Bond vs Bond Fund

[COcheesehead]

If nothing else there is one government institution that has some control of interest rates - the FRB. I know of no government institution that can raise or lower equity prices on its own. So, yes, predicting interest rates would be somewhat easier than stock prices, especially when the FRB announces its intentions ahead of time. Note, that I did not say EZ.

So with the Fed saying they will raise rates…all that has happened to rates over 5 years in duration is…they have dropped.

 

[daylatedollarshort]

If it were this simple, actively managed bond funds would consistently beat index funds.

They don't, of course.

No one here has recommended an actively managed bond fund in the current environment. See the Kiplinger article. That advice has worked. It is simply math. The only way the bond funds would have big NAV increases in the coming months is if interest rates went back down. That is always possible, but given inflation still at 8% and the Fed's target at 2%, not a very likely scenario, at least not without some advance warning by the Fed of their intent to change strategy as well as changes to the inflation and recession indicators. Or an asteroid strike.

 

[daylatedollarshort]

So with the Fed saying they will raise rates…all that has happened to rates over 5 years in duration is…they have dropped.

10 year Treasuries went up quite a bit this year when the Fed first started the rate increases. Now it is not as clear if they will have more big increases planned than what has already been announced.

Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an Investment Basis (DGS10) | FRED | St. Louis Fed (stlouisfed.org)

 

[Freedom56]

Bond funds are not bonds. Individual bond investors lock in higher yields as rates rise. It's a period where you increase your income moving forward. Bond fund investors lose money. The idea of a bond index is ridiculous. Index of what? Most bonds have a finite term. Broad diversification is not something you want with bonds. There are many sectors such as retail, malls, mining, airlines, and others that investors should just avoid. Timing the market is absolutely what fixed income investors do. This is why the vast majority of bond investors outperform bond funds. Investors don't lock in 5 year duration notes, CDs, and treasuries when yields are down at 0.55% like many bond funds did like the morons that manage Vanguard's TBM. Fixed income investors buy short durations or stay in cash when yields are low and lock in longer durations when yields rise like many are doing this year. This is commons sense that completely escapes those managing passive bond funds/ETFs. As rates continue to rise, I will continue to invest my coupon payments at higher yields. Bond funds on the other had will continue their "buy high sell low" trend. Short and medium duration bonds funds are about to feel some massive pain as the Fed raises rates. The only thing that will stop the hemorrhaging is if they start cutting rates September. What are the chances of that happening?

 

[COcheesehead]

10 year Treasuries went up quite a bit this year when the Fed first started the rate increases. Now it is not as clear if they will have more big increases planned than what has already been announced.

Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an Investment Basis (DGS10) | FRED | St. Louis Fed (stlouisfed.org)

Since the peak in June, they have gone down significantly.

 

[GravitySucks]

"You can own CDs or Treasuries today and always pivot back to bond funds when rates level off or decline. "

My largest bond holding is FUAMX which is down around -5%. If I sell FUAMX and buy TIPS or treasuries won't I be locking in the loss? Or am I missing something?
(I have a bond ladder that should keep me from having to sell FUAMX for another 5 years or so.)

 

[daylatedollarshort]

Since the peak in June, they have gone down significantly.

The Fed hasn't announced any new rate increases beyond what they said they were going to do early in the year, recession fears are setting in and inflation has cooled.

 

[Graybeard]

I understand people who hold bond funds, I did my entire working/investing life if I held any fixed income and at times I didn't. I lost a lot of money this year in short term investment grade and ultra short term bond funds. They had short durations so I thought I was OK. I wasn't. I finally exchanged out of both, accepted the loss and put the money into the Vanguard Settlement Fund. I learned how easy it is to buy T bills and have been though most of it is in the Settlement Fund as the yield is very good re 1 to 3 month T bills.

I can go back to bond funds when rates stop rising and the Fed cuts rates driving up the nav of funds and making money on the capital appreciation. Until then, I'll keep that money in something short term that won't make a lot but won't lose anything other than to inflation which bond funds will do too. I don't feel comfortable buying corporate bonds and I don't want any treasuries longer than 6 months currently.

