Bond vs Bond Fund

[jazz4cash]

The fact that when fund holders panic out of the fund during flights to cash, is the issue for me.

This is my primary objection also. Bonds seem simple and safe but they can be complicated and risky. Many bond fund holders seemed very surprised when their funds dropped due to higher rates but that’s just the math of bonds. Higher rates are good for fixed income, right? Not if your fellow shareholder panics over the drop in NAV. The fund is OK if you ride out the volatility of panic selling but many realize it is too painful. That exacerbates the selling. With individual bonds I can at least choose which bonds to sell if I get uncomfortable or have an emergency.

 

[daylatedollarshort]

The same reason why a CD investor holds a brokered CD if the price falls. The coupon is fixed and it pays back 100% at maturity. Bonds are not stocks. Bonds have a par value. Bond funds don't have a choice when they sell a bond at a loss to satisfy redemptions. Also most individual bond investors would not buy a 5 year note\bond with a coupon of 0.55% at or above par. However bond funds (like BND) do just that. In fact, if you look at the holdings of BND you will find the Apple 0.55% 2025 notes in the portfolio. The BND ETF is holding so much low coupon debt, that it is doomed in a rising rate environment.

And this was all very predictable since the beginning of the year when the Fed said they were going to raise rates 6 - 7 times in 2022. The Worst Income Investments for the New Year | Barron's (barrons.com) - Hint: They’re all longer-term bond funds.

 

[all4j]

And this was all very predictable since the beginning of the year when the Fed said they were going to raise rates 6 - 7 times in 2022. The Worst Income Investments for the New Year | Barron's (barrons.com) - Hint: They’re all longer-term bond funds.

You're right this has been very predictable, well-telegraphed. And so behavior puzzling to me, but then this example may have shed some light for me. I don't mean to speak for anyone, but piecing together what I'm hearing, it may come down to investor objective.

Likening buying individual bonds & brokered CDs -- what is in common? It seems the point is that buyers of those are focused essentially on predictability of nominal distribution & preservation of capital. Perhaps a liability matching situation.

Considering a rising interest rate, high inflation environment, this locks in nominal returns while setting a ceiling on return (assuming holding to maturity which example calls for). The fund holder, on the other hand, gives up predictability in hopes of gaining some added return from managing reinvestment/opportunity risk, gaining liquidity, etc. If either doesn't understand what they are buying, they'll be disappointed & perhaps want out. But readily available data makes the fund holder more likely to feel nervous?

 

[daylatedollarshort]

Considering a rising interest rate, high inflation environment, this locks in nominal returns while setting a ceiling on return (assuming holding to maturity which example calls for).

One year Treasuries are are at 3.23% today with no long term locks and no loss of principal. What are the yields on most bond funds currently?

 

[all4j]

The most important trading expense is sometimes called "market impact." You won't find it written down anywhere. As soon as a whale starts taking a position, there is the near-certainty of front runners.

I was was really addressing what I thought was a question around the expense associated with trading. I'm not sure I follow your example fully; I'm not much for conspiracy theories. But how does this impact a bond bought by a individual differently than when the bond is bought for a fund?

I went ahead & took a peek at the annual report for bnd, etf shares. It covers the time from 6/30/2021 to 12/31/21 (semiannual report should be out soon from 1st half of 2022, but this seemed most recent). For $1000.00 account value at the start, the actual expenses paid were $0.12; ending value was $999.80. Pretty stable, but no such much for other time periods. Hard to recall how volatile things were that far back. Would be interesting to see 2022 data

 

[COcheesehead]

One year Treasuries are are at 3.23% today with no long term locks and no loss of principal. What are the yields on most bond funds currently?

A typical multi sector fund is above that. PTIAX yields 5.15% for example. FADMX is 4.7%. If you are more aggressive RSIVX will get you 6.5%

With all that being said, I am a ladder guy because nothing kills total return faster than a nice NAV drop in a bond fund like we just had.

 

[OldShooter]

... how does this impact a bond bought by a individual ...

Huge difference. The individual has a significant advantage because they are dealing with tiny money, rarely enough to move even a thinly traded issue. To have any impact, a fund's position has to be much larger. The current bid or ask volume will not be enough so the fund will have to chase after as the price inevitably moves away from it.

 

[youbet]

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.

Yep. Folks who don’t value interest bearing investments at current market value are simply messing with themselves.

 

[daylatedollarshort]

The whole point of bond ladders is holding to maturity. It is part of the definition of what a bond ladder even means. My only long term bonds are a TIPS ladder with real yields so they've been earning more than I-bonds this year.

Regardless, it doesn't change the math on the current yields, market risk and safety of short term Treasuries / CDs vs. bond funds.

 

[sengsational]

I'm curious as to why an individual would hold an individual bond that went down in value, but not a bond fund.

