Why does anyone own bond funds?

[pb4uski]

If rates spike, you will continue getting your lower interest rate payments with those individual bonds. Held to maturity, you will get your original investment back (assuming no default), but it is in devalued dollars. Unless you are immune to inflation, you take a hit. Holding to maturity isn't some magic pill that fixes any issue with rising interest rates.

Of course with falling rates, continuing to get the higher rate payment is a plus, unless the bond is called. But maturity is essentially a forced sale. Your ride with the higher rate bonds is over.

If rates spike, with individual bonds I will continue getting the same interest coupons... not lower. And if rates fall I continue getting the same coupon not a higher payment. I'm unsure what you are talking about. You agree that with an individual bond that the interest payment received is unchanged no matter what interest rates do during the term of the bond, right?

On the devalued dollars thing it is the same if I own an individual bond until maturity or own a bond fund until the same date, so I'm not sure what your point is.

If inflation occurs, and it usually does, then any maturity proceeds will be in devalued dollars BUT I'll be ahead as long as the coupon exceeds inflation (which it also usually does).

Not sure about a magic pill, but holding maturity does reverse any interest rate losses to zero at maturity and also gives me the option to reinvest the proceeds at higher rates. A bond fund doesn't give me that.

 

[pb4uski]

With a ladder you at least mitigate interest rate risk

Bingo! With a held-to-maturity ladder as rates rise you get the opportunity to reinvest the proceeds from maturities at a higher rate than if you just had a slug of bonds with a weighted average maturity of the bond ladder. The ladder smooths things out whether interest rates rise or fall.

 

[RunningBum]

If rates spike, with individual bonds I will continue getting the same interest coupons... not lower.

You get lower than the prevailing interest rate. That's the crux of my point.

 

[Diogenes]

Apparently a lot of people bought those bond funds with the 1% bonds and now say bond funds are bad as a result because their returns were nil. You get what you pay for and pay for what you get.

Conventional investment advice from Fidelity/Schwab/Vanguard isn't to wait until rates rise, before buying bonds (that is, buying into bond-funds). It is to dollar-cost average. A portion of every paycheck goes into those funds, every month, whether rates are rising or falling, high or low, green or red. So, here we are, following conventional advice, plus the ubiquitous advice to be patient, and some 5-6 years later, are wondering why cumulative growth (interest + NAV) is lagging inflation, or in some cases is outright negative.

What were we supposed to have done? Market-time?

 

[COcheesehead]

Conventional investment advice from Fidelity/Schwab/Vanguard isn't to wait until rates rise, before buying bonds (that is, buying into bond-funds). It is to dollar-cost average. A portion of every paycheck goes into those funds, every month, whether rates are rising or falling, high or low, green or red. So, here we are, following conventional advice, plus the ubiquitous advice to be patient, and some 5-6 years later, are wondering why cumulative growth (interest + NAV) is lagging inflation, or in some cases is outright negative.

What were we supposed to have done? Market-time?

Conventional wisdom isn’t always right. Interest rates are one of the easiest market timing indicators for the average investor. When rates are rising your bond/bond fund value will erode.
During 2022 some of the smart money folks on here posted that they were at least shortening duration. Otherwise you got hammered.

 

[YellowSubmarine]

Conventional investment advice from Fidelity/Schwab/Vanguard isn't to wait until rates rise, before buying bonds (that is, buying into bond-funds). It is to dollar-cost average. A portion of every paycheck goes into those funds, every month, whether rates are rising or falling, high or low, green or red. So, here we are, following conventional advice, plus the ubiquitous advice to be patient, and some 5-6 years later, are wondering why cumulative growth (interest + NAV) is lagging inflation, or in some cases is outright negative.

What were we supposed to have done? Market-time?

Buy high; sell low, i.e. buy when rate are up and sell when interest rates are down -if you are a trader; otherwise stay put and enjoy your high % return (relative to others). When I buy a bond, I expect to hold for the maturity. I will sell when there's favorable, huge price swings and personal tax feasible.

 

[COcheesehead]

Someone much smarter than me told me long ago that the best time to buy bonds is when inflation is raging and it’s true. 2023/2024 maybe a bit of 2025 was a great time to lock in yield.

