Is this the worst possible time to buy a bond fund?

[Free To Canoe]

Bad time for bond funds? I currently have all equities in my portfolio. I would like bonds to generate income while providing safety of principal. I also want them to reduce the volatility of my portfolio. I was thinking of starting by buying some for my IRA. Learn by doing. With interest rates at historic lows and equities so cheap, perhaps it is almost foolish to buy bonds at this time. To bond or not to bond, that my friend, is the question for this paragraph.

If one were going to buy bonds at this time…I searched the forum on the subject and it seems that for smaller amounts, it is common to go into a bond fund for convenience and economy. However, would prefer the safety of an individual bond.

Why not treasury or agency bonds from the government auction? The interest spread between corporate bonds and government bonds seems so great that one would be foolish to buy treasuries at this time.

How many questions is this?
Enough for now. Thanks in advance for your thoughts.

Free to Canoe

 

[clifp]

IMO we are in the midst of a Treasury Bill bubble. Corporate and Muni bonds on the other hand I think provide a good risk adjusted return right now. In general you can't go to wrong buying a Vanguard Fund offering

My $.02 cents (which will be worth less than $.01 if my and other forecast of significant inflation comes true.)

 

[LOL!]

No, it is not a bad time to buy a bond fund.

I think it is a bad time to buy some bond funds. I would not buy any long duration bond funds. I would not buy TIPS. I would not buy Treasuries. I would not buy high yield or junk bonds. That leaves you with plenty of other bond funds to choose from.

I am buying Vanguard GNMA bond fund shares this week. The current duration of this fund is quite short. I think the Vanguard short term investment grade bond fund is also worthy of some money, but I own alot of it already.

Not everyone agrees with me.

 

[ziggy29]

There are so many different types of bond funds with so many different risk profiles and in so many different phases of the market cycle that one can't say anything sweeping about "bond funds." There are Treasuries, TIPS, high yield corporates, investment grade corporates and munis, not to mention different maturities.

There are at least 10 different bond markets and 10 different risk profiles for bond funds. I like intermediate term investment-grade corporate bonds right now. Some of these funds are yielding 6.5-7% with strong diversification and probably not all that much risk. I wouldn't go out more than about 6-7 years on average maturity, though.

 

[FIREd]

I am still buying short- and intermediate-term municipal bond funds as well as short- and intermediate-term investment grade bond funds. The spread between these bonds and treasuries make them attractive IMO. But I would keep the duration short.

I am staying away from long-term and high yield bonds but I always do. And government bonds seem a bit pricey at the moment.

 

[DblDoc]

Just as I don't try to time equity classes I don't time bonds. My AA has short, intermediate gov't treasuries and TIPs. They provided safety and reduced volatility during the last 18 months. As my equity portion has taken such a hit I am buying them exclusively until my equity:bond ratio returns to target. I will then be buying whatever is lagging bond wise from the three classes above.

DD

 

[mathjak107]

the consensus back in jan 08 was its an awful time to buy long term bonds, everyone here and in the press were dead against it as rates were already quite historically low. it was a given the fed was raising rates again and all you heard from the experts on this forum and the press was stay away from bonds and run like hell from long term treasury bonds...

then as the markets usually do,, stuff that wasnt even on the radar altered the course once again of the obvious..

long term treasuries soared 28% for 2008... in fact my bonds and gold actually offset the stock loses..gold was another catagory shunned by the experts here.. we used to have endless battles about gold.. well im sure all the experts are now licking their wounds and maybe thinking trying to predict the future is like trying to guess next years weather or sports scores.

can long term treasuries do it again from here ? maybe... just that one day when the treasury dept announced they were buying debt saw them spike up 8% in an hour before falling back... the equal to an over 600 point rise in the equities markets. theres still alot of capital gains left if things go wrong in the economy further..... its not about interest at this point its all about capital gains..

my feeling is i wont attempt to time the bond market after seeing what just happened and the state of the world economies.. TLT is always a part of my mix

shorter term bonds dont provide enough interest or fighter cover for my equities to be of much use to me right now ..

 

[RonBoyd]

Key to economic recovery may be in California

The credit crunch rolled from the East Coast across America like a tidal wave. But the U.S. is about to be whipsawed by a riptide rolling back from Southern California.

Best known for its celebrities and beaches, the region also is an enclave of the world's largest and most influential bond fund managers. And it will be these bond fund managers and their decisions of how to use their massive pools of cash to buy that will determine in large part when the credit crisis ends and the bond market stabilizes.

 

[dex]

IMO we are in the midst of a Treasury Bill bubble. Corporate and Muni bonds on the other hand I think provide a good risk adjusted return right now. In general you can't go to wrong buying a Vanguard Fund offering

My $.02 cents (which will be worth less than $.01 if my and other forecast of significant inflation comes true.)

