Bond fund appreciation over long term

[Sojourner]

Fixed income novice questions of the day:

• Should an investor holding a bond fund expect that it will, in all likelihood, appreciate in value over long (say, 20+ year) time periods? VBMFX has a 5.86% CAGR since its inception in 1987, for example.
  
• If it's reasonable to expect such appreciation in bond fund value, what drives this appreciation? Inflation? Something else?
  
• Should a prospective investor looking to buy into a particular bond fund be concerned with (or driven by) the current share price? Would it be best just to buy all at once without regard to current share price, or would some sort of DCA over say, 6-12 months, be worth considering?

Thanks in advance for helping me get smarter about these puzzling but important parts of our investment world.

 

[njhowie]

If it's reasonable to expect such appreciation in bond fund value, what drives this appreciation? Inflation? Something else?

You need to keep in mind what interest rates have done over the past 30+ years - they've been in continual decline, which has certainly helped bond fund appreciation over that period.

Now, going forward, should we expect more of the same? Who knows? If interest rates go negative, it may well continue for the next 30 years. On the other hand, if at some point rates hit bottom and decide to go higher, long term bond funds could see a decline in value for an extended period. While rates are so low at this time, any move higher will immediately hit (long term) bond funds swiftly and considerably.

 

[pb4uski]

Appreciation is driven by lower interest rates. When rates decline, the values of bonds increase (and vice versa). This is known as interest rate risk.

Given that interest rates are at historical lows, if they reverted to the mean then the increase in interest rates would cause the value existing bond portfolios (or bond funds) to go down.

Now to be fair, a number of us have been concerned about interest rate risk for many years and rates stay stable and even went lower in 2019... so it shows you what we know.

Interest rate risk is why I prefer CDs to bond funds at this time.... until interest rates normalize (if they ever do).

 

[OldShooter]

... Now to be fair, a number of us have been concerned about interest rate risk for many years and rates stay stable and even went lower in 2019... so it shows you what we know. ...

I think that's a pretty good strategy. Remember William Bernstein's comment on the purpose of investing for retirement: “Make no mistake about it: The object of this particular game is not to get rich – It’s to not get poor.”

@Sojourner, I suggest that you do some reading. I think the "Bogleheads' Guide to Investing" might be a good place to start, but others here may have suggestions for a more specifically bond-oriented read.

 

[Sojourner]

You need to keep in mind what interest rates have done over the past 30+ years - they've been in continual decline, which has certainly helped bond fund appreciation over that period.

Appreciation is driven by lower interest rates. When rates decline, the values of bonds increase (and vice versa). This is known as interest rate risk.

Interesting. While I've known about the inverse relationship between interest rates and bond prices for some time, I didn't realize that the overall trend of falling interest rates over the past 35 years has been the only(?) factor driving bond fund valuations higher.

@Sojourner, I suggest that you do some reading. I think the "Bogleheads' Guide to Investing" might be a good place to start, but others here may have suggestions for a more specifically bond-oriented read.

Thanks. In fact, I recently picked up that very book to continue my education in the art of "total market investing". I'd certainly appreciate any other recommendations for getting smarter about the fixed income side.

 

[gwraigty]

Interesting. While I've known about the inverse relationship between interest rates and bond prices for some time, I didn't realize that the overall trend of falling interest rates over the past 35 years has been the only(?) factor driving bond fund valuations higher.

As in many things, supply and demand can be a factor. Here is a link for a quick read:

What Causes a Bond's Price to Rise?

 

[steelyman]

I’ve posted this a couple of times before and first learned of the book when another member here posted a link to get an e-copy for free when it was first published.

As an admitted novice regarding bonds I thought it is a good introduction to bonds for others like me. It’s readable and not excessively long.

https://www.amazon.com/Why-Bother-Bonds-All-Weather-Independence/dp/0985800402/

 

[ncbill]

Fixed income is the ballast in your asset allocation.

Risk taking should be on the equity side of that allocation, not fixed income.

 

[COcheesehead]

Fixed income is the ballast in your asset allocation.

Risk taking should be on the equity side of that allocation, not fixed income.