 

[Montecfo]

Someone much smarter than me told me long ago that the best time to buy bonds is when inflation is raging and it’s true. 2023/2024 maybe a bit of 2025 was a great time to lock in yield.

true. But there were people insisting we should wait for 6-7%. Those folks are still waiting I guess.

 

[COcheesehead]

true. But there were people insisting we should wait for 6-7%. Those folks are still waiting I guess.

That was true too. I remember a few posts like that.

 

[engineernerd]

[snip]... So, if bond funds are not well liked by those who have replied, who do we believe likes them and why? ...[snip]

Most here who hold bond funds (instead of CDs, individual bonds, MYGAs, etc.) probably don't post much in the Active Investing forum.

The reason I hold a couple of boring bond index funds as a big share of my fixed-income investments is that they are less work compared to other fixed-income options and I am lazy.

The reason I hold the amount of fixed-income that I do is my FIRECalc results from "Investigate changing my allocation" showed higher odds of success.

I do not expect my bond funds to beat inflation, that's not realistic. They do their job if they just reduce the impact of the worst stock-market downturns my portfolio will experience.

 

[pb4uski]

You get lower than the prevailing interest rate. That's the crux of my point.

and a perceptive glimpse of the obvious.

But technically I could sell the bond at a loss, but back the same bond with the proceeds at a discount to par and get that higher yield that you seem so fixated on.

 

[FD1000]

What is it about "held to maturity" that is so hard for you to understand? Even if rates spike and values drop your "several percentage points", I don't care as I intend to hold to maturity and any value decline will reverse before maturity. And if it happens that I do need cash, because I'm not in a bond fund I have choices as to what to sell.

Suppose I bought a 5-year target-maturity bond ETF in mid-2021.
Then, in 2022, I realized rising rates were going to hurt it and wanted to sell.
The problem was that selling would have locked in a loss of several percentage points, so I held on instead. Yes, if I keep it until maturity, I’ll eventually receive the expected payout.

But, in the middle of the 5 years, the markets gave me great opportunities. This is why I made 11.6% in the last 5 years. Target-maturity bond ETF can't compete with that.

Most investors who buy bonds to maturity are happy with their lock. I'm not. It's similar to CD and MYGA.
Give me 8% and I'm happy.

 

[pb4uski]

....The reason I hold a couple of boring bond index funds ...

Bond index funds are the worst bond funds to own. Unlike stocks, bonds are an area were professional management can optimize returns so managed bond funds are preferable to bond index funds.

 

[pb4uski]

Suppose I bought a 5-year target-maturity bond ETF in mid-2021.
Then, in 2022, I realized rising rates were going to hurt it and wanted to sell.
The problem was that selling would have locked in a loss of several percentage points, so I held on instead. Yes, if I keep it until maturity, I’ll eventually receive the expected payout. ...

A hold-to-maturity bond investor is quite happy with the expected payout and is unconcerned with changes in value from purchase to maturity and could care less about chasing "great opportunities" like you do.

 

[RunningBum]

and a perceptive glimpse of the obvious.

But technically I could sell the bond at a loss, but back the same bond with the proceeds at a discount to par and get that higher yield that you seem so fixated on.

Well, you didn't understand what I said the first time, so I made my point a second time. That's all. I'm out.

 

[pb4uski]

Well, you didn't understand what I said the first time, so I made my point a second time. That's all. I'm out.

No, I got your point... it just wasn't a very good point (which is unusual from you in my experience).

 

[engineernerd]

Bond index funds are the worst bond funds to own. Unlike stocks, bonds are an area were professional management can optimize returns so managed bond funds are preferable to bond index funds.

I don't care enough to do a deep dive into this question, but opinions do seem to differ:

https://www.etf.com/sections/index-investor-corner/swedroe-active-fails-fixed-income

 

[Spock]

From spending too much time on reddit (r/bonds) one big reason people own bond funds is because they think/believe it is the same as owning bonds.
Can't remember where I read it, might even have been a post on here, but the concept was "bond funds are more similar to a dividend paying stock than holding an individual bond to maturity".

