Bond vs Bond Fund

[gayl]

Thanks. I think I must have misunderstood the post I cited earlier & perhaps muddied the water. I thought previous post was saying you were considering whether to use individual bonds or a bond fund until RMD time when you would change to something else. Usually when selecting "bonds" (or their alternative, I just don't care for the fixed income terminology), someone picks duration/maturity based on their need. That is complicated now due to anticipated frequent rate shifts. So, one has to balance which risk is more important to them.



I think in your case I'd try to not overthink it & build a ladder of some sorts; but not one that stops with year 1 rmd.



btw, I didn't pick up on what "FTB" is...



Good luck & whatever you decide, don't look back!

FTB = California state taxes. Ugh.

 

[RetMD21]

Well, my revised strategy has me holding no more than 10 years in fixed so that skews my AA to a higher stock position. As mentioned, I could choose the more conservative approach of reducing my stock allocation and "stop playing", but I choose to "keep playing" as I feel 10 years worth of highly discretionary spend (along with levers to pull to reduce spending if needed) is enough to ride out most bear markets.

I think when you are "overfunded" a large range of asset allocations will work

 

[BackcountryMe]

I'm not aware of any 3.5% notes. There was a 3.75% one year note form Citigroup that pays monthly which was good alternative to a one year CD at the time. However before buying a high grade corporate note, I always compare yield with CDs, agency, and treasuries. The corporate notes mentioned and that I bought were high grade notes at the following yields:

CIBC 42 month - 4.47%
Bank of Montreal 36 month - 4.5%
TD Bank 5 year - 5%
Citigroup 5 Year - 5%
Wells Fargo 3 year - 4.5%

All the above notes are safe alternatives to CDs and treasuries. However the bulk of my corporate note buys this year were from the secondary market and were high yield and lower investment grade with YTMs in some cases over 9%. However, I won't put 100% of my capital into high yield. I don't invest in equities at all and high yield notes in my mind are a safer bet than the casino mentality of the stock market.

Thanks for clarifying. I appreciate your perspective. Thanks to you, I pulled out my old copy of Graham's Security Analysis and feverishly re-read the chapters on fixed income investing. I'm not sure I'd buy these in a taxable account yet, but it seems like a no-brainer to replace my VBTLX/BND position with individual bonds. If we've learned anything, those mega banks are too big to fail (and far safer than they once were). I'm not sure I'd go five years out on the curve, but it's nice to be able to earn some decent yield finally.

The only reason to hold BND is if you think the Fed will go dovish again and you don't want to hassle of buying individual notes.

 

[mrfeh]

The only reason to hold BND is if you think the Fed will go dovish again and you don't want to hassle of buying individual notes.

One doesn't hold total bond funds for appreciation of the NAV. They are held for the dividend.

 

[BackcountryMe]

One doesn't hold total bond funds for appreciation of the NAV. They are held for the dividend.

That's so 2006!

The reality is that BND pays almost nothing and with a duration of 8+, you're more likely to get your tushy handed to you in capital losses than you are to make a real return through interest income.

 

[mrfeh]

That's so 2006!

The reality is that BND pays almost nothing and with a duration of 8+, you're more likely to get your tushy handed to you in capital losses than you are to make a real return through interest income.

If you hold it for 8 years, you should expect the total return to be the current SEC yield.

The NAV at sale may be higher or lower than the NAV at purchase. Nobody knows which.

Recency bias has apparently overwhelmed many posters on this site.

 

[Freedom56]

The only reason to hold BND is if you think the Fed will go dovish again and you don't want to hassle of buying individual notes.

With Fed funds rates at 2.5% and headed to 3.5%, money market funds yields should climb to around 2.5% short term and even higher if rates continue to rise exceeding the distribution of funds like BND. There is no rational argument to put new money today into ETFs like BND. Treasuries, CDs, agency and corporate notes are a better options and offer higher yields. If rates fall, yes BND will rise but individual corporate notes with yields of 4.5-5% will rise more.