I'll just cover this one point. If I have purchased a bond that guarantees my original investment back, even though the payments along the way are lower than current prevailing rates, I'm not selling! I'll tough it out at $400 every 6 months for a year or two instead of $600 of I know at the end of the road, I get my entire nominal investment back. Contrast that with the bond fund with investors seeing the NAV drop, and cashing in their shares. That's the forced sales that we're talking about. Those sales, in the face of an environment that lots of people want out of their bond fund, is what lead me to conclude a disadvantage in getting a high price during the liquidation for these redemptions. Then, once the environment turns around, the ratio of buyers increases, and it's likely prices will be higher. So although the fund may not buy back that exact set of bonds they were forced to liquidate, as money flows back into the fund, the purchases are made in an environment where funds aren't being forced to dump issues to pay disenchanted fund holders. I imagine the buying doesn't set up an environment hostile to buying, because the inflow is likely to be slow enough. But even that assumption was questioned in this thread (whales trying to act like they're not buying so as not to move the market). Big is bad in bonds. I want that on a tee shirt, lol!

 

[Freedom56]

Contrast that with the bond fund with investors seeing the NAV drop, and cashing in their shares. That's the forced sales that we're talking about. Those sales, in the face of an environment that lots of people want out of their bond fund, is what lead me to conclude a disadvantage in getting a high price during the liquidation for these redemptions. Then, once the environment turns around, the ratio of buyers increases, and it's likely prices will be higher.

It's a very predictable behavior of passive bond and preferred stock funds that individual bond and preferred stock investors can take advantage of with low ball limit orders waiting for desperate funds seeking liquidity to satisfy redemptions. This pattern has occurred in 2013, 2015, 2016, 2018, 2020, and now 2022. If the Fed signals that it will continue to raise rates through the end of the years and into next year, this years tax loss selling season will be another opportunity to add to a bond ladder as investors will exit their bond fund holdings. What's great about this year is cash balances can currently earn 2.18% which is close to the distribution rate of an ETF like BND with no risk to your principal. So you can be patient and wait for the bargains to appear.

 

[Markola]

Look at the column that indicates "% of Fund". It declines as you move to the following pages. You should keep scrolling and find bonds/notes from American Airlines that are rated B (lower tier of junk bonds) and this one from Charter Communications that is rated high yield (junk) on page 54:

https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C695587&symbol=CHTR4513437

So your statement that BND has bonds rated AA is clearly not true. They are holding many junk bonds in their portfolio and losing money on them at the same time. These are facts for anyone to see if they are willing to look. Also consider that ETF management companies allow you to download their entire holdings to analyze. Vanguard does not. I wonder why?

This is nuts. See my comment #132 above. I pulled the fund’s bond ratings from the Vanguard site and the top ten holdings, which are all Treasuries, from ETF.com. You can’t even accept the mechanics of a simple computer driven index fund. I’m only interested in engaging in fact-based discussions, not in arguing about easily disproven nonsense. Moving on.

 

[daylatedollarshort]

I'll just cover this one point. If I have purchased a bond that guarantees my original investment back, even though the payments along the way are lower than current prevailing rates, I'm not selling! I'll tough it out at $400 every 6 months for a year or two instead of $600 of I know at the end of the road, I get my entire nominal investment back. Contrast that with the bond fund with investors seeing the NAV drop, and cashing in their shares. That's the forced sales that we're talking about. Those sales, in the face of an environment that lots of people want out of their bond fund, is what lead me to conclude a disadvantage in getting a high price during the liquidation for these redemptions. Then, once the environment turns around, the ratio of buyers increases, and it's likely prices will be higher. So although the fund may not buy back that exact set of bonds they were forced to liquidate, as money flows back into the fund, the purchases are made in an environment where funds aren't being forced to dump issues to pay disenchanted fund holders. I imagine the buying doesn't set up an environment hostile to buying, because the inflow is likely to be slow enough. But even that assumption was questioned in this thread (whales trying to act like they're not buying so as not to move the market). Big is bad in bonds. I want that on a tee shirt, lol!

This article in Forbes also explains the buy high, sell low issue, in a rising rate environment: This Is Why You Should Ditch Your Bond Funds And Buy Some Bonds Instead (forbes.com) - "With the Fed in a rate-hiking mission, bond funds are doomed to continue their money-losing record. This may be hard to accept for some market participants, because they have had a good run with bond for 40 years. Since 1982, the super-cycle of declining interest rates gave bond portfolio managers the built-in advantage of buying their fund constituents at low prices (high rates) and selling them at higher prices (lower rates). This trend is now starting to reverse, and is turning this process-driven bonanza into a curse."

From now on I'm going to try to remember to just link back to this post and article when this subject comes up because it pretty much encapsulates the major points that keep coming up in these types of threads besides the buy high sell low issue, like bond funds not having a maturity date; how stock funds mimic individual stock holdings but bond funds do not act like individual bonds; yields and risks with the funds vs. Treasuries, etc.