 

[Quattro73]

true. But there were people insisting we should wait for 6-7%. Those folks are still waiting I guess.

Confirmed.

 

[Texas Proud]

What is it about "held to maturity" that is so hard for you to understand? Even if rates spike and values drop your "several percentage points", I don't care as I intend to hold to maturity and any value decline will reverse before maturity. And if it happens that I do need cash, because I'm not in a bond fund I have choices as to what to sell.


I certainly would not recommend that anyone put their whole nestegg in a few different concentrated funds with great Sharpe ratios, even if they watch those eggs very carefully. I'm glad what you are doing is working out for you so far, I don't think it is a good approach to advocate. The concentration risk is a bit scary... but good luck to you.

Responding to you quoting me... I do not invest the way you think... I am answering the question the way I think is the correct answer about bonds... heck, I am probably 80% stock...

 

[audreyh1]

Bond index funds are the worst bond funds to own. Unlike stocks, bonds are an area were professional management can optimize returns so managed bond funds are preferable to bond index funds.

I switched from active bond funds to index bond funds because my experience was that the active bond funds underperformed at the worst times. And the reason was simple - overall they held lower credit quality. It came down to index funds having slightly less correlation against equities. I decided I wanted higher credit quality in my fixed income.

 

[pb4uski]

Responding to you quoting me... I do not invest the way you think... I am answering the question the way I think is the correct answer about bonds... heck, I am probably 80% stock...

I wasn't reading anything about how you invest one way or another when I quoted you. You just happened to post something that was totally right and relevant to the post that I was making, so I quoted you.

 

[iloveyoga]

From spending too much time on reddit (r/bonds) one big reason people own bond funds is because they think/believe it is the same as owning bonds.
Can't remember where I read it, might even have been a post on here, but the concept was "bond funds are more similar to a dividend paying stock than holding an individual bond to maturity".

I like the monthly dividends from my low duration bond funds.

 

[pb4uski]

I like the monthly dividends from my low duration bond funds.

Why? Do you spend them? Or reinvest them?

 

[Lorenzo]

I can go thru history and show how I found great risk-adjusted performance funds that did better than that.
I held PIMIX for about 7-8 years from 2010 to 2018. It beat 60/40 SharpCharts | StockCharts.com
I held IOFIX from 2018 to the end of 02/2020 and made about 20%. In early April I bought again and sold at the end of the year and made about 20% in 2020. SharpCharts | StockCharts.com
I held HOSIX and CLOZ for most of 2023-24 and made over 10% annually. It was the lowest SD and highest Sharpe ever. SharpCharts | StockCharts.com
I bought EGRIX in April 2025.

It doesn’t matter to me if thousands of bond funds are struggling. I only need two or three that are working.

I re-read the original post, and I see now that the OP did not limit the question to the kind of bond funds used as Examples A and B, SPAB and BND. I read the question as limited to those kinds of funds, held by millions of investors and favorites of the buy-and-hold crowd. The potential benefits, or should I say risk-adjusted performance, is more evident to me for the more specialized bond funds you mentioned than for the plainer funds in the OP's examples. I wonder if the OP just had these plain-vanilla funds in mind and was not thinking of the huge variety of bond funds that are available?

Most here who hold bond funds (instead of CDs, individual bonds, MYGAs, etc.) probably don't post much in the Active Investing forum.

The reason I hold a couple of boring bond index funds as a big share of my fixed-income investments is that they are less work compared to other fixed-income options and I am lazy.

The reason I hold the amount of fixed-income that I do is my FIRECalc results from "Investigate changing my allocation" showed higher odds of success.

I do not expect my bond funds to beat inflation, that's not realistic. They do their job if they just reduce the impact of the worst stock-market downturns my portfolio will experience.

Until now, I hadn't realized this thread was in the Active Investing forum. As noted by others, the kind of index bond funds mentioned in the original post appear to be favored by buy-and-hold investors.

For "less work," I'd check out the target-date maturity ETFs that pb4uski favors. The behavior of individual bonds plus diversification against default risk, bought and sold with the ease of any ETF.