You can lose a lot more in equities than you can in bonds. A bit more risk in fixed income can yield some wonderful results.

 

[scrabbler1]

I have been in bond funds for 30 years. Over that time, whenever I made the rare sale of some shares, I sometimes made money, sometimes lost money. I buy bond funds for their income, not to make any money on the rare times I sell.


My bond funds now serves as second-tier emergency funds. I tap into them if I need a large amount of money I can't get from my local bank account's cushion. But before they served only this function, I did some rebalancing into and out of my stock funds. Again, if I happened to make a few dollars by selling bond fund shares, great. If I lost a few dollars, oh well.


Only once, in 2003, did I go out of my way to sell bond fund shares and buy stock fund shares. That year, bond fund prices had reached some highs when I looked at the general range of the bond fund prices of my fund. And stock fund prices were still pretty low, coming off the 2001-2002 downturn. So, I made a special rebalancing move to sell some bond fund shares and buy some stock fund shares.


In late 2008, when the markets were tanking, bond fund prices dropped, too. According to a WSJ article I saw around that time, a big reason was that the demand for bonds themselves had dropped because nobody had any money to buy them. This proved to be a huge break for me because I had just ERed and had $300k to invest in a bond fund at bargain-basement prices. The extra shares I was able to buy benefit me to this day.

 

[JustCurious]

Should an investor holding a bond fund expect that it will, in all likelihood, appreciate in value over long (say, 20+ year) time periods? VBMFX has a 5.86% CAGR since its inception in 1987, for example.

No. You should expect the NAV of an investment grade bond fund to remain unchanged over long periods of time (of course there will be fluctuations). The NAV of investment grade bond funds has a tendency to revert to par value over time and over the long term, almost all of the return of an investment grade bond fund will come from dividends.

 

[steelyman]

No. You should expect the NAV of an investment grade bond fund to remain unchanged over long periods of time (of course there will be fluctuations). Over the long term, almost all of the return of an investment grade bond fund will come from dividends.

One way to check this out is to go to a charting site (Yahoo or whatever), pick an index-type bond fund like a total bond index, and look at the share price over different periods. I think it will support the point.

 

[Montecfo]

Interesting. While I've known about the inverse relationship between interest rates and bond prices for some time, I didn't realize that the overall trend of falling interest rates over the past 35 years has been the only(?) factor driving bond fund valuations higher.

Don't miss this: declining rates have been a huge tailwind to equity returns also!

 

[Sojourner]

I’ve posted this a couple of times before and first learned of the book when another member here posted a link to get an e-copy for free when it was first published.

As an admitted novice regarding bonds I thought it is a good introduction to bonds for others like me. It’s readable and not excessively long.

https://www.amazon.com/Why-Bother-Bonds-All-Weather-Independence/dp/0985800402/

Thanks for the recommendation. Definitely plan on reading this soon.

 

[Sojourner]

One way to check this out is to go to a charting site (Yahoo or whatever), pick an index-type bond fund like a total bond index, and look at the share price over different periods. I think it will support the point.

Yeah, I did that recently with VBMFX and a few others. It makes perfect sense that a bond index fund shouldn't appreciate like a equity fund, so it was puzzling to me why VBMFX and others had risen fairly steadily and substantially over the past 35 years. But now it's making more sense.

 

[Sojourner]

In late 2008, when the markets were tanking, bond fund prices dropped, too. According to a WSJ article I saw around that time, a big reason was that the demand for bonds themselves had dropped because nobody had any money to buy them. This proved to be a huge break for me because I had just ERed and had $300k to invest in a bond fund at bargain-basement prices. The extra shares I was able to buy benefit me to this day.

This speaks to my biggest concern about buying into a bond fund right now (which I'm actively contemplating due to AA rebalancing). I'd be buying at historic highs, resulting in far fewer shares than if I waited until bond funds come back down to earth. Market timing, I know, I know... but in this case, it seems prudent to wait since we know interest rates really have nowhere to go but up eventually. So now I'm thinking of just waiting it out in VMMXX and CDs for a while to see what happens.