Pssst - I agree, High Yield Corp - they took a hit equal to stocks. Vanguard's is yielding 9%. So you are getting 9% yield while waiting for the recovery.

 

[Free To Canoe]

Lot's of good info for me to learn! The bond market is diverse and serves multiple purposes. I see that no one is recommending individual corporate bonds. I guess it is money well spent to get a good bond fund.
No one is going to make a tawdry crack about "to bond or not to bond"?

Free to Canoe

 

[W2R]

I hope it's not a bad time to buy bond funds, since I just put $50K into VBMFX, Vanguard's Total Bond Market Index Fund last Friday.

I also have a little in VFSTX, Vanguard's Short Term Investment Grade Bond Fund, which got clobbered in the economic mess and has not come back very much yet. I lost 10% in that fund from May '08 to the bottom, and it is still down 8% from May '08. Better than my equity funds but not bringing smiles to my face quite yet.

Otherwise I really battened down the hatches and reinforced the fortress during the economic collapse, so to speak, with most of my fixed income money in treasury money market. It is time for me to tentatively start venturing out. So, I moved my money from Vanguard's treasury money market VUSXX back into prime money market VMMXX, as well as buying the total bond market index last Friday.

I am not wanting to take much risk with this money but the yield on treasury money market has been utterly abysmal.

 

[clifp]

Lot's of good info for me to learn! The bond market is diverse and serves multiple purposes. I see that no one is recommending individual corporate bonds. I guess it is money well spent to get a good bond fund.
No one is going to make a tawdry crack about "to bond or not to bond"?

Free to Canoe

In word yes Bond funds not individual issues, unless you know what you are doing. Even when you do, a search of the forum for the terms ISM OSM will provide you with hours of low cost education (and perhaps entertainment) on the trials and tribulations of buying individual corporate bonds. Suffice to say that these ISM and OSM bonds, (issued by student loan giant Sallie Mae) were recommended by a Wall St professional a few years ago. Endorsed by other Wall St types, analyized by a number of us with years of investments background, and a willingness to pour through multi-page SEC fillings. Despite a significant amount of due dillegence.

Most of these bonds were orginally purchased by members of the forum at prices at least twice there current trading level. I am not sure if collectively the forum has suffered a million dollars in paper/actual losses on this particular corporate bond, but it is certainly in the multi hundred thousand range.

 

[MichaelB]

Bad time for bond funds? I currently have all equities in my portfolio. I would like bonds to generate income while providing safety of principal. I also want them to reduce the volatility of my portfolio. I was thinking of starting by buying some for my IRA. Learn by doing. With interest rates at historic lows and equities so cheap, perhaps it is almost foolish to buy bonds at this time. To bond or not to bond, that my friend, is the question for this paragraph.

Free to Canoe

Generating income while reducing volatility and providing safety is best accomplished with short duration high quality bonds. Traditionally they would be treasuries, but as you pointed out, right now those are expensive. Suitable alternatives would be agencies or corporate.

Bonds vs bond funds is another challenge. Bonds, especially small quantities, have very high markups and transaction costs. Most folks are better off with low cost bond funds.

As for timing, bonds prices are rising right now, so it's not a bad time. Investment grade bonds are not a bargain but still reasonable. For example. Vanguard Short term Investment Grade has a distribution yield of 4.5%, a YTM of 7.6% and avg. duration of 2.7 years.

 

[ERD50]

No, it is not a bad time to buy a bond fund.

I think it is a bad time to buy some bond funds. ... I would not buy high yield or junk bonds.

I am buying Vanguard GNMA bond fund shares this week.

I do think the GNMA have been a rock solid (well almost) investment. Small volatility, steady divs. I am soooo glad I had the kids college funds mostly in GNMA, even though I was kicking myself when the market took off in 2003-2007!

Curious why you think this is bad time for Junk Bond funds? I certainly agree they aren't for everyone - I allocate about half of mine as "stocks" when I look at my AA.

Pssst - I agree, High Yield Corp - they took a hit equal to stocks. Vanguard's is yielding 9%. So you are getting 9% yield while waiting for the recovery.

I'm with Dex, this seems like a good time to buy and get ~ 9.8-10% yield!

Again, if they don't fit your volatility tolerance, that's a good reason to stay away, but I don't think I'd call this a bad time to buy them if you were considering them anyhow.

Oh, this graph does not included divs. So while it is true they took a big NAV hit, if you add the 7-8-9-10% annual yields they have been paying, that graph smoothes out a lot. Hmmm, looking at Yahoo's "adjusted prices" for the past 5 years (this includes divs), Vanguards Junk fund is up slightly, from 4.39 to 4.44, while SPY (with divs) is down from 100.91 to 82.53.

So with divs, the junk bond graph would be pretty flat, with a slight upward trend. Really paints a different picture.

