Two types of bond ladders; When to replace a bond fund/ETF

[daylatedollarshort]

Nothing but fear mongering. Not gonna happen.

Look at the highest and lowest prices for TLT even now and consider how high interest rates went in the 80s under Volker, and Powell is a big fan of Volker. I'm not saying it will happen, but with funds you can make or lose a lot of money based on what current interest rates are.

Funds are a different investment vehicle than individual bonds and it is simply not true to say you'll come out ahead if you hold for X years. You can see that isn't true from the Google chart by picking different points in time. You may have made or lost on the share price depending what times you bought and sold. As Freedom56 has pointed out in past threads, bond funds introduce market risk into an asset class that normally has none.

 

[foxfirev5]

While I hold bond ladders, both rolling and LMP, I find the bashing of bond funds a bit misleading. I've laddered individual holdings in my IRA's since I rolled over my 401k in 2016. However, the funds are not a scam and may provide a very logical place in a portfolio. Anyway to each his own. I have enough confidence in my plan to not worry about the path others chose.

 

[mrfeh]

Look at the highest and lowest prices for TLT ...

Again, NAV is irrelevant. All that matters is total return.

 

[friar1610]

One holds total bond for dividends; the NAV is irrelevant.

Well, actually, NAV is relevant in one case I can think of. If one has (a) totally bond fund(s) IRA and is taking RMDs, the NAV matters very much. Or, an IRA composed of a stock fund plus a bond fund and the bond fund, while having lost NAV, has lost less than the stock fund. This would have been the case for me this year had I not had several years of RMDs sitting in CDs of appropriate maturities. Hopefully bond fund NAVs will have recovered before the last of these CDs matures.

 

[mrfeh]

Well, actually, NAV is relevant in one case I can think of. If one has (a) totally bond fund(s) IRA and is taking RMDs, the NAV matters very much. Or, an IRA composed of a stock fund plus a bond fund and the bond fund, while having lost NAV, has lost less than the stock fund. This would have been the case for me this year had I not had several years of RMDs sitting in CDs of appropriate maturities. Hopefully bond fund NAVs will have recovered before the last of these CDs matures.

As I said previously, the duration of a given bond fund should align with your time horizon.

 

[friar1610]

As I said previously, the duration of a given bond fund should align with your time horizon.

I don’t disagree with you. That’s why I have CDs maturing in future years - so I don’t have to access the intermediate bond fund for RMDs when its NAV is down. But you said NAV is irrelevant; I was simply giving an example of a case where it is relevant. I see your point and hope you see mine. ‘Nuff said.

 

[walkinwood]

... Right now with an inverted yield curve, short duration bonds funds are incurring capital losses that are not only preventing them from increasing distributions but not allowing them to even payout anything close to their stated average coupon
....

Nevermind that the distributions are nowhere close to the funds stated SEC yield, but they aren't even close to the funds average coupon as they are incurring capital losses as the year progresses and they are stuck with a portfolio of low coupon debt.

Freedom56, would you explain further. I've been confused about the discrepancy between the 7 day SEC yield (going back a few months) and the distribution yield of my bond funds.


How do capital losses (I assume that arises from funds selling bonds at a loss) affect distributions?

 

[mrfeh]

I don’t disagree with you. That’s why I have CDs maturing in future years - so I don’t have to access the intermediate bond fund for RMDs when its NAV is down. But you said NAV is irrelevant; I was simply giving an example of a case where it is relevant. I see your point and hope you see mine. ‘Nuff said.

+1

Any money I need in 2-3 years is in CDs/savings accounts/individual treasuries. Going farther out on the horizon, I have short term bond funds and total bond funds.

 

[daylatedollarshort]

Ok, so from this quote I am guessing we should all be timing the interest rates between individual bonds and bond funds? Is this your point?

"The other option ignored in the article is that people are free to switch from bond funds to bonds and, if rates decline enough, back to bond funds. There is no benefit to sticking with a bond fund when investors can get higher yields with less risk in individual bonds when rates are rising. It isn't like a bad marriage where one may need to stick it out due to the kids or finances. Investors can switch back and forth as much as they want and the bond funds will always welcome them back with open arms."