If you look at fund flow data, you can clearly see that investors are exiting bond funds and buying individual bonds as prices of individual bonds are rising.

https://www.lipperusfundflows.com/#create:home:Home:/php/signup_trial.php

 

[BackcountryMe]

With Fed funds rates at 2.5% and headed to 3.5%, money market funds yields should climb to around 2.5% short term and even higher if rates continue to rise exceeding the distribution of funds like BND. There is no rational argument to put new money today into ETFs like BND. Treasuries, CDs, agency and corporate notes are a better options and offer higher yields. If rates fall, yes BND will rise but individual corporate notes with yields of 4.5-5% will rise more.

If you look at fund flow data, you can clearly see that investors are exiting bond funds and buying individual bonds as prices of individual bonds are rising.

https://www.lipperusfundflows.com/#create:home:Home:/php/signup_trial.php

I completely agree. I think most folks are intimidated by buying individual securities (stocks or bonds) and therefore they stick with funds. But unlike stocks, where it's hard to tell ex-ante if you're going to do better, it's much easier with bonds (as you've correctly pointed out).

Just curious, what were some of the 9% high yield bonds you picked up?

 

[Quattro73]

If you hold it for 8 years, you should expect the total return to be the current SEC yield.

The NAV at sale may be higher or lower than the NAV at purchase. Nobody knows which.

Recency bias has apparently overwhelmed many posters on this site.

Recency bias skewed Bogleheads into believing bond index funds=stock index funds.

 

[daylatedollarshort]

Recency bias skewed Bogleheads into believing bond index funds=stock index funds.

With interest rates rising significantly for the first time in decades, many of us former bond fund holders have had to get used to our cheese being moved.

 

[Freedom56]

Just curious, what were some of the 9% high yield bonds you picked up?

I bought this 6.75% December 2023 Note from Centurylink at $98.12 in June.

https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C647494&symbol=CTL4071342

I bought a lot more of this one that I have held since 2017 and every time it drops below par, I load up. This time I picked up a bunch at $98 for YTM of about 9%. Centurylink 7.5% 4/1/2024 Notes.

https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C649205&symbol=CTL4346902

Those bond funds that were buying this debt late last year to early this year well above par were selling it below par and now are buying back above par. This is a very predictable pattern that individual bond investors can take advantage of.

The company has been on a debt buying binge since 2018 due to covenants on their secured bonds with respect to leverage. They plan to spend $7 billion in cash buying back debt this year from the sale of their legacy assets.

 

[RunningBum]

Recency bias skewed Bogleheads into believing bond index funds=stock index funds.

I haven't been able to get my mind around bond index funds.

With stock index funds you get a % of each company in the index you are tracking equal (as best the fund can make it) to the % value each company has in the index. That means as companies do well and get bigger, you own an increasing amount of the company, and as they do poorer, you hold less. Seems good.

But what does a bond index track? Do they try to get a part of every bond issue out there? Do businesses issue bonds because they are going to grow and be more successful, or because they aren't doing well enough to raise the capital on their own? Do you really want to own more bonds from a company that has to borrow more and more money? Or is so much of it government bonds that the other bonds are just noise?

 

[all4j]

I haven't been able to get my mind around bond index funds.

With stock index funds you get a % of each company in the index you are tracking equal (as best the fund can make it) to the % value each company has in the index. That means as companies do well and get bigger, you own an increasing amount of the company, and as they do poorer, you hold less. Seems good.

But what does a bond index track? Do they try to get a part of every bond issue out there? Do businesses issue bonds because they are going to grow and be more successful, or because they aren't doing well enough to raise the capital on their own? Do you really want to own more bonds from a company that has to borrow more and more money? Or is so much of it government bonds that the other bonds are just noise?

You raise some important questions. I'll not really try to fully answer, but give a bit of a different perspective to speak to some of what I think you are getting at. I think you have 2 broad areas: (1) Why do companies issue bonds? (2) How do index funds work?

I think funds mostly use statistical sampling techniques so that they don't need to try & buy some of every bond. There are fundamental difference in the nature of bonds & stocks that make this much easier on the bond side. There are a few factors that affect the price of a bond: credit quality, duration, etc. So, when a bond is bought, there is somewhat of a ceiling in place for that bond's return & certainly for bonds with the same characteristics. With stock, the investor has greater risk, but also a chance at upside making more of a differentiation.

