Holding Bonds when Interest Rates are Rising... Why Worry??

[DawgMan]

It seems to get drilled into us by the pundits to run from bonds in a rising interest rate environment. Sure, the logic makes sense that bonds will get hammered as interest rates rise, but will they really? I, like many, get a little antsy sometimes with my bond allocation anticipating an eventual rise in interest rates. While I subscribe to the the "ballast" argument in holding primarily short and intermediate bond ETFs in my 60/40 allocation, I continue to research better mousetraps, if nothing else, to appease my greed gland. Of course, I will do nothing in the end but stay the course, but found the article below interesting...

"1976-1981: Rising Rates

The six-year period from January 1976 to December 1981 saw an increase in the Federal Discount rate from 5.79% to 12.10%—and rising rates generally represent a head wind for fixed income. As might be expected, the long bond index was hit hardest, and experienced a six-year annualized return of 2.47%, which was substantially below its 8.88% annualized return over the past nearly 45 years (1976 through Oct. 31, 2020).

The short and intermediate bond indexes posted reasonably impressive gains of 7.31% and 6.34%, respectively. The aggregate bond index had a 5.04% annualized return... For those who do not remember the late 1970s, we are the aged messengers to remind you that inflation (as measured by the CPI) grew at an annualized rate of 9.18% from 1976-1981—essentially eclipsing the performance of all the fixed income indexes. Thus, all four fixed income indexes had a negative real rate of return between 1976-1981."

And more recently...

"2002-2007: Rising Rates Again

The second period that we will examine in which interest rates rose was the six-year period from January 2002 to December 2007. The Federal Discount rate moved from 1.25% to 4.75%. During that same time, short-term bonds cranked out a return of 4.34%, intermediate bonds returned just over 5.4%, and the aggregate bond index had a 5.37% annualized return."

I suppose it begs the question... should we really bail on our short/intermediate bonds? At least in the short term, while inflation has raised its head at least for now, my crystal ball says the current effects from Covid, supply chain challenges, employment, and current political policies, the Fed may slow play a run up in interest rates until the economy gets it's sea legs back again.

What say you?

https://www.etf.com/sections/etf-st...-class-returns-during-rising-rates?nopaging=1

 

[REWahoo]

Running from bonds in anticipation of interest rate increases is market timing, something I'm unable to do successfully.

 

[gauss]

I just ladder them and plan to hold them to maturity. Just need to be careful about purchasing them at a premium.

Problem solved IMHO.

Note that you can't do this with a traditional bond fund with a "rolling" average maturity date.

-gauss

 

[Markola]

Good article. Look at the paragraphs about how equities performed during these periods. Together, portfolio returns kept pace. This is why we own a 50/50 allocation, and why our stock side is 40% international/60 domestic.

Also, if you take the long view, wouldn’t folks have been pretty happy that their index funds were chock full of high-rate bonds during the many years of falling rates and higher bond prices between the study periods? Folks here seem wistful about the high rate CDs they once owned, too. And home prices typically climb during periods of falling rates.

Gotta have the long view to be an investor vs. a speculator.

 

[VanWinkle]

I agree that increased rates will make a bond fund whole again based on the duration of the fund. I have a 2 year target for a house(hopefully in Tennessee) and have that money in the Ultra Short term Bond fund. My retirement account for RMDs in 6 years has 2 intermediate bond index funds.

I still believe in bonds for ballast!!

VW

 

[audreyh1]

I guess you’ll never be able to sit on your hands.

 

[Markola]

^^^^^ After trying and failing at the alternatives, I’m now pretty good at sitting on my hands.

 

[jazz4cash]

I have a few individual bonds but no bond funds except MM fund and an intermediate single state muni fund. The individual bonds will be held to maturity so I don’t expect rising rates will be too painful. Hopefully we’ll get some decent CD rates.

 

[RobbieB]

Not selling any bonds. Selling stocks -

 

[njhowie]

As I mentioned on another thread, insanity continues in the (municipal) bond market. Though rising interest rates are being seen on the horizon, and rates should be trickling higher, and prices lower, I am continuing to see incredible demand...which makes little sense. On Friday, just feeling out the market and requesting bids on a bunch of my bonds that are past call date (could be called tomorrow and price would almost immediately go to 100.0), I received bids on all of them much higher than 100.0, with many offering nearly a years worth of interest today for selling. That is unbelievable, that folks are actually wagering/gambling that they can buy these bonds today, and the issuers won't be calling any time soon, locking them in with a loss. The issuers could go to market to refinance today, sometimes at half the rate they are currently paying. Again, it is insanity, and I'll continue selling my bonds if they keep showing that kind of interest in them.

