1 Year Treasury Note vs. Total Bond Fund

[sdfire]

Had two Muni Bonds called. Sad to see the 5% tax free go in taxable account. But, I am amazed that California waited this long.

I am debating whether to follow what has been my normal strategy and put the money into a total bond fund (at Fidelity). Or, should I grab a 1 year treasury note at about 1.9% and wait a year or more to put the money into the bond fund.

I have been steadily trying to replace the stock funds in my IRA with Bond funds or other fixed income. So, normally when I received unexpected cash such as this, I buy a stock fund in my taxable account with the money, sell the same amount of a stock fund in my IRA and buy a Fidelity total bond fund. This is money that I will not touch for 10+ years.

I am hesitating simply because I know that the net value of the bond fund will go down with increased interest rates. But, FTBFX is now showing 3.1% 30 day yield. And, obviously 3.1% is higher than 1.9% and over time I should get the 3.1%.

I just hate watching the net value go down.

What would you do?

Thanks

 

[OldShooter]

We don't buy bond funds as a matter of principle, so I guess it's not surprising that I don't see why this is a hard question. Buy something that will probably go down by an unknown amount in the next year vs buy something that won't?

 

[COcheesehead]

I like individual bonds because they have a par, a value they will return to short of default at maturity and they have a very specific duration. Bond funds have neither.

 

[pb4uski]

We don't buy bond funds as a matter of principle, so I guess it's not surprising that I don't see why this is a hard question. Buy something that will probably go down by an unknown amount in the next year vs buy something that won't?

I like individual bonds because they have a par, a value they will return to short of default at maturity and they have a very specific duration. Bond funds have neither.

+1. Not keen on bond funds given imminent rises in interest rates. Prefer individual bonds.

 

[mrfeh]

Since it's money you won't touch for 10 years, the answer is easy: total bond fund.

Ignore the NAV changes. They are irrelevant if you aren't selling.

 

[VanWinkle]

We don't buy bond funds as a matter of principle, so I guess it's not surprising that I don't see why this is a hard question. Buy something that will probably go down by an unknown amount in the next year vs buy something that won't?

What principle are you basing your opinion about bond funds?

VW

No one complains when interest rates are falling......

 

[RunningBum]

What principle are you basing your opinion about bond funds?

VW

No one complains when interest rates are falling......

Right. Just like stocks, I focus on total return for bonds. Bond funds do just as well as individual bonds, minus the small drag that the fund fee causes. Rather than locking in on a low individual bond rate and getting full value at term, when interest rates rise bond funds may have a lower NPV but make up for it with better yields. We've gone through this in the past.

To the OP, I'd go with the T-note for a year and then reevaluate. Neither bonds nor bond funds do that well when interest rates rise. I don't mind a little market timing with bonds/cash.

 

[COcheesehead]

The beauty of an individual bond is you know what you’re going to get and when you are going to get it. With a fund, its like a box of chocolates.

 

[mrfeh]

The beauty of an individual bond is you know what you’re going to get and when you are going to get it. With a fund, its like a box of chocolates.

But you know you will be getting a chocolate, and not a kumquat or a pineapple.

Current SEC yield for VBTLX is 2.7%, which is a very reasonable expectation for return if held for several years, as the OP will be doing.

 

[RunningBum]

The beauty of an individual bond is you know what you’re going to get and when you are going to get it. With a fund, its like a box of chocolates.

But you don't know what you can buy with what you get when the term is up. Inflation.

But you're right, if you really want to know exactly what you'll get with each interest payment and at the end of the term, an individual bond is how to go. I keep my bonds in my IRAs and don't care about that, just the total return.

 

[COcheesehead]

But you know you will be getting a chocolate, and not a kumquat or a pineapple.

Current SEC yield for VBTLX is 2.7%, which is a very reasonable expectation for return if held for several years, as the OP will be doing.

I am a ladder guy. I like precision. I have owned too many bond funds where the coupon doesn’t make up for the NAV drop in a rising rate environment.
For the bond segment of my portfolio, I like having a par value to return to. That’s just me because I buy bonds for income first, capital preservation second. I don’t like it when my total return drops and anyone holding a bond fund now likely has seen a 5%-10% drop in value, there are exceptions of course.