-ERD50

 

[LOL!]

Curious why you think this is bad time for Junk Bond funds? I certainly agree they aren't for everyone - I allocate about half of mine as "stocks" when I look at my AA.

I want my bond funds to mitigate risk and not to be correlated with equities. If I want risk, I buy equities. Since junk bond funds behave pretty much like equities, why not just buy equities? You are just fooling yourself if you think otherwise. But if you call your junk bond funds "stocks", then I guess that's OK. OTOH, if your asset allocation calls for 40% stocks and 60% bonds, and you then fill up half your bond allocation with high yield or junk bonds, then you are only fooling yourself.

And bond dividends are taxed differently than stock dividends and LT cap gains. That's another plus for equities vs junk bonds for me.

 

[LOL!]

So with divs, the junk bond graph would be pretty flat, with a slight upward trend. Really paints a different picture.

-ERD50

Are you saying that Vanguard VWEHX returned about 0% last year? Now, I'm really LOL!

 

[ERD50]

Are you saying that Vanguard VWEHX returned about 0% last year? Now, I'm really LOL!

No, flat for 5 years. For the past 12 months, down ~ 18% with divs. Again, that is why I would think that this is a relatively good time to buy *if* (big IF) they are something you want to hold.

I want my bond funds to mitigate risk and not to be correlated with equities. If I want risk, I buy equities. Since junk bond funds behave pretty much like equities, why not just buy equities? You are just fooling yourself if you think otherwise. But if you call your junk bond funds "stocks", then I guess that's OK. OTOH, if your asset allocation calls for 40% stocks and 60% bonds, and you then fill up half your bond allocation with high yield or junk bonds, then you are only fooling yourself.

And bond dividends are taxed differently than stock dividends and LT cap gains. That's another plus for equities vs junk bonds for me.

Good points. I'm not really advocating them to others, I was just questioning the logic of "bad buy at this time", rather than whether someone should buy them at all.

Now, here is my thinking on why I own some. Not saying this is right even for me, it just explains my logic, which may well be flawed, but FWIW:

Consider $1M split 50-50 GNMA and SPY, divs would be:

GNMA/VFIIX ---- 0.5 4.80% 1,000,000 24,000
SPY ----------- 0.5 3.70% 1,000,000 18,500
---------------------------------- -------
total divs ------------------------ 42,500


Now consider $1M with a 'virtual" split 50-50 GNMA and SPY, but we sub VWEHX Junk Fund in there. We allocate half of the junk to bonds and half to stocks, so decrease each of those holdings so we get this:


VWEHX allocated -- 0.50 9.86% 1,000,000- 49,300
GNMA/VFIIX ------- 0.25 4.80% 1,000,000- 12,000
SPY -------------- 0.25 3.70% 1,000,000-- 9,250
-------------------------------------- -------
total divs ----------------------------- 70,550

So, I'm getting a much higher div payout, which keeps me from liquidating stocks while they are down.

That's my thinking. Not 100% sure it makes good sense or not, but that's it. Now, I know this one aspect is a bit fuzzy in a "mark-to-market" way, but it is real - those extra divs do help to keep from liquidating, so I can ride out these dips better, NAV dips are really a "paper loss", and I'm a bit more isolated from them.

-ERD50

 

[MichaelB]

High Yield?

OP specifically stated

I would like bonds to generate income while providing safety of principal. I also want them to reduce the volatility of my portfolio

Seems to me high yield dosn't meet either of these. I'm with LOL! - junk bonds are equity-like risk without the return potential.

 

[ERD50]

OP specifically stated


Seems to me high yield dosn't meet either of these. I'm with LOL! - junk bonds are equity-like risk without the return potential.

True to a point, but Junk is less volatile than stocks. More volatile than higher Q bonds.

It's a matter of degrees.

-ERD50

 

[freebird5825]

Munis all the way for this girl.
Normally a safer bet than most bonds until 2008 happened. No guarantee of principal, of course.
However, right now, states need money and are willing to pay for it in the muni bond arena.
My favorite VWAHX (muni national) took a -10.5% hit in 2008, but it was yielding 5.48% when things were really ugly.
It is slowly recovering...I have a long enough time horizon to not worry about that.
Data source is Morningstar, values are Yield YTD for the exact date I recorded the values.
Comments are my own.

VWAHX
4.37 Dec 07 (Oct 07 called the beg of bear market)
4.94 Mar 08
4.83 Apr 08
4.78 May 08
4.43 Jun 08
4.82 Jul 08
4.79 Sep 08 (slumped market, financial crisis, bailouts by Fed)
5.07 Oct 08 (killer market, VFINX S&P500 fund down 37%)
5.31 Nov 3, 08 (election day)
5.39 Dec 3, 08
5.48 Jan 3, 09
5.26 Feb 4, 09 (continued slumped market, financial crisis, bailouts by Fed)
5.21 Mar 3, 09
5.24 Apr 6, 09

 

[audreyh1]

I expect my corporate bond funds to recover well before the equity funds recover. In the mean time I'll take the 6 to 7.5% yields, thank you very much!