 

[Montecfo]

Sell all short/intermediate bonds? No.

But recognize duration risk and keep it short, 1-3 years or shorter, and consider floating rate issues and alternatives? yes

Easy to look back and see what has happened to bonds even in this mini rate rising cycle. Total bond (Agg-based) funds have been down even on these small moves. Duration 6.5.

Equity issues carry greater interest rate risk than bonds on my view but, unlike bonds they carry the possibility of rising earnings which can mitigate that risk. But it does not go to zero.

 

[Lsbcal]

We have had about 5% inflation over the last 12 months. Here are the returns on some bond funds I track over the last approximately 12 months (from Nov 2020 to Oct 9, 2021):

VFIUX (intermediate Treasury) = -1.5%
VFIDX (intermediate investment grade) = 0.9%
VBTLX (total bond fund) = -0.8%
VFIRX (short term Treasury) = -0.1%
VFSUX (short term investment grade) = 1.2%

So in real terms all of these funds were losers. The question is how long will this continue?

I personally favor short term investment grade since some data suggests it did comparatively better in the 1970's inflation.

 

[Freedom56]

If you own individual bonds, you don't have to worry. Just continue to hold them to maturity. Every single bond I own was purchased below par and is now trading above par. The average coupon is 7.2% and average YTM is 8.6. I'm holding a lot of cash waiting for the next bond and preferred ETF/Fund sell-off to pick up some more individual bonds like I did in March 2020. If you take a disciplined approach to bond investing and buy only when they are a bargain and avoid high risk companies, you can outperform just about any fund.

 

[gcgang]

Vanguard Intermediate VBILX has a duration of 6.6 years and an SEC 30 yield of 1.48%.

So what does that mean? A 1% rise results in what, a 6.6% decline in price?

Think I’ll just miss out on the extra 1% and hold cash for a while.

Was it Buffett that said, at these yields, bonds are return free risk?

 

[SecondAttempt]

One of the issues I see is that so much of the bond market is on autopilot by policy or law. Big pension funds and insurance comapnies usually are required to hold a certain amount in bonds and sometimes with specific maturities. So while undoutedly bond values will go down predictably when rates go up, forced demand might mitigate the impact.

Personally I am avoiding all but the shortest terms right now because I think rates will start going up in a year or less and bond values will go down. But the world financial markets are much much different than they were in the 1970s, so we have little relevant history to go on. They have even changed dramatically since 2008.

I see some of the biggest risks in "credit opportunities," "dynamic credit," and similar funds. These often have short durations but hold debt of the riskiest borrowers. They have paid pretty well recently but I think we may see some fireworks when their borrowers can't handly higher rates and start to default. In other words, I don't think it is rising rates and the mathematical effect on value that will be the major issue. I think it will be the impact of higher rates on the uncreditworthy borrowers. That is much harder to predict.

If you buy quality and understand the predictable effect of duration on price you should be fine.

 

[Closet_Gamer]

As I mentioned on another thread, insanity continues in the (municipal) bond market. Though rising interest rates are being seen on the horizon, and rates should be trickling higher, and prices lower, I am continuing to see incredible demand...which makes little sense. On Friday, just feeling out the market and requesting bids on a bunch of my bonds that are past call date (could be called tomorrow and price would almost immediately go to 100.0), I received bids on all of them much higher than 100.0, with many offering nearly a years worth of interest today for selling. That is unbelievable, that folks are actually wagering/gambling that they can buy these bonds today, and the issuers won't be calling any time soon, locking them in with a loss. The issuers could go to market to refinance today, sometimes at half the rate they are currently paying. Again, it is insanity, and I'll continue selling my bonds if they keep showing that kind of interest in them.

Did you sell all of your callable bonds that received bids over 100?

If not, you're choosing to maintain the exact same level of risk that others would be purchasing if they bought them from you. (Unless there is a cap gain issue that changes your math somewhat.)

BTW -- not trying to be provocative...you know from other threads I find this whole interest rate situation a condundrum as well.