Bond Funds or Bonds?

[COcheesehead]

I was a bond fund guy for years. As I neared retirement I discovered Kitces bond tent strategy as a tactic for SORR and realized if I wanted income AND capital preservation I would need to be in individual bonds and not a fund. Funds have several issues.

No par value. So even if held over time, there is no guarantee you’ll end up where you started. People are discovering this pitfall now.

Forced redemptions. With a bond I am responsible for holding it. With a fund I am depending on others to hold it as well, but they don’t. They sell, forcing the manager to sell at whatever the mark to market price is that day. And I get to pay them for the privilege of doing it. The NAV reflects both the expense and the forced sales.

Misleading yield. If you do the math, the SEC yield that is reported is not what you get in income. Take the actual distribution income and divide it by the NAV. That’s your actual yield and in many cases it’s less than the SEC reported yield.

If I can buy and ladder bonds, anyone can. Today I own over 180 bonds. They overfund our retirement income needs, a bunch of it is tax free. I have a 5.2% yield on my fixed income assets and withdrawal of about 2.5%. Thats a lot of inflation and unforeseen expense protection.

Buy funds if you want. Just know what you are getting into.

 

[Freedom56]

Investors need to distinguish between passive bond funds and actively managed close end funds (CEFs). Some CEFs, depending on the fund manager, can adapt to the rise in rates and adjust their portfolios accordingly. Passive bond funds cannot and are fighting the Fed with both hands tied behind their back. Just over a year ago I stated that passive bond funds would be dangerous to own and they would be unable to increase distributions as rates rise. That scenario has not changed and will not change unless the Fed reverses course and brings rates to zero again. What are the chances of that happening? You have to dispel with "magical thinking" and statements like "recency bias" and look at your investments objectively. In what reality do bond funds that offers no capital capital protection and distributes 1.5%-2.5% versus money market funds, treasuries, CDs, agency notes, and high grade corporate bonds offering yields 3-4 times that attract inflows versus outflows?

 

[audreyh1]

I don't understand this change in holding bond funds due to a bad 2022. How is this different from stopping holding equities due to 2022? You have a long term plan that makes simplicity and long term gains the priority. One year changes the results, and scraps the whole plan? Recency bias is pervasive and makes us all feel safer. If you like to buy individual bonds, by all means keep doing that. But don't let one year change your long term plan of simplicity.
YMMV.

VW

Hear hear.

But if someone is a hard core income investor I can understand them doing things differently.

 

[all4j]

I don't understand this change in holding bond funds due to a bad 2022.

I have an opinion on this – doesn’t explain all of it, but some. Basically boils down to 2 things.

First, I’m a believer that an investor should know “why” they are buying a particular investment & “how” that investment will accomplish their objective. Second, there is clearly a lack of understanding as to how bonds & bond funds work. In the early 1980s, the fed went to work & for roughly 40 years, the trend in interest rates was falling; the yield curve was usually a bit steep. In early 2020s, the fed said they’d be raising rates & yield curve is inverted. Many, many can’t connect those dots & the misinformation continues to abound. They bought without understanding why or how, but the environment was favorable enough to cover that.

I agree that both bonds & bond funds have their place; depending on the investor objective & the investing environment. For some, the answer may be bonds; for another, funds; for yet another “neither”. If you honestly use the same measuring stick for bonds that you do for funds, you may realize individual bonds don’t solve much of the problem. ‘buyer beware’ if you are buying without understanding.

 

[walkinwood]

Here's Vanguard's Bond Index Fund total return results for 2022 v/s the index it mirrors.


I assume that the index doesn't have to deal with redemptions.


Vanguard Intermediate-term Bond Index Fund Adm : -13.27%
Spl Bloomberg US 5-10 yr (the index the fund mirrors) : - 13.13%


I see the fund underperforming the index by .14%


Help me understand where the negative impact of fund redemptions is showing up?

 

[audreyh1]

Here's Vanguard's Bond Index Fund total return results for 2022 v/s the index it mirrors.


I assume that the index doesn't have to deal with redemptions.


