Isn't it a good thing if bond prices fall?

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Re: Isn't it a good thing if bond prices fall?

Postby joer1212 » Tue Jul 16, 2013 7:40 pm

Kevin M wrote:It sounds like OP's entire portfolio is in a 401k, so CDs aren't an option. However, the SV fund sounds like a good alternative.

OP, what is the current yield on the SV fund?

You say it's higher than CDs. You can earn about 2% on a 5-year CD, which is higher than the SEC yield of Intermediate-Term Treasury fund (1.38%, comparable credit risk, much more interest-rate risk), and comparable to Total Bond Market (2.00%, more credit risk, more interest-rate risk).

If you can earn 2% or more in the SV fund, then your expected return over the next 5-10 years is comparable to TBM, but there is no interest-rate risk. There is some credit risk in SV funds, but my understanding is that it typically is quite low. I probably would use the SV fund.

Yes, if rates fall from here, you will recover some of the NAV loss you have experienced (you've already recovered some). Not being able to predict the future, I just look at the expected return vs. risk, and conclude that a stable value fund yielding 2% or more (or a good 5-year, non-brokered CD with decent early withdrawal terms) is a better proposition.

If still unsure, you could gradually increase your allocation to the SV fund over the next few months, perhaps increasing it more if TBM NAV increases, and less if TBM NAV decreases (kind of a value averaging approach).

Kevin


Here's the info I've got on my stable value fund:


Annualized performance

Periods Ending 03/31/13

Fund/ Benchmark

YTD 0.62%/ 0.33%

1 Year 2.68%/ 1.25%

3 Year 3.17%/ 1.78%

5 Year 3.64%/ 2.25%

10 Year 4.27%/ 3.33%



......and here is the info for my bond aggregate index fund:


Fund/ Index

YTD -0.16/ -0.16

1 Year 3.69/ 3.77

3 Year 5.48/ 5.52

5 Year — — 5.62

10 Year ----- 5.02

Since Inception 5.62
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Re: Isn't it a good thing if bond prices fall?

Postby Kevin M » Tue Jul 16, 2013 7:52 pm

^I wouldn't pay much attention to any but the most recent numbers, since interest rates were higher before. A 0.6% YTD return as of 3/31 implies a yield of about 2.4%, which is very good. I probably would use this SV fund instead of a bond fund.

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Re: Isn't it a good thing if bond prices fall?

Postby joer1212 » Tue Jul 16, 2013 8:01 pm

Kevin M wrote:^I wouldn't pay much attention to any but the most recent numbers, since interest rates were higher before. A 0.6% YTD return as of 3/31 implies a yield of about 2.4%, which is very good. I probably would use this SV fund instead of a bond fund.

Kevin


That's assuming interest rates rise immediately after I switch into the stable value fund, and continue to rise. If they don't, I stand to lose a significant return by being out of TBM, as evidenced by the the charts I posted, which compares the two.
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Re: Isn't it a good thing if bond prices fall?

Postby Kevin M » Tue Jul 16, 2013 10:26 pm

joer1212 wrote:
Kevin M wrote:^I wouldn't pay much attention to any but the most recent numbers, since interest rates were higher before. A 0.6% YTD return as of 3/31 implies a yield of about 2.4%, which is very good. I probably would use this SV fund instead of a bond fund.

Kevin


That's assuming interest rates rise immediately after I switch into the stable value fund, and continue to rise. If they don't, I stand to lose a significant return by being out of TBM, as evidenced by the the charts I posted, which compares the two.

What I'm saying does not assume anything about future interest rates; it's simply trading off expected return and risk.

I don't know what charts you're referring to, but assuming you are looking at some historical charts, they don't apply at all if you're looking at most periods within the last 30 years or so. That applies to the 3, 5 and 10 year returns you posted as well, which for TBM are a result of rates that were higher 3, 5 and 10 years ago. Those returns are not at all indicative of what to expect from TBM going forward.

If interest rates don't change at all, you should expect about a 2% return for TBM over the next five years or so, since that is the SEC yield. According to folks at Vanguard, you should expect about a 2% annualized return for TBM over the next 10 years, regardless of what happens to interest rates.

Since the yield on your SV fund appears to be higher, the expected return of the SV fund is higher, and the risk probably is lower (there is some dependency on the credit worthiness of whatever institution(s) stand behind the SV fund).