My point is I see how bond funds can be harmful to your financial well being. If you are in your 30's to 50's you have time and can just ride out the ups and downs, I don't want to be in that boat with fixed income at this point.

 

[daylatedollarshort]

"You can own CDs or Treasuries today and always pivot back to bond funds when rates level off or decline. "

My largest bond holding is FUAMX which is down around -5%. If I sell FUAMX and buy TIPS or treasuries won't I be locking in the loss? Or am I missing something?
(I have a bond ladder that should keep me from having to sell FUAMX for another 5 years or so.)

Here is Vangard's couterpoint article on why you should stick with your bond fund that addresses that question. You can read the Kiplinger article, the Vanguard article, Freedom56's take on bond funds and decide what works best for you. I sold all my bond funds early in the year.

3 bond questions you should consider | Vanguard - ...you may not need to wait until the end of the rate hike cycle to benefit from positive returns. In fact, if you wait until the Fed is done raising rates, bonds may have partially or even fully recovered and you’ll risk locking in any losses."

But the issue posters here have pointed out is that bond funds may lose even more NAV if the Fed continues to increase interest rates, because funds don't mature like individual bonds do, and rates may never go back down to what were recently historic lows. And the posters here are not in cash for the most part which Vanguard gives as an alternative to bond funds in the article. Most are buying individual bonds at rates of over 3% currently on one year Treasuries, or more on some corporate bonds, with no loss of principal because of the maturity dates. And those yields may be higher than many of the bond funds. So there's that to consider.

 

[tulak]

I had a total bond fund until last year, when I realized that my stable value fund was close in yield. I sold the total bond fund and bought the SV fund. Lucky timing on my part.

I’m not a bond guy and I look for growth in equities, not bonds. I have a fixed amount for the FI part of my portfolio and going forward, I’ll avoid funds. I decided to keep durations short, 2-3 years tops, no more than one year right now, and buy whatever is yielding the most. Right now that’s iBonds and treasuries. For treasuries I only go out six months and will most likely build a ladder.

A lot of my thinking around this comes from the threads on the forum, which I appreciate. I’m not in a 100% agreement with Freedom56, since I think if trading bonds worked the way he says, you’d find bond funds that use that strategy resulting in better gains than an index bond fund. But it could be they’d still be forced to sell due to find outflows, mitigating any gains?

Like Oldshooter, I’d be curious to know if there are any data/studies in this area.

 

[Markola]

3 bond questions you should consider | Vanguard - ...you may not need to wait until the end of the rate hike cycle to benefit from positive returns. In fact, if you wait until the Fed is done raising rates, bonds may have partially or even fully recovered and you’ll risk locking in any losses.".

Thanks for the article, which basically says, your bonds are a counter weight to your stocks. Even now, bonds are down this year but stocks are down even more, so bonds are doing their job. If you can, stay put with your index fund allocation for the long term and through the cycles. It also acknowledges that not every one can invest long term.

As for me at 56, what cures me from fiddling with my portfolio allocation every time is asking myself, “Ok, how am I right and Vanguard is wrong.”

 

[tulak]

I am curious to see what bond funds do over the next 5-10 years. For the most part, we only have data on total bond fund performance while there was a 20+ year bull market in bonds.

Seeing how they perform over the fund duration plus a couple of years will provide an interesting data point. My gut feeling is that it’ll be a wash, as long as you hold for the duration.

 

[pb4uski]

....“Ok, how am I right and Vanguard is wrong.”

Because Total Bond is one of Vanguard's largest funds and they don't want to see a flood of redemptions so they have to sell stupid like Freedom describes?

Vanguard has said numerous times that a buyer of bonds funds can reasonably expect to get a yield equal to the 10-year treasury... which is currently 2.8%.

In a declining rate environment I think bond funds make sense... not so much in a rising rate environment which I think we'll have in the next 6-12 months... so Ive transitioned to CDs and UST for fixed.