This year when real interest rates were something like -8% and The Fed said they were going to raise interest rates 6 - 7 times, I'm not sure what the point of holding on to bond funds would have been. We don't always get such a clear signal on what is going to happen to interest rates but when we do why ignore it? Those that sold off early in the year avoided big losses. You can also read the suggestions in the Kiplinger article in the prior link on switching between bonds and individual funds.

I can't really add more between the Kiplinger and Forbes articles, which you can visualize on the price front with the Google charts, and look at the comparable current yields based on Freedom56 posts.

 

[Freedom56]

However, the bolded/underlined comment above does have me wondering if that is a reasonable strategy if/when bond yields truly have a downward trajectory? Of course, I could make the decision to buildout my bond ladder with 5+ year maturities at any time between now and next 3 years (currently all my bonds mature within 3 years).

Maybe I am missing something, but as a former bond fund guy, I find individual bonds more effective in my particular strategy.

Don't be fooled by how bond traders bid up securities and send yields tumbling. These traders are not risking their own money but "other peoples money". These are the same traders that bid up yields below zero. When CD/Bond yields approach zero, the are un-investable except for the shortest duration. When they become zero or negative you avoid them. You are better off holding cash until yields improve. Very few fund managers have that discipline. The notion that there is some incredible wisdom behind those that manage bond funds is complete nonsense. In reality, many are similar to the idiot that became the CEO of Alameda Research or it's just a bot buying and and selling based on fund flows and duration. The name of the game in the fund industry is to collect fees, both declared and hidden, for assets under management. The investor always comes second.

 

[LaDolceVita]

The only bond funds I had this year are TIPS, an acronym for “Treasury Inflation-Protected Securities”. Really bad name, IMO. Silly me thought that holding these funds would offer protection from rising inflation. The opposite has happened.

 

[copyright1997reloaded]

+1

Any money I need in 2-3 years is in CDs/savings accounts/individual treasuries. Going farther out on the horizon, I have short term bond funds and total bond funds.

The issue with open ended funds (e.g. ETFs and Mutual Funds) is that they MUST SELL holdings if there are outflows, and MUST BUY if there are inflows. Thus, they may be forced to liquidate under water holdings at inappropriate times. You as an individual holder of a bond are typically not forced to sell but rather can wait until maturity. This is an inherent advantage of individual holdings. An inherent disadvantage is that it is harder to minimize single issue risk, i.e. quality diversification (in terms of corporate bonds, not really an issue with US Treasuries).

 

[Freedom56]

Freedom56, would you explain further. I've been confused about the discrepancy between the 7 day SEC yield (going back a few months) and the distribution yield of my bond funds.


How do capital losses (I assume that arises from funds selling bonds at a loss) affect distributions?

First of all SEC yields have nothing to do with what a fund earns. It was create to compare one bond fund to another. Take a look at this short duration Bond ETF loser from Vanguard, BSV:

https://investor.vanguard.com/investment-products/etfs/profile/bsv

It is loaded with so much low coupon debt that the average coupon of the entire portfolio is only 2.2% but it claims to have an SEC yield of 4.8%. Bogleheads will have you believe that the distributions will approach the SEC yield and yet we are 11 months into the year and the distribution yield is only 1.7% if we assume that the latest distribution reported today will continue moving forward. The fund claims to have an expense ratio of .04% but after 11 months into the year, the distribution yield is still lower than the average coupon and nowhere close to approaching the SEC yield. So where is the money going? The fund is reporting that it currently has 8% unrealized losses in its portfolio. Those low coupon bonds that the fund is selling every month are being sold at a loss. That is being reflected in the low distributions. Bogleheads will have you believe that the fund buys new higher coupon bonds and replacing the low coupon bonds that mature. That is 100% false. Bond funds do not hold securities to maturity. In the best case, the fund is selling those low coupon bond on average at a 3.5-4% loss. However, when the fund is hit with massive redemptions, it is forced to sell longer duration bonds in its portfolio at even greater losses sometime in excess of 10-15%. We are at a time when money market funds are now yielding 3.81% and a 3 year CD close to the duration of this fund is yielding 4.8% and both offer 100% capital protection. Yet this fund is down 5.8% for the year and pays only 1.7% base on the last 30 days and much lower based on the last 11 months.

