Bond Question

[mbnj77]

Hey all, I have a novice's question, (and a bit of long one I'm afraid), but I never have quite understood bonds and what affects them.

We are building a sizeable, for us, after-tax bucket with Fidelity that we will need to tap to cover our pre-SS gap in about 5 years. (we are both 52 and will FIRE at 57). I always thought that bonds, though yielding less than stocks, were a much safer haven. In this bucket, we do have equities but we also put in a big chunk in a municipal bond fun, (about 45% of the total bucket), as gains are tax free. We did this only weeks ago thinking that though we weren't shoving the money under the mattress, this would be fairly safe if not lucrative.

Well, the fund has dropped significantly over the last couple of weeks and we haven't even gotten the first monthly dividend yet. Did we make a mistake?

I know with inflation and the likelihood of rising interest rates, bond prices will fall, (my fund will decrease in value, yes?), but should I expect the yield to rise enough for this investment to still make sense?

We also have some with Vanguard and for bonds, they allocate across three funds with varying durations. That also has decreased.

Should I move the money to Vanguard because the funds are at least a little more diversified? Or should I just move to Ally or a CD as discussed in another recent thread.

Thanks much; a stock I get, but I just can't seem to wrap my head around bonds.

[Senator]

Quote:

Originally Posted by mbnj77 Well, the fund has dropped significantly over the last couple of weeks and we haven't even gotten the first monthly dividend yet. Did we make a mistake? I know with inflation and the likelihood of rising interest rates, bond prices will fall, (my fund will decrease in value, yes?), but should I expect the yield to rise enough for this investment to still make sense? We also have some with Vanguard and for bonds, they allocate across three funds with varying durations. That also has decreased. Should I move the money to Vanguard because the funds are at least a little more diversified? Or should I just move to Ally or a CD as discussed in another recent thread. Thanks much; a stock I get, but I just can't seem to wrap my head around bonds.

Only time will tell if you made a mistake, but if you have proper asset allocation, it may work itself out. I am 50% equities, 50% real estate. I only own index ETFs, not individual stocks. IVV, IVW, DVY, QQQ, IWM,

As interest rates rise, you can expect the yield to rise, on the NEW asset price. The new asset price will be lower to account for the higher yield. That is why prices fall to take into account for inflation and new market yields.

I think you can find diversified yields most anywhere. There are ETFs, mutual funds everywhere, and many of them are similar (or identical). Look for expense ratios too.

[Big_Hitter]

I have a nice chunk in muni bonds, not bond funds. Since I plan on holding them indefinitely I don't worry about the fluctuation in value. Bond funds however....

the price of a bond = FRANK - check out the theory of interest by Steven Kellison

[pb4uski]

What you are probably seeing is interest rate risk... interest rates have ticked up over the last 30 days and as a result bond prices decline and the value of your proportional interest in the fund (a portfolio of muni bonds) declines. For example, the Vanguard Intermediate Term Tax-Exempt fund has declined about 1% so far this month ($14.32 now vs $14.46 at the beginning of October).

[Big_Hitter]

there are 10 risks associated with investing in fixed income securities - OP, you may want to read the handbook of fixed income securities by Fabozzi

[pb4uski]

Quote:

Originally Posted by Big_Hitter I have a nice chunk in muni bonds, not bond funds. Since I plan on holding them indefinitely I don't worry about the fluctuation in value. Bond funds however....

If you plan on "holding them indefinitely" there isn't much difference between holding bonds or holding a bond fund... as interest rates change eventually the bond fund will catch up as bonds in the fund mature and the proceeds get reinvested.

[Big_Hitter]

Quote:

Originally Posted by pb4uski If you plan on "holding them indefinitely" there isn't much difference between holding bonds or holding a bond fund... as interest rates change eventually the bond fund will catch up as bonds in the fund mature and the proceeds get reinvested.

indefinitely in my world is to maturity?

[Senator]

Quote:

Originally Posted by Big_Hitter indefinitely in my world is to maturity?

