Get crushed...Hold Bonds for 10 years.

[FIREd]

This is a good read:

https://personal.vanguard.com/pdf/icrdir.pdf

Figure 11 illustrates how an intermediate term bond index fund fared in the late 1970's.

Over the long term, it’s interest income—and the reinvestment of that income—that accounts for the largest portion of total returns for many bond funds. The impact of price fluctuations can be more than offset by staying invested and reinvesting income, even if the future is similar to the rising-rate environment of the late 1970s and early 1980s

 

[samclem]

Holding the actual bond to maturity should be safe.

I'm with NW-Bound. Folks who hold on to that low-yielding bond to maturity will get paid back what they were promised, but that's not "safe" if inflation is 8% and your bond interest is 3%. You're losing 5% per year plus there's the opportunity cost of not being able to re-invest in new bonds that are presumably yielding more than expected inflation (or folks wouldn't buy them).

 

[ejman]

Thank you Ha. Of course you are right that on a total return basis the result will be negative. But in my particular case, I just need these $ dividends from my taxable accounts to hold up reasonably well for the next 8 years until I start taking the RMD's. Once the RMD's start there should be quite a bit more income than I'm used to spending anyway unless Rewahoo's proverbial asteroid shows up.

 

[brewer12345]

I'm with NW-Bound. Folks who hold on to that low-yielding bond to maturity will get paid back what they were promised, but that's not "safe" if inflation is 8% and your bond interest is 3%. You're losing 5% per year plus there's the opportunity cost of not being able to re-invest in new bonds that are presumably yielding more than expected inflation (or folks wouldn't buy them).

And cue the ignorant, rude response in 3...2...1...

 

[ejman]

This is a good read:

https://personal.vanguard.com/pdf/icrdir.pdf

Figure 11 illustrates how an intermediate term bond index fund fared in the late 1970's.

Thank you FIRED. Very interesting read. Looking at table 11, I see that the interest on interest portion is relatively small, capital losses in a rising rate environment are relatively minor and income growth during the increasing rate period is substantial. (But maybe I'm seeing what I want to see...)

 

[FIREd]

But maybe I'm seeing what I want to see...

Don't we all...

 

[audreyh1]

Rising interest rates will translate to higher yields (and lower NAV), but if you're in bonds/bond funds for long term income, does it matter?

I could tolerate a lower NAV and NW as long as the dividends came in (or came in even higher). What am I missing?

That's how I see it. And I'll also be adding to bonds since they will have dropped as a % of my portfolio. That is if stocks aren't hammered at the same time (since they could be).

Most of my bond funds I have owned since 2000 and seen a tremendous appreciation, so the reverse doesn't bother me that much.

BTW - I only hold intermediate and short-term bond funds.

 

[hlfo718]

a short or interm term bond fund is essentially a ladder with X% maturities due every year. You have two ways to catch the higher rate when you invest in a fund, the bonds that will mature in the fund and the reinvestment of dividend each month. Unless you need the income to live off, higher rate is no big deal.

 

[Independent]

This is a good read:

https://personal.vanguard.com/pdf/icrdir.pdf

Figure 11 illustrates how an intermediate term bond index fund fared in the late 1970's.

I've often wished I had a good source for an actual bond index fund for that time period. From a retiree's standpoint, the unit price of the fund is the critical result, because that's what we're selling to fund our withdrawals. I thought this might be it.

But, this one looks hypothetical to me. I'm pretty sure that I don't know what they were holding in Dec 1975, what matured in 1976, what coupons they received, and what new bonds they bought. And, I don't know the duration of the holdings on any date. I guess I'd like to know more about how this was constructed.

I also think I'd like to see the graph adjusted for CPI, as I know that's how I think about retirement income.

My belief has always been that any reasonably "long" bond fund would have had CPI-adjusted losses during part of this period, but I haven't seen the data.