 

[daylatedollarshort]

The only bond funds I had this year are TIPS, an acronym for “Treasury Inflation-Protected Securities”. Really bad name, IMO. Silly me thought that holding these funds would offer protection from rising inflation. The opposite has happened.

The TIPS bond funds were likely buying TIPS when yields were negative the last year or so, something most individual investors would not do, and then they have the same no maturity date issue other bond funds have in a rising rate environment. This is explained here by Annette Thau, in an excerpt from The Bond Book, An Investors Guide to Inflation Protected Securities - https://www.aaii.com/journal/article/an-investor-s-guide-to-inflation-protected-securities. For investors with ladders made up of TIPS with real yields, the returns this past year have been better than I bonds. I have not checked the TIPS funds NAVs in awhile, but the last time I did many had not kept up with inflation in the past ten year period.

"An Investor's Guide to Inflation Protected Securities: "Is there any advantage to buying TIPS through funds rather than by buying the individual bonds? For reasons that escape me, individual bonds and bond funds are treated in the financial press as interchangeable instruments. But they are not. For starters, if you hold individual TIPS and redeem them when they mature, you will receive, at minimum, no less than the initial face value of the bond; or more likely, the adjusted value of principal. On the other hand, a TIPS fund, like any other bond fund, has no “maturity” date. That is to say there is no date at which the entire portfolio matures. Given the volatility of the underlying bonds in the portfolio, there is no way to know what its price will be when you want to sell."

ETA: Just like with other bond funds, you can type the name in Google and check out the history chart and click on MAX history. I typed in Vanguard TIPS fund into Google and the first one that came up was VTAPX. The NAV has not only not kept up with inflation, it is at a lower price than it had since inception in 2012, $25. $25 in October, 2012 inflation adjusted would really be worth $32.21 in today's dollars. But the fund share price was at $23.92 after 10 years, in October, 2022. If you bought a TIPS bond in the same time frame, a $1K par value bond would have inflation adjustments to October, 2022 of this year to make the new principal around $1,288 to match CPI inflation.

 

[daylatedollarshort]

we are 11 months into the year and the distribution yield is only 1.7%

One year Treasuries are at 4.66% today with no market risk - https://www.bloomberg.com/markets/rates-bonds/government-bonds/us.

 

[walkinwood]

Thanks for your response, Freedom56.

I think I now understand the variance between the SEC yield and distribution yield.

The individual bonds in the fund are trading (valued) below par. Since SEC yield is the average 30 day Yield to Maturity, it takes into account the increase in the bond value to par at maturity plus the dividends received. Hence, it is much higher than the current dividend yield of the bonds in the portfolio.

The distribution yield is tied to the current dividend yield of the bonds in the portfolio.


PS: I understand, as Freedom56 stated, that bond funds do not typically hold bonds to maturity.


This post at bogleheads finally made it clear to me.

 

[Freedom56]

Thanks for your response, Freedom56.

I think I now understand the variance between the SEC yield and distribution yield.

The individual bonds in the fund are trading (valued) below par. Since SEC yield is the average 30 day Yield to Maturity, it takes into account the increase in the bond value to par at maturity plus the dividends received. Hence, it is much higher than the current dividend yield of the bonds in the portfolio.

The distribution yield is tied to the current dividend yield of the bonds in the portfolio.


PS: I understand, as Freedom56 stated, that bond funds do not typically hold bonds to maturity.


This post at bogleheads finally made it clear to me.

I don't believe that those Bogleheads understand the problem they are facing nor the math. If they hold a bond with a 2% coupon at one year to maturity, it will trade at a discount to par given where rates are today (4.7% for a treasury note and about 5.5% for a high grade corporate bond). So when it is sold, to either maintain a constant duration or sold due to redemptions, it would be sold at a loss of about 3-4%. That yield to maturity is never realized. So the SEC yield just becomes a theoretical number that will never be achieved in a rising rate environment. Even worse, the fund won't even achieve anything close to the average coupon due to recurring capital losses. At some point, those Bogleheads will realize that they have been duped by Wall Street and they own a financial sinkhole.

