Question for an advisor about bond funds. Suggestion?

[mikes425]

Appreciate any feedback here, because i'm about to get a review from my hourly occasional FA whom I've worked with for about 12 years now. I'm in what's considered a moderate to moderate-conservative AA PF. I'm grateful for an accumulation to about 2.6/2.5m (fluctuates depending on any given week) - have no debt, low COLA, single, sorta segueing into semi-retirement at age 65 as of this year. PF generates about 87k/yr in div income. My AA is now about 50% FI and that's comprised largely of ETFs primarily short duration;-ST bond funds, (Treasury), floating rate bond funds,TIPS, such as SCHP, a little in intermediate-VGIT, and the ST etfs are primarily SHY, VCSH, SCHO, VGIT, BILS with some international debt/bond positions too. I work less as of this year...so div. income will ultimately become more important...and i am concerned about preservation, but don't want to just dismiss Growth. Firecalc doesn't give me any indication i've got any problems even with a 4% random return per year going forward, for a 30 year timeframe....

So, my big question on this particular periodic review with him is...why am i sitting in these bond funds that lost major NAV last year - which was of course the worst year in bond history - but over the past couple of years now, in response to specific questions - FA hasn't felt any compelling reason to exit any of them - even when we can get a 5+ % return on a no-risk MM or equivalent - investment. On that note, the 'rule of bonds' does hold that if you do not sell, you will (eventually) get back to even and get your ROI, if you hold and do nothing since div income theoretically improves as interest rates stay high or increase. But by far, bond funds have been my PF's biggest losers YTD and big time in 2022; major NAV losses far exceeding equity fund losses. All this said, what would the best question be to ask him as to why, at this juncture and in these market conditions, one would want to continue to stay in bond FUNDS - even those of ultra short duration -which are in fact STILL losing NAV with the prospect of continued high or higher interest rates - versus what would amount to taking big losses in a taxable account and otherwise by selling out of these funds and putting the proceeds into say, 5% guaranteed return/zero volatility Money markets - or other no-risk FI positions - that aren't subject to more market fluctuation driven by fear and obvious political manipulation. Sorry for the long-winded post but it's rather time-sensitive as I'm frankly weighing why I'm even continuing to work with him. I would imagine the response - as in the past will be that i need to ignore the short term volatity and think long-range but it sure seems we may well be in for this sort of volatility for even years to come. OTOH maybe i'm just being over-hyped by financial media BS. Thanks alot for any thoughts. Happy to elaborate on any details/questions.

[pb4uski]

If you look around here you will see lots of debates on the lack of vitrue of bond funds. Many of us got out of them long ago when it was clear that rates couldn't go any lower because they were close to nil and interest rate risk was a concern, perticularly for longer duration bond funds and bond ETFs.

It took a long time but rates finally did go up and the bond funds and bond ETFs got creamed.

Today, many of us are in individual bonds... brokered CDs, US Treasuries, agency bonds, corporate bonds with a little spice of some high quality preferred stocks. Since we intend to hold to maturity, we pretty much ignore market value fluctuations. I have 52 different positions that are still pretty short 9shorter than I would like)... a weighted average maturity of 2.6 years and weighted average yield of 5.2% with 89% of the portfolio rated A or better by S&P (78% AA+ or better).

I much prefer the control of individual bonds to bond funds or bond ETFs.

Just keep in mind that your bond fund losses are sunk costs at this point.. not much you can do about them... its the future that is more important.

[gcgang]

Sell the bond funds in taxable accounts that are at a loss!

[VanWinkle]

Quote:

Originally Posted by pb4uski If you look around here you will see lots of debates on the lack of vitrue of bond funds. Many of us got out of them long ago when it was clear that rates couldn't go any lower because they were close to nil and interest rate risk was a concern, perticularly for longer duration bond funds and bond ETFs. It took a long time but rates finally did go up and the bond funds and bond ETFs got creamed. Today, many of us are in individual bonds... brokered CDs, US Treasuries, agency bonds, corporate bonds with a little spice of some high quality preferred stocks. Since we intend to hold to maturity, we pretty much ignore market value fluctuations. I have 52 different positions that are still pretty short 9shorter than I would like)... a weighted average maturity of 2.6 years and weighted average yield of 5.2% with 89% of the portfolio rated A or better by S&P (78% AA+ or better). I much prefer the control of individual bonds to bond funds or bond ETFs. Just keep in mind that your bond fund losses are sunk costs at this point.. not much you can do about them... its the future that is more important.

I agree that with the low rates of 3 years ago, the only likely path was for rates to increase. Using the same logic, with today's rates, wouldn't the logical path for rates be to decrease and reward anyone holding bonds in a fund with low credit risk?

[COcheesehead]

The problem with bond funds is they hold below market rate coupon bonds. So the distribution yield - what you should pay attention to - is in many cases below money markets and certainly below what you can get in investment grade bonds today. Lots of 6%++ yields out there with almost certainty of getting your capital back at maturity.
There are a few threads on here asking the same question.