 

[rbmrtn]

I'm with NW-Bound. Folks who hold on to that low-yielding bond to maturity will get paid back what they were promised, but that's not "safe" if inflation is 8% and your bond interest is 3%. You're losing 5% per year plus there's the opportunity cost of not being able to re-invest in new bonds that are presumably yielding more than expected inflation (or folks wouldn't buy them).

agree, you get the value of the bond and are risk for loss from inflation.

 

[mathjak107]

If that silly fiction makes you happy, please continue toking away at your drug of choice. At least it is legal in all 50 states.

you have to explain this one....

if i own a bond and hold to maturity regardless if rates triple or credit risk changes i get my money back as agreed assuming they do not default...

a bond fund changes based on interest rates and credit risk. there is a big wild card in there ,credit risk.

you have no idea what you will get when you sell the fund.

only a treasury bond fund can act close to an individual bond since credit risk rarely effects it.you have to stay in the fund for the duration time frame of the fund to make it happen.

inflation is the wild card in either case. even if you stay in the bond fund for the duration if rates are rising still you are always behind the curve.

 

[audreyh1]

I've often wished I had a good source for an actual bond index fund for that time period. From a retiree's standpoint, the unit price of the fund is the critical result, because that's what we're selling to fund our withdrawals. I thought this might be it.

But, this one looks hypothetical to me. I'm pretty sure that I don't know what they were holding in Dec 1975, what matured in 1976, what coupons they received, and what new bonds they bought. And, I don't know the duration of the holdings on any date. I guess I'd like to know more about how this was constructed.

I also think I'd like to see the graph adjusted for CPI, as I know that's how I think about retirement income.

My belief has always been that any reasonably "long" bond fund would have had CPI-adjusted losses during part of this period, but I haven't seen the data.

Barclays Capital Aggregate Bond Index - Wikipedia, the free encyclopedia

It's an intermediate term index.

 

[MichaelB]

you have to explain this one....

if i own a bond and hold to maturity regardless if rates triple or credit risk changes i get my money back as agreed assuming they do not default...

a bond fund changes based on interest rates and credit risk. there is a big wild card in there ,credit risk.

you have no idea what you will get when you sell the fund.

only a treasury bond fund can act close to an individual bond since credit risk rarely effects it.you have to stay in the fund for the duration time frame of the fund to make it happen.

inflation is the wild card in either case. even if you stay in the bond fund for the duration if rates are rising still you are always behind the curve.

What does the fund get when the bond matures? Is it different than what you get?

 

[mathjak107]

the issue is bonds in a fund rarely mature. they are bought and sold all the time. that makes credit rating a big wild card as to what you will get .

while as an example my coca cola bond will pay me at maturity full value even if coca cola takes a credit rating hit. but if it is sold before maturity the markets determine what i get based on the credit rating and interest rates at the time it is sold.

 

[Running_Man]

A huge misconception. Take 100 different bonds. Put them in a bag labelled "bond fund." Are they any different than when they were not in the bag?

So you are saying if you buy a 10 year individual bond there will be no performance difference in 10 years between that and a long term bond fund? I would think in 9 years the bond fund will still have a 8-10 year duration and the individual bond will have a 1 year duration resulting in quite different investment returns.

Likewise I do not see how an annual investment in individual 10 year bonds will yield the same result as an annual investment in a 10 year bond fund. Yes after 10 years if you continue you will have an average duration of 5.5 years but your return over the next 10 years beyond that would not be the same as a bond fund with a 5.5 year average duration. And beyond that one would be able to schedule exactly what the cash flows from the individual bonds will be over the next 10 years. In the case of purchasing the individual bonds you will know, assuming the bond does not default, exactly the amount of money that would have been returned to you over the next ten years. Can you provide the cash return I will receive over the next ten years from the PIMCO long term government bond fund?

 

[MDJO]

All in strictly intermediate term (5 years or less) for my bond allocation.

 

[pb4uski]

There is definitely a difference in the end game between a bond fund and a bond portfolio. In a bond fund, your only option is to exit at NAV (fair value of the underlying bond portfolio). If you own a bond portfolio, you can chose to just run it off and let the bonds mature and collect the par value. That is why Guggenheim created bulletshares.