 

[COcheesehead]

But you don't know what you can buy with what you get when the term is up. Inflation.

But you're right, if you really want to know exactly what you'll get with each interest payment and at the end of the term, an individual bond is how to go. I keep my bonds in my IRAs and don't care about that, just the total return.

I don’t buy bonds for inflation protection. No one should. Bonds are not an inflation hedge. There should be other components in a portfolio to use as an inflation hedge. I look at my total return of my portfolio in relation to inflation and even with a significant amount of funds devoted to my ladder, I’ve done OK with inflation. My bonds are my retirement paycheck, steady and (almost) assured.

 

[mrfeh]

I am a ladder guy. I like precision. I have owned too many bond funds where the coupon doesn’t make up for the NAV drop in a rising rate environment.
For the bond segment of my portfolio, I like having a par value to return to. That’s just me because I buy bonds for income first, capital preservation second. I don’t like it when my total return drops and anyone holding a bond fund now likely has seen a 5%-10% drop in value, there are exceptions of course.

Ok, but this puts you in a fundamentally different scenario than the OP.

 

[OldShooter]

Since it's money you won't touch for 10 years, the answer is easy: total bond fund.

Ignore the NAV changes. They are irrelevant if you aren't selling.

That is an answer a question that the OP is not asking. He is asking about parking his money with a one-year horizon. I think the thread consensus is the right answer to that question.

What principle are you basing your opinion about bond funds? ...

Several reasons, maybe even dismissable as superstitions.

1) The oft-mentioned problem that you never know what you're gonna get.

2) Fees. As fees have dropped this has become less of an issue but it is still true that a trained monkey could run a govvie portfolio and would work for peanuts not bps.

3) Many people don't realize it, but there is a third person at the table when playing with an ETF fund, the "authorized participant." (https://www.investopedia.com/terms/a/authorizedparticipant.asp) This is an entity whose sole interest is their own P&L and who has absolutely no concern for the best interests of the ETF holders. From long experience in business, I believe that bad things can happen in relationships where interests aren't aligned. For example, in a falling market the authorized participants can just sit on their hands and refuse to redeem shares. This is why ETF prices can diverge from NAV.

4) Unlike stocks, there are jilliions of bonds, many of which are small and illiquid issues. This creates problems for a fund that is growing or shrinking; it is forced to deal primarily in the liquid issues like govvies, which may cause the composition of the portfolio to vary from the prospectus. The fund becomes a black box where holders can't see what's inside and the contents are constantly changing. Occasionally you'll see an article on this liquidity issue, but it is not something that the bond ETFs like to see discussed and they vote with their advertising dollars.

All that said, the huge advantage of corporate bond funds is diversification where bond diversification is impossible for most retail investors. --- they just don't have enough time or money. So staying away from bonds for us essentially means staying away from corporates. In contrast, I am on the investment committee of a nonprofit and we hold no bond funds. We are pretty well diversified, holding hundreds of investment-grade bond issues typically in $10K chunks. Maturities are laddered or liability-matched, and we pay no attention to the current value of the portfolio, only to values at maturity. We also aren't concerned about liquidity.

As they say, YMMV.

... Bond funds do just as well as individual bonds, minus the small drag that the fund fee causes

and minus the drag of the spread on every trading transaction and minus the drag of trades' market impact and minus the drag of trading costs and fees. The OP mentioned FTBFX; Yahoo says their holdings turnover is 222%. (!)

FTFY.

 

[COcheesehead]

Ok, but this puts you in a fundamentally different scenario than the OP.

How so. The OP doesn’t want capital loss. An individual bond virtually guarantees no loss vs a fund which is an unknown.

 

[mrfeh]

That is an answer a question that the OP is not asking. He is asking about parking his money with a one-year horizon. I think the thread consensus is the right answer to that question.

He explicitly stated this is money he won't be touching for 10+ years.