[DuluthGA]

How long are you willing to wait for bond funds to get back to even? It may take a while

[VanWinkle]

Quote:

Originally Posted by COcheesehead The problem with bond funds is they hold below market rate coupon bonds. So the distribution yield - what you should pay attention to - is in many cases below money markets and certainly below what you can get in investment grade bonds today. Lots of 6%++ yields out there with almost certainty of getting your capital back at maturity. There are a few threads on here asking the same question.

When interest rates go down, won't they be holding above market rate coupon bonds and reward those that are holding the funds at that time- like in 2019 and 2020 for Total bond? Are risk and reward different for a bond fund than for an individual bond?

I am a long term investor with a lot of patience(maybe too much at times).

VW

[COcheesehead]

Quote:

Originally Posted by VanWinkle When interest rates go down, won't they be holding above market rate coupon bonds and reward those that are holding the funds at that time- like in 2019 and 2020 for Total bond? Are risk and reward different for a bond fund than for an individual bond? I am a long term investor with a lot of patience(maybe too much at times). VW

Rates would have to drop back below where they were when the bonds were purchased. By charter many funds continued to buy 1% ish bonds and the like. I don’t think we’ll ever see rates at those levels in my lifetime.

[mikes425]

Quote:

Originally Posted by DuluthGA How long are you willing to wait for bond funds to get back to even? It may take a while

Depends I guess. What is a realistic educated guess as to what that timeframe looks like? Also have to figure in of course, what is the "real" loss relative to increased divs being generated due to the higher interest rates for longer.... not an easy question for me to answer... guess it's one for the FA if he has any better idea...It's unnerving seeing those NAV losses just lying there going nowhere but even further down from last year - I mean, in the grand scheme if they're not going to just go bust, I guess I'm in a position to wait it out for years.... I'd just like to have some sense of how many years that could be? Presumably they'll all still be contributing to about 90k a year in dividends in my case but...could I be getting those same or better returns in a guaranteed no-volatility alternative set of funds or individual. bonds...rather than seeing MORE NAV erosion... or is "more NAV erosion" unlikely at this point?

Two years ago I was feeling pretty good about the prospect of seeing about 2.2M climbing toward 3M in the next 5-8 years. That hope is evaporating based on this seemingly, largely politically-driven disconnect between the traditional bond/equity relationship for a moderate portfolio's growth and stability.

[mikes425]

Quote:

Originally Posted by gcgang Sell the bond funds in taxable accounts that are at a loss!

Well that would be....all of them I think.

[DuluthGA]

Quote:

Originally Posted by mikes425 Depends I guess. What is a realistic educated guess as to what that timeframe looks like? Also have to figure in of course, what is the "real" loss relative to increased divs being generated due to the higher interest rates for longer.... not an easy question for me to answer... guess it's one for the FA if he has any better idea...It's unnerving seeing those NAV losses just lying there going nowhere but even further down from last year - I mean, in the grand scheme if they're not going to just go bust, I guess I'm in a position to wait it out for years.... I'd just like to have some sense of how many years that could be? Presumably they'll all still be contributing to about 90k a year in dividends in my case but...could I be getting those same or better returns in a guaranteed no-volatility alternative set of funds or individual. bonds...rather than seeing MORE NAV erosion... or is "more NAV erosion" unlikely at this point? .

If you think rates continue to climb I’d sell now. My crystal ball/magic 8 ball says it will be a couple of years before they get back, maybe more.

[Midpack]

If you are still holding bond funds, you've probably taken most if not all the NAV loss, unless you think (individual) bond yields still have a lot of upside (I don't). So it doesn't make much difference what you do now? Like many others I sold off all our bond funds and moved that money to treasuries in early 2022 when rates started to shoot up - thankfully. I'm getting just over 5% now. I'm certainly in no rush to put money in bond funds now, I'd guess mostly sideways from here for a while.

[Sunset]

OP - Did your advisor not sell the bond funds ??

If you are actually holding the bond funds but like the idea of them, sell the ones in a taxable account, put the money into a money market account paying ~5% (NET). Wait 35 days and then buy back the bond funds.

Then you will have a taxable loss to deduct on your income tax, letting Uncle Sam pay for some of the losses... While still holding the same funds.

[pb4uski]

Quote:

Originally Posted by VanWinkle I agree that with the low rates of 3 years ago, the only likely path was for rates to increase. Using the same logic, with today's rates, wouldn't the logical path for rates be to decrease and reward anyone holding bonds in a fund with low credit risk?

Not necessarily. I personally think that rates will drift a hair higher from here and later the long end will rise and the short end will decline if/when the Fed eases rates resulting in a more normal yield curve. It's possible that rates may stay at current ~5% levels for a prolonged period or perhaps drift a little lower, but I hope that we don't see the very low rates of 2010-2021 and the resulting war on savers.

I invest in bonds for income, not for capital gains.

[Qs Laptop]

To the OP: Knowing what you know now, if you were not in these bond funds, would you buy them right now?