 

[pb4uski]

I understand people who hold bond funds, I did my entire working/investing life if I held any fixed income and at times I didn't. I lost a lot of money this year in short term investment grade and ultra short term bond funds. They had short durations so I thought I was OK. I wasn't. I finally exchanged out of both, accepted the loss and put the money into the Vanguard Settlement Fund. I learned how easy it is to buy T bills and have been though most of it is in the Settlement Fund as the yield is very good re 1 to 3 month T bills.

I can go back to bond funds when rates stop rising and the Fed cuts rates driving up the nav of funds and making money on the capital appreciation. Until then, I'll keep that money in something short term that won't make a lot but won't lose anything other than to inflation which bond funds will do too. I don't feel comfortable buying corporate bonds and I don't want any treasuries longer than 6 months currently.

My point is I see how bond funds can be harmful to your financial well being. If you are in your 30's to 50's you have time and can just ride out the ups and downs, I don't want to be in that boat with fixed income at this point.

+1 same thing happened to me and I'm adopting a similar strategy.

 

[sengsational]

I am curious to see what bond funds do over the next 5-10 years. For the most part, we only have data on total bond fund performance while there was a 20+ year bull market in bonds.

Seeing how they perform over the fund duration plus a couple of years will provide an interesting data point. My gut feeling is that it’ll be a wash, as long as you hold for the duration.

I remember back in the late '80s when I was led to believe bonds zigged when equities zagged. My BIL had told me in advance that bonds were great, bond funds were not. Then a big flight to cash happened, and my bond fund had to sell low, while I stayed invested. I consoled myself because it was in a 401k and there was no way to invest in individual bonds.

It would seem to me there could be a fair analysis of bonds/bond fund market timing. There's a risk of over fitting the model, but the news about interest rates are in the historical record, as are the bond fund prices and payments. I'm not sure how one would model what individual bonds were selling for, though. But a set of rules could be defined based on hard news, and a model built to see how this approach would have fared, historically. My gut feel is that any reasonably simple set of rules would only beat the bond fund by a "little bit".

 

[Freedom56]

The issue is that the financial industry has scammed people into believing bonds are complex instruments that need experts to manage. Those so called experts are also the type of people that need a calculator to compute 10% of a number. Somehow it's okay to buy individual stocks but buying bonds of the same company is somehow a high risk proposition. Nothing could be further from the truth. Bond funds are just a vehicle for for the financial industry to extract fees (management and trading) for an otherwise lower risk investment. I'm waiting for the day when Vanguard introduces CD funds since there are too many banks and credit unions in this country issuing CDs and their team of experts can carefully analyze all those complex products and package it in a fund that can lose capital and pay a lower yield for that service.

 

[daylatedollarshort]

One more shower thought I had to add, which Freedom56 has astutely pointed out previously regarding the bond funds, but I don't think has been mentioned lately, is how at least some of the funds hold a large proportion of Treasuries in their bond mix. There is no point is paying someone else to charge you annual expense fees on Treasuries. Those are easy enough to buy on your own, with maturity dates and no research needed, and hold at no cost, especially if the rates are the same or even lower than what you can buy Treasuries on your own at current market rates.

 

[Freedom56]

One more shower thought I had to add, which Freedom56 has astutely pointed out previously regarding the bond funds, but I don't think has been mentioned lately, is how at least some of the funds hold a large proportion of Treasuries in their bond mix. There is no point is paying someone else to charge you annual expense fees on Treasuries. Those are easy enough to buy on your own, with maturity dates and no research needed, and hold at no cost, especially if the rates are the same or even lower than what you can buy Treasuries on your own at current market rates.

Some funds are nearly 100% treasuries and hence the idea of Vanguard's Admiral CD fund is not so far fetched.

 

[daylatedollarshort]

Thanks for the article, which basically says, your bonds are a counter weight to your stocks. Even now, bonds are down this year but stocks are down even more, so bonds are doing their job. If you can, stay put with your index fund allocation for the long term and through the cycles. It also acknowledges that not every one can invest long term.

As for me at 56, what cures me from fiddling with my portfolio allocation every time is asking myself, “Ok, how am I right and Vanguard is wrong.”

