Bond fund questions

[charlie]

Of course you are right, Audrey, that it is not that simple. Generally, however, the Fed increases interest rates to combat inflation, no?
Longer rates don't always follow in lock-step. Also, I think I read somewhere that munis are somewhat less sensitive than corporates or treasuries.

That said, however, if you have a better way of making a ball park guess, please feel free to elaborate.

Cheers,

charlie

 

[youbet]

No, it's just not that simple - not all durations react the same way to Fed rate increases. Please see my reply #6 above:

http://www.early-retirement.org/forums/f28/bond-fund-questions-47566.html#post880616

You're formula may be a decent predictor for the reaction of different durations due to increasing inflation, but not due to Fed interest rate increases.

Audrey

charlie said "market interest rates," not "Fed interest rate increases." I believe he is correct. If corresponding market rates increase, the fund will lose value by approximately the duration x the market rate increase.

 

[youbet]

If market interest rates go up, you will see about 1% drop in the NAV of your bond fund for every year of "duration". Your initial cash flow won't change at first, but as the lower yielding bonds are replaced with higher yielding bonds, your income will gradually rise until the extra income replaces the loss of NAV. For example, if the duration of your fund is 10 years, the initial NAV will drop 10% if interest rates rise 1% and it will take 10 years to recover the loss. The reverse is true if interest rates drop.

I hope I did not screw this up. Somebody please correct me if wrong.

Cheers,

charlie

I believe that is the generally accepted theory charlie. Your clear distinction that it's market interest rates and not Fed rates is key.

 

[brewer12345]

Actually, as a point of clarification, the price response to duration is only valid for 1) an instantaneous parallel shift in the yield curve and 2) a bond with zero convexity. IOW, its rare to see bonds move exactly according to the formula.

 

[clifp]

Uhoh. Someone did something on my advice? Lucky it randomly turned out to be good...

Always do your own DD folks. Some yahoo on the interweb may spout something random off, but you have to live with the consequences.

I do listen to your advice, and believe it not take full responsibility for the bad investments, and give you partial credit for things that go up. So it is really a can't lose situation for you.

So with that in mind, what is your feeling on junk bonds, specifically Vanguard's junk bond fund. It is up over 46% since I bought it in Nov last year. Both its yield and the relative spread vs Treasury have dropped considerably. I really bought it for the income but I can't complain about the stock like capital appreciation. Of course if I do sell it other than paying of my mortgage, I am not sure what I'd do with the money..

 

[mathjak107]

the problem for any bond funds other then treasuries is that they trade on other factors besides where rates rise. its impossible to figure out if you will ever be whole again if rates rise and your municipal bond fund or corporate bond fund drops .

with treasuries the eventual offset by higher paying bonds will eventually bring you back whole if you stay in the fund long enough . the credit risk, defaults and credit down grades effect muni bonds and corporates more then interest rate changes...

i use the vanguard intermediate investment grade bond fund and fidelity investment grade bond fund for 25% of my portfolio and fidelity strategic real return for 11% of it..


for speculation i dart in and out of TLT

 

[brewer12345]

Personally, I think the easy money has been made on junk. It is quite possible that the rally will continue, but it will not be the rocket ride it has been. But people seem to be reaching for yield. In the recent past I have seen covenant lite deals, a junk issue that will fund a sponsor dividend, a new CMBS deal, and I am even hearing rumors of imminent new CLOs, believe it or not.

If you have a big gain that has unbalanced your portfolio, take some junk winnings off the table, IMO. I have been selling off my appreciated bonds to reallocate to other sectors (equities, bank loan funds, commodities, MERFX), and to pay down debt