 

[sengsational]

From now on I'm going to try to remember to just link back to this post and article when this subject comes up because it pretty much encapsulates the major points that keep coming up in these types of threads ....

I have such a hard time finding threads that I want to refer back to. Your post had the word "bonanza", but maybe we should add "Cartwright" and "Ponderosa" to get back here

 

[daylatedollarshort]

I have such a hard time finding threads that I want to refer back to. Your post had the word "bonanza", but maybe we should add "Cartwright" and "Ponderosa" to get back here

Good idea. I had posted this link once before but was unable to find that thread using the search function since we have so many bond fund discussions. Bonanza, Cartwright and Ponderosa - those should be pretty unique terms to search for.

 

[Graybeard]

I have such a hard time finding threads that I want to refer back to. Your post had the word "bonanza", but maybe we should add "Cartwright" and "Ponderosa" to get back here

Why not just bookmark the thread? You could add a note to a specific post if you want. I have never found any sites' search engine capable of finding what I am looking for. BH is probably the best but they use Google.

 

[RunningBum]

I find that Advanced Search here works well.

 

[Montecfo]

You must be lost. Only two of the top ten holdings of BND are rated AA. The rest are lower. Ally financial is rated BBB-. The whole idea of a market weighted bond index is just dumb given that corporations that have issued the most debt have the highest weighting. This is counter-intuitive given that corporations with the highest level of debt have higher credit risk. Yes bots are used to buy and sell bonds based on inflows and outflows but there are some humans involved in deciding what issues to buy as bonds/notes have a finite life.

Yes! This is one of the things equity index investors miss. The issuers issuing the most debt are often not the most credit worthy.

Equity and bond indexing are not similar

 

[Montecfo]

You are correct and if you download the spreadsheet and sort on holdings you will find all those high yield bonds/notes from American Airlines, Charter Communications, Diamondback Energy and others. So the myth propagated by others that BND is tracking AA rated and higher bonds is completely false.

I think they must be mistaking the average for a minimum.

 

[baseman250]

So, I sat on this way too long, but wondering if it would still be best to make the move. Here's the situation:

My 401k is in a blended Fidelity Fund (FIWTX) which is about 47% stock/53% bond. Looking at the bond side of this in more detail, about 33% of the 53% is in Fidelity's Series Bond Index Fund. The "meat" of this fund looks like this:

US Treasuries - 40%
Corporate - 24%
MBS Passthrough - 28%
(What is MBS passthorugh?)

This 401K makes up 45% of my total nest egg. I do have a Large Cap Total Market option (FSKAX) and a stable fund option (Goldman Sachs SVC trust) I could move into. The stable value fund is at 1.32% YTD.

Should I just stay put or move out of the blended fund and into the FSKAX and Stable Fund? I have no plans to change my AA, just trying to minimize bond fund losses.

Thanks,

 

[Born2Fish]

So, I sat on this way too long, but wondering if it would still be best to make the move. Here's the situation:

My 401k is in a blended Fidelity Fund (FIWTX) which is about 47% stock/53% bond. Looking at the bond side of this in more detail, about 33% of the 53% is in Fidelity's Series Bond Index Fund. The "meat" of this fund looks like this:

US Treasuries - 40%
Corporate - 24%
MBS Passthrough - 28%
(What is MBS passthorugh?)

This 401K makes up 45% of my total nest egg. I do have a Large Cap Total Market option (FSKAX) and a stable fund option (Goldman Sachs SVC trust) I could move into. The stable value fund is at 1.32% YTD.

Should I just stay put or move out of the blended fund and into the FSKAX and Stable Fund? I have no plans to change my AA, just trying to minimize bond fund losses.

Thanks,

I had a similar situation with a Fidelity 401k. I moved the 401k Bond fund holdings into the Stable Value Fund early 2022. My SVF paid about 1% after paying the $0.3 annual fee for the SVF.

After learning about fixed income investments from the threads here at ER org, I rolled over all the of the SV funds from the 401k into a new Fidelity Rollover IRA. Then I invested all in CDs and T-bills, earning $3.8-4%.

I think it took a day to create the new account and transfer the 401k funds into it. Another 4 weeks or so the add the T-Bills and CDs I wanted.

Easy-peasy!