Vanguard Intermediate-term Bond Index Fund Adm : -13.27%
Spl Bloomberg US 5-10 yr (the index the fund mirrors) : - 13.13%


I see the fund underperforming the index by .14%


Help me understand where the negative impact of fund redemptions is showing up?

Part of that difference is the fund expense ratio.

 

[daylatedollarshort]

Here is a good article explaining the pros and cons between bond funds and bonds.

Don’t Let Them Fool You—Here’s Why Bond Funds Are Not Bonds - "Depending on your financial situation, your retirement portfolio advisor may choose to invest in bond funds or individual bonds,” says Bill Lyons, CEO of Griffin Funding in Incline Village, Nevada. “Individual bonds tend to be a safer investment for retirement portfolios because you’re guaranteed to get your full principle back, capitalize on interest, and hold it until your bond matures. With bond funds, there tends to be greater risk associated with volatile interest rates. With bond funds, if the price falls, your principal investment may also decline.....Ultimately, you need to understand that a bond fund is not a bond. It is a mutual fund. And the 1940 Investment Company Act, which created mutual funds, defines these products as equities, even if they own just bonds. https://www.forbes.com/sites/chrisc...-fool-you-heres-why-bond-funds-are-not-bonds/

 

[Golden Mean]

I don't understand this change in holding bond funds due to a bad 2022. How is this different from stopping holding equities due to 2022? You have a long term plan that makes simplicity and long term gains the priority. One year changes the results, and scraps the whole plan? Recency bias is pervasive and makes us all feel safer. If you like to buy individual bonds, by all means keep doing that. But don't let one year change your long term plan of simplicity.
YMMV.

VW

My issue with my bond fund (VBTLX) is that it doesn't behave like a bond ladder held to maturity.

1) Its current balance (in my account) is less than what a cash balance would have been with the same money over the last 10 years.
2) It is still paying < 2.5% yield in an environment with tbills paying > 4% for the last 6 months.
3) (Speculation here) It will take years for the NAV to recover, all the while it's returning < 3%.

 

[Yipper]

There is a middle ground to be considered also... target maturity bond ETFs have attributes of both bond funds/ETFs and individual bonds.

For those who prefer the control that one gets from individual bonds but dislike the idea of having to research and select individual bonds, target maturity bond ETFs might be attractive.

Personally I like this option even though I'm sure there are detractors. iShares iBonds and BulletShares are attractive from a "less work" but still superior to open-ended bond ETFs in my opinion.

 

[audreyh1]

My issue with my bond fund (VBTLX) is that it doesn't behave like a bond ladder held to maturity.

1) Its current balance (in my account) is less than what a cash balance would have been with the same money over the last 10 years.
2) It is still paying < 2.5% yield in an environment with tbills paying > 4% for the last 6 months.
3) (Speculation here) It will take years for the NAV to recover, all the while it's returning < 3%.

You don’t know that it will return <3% annually from here on out. The distribution yield is currently <3%. That is not the only component of return. Don’t confuse distribution yield and return with bond funds.

 

[daylatedollarshort]

You don’t know that it will return <3% annually from here on out. The distribution yield is currently <3%. That is not the only component of return. Don’t confuse distribution yield and return with bond funds.

The only other component to total return than distribution yield is the NAV price. The only way for the NAV price fully recover from their pandemic highs is to have interest rates drop to their near 0% lows again, which is Freedom56's point.

ETA: Google finance shows VBTLX share price is currently $9.61, down from $10.18 in 2001. The average total return for the last ten years has been 1.39%, https://investor.vanguard.com/investment-products/mutual-funds/profile/vbtlx#performance-fees, which is less than the average inflation rate for the last ten years of 1.88%, https://www.forbes.com/sites/qai/20...s-past-breaking-down-inflation-rates-by-year/.

 

[Montecfo]

Investors need to distinguish between passive bond funds and actively managed close end funds (CEFs).

This is a good opportunity to sharpen our terminology.

Most open end funds are "actively managed". This means the fund has a manager who is picking individual securities to meet the fund objective. These are "active" funds. These are the funds most folks are most familiar with.

