Trying to understand bond funds

[digger1959]

I had an old IRA that I brought from Merrill Lynch to Fidelity. I transferred everything that I could as is (which was most of the investments) and really haven't made any changes to it so the AA went from 60/40 to 80/20. And then recently I moved my 401K to the IRA and everything had to be converted to cash because the investments were no transferrable.
So now I am trying to get back to a balanced AA and I opened a few CDs but I am trying to understand the bond funds that my ML guy got me into. All of these bond funds (PGIM, AGG, BND and IEI) are down quite a bit from -17% t0 -7% and I am wondering what I should do. I thought that bonds were a "fixed income" investment and I would preserve my capital.
Please help or direct me to something that will educate me.
TIA.

 

[COcheesehead]

Bond funds are not bonds and have no par value, a predetermined amount to return to. So while income producing, they may not preserve capital like a par bond will and they will fluctuate in total value.
Bond funds just went through one of the worst periods for bond funds ever.

Here is a good comparison of income producing investments.
https://www.fidelity.com/fixed-income-bonds/compare-income-products

 

[imbatman]

Yeah I feel your pain, had a few funds ding me last year too. COcheesehead is correct, but another way to think of it is if you had bought some individual new issue bonds in say August 2020 and then tried to sell them in October 2022, there is a good chance you would have had similar losses there too (if you bought similar duration / quality individual bonds as your bond fund typically holds). The issue isn't as much your "funds" as much as interest rates went up/ prices went down....so trying to sell during such a time will hurt.......but if you ride it out, they ("bonds", individually or in funds) will likely make some recovery while you earn dividends (which probably went up in this time).

Anyhow, I do like the surety of looking at my individual bond holdings and knowing as long as they are good quality, they have a definite value if I hold them to duration. Bond funds are always market priced (based on the value of the underlying collection of funds) and also limited by their holdings/ published prospectus rules (while I can change my purchasing habits at any time).

 

[UpQuark]

...All of these bond funds (PGIM, AGG, BND and IEI) are down quite a bit from -17% t0 -7% and I am wondering what I should do. I thought that bonds were a "fixed income" investment and I would preserve my capital.
Please help or direct me to something that will educate me.
TIA.

I've had the same problem. My bond portion of my AA is in bond funds (mostly inside the retirement target year funds that I have in my IRA) and I always thought the bonds would preserve capital and so I was shocked this past year when my investments dropped horribly partly because bond funds have a share price that fluctuates up and down just as much as equities.

On Fidelity it says that a person needs at least $350,000 to properly diversify when buying individual bonds (i.e., use bond funds if have less money), but I am going to ignore that and I don't plan to buy into any bond funds after seeing what they've done to my target year balance.

I'm still trying to figure out the purpose of bonds for me. It seems like they can be used for income (such as buying a lot of 20 yr bonds having a 4% coupon), but inflation would gradually eat away the value of the income and basis, so I feel that is kind of iffy (especially since I'd need a lot more money than I have to produce enough bond income to cover my expected future RMDs).

Mostly I've used individual bonds as a way to park my money until I wanted to spend it (e.g. when I sold my house last year I parked money into bonds until I bought a condo later on).

I've bought some TIPS and i-bonds as potential income for future years if the stock market is performing so poorly that I would be reluctant to sell equities.

But recently I was watching a YouTube video that was explaining how rebalancing increases returns, and someone on this board said they use guard-rails so I'm trying to learn about their use to determine when to rebalance.

This is the video I was watching on YouTube, I'd recommend skipping ahead to minute 4 in it.

 

[scrabbler1]

I have been in various bond funds since 1990. They have risen and dropped in value over time, I never really cared much about that. Before I ERed in late 2008, I reinvested the monthly dividends somewhere, either within the same fund or into another mutual fund, the latter sometimes acting as an account builder.

After I ERed, I set up one large bond fund to generate enough monthly income to cover my expenses. So, the fund's daily NAV still didn't matter. What matters the most is the monthly dividends per share the fund spins off. That amount was higher back in late 2008 and 2009, but it has fallen over the years before rebounding some lately, to my delight.

I have sold some shares of my bond funds over the years (not the big one I rely on in ER). This happens rarely (on average, less than one per year); sometimes I made a few dollars off a sale, sometimes I lost a few dollars. Overall, I have come out slightly ahead, by less than 1%. One bond fund has checkwriting privileges, a valuable feature because that acts as a second-tier emergency fund in case I need a large sum of money quickly by writing a check immediately.

 

[freedomatlast]

I'm the opposite of Scrabbler when it comes to bond funds. Although I have a small position in one, I've mainly avoided them for the last 40 years, investing mainly in stocks, stock funds and cash. And history shows this was the right decision for me in comparison.

 

[DrRoy]

Bonds and bond funds are fixed income in that the interest paid is steady. The market value of the bond will change with interest rates. If you hold individual bonds (and they do not default), you will get face value at maturity.