 

[DawgMan]

So, I have read most of the posts and really appreciate the expertise many of you have here. Like many, I was always been a bond ETF guy during accumulation phase and my experience was my bond funds acted for the most part like the ballast they were expected too. As I transitioned to full retirement at the beginning of 2022 I started to reposition my bond allocation into 10 yrs of laddered individual bonds, however, initially only converting years 1 - 5 of planned spend with yrs 6 - 10 left primarily in 2 bond ETFs (SCHO -70% & SCHZ - 30%). While I believe I get the arguments regarding how these bond funds/ETFs operate and some of the additional fees, I'm still scratching my head if it is prudent to sell my 6 - 10 yr bond ETFs now and lock in my losses or ride them out since I have 5+ years for them to recover?? How much of the future Fed predicted raises are baked in? It seems to me there is a very strong likelihood the Fed starts lowering interest rates in 2 - 3 years should they drive us into a hard recession? I suppose my simple justification for holding these bond funds earmarked for 6+ years is looking at their past TR performance when interest rates were extremely low. As an example, since 2012, excluding 2022 YTD which has been the worst performance, they performed as follows...

SCHO: Worst -4.60% YTD 2022, -.66% 2021 Best 3.53% 2019 Excluding 2022, 1 out of 10 negative years
SCHZ: Worst -14.74% YTD 2022, -2.19% 2013 Best 8.64% 2019 Excluding 2022, 3 out of 10 negative years

During the last 10 years, I am assuming the yield on any Treasuries or highly rated corporate bonds was very little, so would this not have made a better argument for bond ETFs over that period? I suppose I am trying to understand the risk reward of holding individual bonds over bond funds/ETFs if you have a min hold period of 5+ years? I totally get the argument for shorter term hold periods, but from a TR perspective will we be splitting hairs on longer term bong allocations?

 

[daylatedollarshort]

So, I have read most of the posts and really appreciate the expertise many of you have here. Like many, I was always been a bond ETF guy during accumulation phase and my experience was my bond funds acted for the most part like the ballast they were expected too. As I transitioned to full retirement at the beginning of 2022 I started to reposition my bond allocation into 10 yrs of laddered individual bonds, however, initially only converting years 1 - 5 of planned spend with yrs 6 - 10 left primarily in 2 bond ETFs (SCHO -70% & SCHZ - 30%). While I believe I get the arguments regarding how these bond funds/ETFs operate and some of the additional fees, I'm still scratching my head if it is prudent to sell my 6 - 10 yr bond ETFs now and lock in my losses or ride them out since I have 5+ years for them to recover?? How much of the future Fed predicted raises are baked in? It seems to me there is a very strong likelihood the Fed starts lowering interest rates in 2 - 3 years should they drive us into a hard recession? I suppose my simple justification for holding these bond funds earmarked for 6+ years is looking at their past TR performance when interest rates were extremely low. As an example, since 2012, excluding 2022 YTD which has been the worst performance, they performed as follows...

SCHO: Worst -4.60% YTD 2022, -.66% 2021 Best 3.53% 2019 Excluding 2022, 1 out of 10 negative years
SCHZ: Worst -14.74% YTD 2022, -2.19% 2013 Best 8.64% 2019 Excluding 2022, 3 out of 10 negative years

During the last 10 years, I am assuming the yield on any Treasuries or highly rated corporate bonds was very little, so would this not have made a better argument for bond ETFs over that period? I suppose I am trying to understand the risk reward of holding individual bonds over bond funds/ETFs if you have a min hold period of 5+ years? I totally get the argument for shorter term hold periods, but from a TR perspective will we be splitting hairs on longer term bong allocations?

I also had bond funds for years and only sold this year. I don't plan to go back to bond funds unless the yields are higher than what I can buy in individual bonds and the Fed says they are done raising rates, so I don't have to worry about huge NAV losses. Switching between whatever yields more is described in this Kiplinger article - Bonds Are Having a Rough Year. Here Are 3 Actions That Can Help | Kiplinger

 

[DawgMan]

I also had bond funds for years and only sold this year. I don't plan to go back to bond funds unless the yields are higher than what I can buy in individual bonds and the Fed says they are done raising rates, so I don't have to worry about huge NAV losses. Switching between whatever yields more is described in this Kiplinger article - Bonds Are Having a Rough Year. Here Are 3 Actions That Can Help | Kiplinger

I suppose this makes the argument for me to sell my 6 - 10 yr bond funds now, take the loss, and buy individual bonds?

Per the article, can it really be that easy to just compare the current yields and projected interest rate direction to switch back & forth? I suppose part of the reluctance is the false comparison to stock funds that somehow they will simply come back the same way.

Helpful. Thanks.

 

[daylatedollarshort]

Per the article, can it really be that easy to just compare the current yields and projected interest rate direction to switch back & forth?

I don't know for sure as no one knows the future, but I guess I'm going to find out! I already sold my bond funds, so I don't have to decide that part any more, just when and if to get back into the funds. Good luck with your decision.

For bond funds to have the NAV come back , other than just through time with buying and selling bonds as yields rise, interest rates would have to go back down to when they bottomed out during the pandemic. Possible, but I don't see that as likely, and I'm going with likely.