Companies should issue bonds when that is cheapest form of capital & capital is "needed". Now some may issue bonds because they can. A few years ago Microsoft, Apple, etc were issuing bonds...because they were in trouble? or because capital was cheap (almost to point of being free)? Think thru the company accounting for debt vs equity & you'll see the impact is quite different from both the company side & investor side.

As to question of buying more bonds from a company that has to borrow more and more? Think of it this way...you may also own shares in that company on the stock side. If the company is borrowing inappropriately, there is likely more risk on the equity side than the bond side, right?

For the most part, the lower volatility of bonds lessens the distinction between specific assets. It is important to select the right area of the debt market. The individual bond owner or fund manager can scrape a little bit out on cap gain/loss, but coupon payment will account for lion share of return usually. If the index calls for "investment grade" & the company fails to sustain that level, the fund will have to sell that bond.

Always a good idea to not invest in things that we don't understand, although probably few really understand all the nuances.

 

[aliang0902]

I bought this 6.75% December 2023 Note from Centurylink at $98.12 in June.

https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C647494&symbol=CTL4071342

I bought a lot more of this one that I have held since 2017 and every time it drops below par, I load up. This time I picked up a bunch at $98 for YTM of about 9%. Centurylink 7.5% 4/1/2024 Notes.

https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C649205&symbol=CTL4346902

Those bond funds that were buying this debt late last year to early this year well above par were selling it below par and now are buying back above par. This is a very predictable pattern that individual bond investors can take advantage of.

The company has been on a debt buying binge since 2018 due to covenants on their secured bonds with respect to leverage. They plan to spend $7 billion in cash buying back debt this year from the sale of their legacy assets.

Thank you!

 

[Markola]

I haven't been able to get my mind around bond index funds.

With stock index funds you get a % of each company in the index you are tracking equal (as best the fund can make it) to the % value each company has in the index. That means as companies do well and get bigger, you own an increasing amount of the company, and as they do poorer, you hold less. Seems good.

But what does a bond index track? Do they try to get a part of every bond issue out there? Do businesses issue bonds because they are going to grow and be more successful, or because they aren't doing well enough to raise the capital on their own? Do you really want to own more bonds from a company that has to borrow more and more money? Or is so much of it government bonds that the other bonds are just noise?

I’m no bond expert but half our net worth is in bonded index funds, so the reasons I buy them are:

1) To be honest, Jack Bogle said it was even better to index bonds than stocks, and I trusted his judgment at face value.

2) Diversification of risk. Our domestic total bond index fund is exposed to 10,121 bonds and our international total bond index fund is exposed to 6,728 bonds. We’ll get paid back.

3) Duration. It is painful to be locked in to bond index funds while rates are rising. However, I trust that someday, rates will fall but our index funds at that time will still be chock full of higher yielding bonds for a time.

4) I don’t want to learn to trade bonds.

 

[daylatedollarshort]

I’m no bond expert but half our net worth is in bonded index funds, so the reasons I buy them are:

1) To be honest, Jack Bogle said it was even better to index bonds than stocks, and I trusted his judgment at face value.

2) Diversification of risk. Our domestic total bond index fund is exposed to 10,121 bonds and our international total bond index fund is exposed to 6,728 bonds. We’ll get paid back.

3) Duration. It is painful to be locked in to bond index funds while rates are rising. However, I trust that someday, rates will fall but our index funds at that time will still be chock full of higher yielding bonds for a time.

4) I don’t want to learn to trade bonds.

I am not trying to change your mind, but here are some counterpoints for those who are open to other investment ideas other than Boglehead advice. Right now CDs with FDIC insurance and Treasuries might be yielding more than your bond funds with no potential loss of principal, and government backing, which takes care of the risk part, unless the government collapses. You don't have to learn bond trading to buy CDs or Treasuries. TIPS are earning more than I bonds, up to .99% + CPI inflation, and take maybe 60 seconds to put in an order when the auctions come up.

If you do have short term CDs and Treasuries, you can always switch back to bond funds if rates go down with no penalty. Thinking a bond fund might be a good bet in 2 years doesn't mean you have to own it today. You can own CDs or Treasuries today and always pivot back to bond funds when rates level off or decline.