Some funds do not pick bonds from the entire universe of bonds. Instead they follow an index. These funds are "passive funds". They usually have far lower costs because they do not have to research and vet various bond issues.

Open end funds can be active or passive. Those who came up financially in the John Bogle/Vanguard investing school are used to low cost passive index funds.

Open end funds typically trade at the aggregate value of the underlying securities held, which is called the net asset value, or NAV. As investors enter (buy) or leave (sell) the fund, the fund manager must buy or sell additional underlying securities. That is how the open-end mutual fund structure works.

Closed end funds are different than open end funds. They trade like stocks. The prevailing market price of closed end funds may be higher or lower than its underlying net asset value (NAV). If higher we say it is trading at a premium to NAV. If the market price is lower than NAV we say it is trading at a discount.

Closed-end funds or CEF's raise money to buy securities just as other companies do. Accordingly they are not buying or selling underlying securities as investors buy or sell the CEF. This is a key advantage. They often employ leverage by borrowing funds for additional investment. This can add opportunity but also risk.

So funds which track an index are "passive" funds. All other funds are "active" meaning the fund managers pick securities using judgement and analysis, not by tracking an index.

An excellent source for researching individual funds is your broker, which will have info online for many funds, or morningstar.com, which offers free and subscription performance info and analysis on most funds.

 

[f35phixer]

UGGGH This makes my head hurt...

So first off we don't need the money monthly. Can I assume that's why people are trying to get better % on cash money? Both our Pensions and SS taken at 62 bring us 14K Take-home after medical and Taxes taken out, Fed and State employee.

I Follow you and Bogglehead and have gone with the three fund plan via Boggle 60/40AA.

We'll use just my Fidelity roll over as example.
JAN 2023 - FAGIX reinvest is 115 shares@ 9.35 and FTBFX is 47 shares @ 9.64. JAN 2019 FAGIX was $9.66 and FTBFX was $10.39, don't worry about # of shares.

So all these shares just keep adding up until RMD in 2030 for me.
An approx would be 115X12X7 = 9660 shares in 2030 for FAGIX. and we'll just use $8.80/share = 85K. That's not bad is it? To do absolutely NOTHING, no chasing rates etc etc...

Am i missing anything?

 

[audreyh1]

Cash flow. Some people set up their investments to generate a certain monthly cash flow.

Other folks don’t care about the cash income generated by their investments.

You have to decide which type of investor you are: an income investor or a total return investor.

 

[walkinwood]

Part of that difference is the fund expense ratio.

True.



And that makes the negative impact of redemptions in index bond mutual funds even harder to see. Unless I'm missing something, it hasn't been a factor affecting performance in 2022.

 

[Montecfo]

For me it is funds awaiting investment mostly. Total return investor.

 

[MichaelB]

+1@Audreyh1

Our portfolio has both individual bonds and bond funds, and that allocation has multiple objectives. One is to generate some cash, another (more important) is to diversify and lower the overall risk profile.

Because risk management and rebalancing are critically important, we always have part of the portfolio in bond funds. It is easy to shift allocations between bonds and equities when both are funds or ETFs, and over time they are less volatile than individual stocks and bonds.

Individual bonds and stocks make up the minority of our portfolio. We usually buy when market events lead to opportunity prices, like in ‘09 and last year. When bonds mature we will decide then what to do with the proceeds.

We do have substantial assets in Vanguard Global Wellington. It did well last year, and the bond portion (+/- 35%) was not the drag it was in other funds.

IMO unless one only invests in fixed income, a discussion of bonds vs funds needs to consider these factors. What matters is total return.

 

[yakers]

IMHO the challenge the last few years is what to do for fixed income. Many different answers, the bond index funds like BND have not done well and its fine by me to switch out of them. I don't want to buy indivual bonds (although I do hold ibonds and a couple TIPS. These are also CDs, annuities, munis, corporates and I have been 'saved' buy having the TSP G Fund which is something like a stable value fund. If I were young and just wanted a single fund like VBIAX it would probably be fine. I am getting older and want to simplify things, DW has no interest in things financial, I ponder just VG Wellesley in tax deferred and Wellington in taxable, someday.....

