What's so bad about bond funds?

[atmsmshr]

Glad to see someone else is a fan of Fidelity's FUAMX. When I did my 401k to IRA rollover in January - placed majority of it into this intermediate Treasury bond fund. No fees - and well, if Treasuries become worthless we are down to beans and bullets anyway. While doing nothing but pondering if/how to trade some risk and chase a higher yield, covid came along and kept me from doing anything. Very pleased with my indecisive/utterly brilliant/dumb lucky inaction and the YTD return.

Going forward, I think there is a lot of pain coming in the financial world, from zombie companies, more defaults and bankruptcies that are starting to show up, and remixing of commercial real estate as the telework becomes the new normal. Commercial bond downgrades, defaults and haircuts should start showing up in force in the second half of the year. As a result, I won't buy a mixed bond fund in the near term. Muni bond are probably going to get a whacking as tax base dries up from any tourist tax, commercial and private real estate tax. For those cities that built mega sports stadiums on taxpayers dime that are now closed down this season - ouch.

CDs are probably better, but may have some risk of being illiquid for a time if underwriters go underwater.

Recognizing that rates have to inevitably rise, I have thought about buying Treasuries direct and some other rate juicers, but will probably stick with easily bought and sold FUAMX bond fund for the time being.

Boring and conservative.

 

[maestro]

Exactly.

..... Putting money in to fixed income yielding well under 2% at these levels is akin to picking up pennies in front of a steam roller. The risks are simply not worth it in my view.

Great analogy I've been thinking it's time to cash a portion of my bond fund holdings and sleep better at night...

 

[pb4uski]

Hmmm ... perhaps my math off ...

1 Mar closed 86.53
12 Mar closed 80.33

So, closer to 7.1%?

Whoops ...

I guess my point was that bonds, especially right now - admittedly, right now - are generally following the market - sure, not as erratic as the equity market, but they don't seem like the safe counter-cyclical product that they used to be.

Looks to me like it declined 6.4% from the high on Mar 6 to the low on Mar 19, and then recovered.

Total Bond Market ETF
03/01/2020-03/31/2020

Fund Inception Date 4/3/2007

High High Date Low Low Date
$88.14 03/06/2020 $82.47 03/19/2020

Date	NAV
03/02/2020	$86.50
03/03/2020	$87.14
03/04/2020	$87.03
03/05/2020	$87.49
03/06/2020	$88.14
03/09/2020	$88.06
03/10/2020	$86.99
03/11/2020	$86.47
03/12/2020	$85.61
03/13/2020	$85.17
03/16/2020	$85.92
03/17/2020	$84.48
03/18/2020	$83.12
03/19/2020	$82.47
03/20/2020	$83.59
03/23/2020	$84.32
03/24/2020	$84.29
03/25/2020	$84.60
03/26/2020	$85.18
03/27/2020	$85.92
03/30/2020	$85.98
03/31/2020	$86.14

 

[teejayevans]

If only using it for short term, why not used an ultra short fund, at least it would be better than MM fund? Like VUSFX?

 

[dixter]

I'll never understand why people but a bond " fund " your just paying a company to choose the bonds they purchase for the fund.... just look at your favorite bond fund and look at the top 10 bonds in the fund and then just create your own bond fund... you get to choose the bonds, how many of the bonds and fine tune the maturity dates, fine tune the coupon rates and it costs less than $10 to purchase... you can add/subtract from the holdings as you go... you can take advantage of the bond values as interest rates change or just hold the bonds till maturity.... why pay a company to do what you can do yourself...

 

[Peter]

why pay a company to do what you can do yourself...

As time goes on, there are more and more things I pay a company to do that I could do myself. Painting the house would be an example.

 

[Sunset]

I'll never understand why people but a bond " fund " your just paying a company to choose the bonds they purchase for the fund.... just look at your favorite bond fund and look at the top 10 bonds in the fund and then just create your own bond fund... you get to choose the bonds, how many of the bonds and fine tune the maturity dates, fine tune the coupon rates and it costs less than $10 to purchase... you can add/subtract from the holdings as you go... you can take advantage of the bond values as interest rates change or just hold the bonds till maturity.... why pay a company to do what you can do yourself...

Diversification would be one reason.
A bond fund could easily have 300 bonds in it.
If I buy just the top 10 (which may only account for 20% of the fund) and 2 of the top 10 go bankrupt, I've lost a large percentage, close to 20%.
In the bond fund it would only be 2-3% loss.

 

[2177V]

I see numerous recent, negative comments about putting money in bonds right now.

The current 30-day SEC yield for Vanguard's short-term bond index fund is 1.33%; for the long-term index fund it's 2.17%. If that's the yield, those rates seem decent to me, much better than cash or CDs. And it's easy to transfer money out of the funds if/when things go south.

So what's wrong with parking money there until better options appear? What am I missing?

I am assuming that you are talking about VBIRX. If yes, there is nothing wrong with that. Here are the recent performances of VBIRX:

2020 1st qtr total return 2.52%, 2nd qtr total return 2.33%

2019 Capital return 2.52%, Income Return 2.33% Total Return 4.86%

These are very strong numbers for a safe bond index fund consisting mostly of US Treasuries. Heck a lot safer than Corporate Bonds since corporations can go bankrupt while the US Treasury is less likely to go bankrupt.

