you - but how often/when do you rebalance? I try to limit to twice a year and then only if my AA is out by five points or more.

Pretty much just once a year when I take my withdrawal. If it’s not much out of balance I don’t bother.

 

[JustCurious]

I'm not worried about my bond index fund.

 

[tdv2]

Again no. Every single time an asset class starts to underperform a thread starts and multiple predictions about the future materialize. At this point I just chuckle because I realize it's human nature to look at short term risk or performance and extrapolate it out into the future many years. Is it smooth sailing from here on out?? I wouldn't bet on it. When the stock market looks ugly and prices are tanking is it a good time to sell? Of course not....in fact the opposite it usually true. Put things in perspective and focus on your portfolio performance, some assets might wildly over perform and others may underperfom....unfortunately there is no way to predict what will do what ahead of time. As a result, and as part of my diversified portfolio construct, a portion of my stash in intermediate term bonds....and don't forget to rebalance periodically. Carry on.

 

[disneysteve]

A 90 year old who is living exclusively off bond interest payments clearly is going to be leaving a large inheritance to someone. That’s fine if it’s her plan to do so. I have no desire to do that.

She doesn't just live on bond interest. She also gets SS, dividends from individual stocks, dividends and capital gains from mutual funds, interest from CDs, etc.


The more I thought about it, though, she has taken out money over the years. Sometimes when bonds redeemed, she didn't roll over the full amount so I misspoke on that.


At 90, though, her expenses are pretty minimal. She lives in a subsidized senior apartment. She stopped driving a few years ago. And especially since COVID hit but even before that, she really didn't do much other than the occasional dinner out or tickets to a local community theater. So even with low interest rates, her income is more than enough to fund her lifestyle.

 

[street]

No.

 

[retire to nature]

The bond market may be in a different world than before. Buffett’s view of bonds:

https://www.businessinsider.com/war...leak-future-low-yields-treasury-market-2021-3

Thank you for the article. I sold VGTBX too. It was lower than this low interest banking interest. held less than 1 year and loss $3000. Was wondering about my decision, but this article showed it was righting to do.

 

[RobLJ]

For the last 3 months, once it started to become clear that vacccines would be effective and that we would be in a lengthy 0 yield environment (and before the Dalio article), I've pondered the function of intermediate and long-term bonds in a zero yield environment.
This is in a traditional portfolio, but in a zero-yield environment that I suspect will extend to 2023 to 2024, given unemployment and under-employment coming out of the COVID crash.

I have no answers, and in fact yuge risks are

a) stocks may crash
b) the Fed could go negative yield (in which case intermediate/long bonds will do fine).

Alternatives are
a) Tips/Ibonds (already mentioned)
b) Developing/Emerging market bonds
c) High Yield bonds
d) Real estate/REITS

Save Tips, these all have obvious risks similar to stocks, but I am looking at (gradually) using cash/some bond funds to gradually increase REIT holdings and TIPS. I probably will fund next years withdrawals out of bonds/cash rather than stock gains, if any. This is a lot easier than most of you since I'm at 50-27-23 allocation and I intend to gradually go back up to a 60% stock allocation by the time I'm at SS FRA in 4 years. Just holding on to bonds may make more sense for most of you, and I think the bond losses will cool down in a month or two since I think the market has over-reacted with immediate inflation expectations, but I do think long-term US govt bonds may be painful to hold.

 

[audreyh1]

I’ll just be buying more when I rebalance next Jan, that is if stocks aren’t negative at that time.

 

[skyking1]

Our AA is a mess and I have been doing some research, and this place once again delivers! What a great read this thread has been. My gut going in was to look into Vanguard's bond funds and this thread confirmed it. It will be a small measured start to fixing our AA, which is very cash heavy due to indecision.
We will also be opening an index fund there.

 

[disneysteve]

My gut going in was to look into Vanguard's bond funds and this thread confirmed it. It will be a small measured start to fixing our AA, which is very cash heavy due to indecision.
We will also be opening an index fund there.

VBTLX or the ETF version BND will serve your purpose well. They are currently yielding 1.32 or 1.33% which is probably over double what your cash is earning. If you want to boost your return but not take on more equity risk, it's a perfectly sensible way to go.

 

[skyking1]

Thanks Steve. The CD ladder is going flat over the next 6~12 months, so it will be a gradual move which I am coming to see it always best.

 

[Montecfo]

VBTLX or the ETF version BND will serve your purpose well. They are currently yielding 1.32 or 1.33% which is probably over double what your cash is earning. If you want to boost your return but not take on more equity risk, it's a perfectly sensible way to go.

well, -2.54% YTD total return for VBTLX and duration of 6.6.

Too risky for me in a rising rate environment.

 

[VanWinkle]

well, -2.54% YTD total return for VBTLX and duration of 6.6.

Too risky for me in a rising rate environment.

What's the clue for rates turning around so we can sell short term
and buy back into Total Bond? It's too risky for me to hear the
noise at the right time, so I stick to my plan.

Best to you,

VW

 

[mrfeh]

What's the clue for rates turning around so we can sell short term
and buy back into Total Bond? It's too risky for me to hear the
noise at the right time, so I stick to my plan.

Best to you,

VW

+1

If you're holding such funds long term (as you should be), you don't care that rates are probably going to rise. In fact, you want rates to rise.

 

[skyking1]

+2
You've all been helpful.

 

[disneysteve]

Someone once said that if some part of your portfolio isn’t under-performing at any given time you aren’t adequately diversified.

Yes, bonds aren’t doing great right now. That’s not a reason not to own them.

Especially if you are investing over time, having the NAV be down is a good thing so your money buys more shares.

 

[steelyman]

Someone once said that if some part of your portfolio isn’t under-performing at any given time you aren’t adequately diversified.

Yes, bonds aren’t doing great right now. That’s not a reason not to own them.

Especially if you are investing over time, having the NAV be down is a good thing so your money buys more shares.

That’s how I feel. Come rebalancing time I’ll add more.