 

[all4j]

True.



And that makes the negative impact of redemptions in index bond mutual funds even harder to see. Unless I'm missing something, it hasn't been a factor affecting performance in 2022.

Another key part is the 'cash drag' of any fund -- which helps or hurts depending on the market. Larger funds have a lot of $s dollar cost averaging in from 401k investments etc. I don't think there is never a situation where funds sell when they don't want to, but do think it is overblown. Most people are surprised to look at bond index turnover, but managing incoming cash, redemptions, selling to match the index is all a part of the product

 

[f35phixer]

Maybe I'm just a don't care head in sand person, We have plenty of money type people...
Just wanting DD to have lots of money when i die at 111 ;-)

So this is basically total return?
Example of Total Return
An investor buys 100 shares of Stock A at $20 per share for an initial value of $2,000. Stock A pays a 5% dividend the investor reinvests, buying five additional shares. After one year, the share price rises to $22.

To calculate the investment's total return, the investor divides the total investment gains (105 shares x $22 per share = $2,310 current value - $2,000 initial value = $310 total gains) by the initial value of the investment ($2,000) and multiplies by 100 to convert the answer to a percentage ($310 / $2,000 x 100 = 15.5%). The investor's total return is 15.5%.

 

[all4j]

don't worry about # of shares.


Am i missing anything?

If you are re-investing distributions, then you don't want to disregard this (imo). When interest rates go up, price falls. So your distribution buys more shares. &, of course, vice versa. And probably on a monthly basis. In an active environment, that will be different than with a semi-annual payment that may not be enough to buy another bond.

In a rising rate market, over time, you'll be have an increase in the distribution with a fund whereas the individual bond will be static (nominally) over the life of the bond. I'm not sure I'm following the comments on whether you are cash flow/income investor or total return in this case.

 

[audreyh1]

Another key part is the 'cash drag' of any fund -- which helps or hurts depending on the market. Larger funds have a lot of $s dollar cost averaging in from 401k investments etc. I don't think there is never a situation where funds sell when they don't want to, but do think it is overblown. Most people are surprised to look at bond index turnover, but managing incoming cash, redemptions, selling to match the index is all a part of the product

Cash holdings in index funds tend to be extremely low, like 0.36% for VBTLX.

 

[all4j]

Cash holdings in index funds tend to be extremely low, like 0.36% for VBTLX.

So you're prodding me into more research than I had planned! I don't know your source of info, but willing to accept as accurate. However, maybe some context is in order. Whatever number we look at for cash will be a point in time snapshot & that's at least part of the point. It will vary & allow for incoming/outgoing activity without the "forced redemptions" that seem to strike fear in some hearts.

I went to the Vanguard site for the fund you cited to get the numbers. The easy access was to the semiannual report from June 30 2022. It showed a .5% cash (note I didn't pull "net cash" which may be yet another number). The annual report was from 12/31/2021 & it had 2.2%. So, as expected, the numbers vary & I have no desire to argue over what a good number would be.

In my previous post, I put cash drag in quotes as there are various tools used beside actual cash. I had left out "brokerage fees", but while I had the annual report I looked at that. It showed 5 years of turnover rates: 69%, 79%, 31%, 54%, & 55%.

So, how much do the non-bond holdings & trading cost account for? IDK, but I would personally expect that to be more than the 5 basis point expense ratio.. But all 3 help explain the variance with the pure index.

Anyway, I'm not trying to change the minds that have already locked in on an approach. I appreciated walkinwood bringing in real data & was trying to augment that.

 

[target2019]

We have ~ 15% in bond funds (reduced holdings a few times in 2022 for MM fund).

I also shifted some VBTLX into VWIAX (Wellesley).

I'll keep following the thread, as the question on the table is whether to now increase positions in bond funds. I'm on the fence about this.

 

[Phroig]

I like municipal funds for taxable accounts. Both Vanguard and Fidelity have good offerings. It would be difficult for me to pick out (and monitor) individual muni bonds; unlike the corporates, I don’t know any of the issuers.