 

[mrfeh]

How so. The OP doesn’t want capital loss. An individual bond virtually guarantees no loss vs a fund which is an unknown.

Over 10 years? I will guarantee a total bond fund will not have a loss.

 

[COcheesehead]

Over 10 years? I will guarantee a total bond fund will not have a loss.

In a rising rate environment? I don’t know. The long term returns on BND or FTBFX are pretty slim. Wouldn’t take much to turn it negative.

 

[OldShooter]

Over 10 years? I will guarantee a total bond fund will not have a loss.

Would you guarantee no loss over the 1 year time period the OP is asking about?

OP's question has nothing to do with a 10 year horizon: "I am debating whether to follow what has been my normal strategy and put the money into a total bond fund (at Fidelity). Or, should I grab a 1 year treasury note at about 1.9% and wait a year or more to put the money into the bond fund?"

 

[mrfeh]

In a rising rate environment? I don’t know. The long term returns on BND or FTBFX are pretty slim. Wouldn’t take much to turn it negative.

The CAGR for FTBFX since the start of 2009 (when the 10 year yield was very close to what it is now) is 5%.

OP - I suggest you play with portfoliovisualizer.com to see just how predictable total bond funds are over long time frames (ie. 10 years).

 

[COcheesehead]

The CAGR for FTBFX since the start of 2009 (when the 10 year yield was very close to what it is now) is 5%.

OP - I suggest you play with portfoliovisualizer.com to see just how predictable total bond funds are over long time frames (ie. 10 years).

Those past ten years were in completely different environments than we have now. Dropping rates vs rising. Remember past results are no guarantee of future returns. To quote everyone’s fund disclaimer.

 

[mrfeh]

Would you guarantee no loss over the 1 year time period the OP is asking about?

OP's question has nothing to do with a 10 year horizon: "I am debating whether to follow what has been my normal strategy and put the money into a total bond fund (at Fidelity). Or, should I grab a 1 year treasury note at about 1.9% and wait a year or more to put the money into the bond fund?"

From the original post:

This is money that I will not touch for 10+ years.

 

[mrfeh]

Those past ten years were in completely different environments than we have now. Dropping rates vs rising. Remember past results are no guarantee of future returns. To quote everyone’s fund disclaimer.

As I said, the 10 year yield at the start of 2009 is almost exactly the same as today. And if rates rise, that will increase the dividends, offsetting the decrease in NAV.

And I will now leave the thread, as these "rates are rising, time to sell all bond funds!!!" threads never go anywhere.

 

[sdfire]

Thanks for your thoughts. I am schizophrenic on bonds. I have funds and I purchased individual bonds. I appreciate the debate and I see both sides of the issue.

But, my question is slightly different than just an individual bonds vs. bond funds question. I am asking whether it makes sense to wait to purchase a bond fund by a year or so in a rising rate environment? A treasury note at 1.9% for one year with no state tax vs. a bond fund with a 30 day yield of 3.1% (but, with a likely NAV decrease that should be made up over time with higher rates).

For money in an IRA that I won't touch for 10+ years, does it make sense to just go ahead and buy the bond fund now or to wait a year and avoid the NAV decrease? At the end of the day, would 1 year at 1.9% plus 9+ years at next year's NAV result in more in my account than 10+ years in the bond fund starting now. I realize we don't know the future. But, we all expect interest rates to rise (although some of that is already baked into the bond funds).

So, my question is really 1 year at 1.9% plus 9+ years bond fund at next year's NAV vs. 10+ years buying the 3.1% bond fund today. Thoughts/Math very welcome.

 

[foxfirev5]

I would never guarantee that a TBM fund would not have a loss over 10 years. I'm looking beyond the single jump in rates vs duration that most people use. Imagine a steady increase in rates over a number of years, and your breakeven point gets way out there. Meanwhile I'm sticking to my individual CD/Treasury ladders - 5years rolling and 15 years non rolling. At least I know what my balance will be at the end of every year. Throw in years of Series I Bonds and I'm pretty confident my needs are covered. I'll leave the heartburn for my 50% equities which is probably for the kids anyway.