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Re: Isn't it a good thing if bond prices fall?

Postby joer1212 » Wed Jul 17, 2013 12:27 am

Kevin M wrote:If interest rates don't change at all, you should expect about a 2% return for TBM over the next five years or so, since that is the SEC yield. According to folks at Vanguard, you should expect about a 2% annualized return for TBM over the next 10 years, regardless of what happens to interest rates.

Since the yield on your SV fund appears to be higher, the expected return of the SV fund is higher, and the risk probably is lower (there is some dependency on the credit worthiness of whatever institution(s) stand behind the SV fund).

Kevin


2% total return? That's miserable! Even my stable value fund can do better than that! I thought I could rely on TBM to return 5%-6% on average. Heck, even risk-free CD's should do better than that in the long run!
What a terrible time for me to be investing. I missed out on a 30-year bond bull market run. Now that I show up to capitalize, it's all over.
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Re: Isn't it a good thing if bond prices fall?

Postby floydtime » Wed Jul 17, 2013 7:08 am

"SEC yield" is generally unrelated to what one actually receives (which is all I care about). In fact, Vanguard says...

[SEC yield] will differ (at times, significantly) from the fund's actual experience; as a result, income distributions from the fund may be higher or lower than implied by the SEC yield.


So I would (and do) ignore SEC yield - it is there for legal reasons, but not much else.

The reason I bring this up is that my actual distribution (the actual money I receive) from TBM is now around 2.41%. This is up (as would be expected) from the previous month. This would continue to go up if yields go up. Enjoy it!
"Do not value money for any more nor any less than its worth; it is a good servant but a bad master" - Alexandre Dumas
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Re: Isn't it a good thing if bond prices fall?

Postby Twins Fan » Wed Jul 17, 2013 11:54 am

joer1212 wrote:2% total return? That's miserable! Even my stable value fund can do better than that! I thought I could rely on TBM to return 5%-6% on average. Heck, even risk-free CD's should do better than that in the long run!
What a terrible time for me to be investing. I missed out on a 30-year bond bull market run. Now that I show up to capitalize, it's all over.


Well, then don't save or invest at all, spend all your money, and charge up your credit cards. :D

Your emotions are showing there. If equities were at a low now and not returning much or even negative, would you be so disappointed? Probably not because you're buying at lower prices, right.

How long are you investing for? Over the next 30 years or so, TBM may just end up averaging 5% or so. Who knows?

My personal feeling is that now is a good time for those in the accumulation phase to be investing in TBM, or similar funds. You're buying at a low NAV to get more shares, your reinvested dividends buy more shares at lower NAVs, your dividends are based on number of shares you own, and as yields rise (if) you get more and more shares at low prices to bump up the dividends.

Predictions are just that... predictions. Don't base your investing off them, they're usually wrong.
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Re: Isn't it a good thing if bond prices fall?

Postby Tom_T » Wed Jul 17, 2013 12:36 pm

joer1212 wrote:
Kevin M wrote:If interest rates don't change at all, you should expect about a 2% return for TBM over the next five years or so, since that is the SEC yield. According to folks at Vanguard, you should expect about a 2% annualized return for TBM over the next 10 years, regardless of what happens to interest rates.

Since the yield on your SV fund appears to be higher, the expected return of the SV fund is higher, and the risk probably is lower (there is some dependency on the credit worthiness of whatever institution(s) stand behind the SV fund).

Kevin


2% total return? That's miserable! Even my stable value fund can do better than that! I thought I could rely on TBM to return 5%-6% on average. Heck, even risk-free CD's should do better than that in the long run!

If interest rates don't change (which is what Kevin used as a premise for the 2% return), then CDs certainly won't get any better. Ally Bank's five-year CD currently pays 1.5%. Also, how can you expect a bond fund to return 5% if interest rates are 2%? The fact is that in the current environment, nobody is going to earn a lot of interest on anything. If you have a stable value fund available to you that pays better than 2%, then use it. Most people don't have that option.
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Re: Isn't it a good thing if bond prices fall?