This type of strategy is outlined in this Kiplinger article - Bonds Are Having a Rough Year. Here Are 3 Actions That Can Help | Kiplinger - "When the Federal Reserve cut interest rates to near 0% overnight two years ago to offset the impact of the COVID-19 crisis, we advocated investing in bond funds and decreased our investment in individual bonds where it made sense. We did this because the bonds in those funds were already providing higher yields than if we had purchased individual bonds. Now, as rates have started to rise, the reverse could make sense. Investors may look to replace these bond funds with individual bonds, which have a better yield since the funds now hold bonds with lower yields."

 

[mrfeh]

If you do have short term CDs and Treasuries, you can always switch back to bond funds if rates go down with no penalty. Thinking a bond fund might be a good bet in 2 years doesn't mean you have to own it today. You can own CDs or Treasuries today and always pivot back to bond funds when rates level off or decline.

The whole point of owning a total bond fund is that you don't need to time the market. You just accept what the market provides over time.

 

[daylatedollarshort]

The whole point of owning a total bond fund is that you don't need to time the market. You just accept what the market provides over time.

And that is a great strategy if you don't want to maximize your returns with some minimal effort, but many posters here would like to shield themselves from more potential bond fund losses while earning higher yields from safer investments.

 

[mrfeh]

And that is a great strategy if you don't want to maximize your returns with some minimal effort, but many posters here would like to shield themselves from more potential bond fund losses while earning higher yields from safer investments.

The majority of market timers do worse than those that buy and hold.

That is the problem with trying to "maximize" returns.

 

[daylatedollarshort]

The majority of market timers do worse than those that buy and hold.

That is the problem with trying to "maximize" returns.

You are equating bond funds with stock funds and they are two entirely different asset classes. What holds true for stock prices isn't necessarily true for bond yields. The stock market makes huge moves with no notice. Investors not in the market can lose out if they aren't in the market at those times. When has this ever happened with bond yields and prices? The big interest rate moves for this year were all announced by the Fed months in advance.

 

[OldShooter]

You are equating bond funds with stock funds and they are two entirely different asset classes. What holds true for stock prices isn't necessarily true for bond yields. The stock market makes huge moves with no notice. Investors not in the market can lose out if they aren't in the market at those times. When has this ever happened with bond yields and prices? The big interest rate moves for this year were all announced by the Fed months in advance.

This is just a curiosity question as I am not a bond guy, but are there any studies or data that says that market timing can be successfully done with bonds? It seems logical that it might be easier than with stocks, but I don't recall seeing arguments, credible or not, for this.

 

[Markola]

My entire outlook is to invest. Buy and hold, not trade. So, I can’t see buying and holding everything, except then playing around actively to seek yield in exactly the portfolio component that is supposed to be the most stable: Fixed Income.

 

[mrfeh]

You are equating bond funds with stock funds and they are two entirely different asset classes. What holds true for stock prices isn't necessarily true for bond yields. The stock market makes huge moves with no notice. Investors not in the market can lose out if they aren't in the market at those times. When has this ever happened with bond yields and prices? The big interest rate moves for this year were all announced by the Fed months in advance.

If it were this simple, actively managed bond funds would consistently beat index funds.

They don't, of course.

 

[Chuckanut]

This is just a curiosity question as I am not a bond guy, but are there any studies or data that says that market timing can be successfully done with bonds? It seems logical that it might be easier than with stocks, but I don't recall seeing arguments, credible or not, for this.

If nothing else there is one government institution that has some control of interest rates - the FRB. I know of no government institution that can raise or lower equity prices on its own. So, yes, predicting interest rates would be somewhat easier than stock prices, especially when the FRB announces its intentions ahead of time. Note, that I did not say EZ.

 

[OldShooter]

If nothing else there is one government institution that has some control of interest rates - the FRB. I know of no government institution that can raise or lower equity prices on its own. So, yes, predicting interest rates would be somewhat easier than stock prices, especially when the FRB announces its intentions ahead of time. Note, that I did not say EZ.

Well, yes maybe, but the EMH says all of that is baked into prices, which may be why (IIRC) the SPIVA reports do not reveal fixed income funds to be consistent winners. They do, however, seem to do a little better than the stock pickers.

So back to the question: data or studies?