I think you have a lot of risk in that. If you hold until maturity, you get 100% of your principle back. If you sell prior, you get a price based on current yields. You likely get a lower return overall , than a bond fund or ETF.

If you were someone that got a high yielding bond, the municipality could just call back in the bond, and issue a lower interest rate bond. So, expect that you will never be able to get above market returns for too long.

...I guess i just do not like bonds.

[Big_Hitter]

Quote:

Originally Posted by Senator I think you have a lot of risk in that. If you hold until maturity, you get 100% of your principle back. If you sell prior, you get a price based on current yields. You likely get a lower return overall , than a bond fund or ETF. If you were someone that got a high yielding bond, the municipality could just call back in the bond, and issue a lower interest rate bond. So, expect that you will never be able to get above market returns for too long. ...I guess i just do not like bonds.

I"m not sure any of them are callable or redeemable, I'll have to check.

[LOL!]

When bonds go on sale, you are supposed to buy them ... not sell them.

In a situation where bond funds drop a bit over the course of one or two months, that's a buying opportunity or at least a rebalancing opportunity.

I doubt the bond funds at Vanguard are more diversified than the bond funds at Fidelity. If you give us ticker symbols, then perhaps we can comment on the choices you have made.

Oh, investing is all about losing money. If you don't lose money now and then, then you are not investing.

[FiveDriver]

If you look at the Bond Charts, there has been a fairly sizable decline since last June. If Interest Rates are going up -- the value of currently held lower rate Bonds is going to go down. It's the Theory of Substitution, writ large. The threat of Interest Rate Hikes, the possibility of regime change in Washington, Janet Yellen, British Exit, Mid-East Battles.....altogether too much turmoil for Bonds.

As a tracking vehicle, I put $10K into Fido's Total US Bond Index Fund back in August......it's not been pretty. It's down about 1.5% over the three months. I'd hate to have a lot of dough tied up in that sector.

WARNING -- UNPOPULAR OPINION FOLLOWS.....
IMO, it's not out of the question to have a portion of your Bond Allocation in a Tax-Free MM Fund while things settle down. The direction may become clearer after the Election, or the Inauguration, or whatever else is in the wind. You can move into Bonds with a single phone call.

[Big_Hitter]

Quote:

Originally Posted by FiveDriver IMO, it's not out of the question to have a portion of your Bond Allocation in a Tax-Free MM Fund while things settle down.

why not a taxable MM fund? either pays almost zero

[FiveDriver]

I guess it would depend on your Tax Bracket and your State of Residence. I'm doing my thing inside my Rollover IRA, looking to DCA into the Bond Fund. I think the OP said this was his after-tax bucket.

[akck]

Quote:

Originally Posted by Big_Hitter I"m not sure any of them are callable or redeemable, I'll have to check.

These are referring to individual bonds in the fund. What can happen is a high interest rate bond is called and is then replaced by a lower interest rate bond with the proceeds. The fund value gets a double hit because the called bond added value while the replacement bond likely goes in at par or at a premium which further drops the fund value over time, assuming interest rates go up.

[Big_Hitter]

I have individual bonds, not bond funds.

[Gill]

Quote:

Originally Posted by mbnj77 ...but we also put in a big chunk in a municipal bond fun, (about 45% of the total bucket), as gains are tax free.

Do you know that gains in municipal bonds are NOT tax free? Only the interest is.
Bruce

[mbnj77]

Ok, First, thanks MBMiner, I didn't know that only the interest was tax free. So if I sell and there is a capital gain, (HA!), that will be taxed. Got it.

I have the money at Fidelity in FNJHX. ( I live in NJ) At Vanguard, VWIUX, VMLUX & VWLUX at about 15% each with the rest in Equities.

Again, my time horizon is five years when we will need to tap this. Thanks much.

[mathjak107]

holding bonds to maturity or selling a bond fund still can leave you with the same loss .

selling a bond fund and taking a loss in value or getting repaid 1k on a muni in 25 years and even at 3% inflation and getting back 500 bucks worth of purchasing power can be the same damage .

when rates rise you are always going to be behind the curve