 

[Running_Man]

Buying a US broad base index bond fund makes no sense at the present time, for instance the vanguard total bond fund holds 70% US Treasuries, which you could buy at zero cost versus the 0.15% annual cost of vanguard = to almost 9 percent of the total yield of the bond fund and 30% corporates of which 50% are BBB that trade at historic low yields.

 

[Third Son]

Buying a US broad base index bond fund makes no sense at the present time, for instance the vanguard total bond fund holds 70% US Treasuries, which you could buy at zero cost versus the 0.15% annual cost of vanguard = to almost 9 percent of the total yield of the bond fund and 30% corporates of which 50% are BBB that trade at historic low yields.

There are a few food ones that are cheaper than the 0.15% such as Fidelity FSKAX ER= 0.015%.

 

[Montecfo]

Buying a US broad base index bond fund makes no sense at the present time, for instance the vanguard total bond fund holds 70% US Treasuries, which you could buy at zero cost versus the 0.15% annual cost of vanguard = to almost 9 percent of the total yield of the bond fund and 30% corporates of which 50% are BBB that trade at historic low yields.

Agree.

And I think it makes more sense to actively manage bond investments, either yourself or using a fund or manager.

 

[monte1022]

This speaks to my biggest concern about buying into a bond fund right now (which I'm actively contemplating due to AA rebalancing). I'd be buying at historic highs, resulting in far fewer shares than if I waited until bond funds come back down to earth. Market timing, I know, I know... but in this case, it seems prudent to wait since we know interest rates really have nowhere to go but up eventually. So now I'm thinking of just waiting it out in VMMXX and CDs for a while to see what happens.

I am in the same boat. My AA is currently 60/0/40. Having been 90/0/10 for years, I cannot bring my self to reallocate assets into "high priced" bonds. The stable value fund in my 401k earns 2.75%. For the other portion, FZDXX clocks in at a blistering 1.6%. As a former 90% stock guy, this is like watching icebergs move, paint drying, ............ugh!

 

[COcheesehead]

There are better alternatives in "bond like" assets that yield 2x-3x-4x what a "bond" will get you today.

 

[pb4uski]

Buying a US broad base index bond fund makes no sense at the present time, for instance the vanguard total bond fund holds 70% US Treasuries, which you could buy at zero cost versus the 0.15% annual cost of vanguard = to almost 9 percent of the total yield of the bond fund and 30% corporates of which 50% are BBB that trade at historic low yields.

Not sure where the 0.15% cost is coming from.

VBTLX is 0.05% and the ETF version, BND is 0.035%, so $5 and $3.50 per year on each $10,000 invested.

https://investor.vanguard.com/mutual-funds/profile/vbtlx
https://investor.vanguard.com/etf/profile/bnd

 

[monte1022]

There are better alternatives in "bond like" assets that yield 2x-3x-4x what a "bond" will get you today.

Ok...here goes. Let's say one has 1 mil split evenly between 401k stable value 2.75% and plain ole cash at 1.6%. At 53yo, the purpose for these funds are part 1 of retirement by choice or force, and will easily cover 10 yrs expenses. The w*rk thing, "ugh" again, will continue for 36-48 months.



What would an experienced retiree do? Just spitballing here...... (ALL of my recent numbers were posted a few days ago)

 

[Running_Man]

Not sure where the 0.15% cost is coming from.

VBTLX is 0.05% and the ETF version, BND is 0.035%, so $5 and $3.50 per year on each $10,000 invested.

https://investor.vanguard.com/mutual-funds/profile/vbtlx
https://investor.vanguard.com/etf/profile/bnd

Yes the admiral shares quote a lower fee but the returns are 0.14% less annually since inception than the index they claim to be following. 4.21% vs 4.35. (0.16% for the last year) Interestingly the Admiral shares claim 62% US government bonds vs 70% for the regular fund, I think they don't bother to keep information current with standard bond fund web page.

 

[OldShooter]

There are better alternatives in "bond like" assets that yield 2x-3x-4x what a "bond" will get you today.

Maybe "bond like" in that they pay interest, but guaranteed not with "bond like" risk. TANSTAAFL.