 

[marko]

For me a fund has to deliver 1) growth or 2) a decent dividend, preferably both. My bond fund recently stopped doing either. Dumped it after 30 years. Still holding a modest stake in a high yield bond fund, now paying 6.4%

 

[mrfeh]

I had an old IRA that I brought from Merrill Lynch to Fidelity. I transferred everything that I could as is (which was most of the investments) and really haven't made any changes to it so the AA went from 60/40 to 80/20. And then recently I moved my 401K to the IRA and everything had to be converted to cash because the investments were no transferrable.
So now I am trying to get back to a balanced AA and I opened a few CDs but I am trying to understand the bond funds that my ML guy got me into. All of these bond funds (PGIM, AGG, BND and IEI) are down quite a bit from -17% t0 -7% and I am wondering what I should do. I thought that bonds were a "fixed income" investment and I would preserve my capital.
Please help or direct me to something that will educate me.
TIA.

2022 was the worst year for bonds in at least 40 years.

My only recommendation: do not take any action until you understand what you're doing, and why. Panic selling when an investment has lost value is a common and avoidable mistake.

 

[target2019]

It's probably better to hold one bond fund in an account. PGIM, AGG, BND and IEI?

We're at 10% or so overall for BND (VBTLX).

As someone said, it was the end of a long run for bond index. They will become more attractive.

 

[JoeWras]

If Freedom56 were still here, he/she would be going off on how unfavorable it is to have bond funds, and instead individual bonds should be part of the strategy. Perhaps stronger language would have been used.

As others have said, don't panic right now because we are likely at least at a rate-hiking pause. A lot of us have learned how bonds and bond funds work. It has not necessarily been a pleasant class to attend.

I tried BND a few years ago and realized I didn't understand it. I luckily sold before the rate hikes started. That was just dumb luck.

I have a lot of bonds tied up in "balanced" funds I acquired decades ago. I can't easily unwind them due to the large capital gains.

I guess it comes down to the rule to invest in stuff you understand. I really didn't know what I was doing with those balanced funds 25 years ago.

For bonds, I personally stick with shorter term treasuries, such as Notes. At least I (mostly) understand those.

 

[athena53]

I've become disenchanted with bond funds although I understand this is not the time to panic and sell. They do appear at the top of the Callan chart (I love that graphic) in years when everything else tanks.

One issue I have is that yes, if the bond fund buys and holds eventually you'll get your principal back along with promised coupons unless there's a default but, as with stock funds, if a lot of people panic and sell they may be forced to sell at a loss to raise cash for those exiting.

A few years ago I got into a Separately Managed Municipal Bond account managed by Lord Abbett through my brokerage. I've got about $500K in it now. They buy individual bonds in my name so I own them, and they either hold them to call or maturity unless they see some reason to sell, which rarely happens. I REALLY like this structure. It's got unrealized losses of $13K right now but that's par for the course. Now that I think of it, I may see if they have something similar for corporate bonds.

 

[COcheesehead]

One issue I have is that yes, if they buy and hold eventually you'll get your principal back along with promised coupons unless there's a default but, as with stock funds, if a lot of people panic and sell they may be forced to sell at a loss to raise cash for those exiting.

I think you are convoluting bond funds and individual bonds.
You will get your money back, short of default, plus interest with an individual bond. No guarantee with a bond fund.
If people panic and sell, an individual bond will still return par plus interest if held to maturity. The forced sale only applies to a bond fund which is called redemption drag and one of the reasons why bond funds may not ever return to the value you purchased them at.

 

[athena53]

I think you are convoluting bond funds and individual bonds.

Thanks. I looked back at my wording and it was a little muddled. I edited it. I agree with your explanation.

 

[Phroig]

I All of these bond funds (PGIM, AGG, BND and IEI) are down quite a bit from -17% t0 -7% and I am wondering what I should do. I thought that bonds were a "fixed income" investment and I would preserve my capital.
Please help or direct me to something that will educate me.
TIA.

At this point, most, if not all, of the losses in these funds are probably behind us. Going forward, you should be fine if you wish to continue holding them.

 

[Rianne]

If Freedom56 were still here, he/she would be going off on how unfavorable it is to have bond funds, and instead individual bonds should be part of the strategy. Perhaps stronger language would have been used.

Unnecessary comment IMO. Sold all bond funds starting in April - June 2022. ST laddered CDs and treasuries. Our bond funds were in the tIRA and the 1-year performance is +4.9%. Many of those are maturing this year 2023. We will go long-term for 5-10 years with hopefully a 4-5% coupon rate to keep our principal and have income that is more than the pension. I don't know, strategy is always up for discussion. We keep our principal, generate income, and quit worrying about bond fund losses.

 

[Montecfo]

If Freedom56 were still here, he/she would be going off on how unfavorable it is to have bond funds, and instead individual bonds should be part of the strategy. Perhaps stronger language would have been used.

As much as I respect his views, this orthodoxy should be set aside in my view.

