Bond question

[emi guy]

I hope I placed this in the correct section of the forum.

Can someone please explain what importance the Net Asset Value (NAV) plays in a bond fund if one plans to use the fund for interest income (not owning it for a potential gain) in retirement? I've heard from advisers (on the radio and else where) that owning a bond fund during a rising interest rate environment is bad because the NAV is inversely proportional to rate movement (as rates rise, the NAV of the fund will go down) but if one doesn't care about the NAV, and owns the fund for the interest income, it doesn't matter. I'm confused by this statement and haven't been able to find anything written about it on the net. To me, it seems that, just like stocks, you don't want to own any fund that goes down, right?
I own the Vanguard GNMA Fund that pays a reasonable interest rate and carries no credit risk since it is backed by the Treasury but it's NAV is at historic highs.
As interest rates rise, I expect that it's NAV will fall. Should I care as long as it continues to pay the interest? Is there a way to determine what portion of a funds appreciation is due to appreciation and which is due to the interst pay through? Thanks!

[GregLee]

Quote:

Originally Posted by emi guy To me, it seems that, just like stocks, you don't want to own any fund that goes down, right?

Right. Unless you bought shares in the past and will never sell those shares, in which case you don't need to be concerned about the value of the shares. You're not buying the shares, and not selling them, so why care what their value is?

[Bikerdude]

The managers of VFIIX are keeping duration low in this fund. Most likely they are expecting higher rates. If they are correct, they would be replacing lower yields with higher in a reasonably short period of time. So far mtg rates are still falling making current yields hard to maintain.

If your looking for safe income and not primarily concerned with capital gain, its a good choice.

[DblDoc]

I'd recommend reading this: Individual Bonds vs a Bond Fund - Bogleheads

DD

[DoingHomework]

Quote:

Originally Posted by Bikerdude The managers of VFIIX are keeping duration low in this fund. Most likely they are expecting higher rates. If they are correct, they would be replacing lower yields with higher in a reasonably short period of time. So far mtg rates are still falling making current yields hard to maintain. If your looking for safe income and not primarily concerned with capital gain, its a good choice.

Yes, that is the key. One must always watch duration in a bond fund. If duration is long then if rates rise the fund will be stuck with old bonds that yield less than fresh bonds and you would be stuck in an underperforming fund. You could always get out except that the NAV would have gone down so you would suffer a capital loss.

If the managers move to a lower duration then they will have maturing bonds that they can reinvest at the higher rates right away and avoid underperforming.

As noted, the well managed GNMA bond funds are down to 2-3 duration right now which is very good. We have a ton of money in the TRP GNMA fund and have done quite well from declining rates and are very happy that they now sit at a low duration and are continuing to yield a decent amount.

[Koolau]

I suppose you could make the same argument for owning dividend paying stocks. It doesn't really matter what the NAV is as long as the dividends either continue to rise or at least are not cut. Theoretically, with bonds, you have a "contractual" floor to the income whereas with stocks, there is no floor on dividends. Still, some stocks have been so consistent on paying dividends (and increasing them) that it would be almost as "safe" to depend on dividends as on coupons. As always YMMV and do your own homework on this - plus, I could be full of it.

[emi guy]

The obvious difference being that dividend stock funds carry the additional credit risk of the company and the potential to lose money due to a company failing. The GNMA fund mentioned earlier is 100% backed by the Treasury thus does not contain credit risk. But, as mentioned, there is interest rate risk.

[DoingHomework]

Quote:

Originally Posted by emi guy The obvious difference being that dividend stock funds carry the additional credit risk of the company and the potential to lose money due to a company failing. The GNMA fund mentioned earlier is 100% backed by the Treasury thus does not contain credit risk. But, as mentioned, there is interest rate risk.

With dividend stocks you also have to worry about cash flow problems. A good company might have plenty of money to sustain itself for the long term but might not have enough current earnings to afford a dividend payment for a short period. Think about BP. They suspended their dividend. Other companies have also done that for various reasons. That is a different risk thaninsolvency.

[mathjak107]

what happens with a bond fund is rates are variable and share price varies. the problem in retirement with not watching nav is if the funds interest rates fall you may have to sell shares to make up the shortfall in income and you never want to sell shares when they are down.

same is true about trying to use dividend paying stocks as a proxy for cash vehicles.. dividends usually fall just when share prices drop. if you have to make up a shortfall in income you will have to sell shares when they are down.

[scrabbler1]

Quote:

Originally Posted by emi guy I hope I placed this in the correct section of the forum. Can someone please explain what importance the Net Asset Value (NAV) plays in a bond fund if one plans to use the fund for interest income (not owning it for a potential gain) in retirement? I've heard from advisers (on the radio and else where) that owning a bond fund during a rising interest rate environment is bad because the NAV is inversely proportional to rate movement (as rates rise, the NAV of the fund will go down) but if one doesn't care about the NAV, and owns the fund for the interest income, it doesn't matter. I'm confused by this statement and haven't been able to find anything written about it on the net. To me, it seems that, just like stocks, you don't want to own any fund that goes down, right? I own the Vanguard GNMA Fund that pays a reasonable interest rate and carries no credit risk since it is backed by the Treasury but it's NAV is at historic highs. As interest rates rise, I expect that it's NAV will fall. Should I care as long as it continues to pay the interest? Is there a way to determine what portion of a funds appreciation is due to appreciation and which is due to the interst pay through? Thanks!

I have been in bond funds for the last 20 years, mainly for the income. So, the NAV mattered little if at all to me as long as I was not buying and selling shares often. Thankfuly, the biggest purchase I ever made of bond fund shares I made while the NAV was near its lowest, enabling me to buy about 25% more shares than I expected to.

One good thing about the NAV being low and the yield being high is that when I reinvested the dividends I had a high dollar amount buying shares at a low price, a doubly good scenario.

Another thing I have found over the years is that bond funds don't have cap gains distributions very often. In some of the funds, many years went by without one and often (but not always) they were very small.

[audreyh1]

Quote:

Originally Posted by emi guy I hope I placed this in the correct section of the forum. Can someone please explain what importance the Net Asset Value (NAV) plays in a bond fund if one plans to use the fund for interest income (not owning it for a potential gain) in retirement? I've heard from advisers (on the radio and else where) that owning a bond fund during a rising interest rate environment is bad because the NAV is inversely proportional to rate movement (as rates rise, the NAV of the fund will go down) but if one doesn't care about the NAV, and owns the fund for the interest income, it doesn't matter. I'm confused by this statement and haven't been able to find anything written about it on the net. To me, it seems that, just like stocks, you don't want to own any fund that goes down, right? I own the Vanguard GNMA Fund that pays a reasonable interest rate and carries no credit risk since it is backed by the Treasury but it's NAV is at historic highs. As interest rates rise, I expect that it's NAV will fall. Should I care as long as it continues to pay the interest? Is there a way to determine what portion of a funds appreciation is due to appreciation and which is due to the interst pay through? Thanks!

Most bond funds recover over time. If you use the asset allocation and rebalance method of maintaining your portfolio, you just rebalance and move on. IMO it doesn't matter that much in the long run. Of course, I don't try to live off of interest alone anyway. Just take a fixed % out of total portfolio every year and count on dividends plus capital appreciation to grow the portfolio over time.