Postby joer1212 » Wed Jul 17, 2013 2:15 pm

Tom_T wrote:If interest rates don't change (which is what Kevin used as a premise for the 2% return), then CDs certainly won't get any better. Ally Bank's five-year CD currently pays 1.5%. Also, how can you expect a bond fund to return 5% if interest rates are 2%? The fact is that in the current environment, nobody is going to earn a lot of interest on anything. If you have a stable value fund available to you that pays better than 2%, then use it. Most people don't have that option.


Last night I changed my allocation, from 20% TBM and 10% stable value, to exactly the opposite. By doing this, I am hedging my bets that interest rates will rise for a sustained period. Or, they may not. That's why I left 10% of my portfolio in TBM, just in case.
If an when bond prices fall significantly, I may reverse the allocation back to its original settings.
If what I predict pans out, it will have been a superior strategy than to just holding TBM like a sitting duck, and watching its NAV drop over a long period.
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Re: Isn't it a good thing if bond prices fall?

Postby joer1212 » Wed Jul 17, 2013 2:22 pm

Twins Fan wrote:
joer1212 wrote:2% total return? That's miserable! Even my stable value fund can do better than that! I thought I could rely on TBM to return 5%-6% on average. Heck, even risk-free CD's should do better than that in the long run!
What a terrible time for me to be investing. I missed out on a 30-year bond bull market run. Now that I show up to capitalize, it's all over.


Well, then don't save or invest at all, spend all your money, and charge up your credit cards. :D

Your emotions are showing there. If equities were at a low now and not returning much or even negative, would you be so disappointed? Probably not because you're buying at lower prices, right.

How long are you investing for? Over the next 30 years or so, TBM may just end up averaging 5% or so. Who knows?

My personal feeling is that now is a good time for those in the accumulation phase to be investing in TBM, or similar funds. You're buying at a low NAV to get more shares, your reinvested dividends buy more shares at lower NAVs, your dividends are based on number of shares you own, and as yields rise (if) you get more and more shares at low prices to bump up the dividends.

Predictions are just that... predictions. Don't base your investing off them, they're usually wrong.


I feel that the difference between equities and bonds is that bonds are [somewhat] more predictable in the current environment. Interest rates have nearly nowhere to go but up, so I think it's a fairly safe bet that this will happen soon enough, and possibly over a sustained period. Of course, no one knows the future, but I have hedged my bets by placing 20% of my portfolio in stable value fund, and only 10% in in TBM. This allocation had previously been reversed.
If interest rates do in fact rise for the next couple of years, my strategy will be superior than just holding TBM at a full allocation. I know that a switch of 10% in favor of stable value is not major, but it is a defensive move, nonetheless.
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Re: Isn't it a good thing if bond prices fall?

Postby Kevin M » Wed Jul 17, 2013 5:03 pm

joer1212 wrote:2% total return? That's miserable! Even my stable value fund can do better than that! I thought I could rely on TBM to return 5%-6% on average. Heck, even risk-free CD's should do better than that in the long run!

It's good that you're finally understanding this. It's common for folks to look at past bond returns and somehow think that's indicative of future returns, and it's important to correct this misunderstanding. I've seen quite a few articles on the Vanguard site cautioning investors to set realistic expectations for bond fund returns, but of course they continue to recommend an allocation to bonds anyway.

joer1212 wrote:What a terrible time for me to be investing. I missed out on a 30-year bond bull market run. Now that I show up to capitalize, it's all over.

True, it is a pretty rotten time for savers who don't want to take much (or any) equity risk. Real short-term interest rates are negative, so it's quite likely that without taking some interest-rate and/or credit risk you are losing purchasing power.

Non-brokered 5-year CDs (and your SV fund) may be an exception if inflation remains at or below 2%. Inflation has been running at less than 2% lately, so at least with a CD or SV fund earning 2% or more you are (barely) keeping your head above water (but perhaps not after taxes). With the Fed targeting inflation at 2%, I just figure a 2% nominal return is likely to be pretty close to a 0% real return, which is what you currently earn in I Bonds.

It is what it is, and we just have to adapt as best we can.

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Re: Isn't it a good thing if bond prices fall?

Postby Kevin M » Wed Jul 17, 2013 5:21 pm

Twins Fan wrote:My personal feeling is that now is a good time for those in the accumulation phase to be investing in TBM, or similar funds. You're buying at a low NAV to get more shares

Perhaps low NAV compared to prices over the last year, but go a bit further back and NAV isn't so low. A 2% SEC yield is pretty low compared to historical values.