I think you know the answer to that question.


(You could phrase this to your FA advisor as: "Would you counsel me to buy bond funds right now?")

If they are no good to buy right now, why would you hold on to them? Take your losses and redeploy.

[mikes425]

Quote:

Originally Posted by Qs Laptop To the OP: Knowing what you know now, if you were not in these bond funds, would you buy them right now? I think you know the answer to that question. (You could phrase this to your FA advisor as: "Would you counsel me to buy bond funds right now?") If they are no good to buy right now, why would you hold on to them? Take your losses and redeploy.

Well, I can basically give a partial summation of his response to that question, with an emphasis on the "laddered bond" vs "fund" question. To paraphrase the reply:

"The argument for laddering is you buy the bonds and hold them to maturity.* Thus, you won’t eventually realize any losses.* However, you would see the same losses on “paper” (unrealized) as you see now in your statements, etc. *
For example, if you bought twenty bonds maturing every year for the next twenty years and then rolled each maturing bond into a 20 year bond, you would have seen large losses lately as the average maturity would have been about ten years.* Even if you did 10 bonds and spread them over 10 years you still would have been looking at good sized losses.* Our (my) average maturity of the bond funds we own is just over 3 years and the duration is 3 years.* That is far below most bond funds- the duration of a fund tracking the standard bond index (Barclays Agg) is 6 years or double our duration.* We purposefully have gone very short out of concern of intermediate to long yields going up- and the bonds going down. But - as we’ve discussed, having a modest amount in intermediate to long bonds provides insurance against a market meltdown in that typically if we see a very large market decline investment grade long-term bonds go up.* This was especially the case in the largest meltdown since the depression (2008-2009) as long bond rose nicely.* That said, most of our exposure to funds that have average maturities more than 3 years is to TIPS funds, and those funds should have OK returns if we were to get surprisingly high inflation that would lead to higher rates continuing.** For the last year SCHP (my largest holding of the TIPS funds) returned +0.7%- not exciting but not terrible.*

The only other longer term bonds of note are the EM bond funds.* MSD is the biggest of those and that has a return of 7.1% YTD and 17.3% for the past year.* And yes, it’s important to include dividend income as its yield is 9% and it was even higher a year ago when its price was lower..."

So that said, recomendations include: Liquidating MSD.. selling off some SCHO and PFFD, to buy a bit back into SCHX (LC) and some more into small cap FNDA, (SC) as well as a significant addition to BILS (3-12 mo T-bill fund)... and essentially adding a few percent back into equity, with my ultimate target as 50/50 AA. These trades others will bring me closer to abt. 47% equity to FI. ratio.

Thanks!

[Markola]

nisiprius over at Bogleheads made the case for not selling, but for holding for the fund’s duration (or forever.)

“Interest up, bonds down" is a short-term relationship. Vanguard says that the Vanguard Total Bond Market Index Fund, for example, "may be appropriate for investors with medium-term investment horizons (4 to 10 years)," so that is the kind of time frame we should be looking at. "Interest up, bonds down" is not true in the longer term.

There are other considerations for bonds but they should be considered separately. (e.g. "But inflation." "But TIPS.") The purpose of this posting is to address one single point: even interest rates were certain to rise, that not mean you are certain to lose money if you keep holding the bond fund. In fact, it is the opposite. You will likely make money if you keep holding the bond fund for the appropriate holding period, roughly equal to the duration; you will lose money if you don't keep holding, and sell the fund during the period after the interest rate rises.”

https://www.bogleheads.org/forum/viewtopic.php?t=360575

[pb4uski]

This is getting back into the bond fund debate.

It is true that if you compare a bond fund to a rolling bond ladder in a rising interest rate environment that both will have unrealized losses.

I prefer a ladder due to control. If I need money for spending I can just take it from a maturing bond in the portfolio and only reinvest part of the maturity proceeds so there is no realized loss.

If I want the same amount of money for spending from a bond fund or ETF I have no choice but to redeem shares, which crystallizes the unrealized loss.

With a bond ladder I have more options.

[COcheesehead]

Quote:

Originally Posted by pb4uski This is getting back into the bond fund debate. It is true that if you compare a bond fund to a rolling bond ladder in a rising interest rate environment that both will have unrealized losses. I prefer a ladder due to control. If I need money for spending I can just take it from a maturing bond in the portfolio and only reinvest part of the maturity proceeds so there is no realized loss. If I want the same amount of money for spending from a bond fund or ETF I have no choice but to redeem shares, which crystallizes to unrealized loss. With a bond ladder I have more options.

And a par value which does not exist with a fund. The is no set value that it will return to.

[pb4uski]

Quote:

Originally Posted by Markola nisiprius over at Bogleheads made the case for not selling, but for holding for the fund’s duration (or forever.)

I dunno. BND's total return, with dividends reinvested for the 10 years ended in 2022 was 1.00%... even back in the days of low interest rates it is hardly inspiring.