Bond Mutual Funds

[lawman]

Haven't been here in nearly a year but a question brings me back.Seems that almost everyone hates bond mutual funds these days..For short term investors I get it. For long term investors I don't..Intermediate bond funds should theoretically completely turn over in 8 - 10 years..Assuming one does not want out in the next 10 years why are folks so hung up on interest rate risk..I am heavy into bond funds and I wish interest rates would go up and the sooner the better..My only concern is that something could cause people to make a mass run for the exits forcing managers to sell when buyers are few and far between but for those managers who were able to pick up those bonds at bargain prices it seems to me they would stand to do quite well..So please help me understand the error of my thinking..

 

[daylatedollarshort]

There is not much upside potential in bond funds these days compared to a huge amount of downside risk. And bond funds never mature, so with rising interest rates you may be able to do better with a fixed income ladder with set maturity dates.

 

[BUM]

When they head for the exits its not gonna be pretty. Meanwhile I've been overweight DBLTX with some TGLMX.

 

[lawman]

There is not much upside potential in bond funds these days compared to a huge amount of downside risk. And bond funds never mature, so with rising interest rates you may be able to do better with a fixed income ladder with set maturity dates.

That's what everyone says..Now tell me more about this huge downside risk.

 

[daylatedollarshort]

That's what everyone says..Now tell me more about this huge downside risk.

Interest rates have only so far to fall to get to zero, but could go up to 10% or more.
More on this here:

Bond Funds are Not Exactly Safe Shelters
http://djcoregon.com/news/2002/08/1...-exactly-safe-shelters-they-are-really-loans/

When rates go up, bond prices fall. If you own a bond outright, you can hold it to maturity. In a fund you may never recoup your lost original principal.

 

[lawman]

Interest rates have only so far to fall to get to zero, but could go up to 10% or more. More on this here:

Sometimes You Should Buy The Bonds Directly - Sun Sentinel

"bond funds never mature, because the fund manager is buying new bonds to replace those that mature, or those he sells. So the fund's share price can go up or down, mostly in response to changes in interest rates, and you can never be sure of getting your principal back when you sell the fund shares."

And even more in Annette Thaus' The Bond Book, where she discusses the pros and cons to bond funds. There are many pros, but less so in a rising interest rate environment because bond funds never mature, so you may never recoup your principal. You have to decide what works for you.

I get that..I guess what makes it different for me is that I do not want to go back into stocks and I'm quite happy to never get out of bonds..

 

[daylatedollarshort]

I get that..I guess what makes it different for me is that I do not want to go back into stocks and I'm quite happy to never get out of bonds..

Sorry, I changed my post as I found a less ad ridden article. If you stay with bond funds you will not be likely to go broke and lose all your money. You just might have better odds of making a higher total amount of money in a rising interest rate environment with a ladder. If you like the ease of funds there is no law that says you have to forego them for a more complicated choice, even if the more complicated choice has better odds of a higher total long term return (interest plus market gain / losses). The fund is likely to suffer high market losses if interest rates rise significantly.

 

[LOL!]

Below is a chart showing the huge increase in interest rates on the 10-year note back in 2013 (blue line). The red line is the price (NAV) of a bond mutual fund FSITX (Fidelty Spartan Total US Bond index fund). The red line does NOT show reinvested dividends.

Certainly, the bond fund lost some money, but not enough to really worry about. The bond fund has since recovered.

 

[lawman]

I think what I understand least regarding bond funds is liquidity risk..If managers were forced to sell bonds in order to meet redemptions is that something one could ride out without loss or is that something one might never recoup? I think one might never recoup that but I don't know just how great that risk is? To my knowledge something like that that has never happened on a large scale but it doesn't mean it couldn't..

 

[lawman]

Below is a chart showing the huge increase in interest rates on the 10-year note back in 2013 (blue line). The red line is the price (NAV) of a bond mutual fund FSITX (Fidelty Spartan Total US Bond index fund). The red line does NOT show reinvested dividends.

Certainly, the bond fund lost some money, but not enough to really worry about. The bond fund has since recovered.

That is very interesting...Thanks

 

[foxfirev5]

Over the last 7 years there have been constant projections that interest rates will rise not fall. Each year that has been largely proven wrong. This has led to a certain smugness of bond fund holders when they announce that these forecast were wrong and the TBM gained xxx last year.
However, this could very well end badly as some of the above posters have mentioned. Not having much choice I am forced to hold my nose and invest in the total bond market fund in my 401k. However, upon retirement, I will rollover to an IRA and ladder CD's, maybe some bonds, and minimize a portion of this risk.
The fixed income portion of my portfolio is to add ballast and stability. I don't care about the possible capital gains on bond funds as they very well may turn into losses in the future.

 

[Dash man]

If there is a run to exit bond funds it could cause a liquidity crisis possibly resulting in the closure of the fund or the company running the fund.

 

[LOL!]

Here is a close-up of just the YTD part of the previous chart. I show it because bond funds were UP 2% in January alone. Staid bond funds do not go up 2% in one month. But one sees that it was because of interest rates, the FOMC meeting, ECB announcements, Greece worries, and so on. When all those things played out, interest rates settled again and bond funds gave up in February most of the 2% gains they had in January.

So if plus-or-minus 2% to 5% volatility per month in a bond fund bothers you, then you should not be in a bond fund.

(Chart made at finance.yahoo.com, so you can make your own chart of interest rates compared to bond fund NAV.)

 

[hlfo718]

The same questions have been asked many times, what happens when rates rise? or Will my fund tank if rates rise? That was tested, although briefly, in 2013 when rates rose over 1%. Did your portfolio collapsed? I know my balanced portfolio did more than fine.