Twins Fan wrote:Predictions are just that... predictions. Don't base your investing off them, they're usually wrong.

According to Ken Volpert, manager of fixed income at Vanguard, bond yield (YTM, which for bond funds is pretty close to SEC yield) has been a very good predictor of returns over the following 10 years, so in this case, the prediction has usually been pretty good. Ken Volpert on the current bond landscape. John Bogle also has said that yield is what he uses to estimate bond returns.

Kevin
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Re: Isn't it a good thing if bond prices fall?

Postby Kevin M » Wed Jul 17, 2013 5:44 pm

floydtime wrote:"SEC yield" is generally unrelated to what one actually receives (which is all I care about). In fact, Vanguard says...

[SEC yield] will differ (at times, significantly) from the fund's actual experience; as a result, income distributions from the fund may be higher or lower than implied by the SEC yield.


So I would (and do) ignore SEC yield - it is there for legal reasons, but not much else.

The reason I bring this up is that my actual distribution (the actual money I receive) from TBM is now around 2.41%. This is up (as would be expected) from the previous month. This would continue to go up if yields go up. Enjoy it!

While it's true that distribution yields currently are quite a bit higher than SEC yields for some bond funds, SEC yields are widely accepted as a better indicator of returns going forward.

It's also true that bond funds are required by the SEC to provide SEC yields, but why would the SEC make them provide a number that is of no value?

SEC yield is based on average yield to maturity (YTM) over the previous 30 days. YTM is the return you will earn on an individual bond, assuming no default, regardless of the current (distribution) yield. YTM factors in changes in bond price as the bond approaches maturity. Since a bond fund is made up of individual bonds, SEC yield, which is a form of YTM, is a better indicator than distribution yield of expected return over a period of time equal to the average maturity of the bonds in the fund.

I acknowledge that there are some flaws in SEC yield. For example, other than in short-term bond funds, bonds aren't held to maturity, so the future shape of the yield curve (unknown) could result in better or worse results as shorter-maturity bonds are sold and longer-maturity bonds are bought. There was an interesting, recent post that argued that based on the current shape of the yield curve, SEC yield greatly underestimates expected return. The problem is that we don't really know that the shape of the yield curve will provide this benefit in the future; if we did, then we could make easy money by "riding the yield curve", which some bond managers do indeed attempt to do. To do this you have to take more interest-rate risk, which of course can backfire on you.

In the end, what I really care about is total return. So although I enjoy the higher distribution yields, they haven't compensated for the loss in NAV over the last couple of months--hence the negative 1-year total return for TBM. Yes, distribution yield will go up if yields go up (basically a tautology), but NAV will go down, thus pulling total returns down. Once yield stops rising, the higher yield will eventually make up for the loss in NAV, and eventually we will be better off than if yields had not risen. If one has a long enough time frame, and doesn't want to mess around hedging the interest-rate risk with something like CDs or stable value funds, then be happy!

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Re: Isn't it a good thing if bond prices fall?

Postby ogd » Wed Jul 17, 2013 6:14 pm

Kevin M wrote:I acknowledge that there are some flaws in SEC yield. For example, other than in short-term bond funds, bonds aren't held to maturity, so the future shape of the yield curve (unknown) could result in better or worse results as shorter-maturity bonds are sold and longer-maturity bonds are bought. There was an interesting, recent post that argued that based on the current shape of the yield curve, SEC yield greatly underestimates expected return.

Hi Kevin,

I think the SEC yield flaw is real and currently important, though I don't reliably know what amount I can expect in the future. Fundamentally, the fund will be taking more interest rate risk than holding to maturity, and this is currently rewarded more than it was in the past. E.g. the curve was much flatter at a time like 2007 when Fed fund rates were done increasing, the ten year was 5.35% and the five year 5.19%, only 1.05x. Today that ratio is 1.9x. Perhaps that is the reason for the warning that SEC yield is the typical return, but we are in atypical times.

Reposting the Morningstar article that talks about how complicated this really is: http://news.morningstar.com/articlenet/ ... 471&part=1 . Note how they don't say "SEC yield is what you're gonna get"; far from it.