 

[haha]

There is definitely a difference in the end game between a bond fund and a bond portfolio. In a bond fund, your only option is to exit at NAV (fair value of the underlying bond portfolio). If you own a bond portfolio, you can chose to just run it off and let the bonds mature and collect the par value. That is why Guggenheim created bulletshares.

I am almost certain that they created these shares because they thought they could sell them. There was something very similar when my Dad was still investing, called Unit Investment Trusts. This would have been during the 70s.

Ha

 

[ERD50]

There is definitely a difference in the end game between a bond fund and a bond portfolio.

You and the others with this thought are missing something. For one - when is 'the end game'?

First, you are all correct - the bond fund NAV fluctuates, a bond provides a known NAV at maturity (barring default).

But it is irrelevant to the way most of us would invest in bonds or bond funds. You are looking at it through a microscope (a single bond issue) - you need to look at the big picture (maintaining a portfolio of bonds for many years).

If you are investing for the long-term, you have a ladder of bonds. So guess what - if I say liquidate at some point, you would have to sell some of those bonds before maturity - and the NAV would fluctuate. No different than having to sell a bond fund at some point, and having the NAV fluctuate. It's all the same.

And when one matures, you replace it with another - at a different yield. Overall, that's the same as seeing the NAV vary on a bond fund. The yield can vary, or that can be reflected in the NAV - tain't no difference 'tween the two.

Bond traders arbitrage these things out - a bond of X duration with a high relative yield will attract a higher NAV. One with a lower yield, a lower NAV. They do the math and one is as good as another. Your ladder has an NAV on the open market, probably different than what you paid for it. But no different than a fund of similar bonds, with the same coupon and average duration.


-ERD50

 

[mathjak107]

if not held to maturity then yep it is the same in both cases. but if held to maturity then the credit rating changes on the bonds in the bond fund is the wild card . funds are effected by credit rating , and investor sentiment on the underlying bonds. they are always buying and selling. bonds held to maturity are not effected by credit rating changes or investor sentiment..

what you say would be true if it was interest rate risk only.

 

[ERhoosier]

This is a good read:

https://personal.vanguard.com/pdf/icrdir.pdf

Figure 11 illustrates how an intermediate term bond index fund fared in the late 1970's.

Two observations-

1. The Barclay's Bond Index generally assumes bonds held to maturity. In practice most bond funds have some turnover due to trading. This may improve performance, but often hurts buy-hold investors in intermediate-long term bond funds as fund managers try to swim upstream against current of rising rates. As was said earlier, NAV of int/long bond funds do not act like individual laddered portfolio (except for a few funds specifically structured that way).
2. The late 70's were an unusual scenario of int term rates being historically high & going very high to stay for 2+yrs. Bonds added to the index later during the analysis period contributed a disproportionate absolute return vs a more historically normal rate level. If we apply interest rates from past 8-10yrs & re-run the scenario the results are somewhat different.

In the late 70's scenario interest rates doubled to very high level (6.9-15+%) then stayed near highest level for 2 yrs. Assuming perfect bond quality (e.g. eliminate confounding factor of credit risk), worst case 10yr bond (6.9%) would loose 42% if its value if sold (i.e. fund turned over the bond for higher rate issue). In a continually re-balanced bond fund this would (theoretically) be offset by just 2.8yrs worth of interest.
Contrasting results if you run the same "rising rate" scenario starting Dec 12 and using bond rates of last 8-10 yrs (e.g. 1.6% to 5.2%, or 3.3X if rates go back to '02 levels). The theoretical value of worst case 1.6% 10yr bond would only drop 26%, but that that would require 5 yrs worth or interest in the portfolios newer bonds to offset.

Historical data can be nice in our investing scrapbooks, but the outcome picture can change depending upon when a snapshot is taken.

 

[brewer12345]

You and the others with this thought are missing something. For one - when is 'the end game'?