I'm considering taking a part of my cash position which is in an AMT tax-free money market fund only yielding .34% and putting it in the Fidelity GNMA fund which is government-backed mortgages yet yielding 4.66%. Right now the average maturity is 4 years which is pretty short. In this super low yield environment, I'm thinking my 11% cash position is just too high!

Why are GNMA funds yielding so much more than treasuries? Is the spread usually this wide? I don't remember this wide of a spread.

Audrey

 

[haha]

In word yes Bond funds not individual issues, unless you know what you are doing. Even when you do, a search of the forum for the terms ISM OSM will provide you with hours of low cost education (and perhaps entertainment) on the trials and tribulations of buying individual corporate bonds. Suffice to say that these ISM and OSM bonds, (issued by student loan giant Sallie Mae) were recommended by a Wall St professional a few years ago. Endorsed by other Wall St types, analyized by a number of us with years of investments background, and a willingness to pour through multi-page SEC fillings. Despite a significant amount of due dillegence.

Most of these bonds were orginally purchased by members of the forum at prices at least twice there current trading level. I am not sure if collectively the forum has suffered a million dollars in paper/actual losses on this particular corporate bond, but it is certainly in the multi hundred thousand range.

Amazing how having a printed record improves truth telling.

ha

 

[haha]

I expect my corporate bond funds to recover well before the equity funds recover. In the mean time I'll take the 6 to 7.5% yields, thank you very much!

I'm considering taking a part of my cash position which is in an AMT tax-free money market fund only yielding .34% and putting it in the Fidelity GNMA fund which is government-backed mortgages yet yielding 4.66%. Right now the average maturity is 4 years which is pretty short. In this super low yield environment, I'm thinking my 11% cash position is just too high!

Why are GNMA funds yielding so much more than treasuries? Is the spread usually this wide? I don't remember this wide of a spread.

Audrey

I believe the current spread is quite wide. This author says 1% is more typical.

The reason for any spread at all is negative convexity which is a feature of mortgage backed securites. Briefly, this means that when interst rates rise, your Ginnie Maes go down just like all other bonds of> than 0 duration. But when interest rates fall, Ginnies will not normally rise as much as other bonds of similar duration, because homeowners will often refinance and pay off the higher yielding mortgages.

Ginnie Mae's Day

Yields and Interest Rates
While losses for Ginnie Maes have have been held in check, yields have been appealing. In early 2008, for example, when Morningstar put the average yield for the category at 4.4%, popular Ginnie Mae funds were paying around 5%. The higher yield comes from the fact that Ginnie Mae pass-through certificates may have the same credit quality as Treasury bonds, but they still pay more interest. Often the spread is 100 basis points (one percentage point) or more.

"The higher yield is paid to investors for accepting 'negative convexity,'" Brennan explains. Mortgage-backed securities, including Ginnie Maes, have built-in disadvantages when interest rates move in either direction.
The assets securing Ginnie Maes are loans to homeowners, and the income pocketed by investors comes from monthly mortgage payments. Home mortgages, though, may be prepaid when homes are sold or when the loans are refinanced.
When interest rates rise, Ginnie Maes lose value, as do all fixed-income instruments. In such an environment, mortgage refinancing declines as there's little incentive to refinance at a higher rate. A refinancing slowdown effectively extends the expected maturity of outstanding Ginnie Maes, and longer-duration bonds lose more value than shorter-duration bonds when rates rise. "The more rates increase, the faster the loss in value for mortgage-backed securities," Brennan says.
On the other hand, when mortgage rates drop, refinancing increases, which effectively reduces the duration of Ginnie Maes held by investors. Short-duration bonds don't appreciate as much as long bonds when interest rates drop. Thus, Ginnie Maes don't have the same upside potential as conventional bonds.
As mortgage refinancing increases and loans are prepaid, more capital is returned to investors, who must reinvest at lower rates. Therefore, Ginnie Maes and the funds that hold them are most vulnerable to drops in interest rates and the consequent rise in mortgage refinancing."

Ha

 

[Zoocat]

Thanks for the link on ginnie mae bonds, Ha. I hope they continue to be a good investment because I just bought a lot of Vanguard GNMA today.

 

[brewer12345]

I have been buying corporates, mostly investment grade, both individual bonds and funds. You can buy pretty attractively priced high quality bonds right now in the single A rating range. Yesterday I bought a smidge of a nice BBB+ rated bond maturing in 5 years that yields just shy of 10% to maturity. I know the issuer and own some of the equity and am comfy the credit profile, so picking some up at this kind of yield was a no-brainer.