Interest rates on bonds are actually way up this year. Only the bond funds have lost money. Individual bond holders who hold to maturity have lost $0 and have seen their yields rising. Hence the other thread here on a Golden Age for fixed income investing. Twenty year TIPS are now at .99% + ~8% inflation, more than I bonds. I'm having one of my better investing years since I have a lot of older TIPS with real yields.

 

[pb4uski]

Interest rates on bonds are actually way up this year. Only the bond funds have lost money. Individual bond holders who hold to maturity have lost $0 and have seen their yields rising. ...

To be fair though, while bond funds have lost money I would think that individual bond investors with a laddered portfolio have seen a decline in portfolio value as interest rates have risen... however, those individual bond investors will get par at maturity similar to how bond fund investors will come out even in 6-7 years if they wait out the duration.

 

[daylatedollarshort]

To be fair though, while bond funds have lost money I would think that individual bond investors with a laddered portfolio have seen a decline in portfolio value as interest rates have risen... however, those individual bond investors will get par at maturity similar to how bond fund investors will come out even in 6-7 years if they wait out the duration.

Things may even out only if you don't switch around as the Kiplinger article advises. Even then the funds have trading fees, expense fees, including expense fees on Treasuries, make bad choices like the Apple bonds Freedom56 points out that no sane individual investor would make, etc. so it is not necessarily a wash.

 

[pb4uski]

I don't think it is necessarily a wash in the long run but my main point is that the fair value of individual bonds have dropped in this period rising rates so both bond fund investors and individual bond investors have seen declines in portfolio value in 2022.

 

[daylatedollarshort]

I don't think it is necessarily a wash in the long run but my main point is that the fair value of individual bonds have dropped in this period rising rates so both bond fund investors and individual bond investors have seen declines in portfolio value in 2022.

If you plan to sell your individual bonds prior to maturity, then the market rates have dropped. If you hold to maturity, which is the whole idea of a ladder, then the rates on the secondary market are immaterial since you will redeem your bonds at maturity for par value, or for TIPS and I bonds, par plus inflation adjustments. I am not sure why anyone who planned to hold to maturity would value their bonds at a lower, interim price but I guess that is a personal choice, like if you want to get depressed for no good reason.

 

[Freedom56]

What I and other individual bond investors have lost are the premiums which are not real unless the bonds are sold. Bonds are called or mature at par. Sticking to a discipline of buying below par at attractive yields mitigates short term portfolio drops. Take a look at the top holdings from the bond ETF disaster BND from Vanguard. One of their top holdings is this note from Ally Financial.

https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C933917&symbol=ALLY5047166

They are losing money from this holding that will never be recovered. The note was issued in September 2020 with a coupon of 1.45%. Most individual bond investors would stay clear on an issue like this but these dumb bond funds bid this note up over $102 and continued to "buy high" all the way to January 2022 and now the same fund is "selling low" all the way down to $96. Funds have self imposed duration restrictions which will force them to sell this issue at a loss but the loss is just with "other peoples money" so does Vanguard care? They are telling their investors to "stay the course" as if these notes will magically rise back up to $102 as it nears maturity.

Individual bond investors are focused on increasing income and re-investing that income. The growth comes from compounding returns not from bidding up overpriced bonds and selling them at a loss as passive bond funds are experts at. I own the Ally Financial 5.75% 2025 notes that I recently bought below par thanks to all the bond funds selling. Those same funds are now bidding the note back above par and will once again lose again.

https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C642369&symbol=ALLY4311981

The choice is simple. Do you want to be the individual bond investor buying bonds with YTM of almost 7% and realizing a gain at maturity or the bond fund holder who buys a fund run by morons that bid up 1.45% notes to the point where the YTM is below .7% and then sells the note at a loss? Also consider that Vanguard's fund manager chose this note to be one of their top 10 holdings? How smart was that?

 

[Markola]

^^^^ I’m lost. BND is a total bond index ETF. There is no active manager to be “dumb”, just a computer tracking 10,121 bonds of AA credit or better.