Looking at the past performances, VBIRX had a positive return every single year since 2005 which included the 2008 crash and the 2020 crash. Going to Corporate bonds or equities, you have to accept the risk of a negative return during some years. During a bear market, I personally like to be in Treasuries to minimize my risk. During a bull market, I personally like to be in equities to maximize my return. IMO VBIRX is where you want to be in uncertain times if you are a super conservative investor.

I personally like VUSUX or long term treasuries which carries higher risk but higher rewards during a bear market than VBRIX. The performance of VUSUX are +20.86% for 1st quarter 2020 and +0.54% for 2nd quarter 2020. The +20.86% gain for the 1st quarter 2020 occurred because treasuries are a safe haven for investors. The +0.54% gain occurred because the market rallied. If the market crashes again, I expect a similar quarterly performance to +20.86%. If the market rises which happened during the 2nd quarter, I expect a similar performance to +0.54%. VUSUX can turn negative if there is a vaccine, unemployment decreases significantly and we are back to a bull market. This is because people sell their treasuries to buy equities. However, I do not expect that situation to happen for a while.

 

[OldShooter]

Diversification would be one reason.
A bond fund could easily have 300 bonds in it.
If I buy just the top 10 (which may only account for 20% of the fund) and 2 of the top 10 go bankrupt, I've lost a large percentage, close to 20%.
In the bond fund it would only be 2-3% loss.

I think that is the main issue with corporate bond funds. It is difficult for an individual to research and maintain research on the 100 bond positions that would move individual issue risk to the sub-1% point.

Govvies are another matter. With no credit risk there is no need for diversification. Dress a monkey in a nice suit and he could probably put together a reasonable govvie portfolio. Buying the suit would be cheaper than paying ongoing management fees.

 

[RunningBum]

Govvies are another matter. With no credit risk there is no need for diversification. Dress a monkey in a nice suit and he could probably put together a reasonable govvie portfolio. Buying the suit would be cheaper than paying ongoing management fees.

True, but a bond fund would give you varying lengths, rates, and maturity dates, wouldn't it? It'd be a bond slide, which seems a little better than a bond ladder.

 

[OldShooter]

.... It'd be a bond slide, which seems a little better than a bond ladder.

Interesting concept, a "slide." Better? I don't know. Buying bonds directly and holding them to maturity involves no principal risk, something that is baked into bond funds to various degrees --- but never zero. There are clearly a lot of folks who feel that govvie funds are right for them, though.

 

[Out-to-Lunch]

I'll never understand why people but a bond " fund " your just paying a company to choose the bonds they purchase for the fund.... just look at your favorite bond fund and look at the top 10 bonds in the fund and then just create your own bond fund...

Some of us are still w*rking and have most of their fixed income in 401k accounts! Individual bonds is not a realistic option for a lot of us w*rking (but aspiring) folks.

 

[Al in Ohio]

Bond funds are fine, IMO, if you hold them for a very long period, well past the average duration. And you can simply rebalance with stocks as they go up and down.

But I only use short and intermediate duration bond funds and avoid long.

If thing go south - well, the damage has already been done, so you don’t get any benefit by selling when bond funds are down.

Ditto. I’ve heard the opinions about bond funds tanking if interest rates rise for over a decade now. Meanwhile I’ve made good money in bond funds that whole time with lower risk to balance out my portfolio. I just rebalanced my portfolio and bought $125k more in 8-10 bond funds.

 

[Closet_Gamer]

Very good thread and an interesting discussion of the conundrum created by the Fed's unbelievable forays into the market.

I posed a version of this question several months ago:

"When does AA = Greater Fool Theory"
https://www.early-retirement.org/forums/f28/when-does-aa-greater-fool-theory-102614.html

On one hand, setting and maintaining an asset allocation with rebalancing is designed to deal with exactly this situation. As bonds values rise, rather than having some moment of radical action that requires a decision (its time to sell my bonds), it happens slowly overtime as a natural function of rebalancing. The AA machine just does its work.

On the other hand, ever since they started with QE and its cousins, the Fed has essentially been price fixing the most important asset class in the world (US Govt Debt) and yanking everything else around with it. We're at the intersection of two conventional wisdoms

1) "Don't fight the Fed"
2) "Something that can't go on forever won't"

I read an article the other day suggesting the Fed may come out and explicitly say that until inflation is sustainably in the 2-4% range rates will not be going up. If that happens, wisdom #1 prevails for quite a long time.

However interesting this is ... and I find it quite concerning on many levels ... I've decided to just hit the snooze bar for the time being and let my AA continue to do its job. I may take the action of using CDs and/or defined maturity bonds in place of my bond funds, but for right now I'm just standing pat.

 

[bingybear]

Interesting concept, a "slide." Better? I don't know. Buying bonds directly and holding them to maturity involves no principal risk, something that is baked into bond funds to various degrees --- but never zero. There are clearly a lot of folks who feel that govvie funds are right for them, though.

and what happens when the bond insurer fails to pay off the bond. It does happen. So I would not say no principal risk. When a company goes bankrupt some bond holders may not get paid... but they are higher on the food chain than equity holders.