Bonds and bond funds are both financial tools. They do not do the same job but each has strengths and weaknesses the other lacks.

Last year, when both bond and bond funds were killed, one advantage of bond funds was highlighted: the ability to hold to maturity. But that was in the worst bond market in 40 years.

Painting with such a broad brush is seldom wise in my view.

 

[PatrickA5]

I have very little in bond funds, but I'm not sure now would be the best time to sell at a loss. As others have said, I think the big losses are behind us (for this cycle) and perhaps rate cuts will increase the value at some point (maybe late next year).

I'm not selling mine since they are in a target retirement fund of which I like the overall allocation.

 

[Montecfo]

PatrickA5, I think you are wise.

 

[athena53]

Last year, when both bond and bond funds were killed, one advantage of bond funds was highlighted: the ability to hold to maturity. But that was in the worst bond market in 40 years.

Painting with such a broad brush is seldom wise in my view.

I agree- "always" and "never" financial advice is rarely 100% accurate. Although I'm moving towards more individual bonds in a separately managed account, the number of bonds I have right now (22 in a $525,000 Portfolio) means the impact of a single default would be unfortunate but wouldn't blow the account out of the water. I also have to trust that the people I'm paying to monitor these bonds will watch for default potential and sell if they see it as a risk. So far, so good.

 

[youbet]

I was shocked this past year when my investments dropped horribly partly because bond funds have a share price that fluctuates up and down just as much as equities.

That is certainly possible, but definitely not typical. Generally, bond funds fluctuate in NAV much less than equity funds. But, as you have been recently seeing, bond funds can have significant fluctuations. The government's reaction to the Covid crisis with huge stimulative spending and the Fed lowering interest rates to historically low levels might become commonplace going forward........ or maybe not.

 

[youbet]

I have a lot of bonds tied up in "balanced" funds I acquired decades ago. I can't easily unwind them due to the large capital gains.

.

Being locked into investments because, after decades of holding them, you'd pay hefty cap gains tax upon selling them is frustrating.

 

[all4j]

I thought that bonds were a "fixed income" investment and I would preserve my capital.

When a bond is issued, there is a coupon rate set – or fixed -- for the life of the bond. The holder of the bond gets that as income semi-annually. Thus, “fixed income” – a term I feel is misleading. The price, or asset value, of the bond varies every day as the bond ages toward maturity. If the bond is held until maturity, the end value is predictable in nominal terms. A bond fund is a collection of bonds. Often (usually?), the fund will hold bonds for a certain portion of the yield curve. While this means the fund will target a certain risk profile, it will buy/sell bonds to maintain the portfolio. As interest rates go up, the price of the bond falls so that the resulting yield (based on coupon rate) is competitive. If rates go down, prices go up. Rate movements may result from fed action, market supply/demand, or just the bond aging down the yield curve.

It maybe instructive to look at last 40-something years of rate changes. Start back in early 1980s & rates were in high teens. By early 2001, effective fed rates were about 5.5%. While those rates fell, bond prices went up. In the 22 years since, rates went down to under .5% in late 2008 & changed little for about 10 years. Prices were stable. Recent runup in rates caused prices to fall; and a .25% hike from .25% has different impact than a .25% hike from 5.5%. When rates change, the price falls ‘immediately’, but the increased distribution changes slower for funds (doesn’t change at all for individual bonds).

An important part of future performance is what you do with the distribution – that is, spend vs reinvest. For example, if you reinvest distributions for a bond fund that pays monthly, the distribution will gradually rise over time & buy more shares as prices fall. Or vice versa, for a falling rate environment. One way to think about it is that a fund will have a more steady risk profile, but a variable distribution. Individual bonds will have a steady (in nominal terms) distribution, but risk varies (as defined as duration. This risk is usually mitigated by a buy/hold plan). You didn’t mention if you were already taking RMDs or if that is in the future.

Currently, imho, neither bonds nor bond funds will preserve capital in real terms, not nominal. Future performance will depend upon interest rate changes – magnitude and velocity-- & inflation. Rates have risen & inflation cooled over past months making it better than a year or so ago. Many that held bond funds during the falling/steady rate period didn’t really understand & thus there has been much emotion from those incurring unexpected losses.
Good luck

 

[Sunset]

Prior to this year, I confused bond funds with bonds.
A BIG mistake.
He who shall not be named educated me.
I no longer buy bond funds, but will buy bonds. If for no other reason as ANOTHER WISE fellow on the site said: Why pay a fee to buy and hold bonds. ?

I sold off my most of my holdings in BND at the low price of $75 long after it had fallen, turns out it was still a good idea. Now I earn 5% in Treasuries while BND is paying maybe 2.5%->3%, so I'm still saving/gaining.

 

[Sunset]

Being locked into investments because, after decades of holding them, you'd pay hefty cap gains tax upon selling them is frustrating.

I'd rather pay capital gains than lose money, but if you need some capital loses, I could sell you some stuff, so you could have a loss