And when rates do rise more, I am more than ok with that since all maturities and interest payments in the bond fund will be buying higher yielding bonds.

Will I freak out over a 5% or 10% loss? Hell no. Should worry more about the equity side where is can drop a lot more.

 

[lawman]

The same questions have been asked many times, what happens when rates rise? or Will my fund tank if rates rise? That was tested, although briefly, in 2013 when rates rose over 1%. Did your portfolio collapsed? I know my balanced portfolio did more than fine.

And when rates do rise more, I am more than ok with that since all maturities and interest payments in the bond fund will be buying higher yielding bonds.

Will I freak out over a 5% or 10% loss? Hell no. Should worry more about the equity side where is can drop a lot more.

I can stand a small loss that will almost certainly recover in a few years. What keeps me awake is being in something that can make $1.00 grow to be $.80 in six years like happened between Jan. 1, 1969 and Dec. 31, 1974..

I would be interested in knowing how that compares to the worst 6 year intermediate term bond fund performance in th last 50 years..

CAGR of the Stock Market: Annualized Returns of the S&P 500

 

[LOL!]

What keeps me awake is being in something that can make $1.00 grow to be $.80 in six years like happened between Jan. 1, 1969 and Dec. 31, 1974.

This is where charitable giving comes into play. You just cut out your charitable giving for 5 years and save that 20% for yourself.

 

[photoguy]

When rates go up, bond prices fall. If you own a bond outright, you can hold it to maturity. In a fund you may never recoup your lost original principal.

I've often heard this argument that individual bonds are safer than bonds but it never resonated with me. Here's a counterpoint by Asness:

http://www.cfapubs.org/doi/pdf/10.2469/faj.v70.n1.2

See page 28 (article starts on page 22), item #10

Bond funds are just portfolios of bonds marked to market every day. How can they be worse than the sum of what they own?

If you own the bond fund that fell in value, you can sell it right after the fall and still buy the portfolio of individual bonds some say you should have owned to begin with (which, again, also fell in value!). Then, if you really want, you can still hold these individual bonds to maturity and get your irrelevant nominal dollars back. It’s just the same thing.

 

[audreyh1]

I've often heard this argument that individual bonds are safer than bonds but it never resonated with me. Here's a counterpoint by Asness:

http://www.cfapubs.org/doi/pdf/10.2469/faj.v70.n1.2

See page 28 (article starts on page 22), item #10

Thanks for the link. I am another investor who is mystified by the warnings to own bonds instead of bond funds if you are investing for the rest of your life.

The "never matures" argument has always seemed meaningless to me since a long term direct bond investor has to manage a ladder, and that ladder never matures either.

I'm comfortable with the bulk of my fixed income in intermediate term bond funds. It doesn't concern me that they sell and buy bonds to maintain a duration in the range I picked.

I've never looked at my investments in terms of what is "principal" either. I know where I started I know where I am now. I only care that it doesn't run out in my lifetime. Being able to grow an inflation adjusted portfolio even while withdrawing from it in retirement would be nice, but is not necessary for our plan to succeed.

 

[lawman]

This is where charitable giving comes into play. You just cut out your charitable giving for 5 years and save that 20% for yourself.

 

[fanmail]

Are there any bond funds that hold all bonds to maturity? I guess I could google it, but I wondered if there were any in existence. Seems relevant to this topic.

 

[GTFan]

The same questions have been asked many times, what happens when rates rise? or Will my fund tank if rates rise? That was tested, although briefly, in 2013 when rates rose over 1%. Did your portfolio collapsed? I know my balanced portfolio did more than fine.

And when rates do rise more, I am more than ok with that since all maturities and interest payments in the bond fund will be buying higher yielding bonds.

Will I freak out over a 5% or 10% loss? Hell no. Should worry more about the equity side where is can drop a lot more.

Not to mention that almost all of the simple portfolio recommendations at bogleheads and elsewhere still recommend using Vanguard TBM or something similar. Yeah I know, it's because they're simple but I think if the prevailing wisdom had shifted about bond funds we'd see much different recommendations and we're not.

 

[audreyh1]

Are there any bond funds that hold all bonds to maturity? I guess I could google it, but I wondered if there were any in existence. Seems relevant to this topic.

Yes - Fidleity has some target maturity date bond funds. But I ask - why would you do this unless you needed the funds on date X?

 

[daylatedollarshort]

I found the original AAII article referenced in the link above by Annette Thau here:

Bond Market Strategies for a Rising Rate Environment
AAII: The American Association of Individual Investors

The guidelines at the end are what we generally follow in our household. YMMV. The mutual fund companies are never going to recommend anything but funds because they have a vested interest in funds. There are many advantages to funds but I don't think you will ever hear about the disadvantages from the companies that profit from managing them. Annette Thau doesn't seem to have a vested financial interest in any particular type of investment over another so personally I enjoy her advice.

 

[audreyh1]

I found the original AAII article referenced in the link above by Annette Thau here:

Bond Market Strategies for a Rising Rate Environment
AAII: The American Association of Individual Investors

The guidelines at the end are what we generally follow in our household. YMMV. The mutual fund companies are never going to recommend anything but funds because they have a vested interest in funds.

In our retirement portfolio fixed income we have: 5% in cash and cash equivalents such as CDs and IBonds, 5% in high quality short-term bond fund, and the remainder (37%) in intermediate bond funds, most of which are the broadly diversified bond funds.

This seems to match what she recommends at the end of her (2003/2004?) paper.

 

[fanmail]

Yes - Fidleity has some target maturity date bond funds. But I ask - why would you do this unless you needed the funds on date X?

I meant with different maturity dates, like basically the fund does the laddering for you, but without ever selling any of the existing bonds in the fund, if that makes sense.