 

[DawgMan]

Don't be fooled by how bond traders bid up securities and send yields tumbling. These traders are not risking their own money but "other peoples money". These are the same traders that bid up yields below zero. When CD/Bond yields approach zero, the are un-investable except for the shortest duration. When they become zero or negative you avoid them. You are better off holding cash until yields improve. Very few fund managers have that discipline. The notion that there is some incredible wisdom behind those that manage bond funds is complete nonsense. In reality, many are similar to the idiot that became the CEO of Alameda Research or it's just a bot buying and and selling based on fund flows and duration. The name of the game in the fund industry is to collect fees, both declared and hidden, for assets under management. The investor always comes second.

I finally got around to reading the articles from Kiplinger and Forbes... very helpful. The Kiplinger article pretty much describes my approach going forward. I am assuming your MO is to NEVER own bond funds, even in a falling interest rate environment? While I wouldn't call myself a "market timer" in the dirty sense of the word, it appears that bond yields are a little easier to predict and plan for, at least over shorter periods of time. I suppose I am still wondering if there are times when using a combination of individual bonds and bond funds makes any sense? Here is my example...

Say I have 10 years of funding set up in an individual bond ladder and I have 1 years of spend maturing end of 2023 that was yielding 4%. Let's say we are in a recession by mid 2023 and the Fed/Market starts telegraphing that they are going to reduce rates 3 times over the next 12 months (similar to how they telegraphed multiple rate increases in 2022). I'm assuming my options to redeploy the 2023 maturing funds are 1) buy an individual bond at market (i.e. 2%??), 2) move to cash/money market at __%, 3) buy a short/intermediate bond fund that should have a projected total return of something better than the above??

Again, just wondering if there is a place for bond funds at times inside the structure of a bond ladder?

I really appreciate all the wisdom from many of you on this site.

 

[Trooper]

Again, just wondering if there is a place for bond funds at times inside the structure of a bond ladder?

Great question and I wish I knew the answer.

I feel I know a lot more about bonds and bond funds now than in the past. The main takeaway for me is that bond funds do not behave like individual bonds. However I feel like bond funds deserve a place in our fixed income asset allocations; just not sure how much.

In the first week of November after tiring watching my bond funds bleed, I violated one of my principles and "timed the market" by selling my long-held VBTLX in exchange for a short-term T-bill ladder. Nearly seven figures worth. Immediately after, VBTLX began to climb nearly 4% as of yesterday. Should I be kicking myself, or will bond funds continue to decline as the Fed chases inflation?

I am thinking that as my T--bills mature I will reinvest a small portion (amount TBD) back into VBTLX. That way my fixed income holdings can be more diversified is my thought.

 

[DawgMan]

Great question and I wish I knew the answer.

I feel I know a lot more about bonds and bond funds now than in the past. The main takeaway for me is that bond funds do not behave like individual bonds. However I feel like bond funds deserve a place in our fixed income asset allocations; just not sure how much.

In the first week of November after tiring watching my bond funds bleed, I violated one of my principles and "timed the market" by selling my long-held VBTLX in exchange for a short-term T-bill ladder. Nearly seven figures worth. Immediately after, VBTLX began to climb nearly 4% as of yesterday. Should I be kicking myself, or will bond funds continue to decline as the Fed chases inflation?

I am thinking that as my T--bills mature I will reinvest a small portion (amount TBD) back into VBTLX. That way my fixed income holdings can be more diversified is my thought.

Yep, I feel like I have gotten an education over the last 12 months and learned there is a difference between individual bonds and bond funds. I did get to converting by the middle of the year, but none the less took a hit (unfortunately, more than 1 seven figures ). Most was in a short term bond fund so the bloodshed was limited.

Being a new retiree, my strategy and view of how my fixed allocation functions in my AA is now different. As noted in my earlier posts on this thread, while I would like to achieve the max total return in any given year (with min reasonable risk), I do not really expect my fixed allocation to pull the sled in hitting my desired min total portfolio average returns of 5%+. I could make the argument (to myself) that locking in up to 10 yrs of bonds at 3%+ is enough to let my equities drive the bus and achieve my min total returns. But then, why leave $$ on the table if you get 5%, 6%, or better here in the near term without taking significant risk??

As it relates to bringing bond funds back into the equation, my thought is they may have a place in rung 1 or 2 IF the markets are telegraphing a period of declining interest rates (effectively, the reverse of what we have experienced in 2022). I suppose we won't know if that is a better option until we have that bridge to cross. Until then, take advantage these short term yields and then at some point, make a decision to lock down 5 - 10 yr bonds... or not.