 

[OldShooter]

The context was govvies not corporates. ergo, no principal risk.

 

[RobLJ]

The comments on the risk to bond funds under rising rates and also the points on bonds as a diversifier, etc are fine; I agree.
What I haven't seen (but probably needs to be factored) in terms of "bond risk" is the possibility of negative rates. We aren't there yet, but Europe went there in the Great Recession.

Given the Fed actions over the last months, I would not categorically dismiss the possibility of negative rates, although 15 years ago I would have said you were crazy.
Just a thought. I'm not saying we are going there, but I think the bond (fund) critics might want to factor this into their thinking, now. Before the pandemic, I would have weighted the risks more on the bond risk crowd.
Now, I'm an agnostic; it might happen and it might not. Given the US susceptibility to the virus, I would rank it 50-50 since I don't think the economy will recover until and if we control the virus. Even at that, the current unemployment numbers compare to the GD and GR. I'm in Nevada; y'all may be doing somewhat better than us (and probably are), but I think the market is still assuming a quick economic recovery. I don't see it (hope I'm wrong!).

 

[pb4uski]

and what happens when the bond insurer fails to pay off the bond. It does happen. ....

Do you have any examples or are you just making crap up? I'm not aware of any.

 

[aja8888]

Do you have any examples or are you just making crap up? I'm not aware of any.

Here's a few:

 

[pb4uski]

Here's a few:

View attachment 35917

No... those are defaults and are probably not insured bonds.... typically only municipal bonds have been insured. The post that I was responding to was bingybear's claim that bond insurers had failed to pay (as opposed to the bonds themselves... big difference).

 

[friar1610]

Our (my wife's and my) fixed income includes CDs, I-Bonds and bond funds: VG Total Bond and Short-Term Treasury. The overwhelming majority of the funds are in our modest IRAs from which we take RMDs. We generally reinvest the RMD money in a taxable account or use it for QCDs.

So here's my question: Given the concerns about the impact of rising interest rates on fund NAVs (which I completely understand), are we less affected because the bond funds are in IRAs? After all, we have no plans to withdraw any more than our RMDs for as long as we're alive. So, by definition, the majority of that IRA money is going to remain invested well past the fund durations and only small amounts will be withdrawn annually to satisfy RMDs. It seems to me that this will, over time, moderate the impact of rising interest rates, if and when they occur. What do you think? Please shoot holes in my thinking. (BTW, our only likely alternative to the bond funds is CDs.)

 

[mrfeh]

Our (my wife's and my) fixed income includes CDs, I-Bonds and bond funds: VG Total Bond and Short-Term Treasury. The overwhelming majority of the funds are in our modest IRAs from which we take RMDs. We generally reinvest the RMD money in a taxable account or use it for QCDs.

So here's my question: Given the concerns about the impact of rising interest rates on fund NAVs (which I completely understand), are we less affected because the bond funds are in IRAs? After all, we have no plans to withdraw any more than our RMDs for as long as we're alive. So, by definition, the majority of that IRA money is going to remain invested well past the fund durations and only small amounts will be withdrawn annually to satisfy RMDs. It seems to me that this will, over time, moderate the impact of rising interest rates, if and when they occur. What do you think? Please shoot holes in my thinking. (BTW, our only likely alternative to the bond funds is CDs.)

In the long run, bond fund holder should want rates to rise. In time, the increased return more than compensates for the initial hit to the NAV.

Do a search over on bogleheads.org for details.

 

[VanWinkle]

Exactly.

However, most folks cannot grasp this, or do not understand how big an issue this really is. When interest rates get so low and it appears that it will be that way for some time, folks begin to become conditioned to it and will chase yield wherever they can find it.

I cannot in good conscience be buying any bonds or funds with such low yields. I would rather sit in raw cash, earning nothing (or as others would say, lose to inflation). Putting money in to fixed income yielding well under 2% at these levels is akin to picking up pennies in front of a steam roller. The risks are simply not worth it in my view.

Stocks are too high also and will never go up from here.....
Timing interest rates is no more exact than timing the stock market.
2 years ago, everyone was saying the same thing. I have made 10%
a year for the last 2 years on intermediate bond funds with at least
50% in treasuries/government backed securities.
You will be correct some day, maybe soon, maybe later.
Risk is something you have assume for higher returns than cash.

Cash works for you, and that is great.
Everyone has different goals and ways to get there.

Best to you,

VW

 

[bingybear]

No... those are defaults and are probably not insured bonds.... typically only municipal bonds have been insured. The post that I was responding to was bingybear's claim that bond insurers had failed to pay (as opposed to the bonds themselves... big difference).

When I posted I did not realize it was this limited of scope.


I thought that not all were paid when Detroit went bankrupt. But some went to pensions.


But now this is "insured" and not just government issued.

 

[GNXGuy]

So it would not be wise to invest in something like Schwabs SCHZ bond fund?


https://www.schwabfunds.com/resource-center/insights/resource/schz-fact-sheet