First, you are all correct - the bond fund NAV fluctuates, a bond provides a known NAV at maturity (barring default).

But it is irrelevant to the way most of us would invest in bonds or bond funds. You are looking at it through a microscope (a single bond issue) - you need to look at the big picture (maintaining a portfolio of bonds for many years).

If you are investing for the long-term, you have a ladder of bonds. So guess what - if I say liquidate at some point, you would have to sell some of those bonds before maturity - and the NAV would fluctuate. No different than having to sell a bond fund at some point, and having the NAV fluctuate. It's all the same.

And when one matures, you replace it with another - at a different yield. Overall, that's the same as seeing the NAV vary on a bond fund. The yield can vary, or that can be reflected in the NAV - tain't no difference 'tween the two.

Bond traders arbitrage these things out - a bond of X duration with a high relative yield will attract a higher NAV. One with a lower yield, a lower NAV. They do the math and one is as good as another. Your ladder has an NAV on the open market, probably different than what you paid for it. But no different than a fund of similar bonds, with the same coupon and average duration.


-ERD50

A very elegantly stated response. If others wish to continue claiming that gravity does not affect them, I am happy to let them simmer in their own juices.

 

[pb4uski]

You and the others with this thought are missing something. For one - when is 'the end game'?

First, you are all correct - the bond fund NAV fluctuates, a bond provides a known NAV at maturity (barring default).

But it is irrelevant to the way most of us would invest in bonds or bond funds. You are looking at it through a microscope (a single bond issue) - you need to look at the big picture (maintaining a portfolio of bonds for many years).

If you are investing for the long-term, you have a ladder of bonds. So guess what - if I say liquidate at some point, you would have to sell some of those bonds before maturity - and the NAV would fluctuate. No different than having to sell a bond fund at some point, and having the NAV fluctuate. It's all the same.

And when one matures, you replace it with another - at a different yield. Overall, that's the same as seeing the NAV vary on a bond fund. The yield can vary, or that can be reflected in the NAV - tain't no difference 'tween the two.

Bond traders arbitrage these things out - a bond of X duration with a high relative yield will attract a higher NAV. One with a lower yield, a lower NAV. They do the math and one is as good as another. Your ladder has an NAV on the open market, probably different than what you paid for it. But no different than a fund of similar bonds, with the same coupon and average duration.


-ERD50

WADR you're the one who is missing something. If I were to create a ladder (using individual bonds or Bulletshares or UITs like Ha referred to) I would have the maturities align with my expected cash flow needs so fluctuations in fair value would be interesting but that is about it because the cash flows from the bonds would align with my cash flow needs and would be spent rather than reinvested.

I agree that if I were to have to liquidate this ladder before maturity that I would get NAV rather than maturity value.

BTW, there was an interesting post this morning on the Oblivious Investor on this topic. What Happens to Bond Funds When Rates Go Up?

 

[brewer12345]

WADR you're the one who is missing something. If I were to create a ladder (using individual bonds or Bulletshares or UITs like Ha referred to) I would have the maturities align with my expected cash flow needs so fluctuations in fair value would be interesting but that is about it because the cash flows from the bonds would align with my cash flow needs and would be spent rather than reinvested.

So the plan is to gradually end up with a 100% equity portfolio as you age? Let us know how that works out for you.

 

[pb4uski]

So the plan is to gradually end up with a 100% equity portfolio as you age? Let us know how that works out for you.

If my SS at age 70 ~ my LBYM living expenses then a 100% equity portfolio could be possible I suppose. I doubt that I would do that but it is possible.

I could also see at some point even if there was a funding gap that I might have a bond ladder (using individual bonds or Bulletshares or UITs) where the expected portfolio cash flows align with my cash flow needs for living expenses (including inflation but net of SS), conceptually similar to the way a financial institution would invest assets supporting a closed block of liability cash flows. And any remaining nestegg could be in equities and would become part of my estate.

Why wouldn't that be a prudent approach in either of those circumstances?