 

[Freedom56]

I finally got around to reading the articles from Kiplinger and Forbes... very helpful. The Kiplinger article pretty much describes my approach going forward. I am assuming your MO is to NEVER own bond funds, even in a falling interest rate environment? While I wouldn't call myself a "market timer" in the dirty sense of the word, it appears that bond yields are a little easier to predict and plan for, at least over shorter periods of time. I suppose I am still wondering if there are times when using a combination of individual bonds and bond funds makes any sense? Here is my example...

Say I have 10 years of funding set up in an individual bond ladder and I have 1 years of spend maturing end of 2023 that was yielding 4%. Let's say we are in a recession by mid 2023 and the Fed/Market starts telegraphing that they are going to reduce rates 3 times over the next 12 months (similar to how they telegraphed multiple rate increases in 2022). I'm assuming my options to redeploy the 2023 maturing funds are 1) buy an individual bond at market (i.e. 2%??), 2) move to cash/money market at __%, 3) buy a short/intermediate bond fund that should have a projected total return of something better than the above??

Again, just wondering if there is a place for bond funds at times inside the structure of a bond ladder?

I really appreciate all the wisdom from many of you on this site.

If you want to buy a bond fund buy a close end fund (CEF). Passive bond funds are just poor performers when rates fall and disaster when rates rise. Since rate cycles are cyclical, passive bonds cycle between poor performers to disasters.

 

[copyright1997reloaded]

If you want to buy a bond fund buy a close end fund (CEF). Passive bond funds are just poor performers when rates fall and disaster when rates rise. Since rate cycles are cyclical, passive bonds cycle between poor performers to disasters.

ETA: Great advice, the following is just further explainer and additional questions:

The WHY here is because CEF's don't have to worry about forced redemptions (sell low) or forced purchases (buy high).

Freedom, one of my worries about CEF's is that many are leveraged, i.e. they borrow short to buy long. Just pointing this out to others who might get suckered into a CEF leveraged fund when short term rates are going against them (as in now).

OTOH, do you have any thoughts regarding decent non-leveraged bond CEF's? Especially ones that might invest in areas that are more difficult to purchase individual bonds (e.g. foreign or as a way to limit singe issuer risk, e.g. lower-quality bonds).

One more question/thoughts - are there any advantages regarding taxes on funds that have realized tax-losses on holdings? That is, possible rationale to purchase these in a taxable account?

 

[Lstansbury]

I think I missed the boat to sell my Vanguard Intermediate-Term Treasury Index mutual funds last January. Then Feb, March, etc. :-(

Before each rate hike, I think "I should probably do something". But, I don't.

My investment horizon is plenty long, so I'll just stick with it. Whatever I did do would probably not be the right thing. I'll just stand here.

I feel your pain Bloom. I actually bought into intermediates at the wrong time last year, following the advice of a NY Times published financial writer who will remain nameless. Something like "a set it and forget it allocation strategy is to have 50% in intermediate term treasury bond funds and 50% equities, according to research, you should be fine over the long term."

Duh! And part of me knew better. It kept screaming -- hold the cash, hold the cash, just wait! But that felt worse than buying the bond fund. So I bought. And yesterday I finally sold that stinking sinking turd-of-a-bond-fund Schwab Intermediate term treasury. I learned my lesson a few years back with BND from Vanguard. But forgot it.

The loss was around $1,500, and I will make that back in about a year of holding the CD/Bond that I am going to purchase. I call it my financial planning tuition cost.

Thank goodness for the folks here like Freedom56 and Runningman who talk sense and not clickbait gobbledygook. Also, thank you to Wade Pfau from Retire with Style (McLean Asset Management) for talking sense on a webinar recently. I had the chance to ask in the chat box, "do you mean bond funds when you say fixed income strategy?" and he replied "No. Individual Bonds."

Couldn't have been more clear. Hopefully I won't forget this lesson again. It's an expensive course to retake.

 

[Trooper]

Or you could have been me...selling VBTLX, a total bond fund with a ~7 year duration, at the beginning of November...then watch it climb over 5% in less than a month.

Oh well I still think I am better off with my short term T-Bills for now.

 

[VanWinkle]

Sometimes an advisor really is the best option for some people.