Anyway, the SEC yield is the one number that can't be gamed by fund managers and we know that the fund's bond portfolio is capable of generating this number within the next 5.3 years (for TBM). Everything else is gravy, but if we ding the fund for interest rate risk it's fair enough to expect some rewards. I remain cautiously optimistic :)
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Re: Isn't it a good thing if bond prices fall?

Postby Kevin M » Wed Jul 17, 2013 6:40 pm

Hi again ogd,

Well, at least notice that I've learned something from that other thread. Did you also notice that I've been trying to qualify my CD to treasury comparisons with "maturities up to five years"? I knew you'd be keeping an eye on me. :wink:

I re-read the M* article. It's mostly about how active bond fund managers' actions affect SEC yield compared to trailing twelve-month (TTM) yield (a figure that Vanguard doesn't even publish, incidentally, but M* contends that TTM smooths out distribution yield, as calculated by VG). Also of note is that they don't mention riding the yield curve at all.

Let's check back in in five years to see how things work out--wait, that would be confusing strategy with outcome, so nevermind. :sharebeer

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Re: Isn't it a good thing if bond prices fall?

Postby ogd » Wed Jul 17, 2013 7:11 pm

Kevin: you are indeed being reasonable and I wasn't complaining :) I just wanted to clarify that there are good odds that the fund will distribute more than the SEC yield, sustainably, given the current yield curve.

I don't I think we need to wait five years necessarily for this one: if we get a 6 month period of stable interest rates and we see stable distribution yields that are consistently higher than the SEC yield, in conservative Vanguard funds that aren't trying to play games with the yield, we can perhaps gain more confidence. The perception of interest rate risk is currently elevated (reflected in the market's pricing of the different maturities) and so should be the rewards.

Cheers!
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Re: Isn't it a good thing if bond prices fall?

Postby Kevin M » Wed Jul 17, 2013 9:37 pm

ogd wrote:I don't I think we need to wait five years necessarily for this one: if we get a 6 month period of stable interest rates and we see stable distribution yields that are consistently higher than the SEC yield, in conservative Vanguard funds that aren't trying to play games with the yield, we can perhaps gain more confidence.

Really--you would be happy with that? IIRC, Int-Term Treasury fund is your fund of choice; most recent distribution yield was only 1.50% vs. SEC yield of 1.39%. We can just look back now and already see that although dist. yields jump around from month to month, they have been quite stable over the last 18 months; I wouldn't be surprised to see that continue for another six months, but I wouldn't be very happy with 1.5% given the interest-rate risk.

I think you have to at least factor in the cap gain distributions to be fair (to you), and even then, it doesn't look that attractive to me. During our other discussion, I calculated the total yield, including dividends and cap gain distributions, as 2.13% as a percent of starting NAV for the year ending 6/28/13.

Also, I'm not sure how relevant distribution yields over a 6-18 month period are for a fund with a duration of 5+ years. However, I have to admit seeing distribution yields holding up better than I would have expected in funds with much shorter durations, so once again, some skepticism of SEC yield is warranted--I grant you that.

I'm afraid we're getting back to the discussion we were having in that other thread.

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Re: Isn't it a good thing if bond prices fall?

Postby ogd » Wed Jul 17, 2013 11:16 pm

Kevin M wrote:
ogd wrote:I don't I think we need to wait five years necessarily for this one: if we get a 6 month period of stable interest rates and we see stable distribution yields that are consistently higher than the SEC yield, in conservative Vanguard funds that aren't trying to play games with the yield, we can perhaps gain more confidence.

Really--you would be happy with that? IIRC, Int-Term Treasury fund is your fund of choice; most recent distribution yield was only 1.50% vs. SEC yield of 1.39%. We can just look back now and already see that although dist. yields jump around from month to month, they have been quite stable over the last 18 months; I wouldn't be surprised to see that continue for another six months, but I wouldn't be very happy with 1.5% given the interest-rate risk.

It's too early for distribution yield. Remember it reacts much more slowly than SEC yield (which reflects the future), you actually have to get new bonds with reinvested principal. The dist yield did get adjusted upwards percentage-wise a little because of the NAV drop, but the market yield increases were much bigger proportionately (5 year yield doubled, more or less). E.g. 6 months ago (jan 31st) the VFITX dist yield was still 1.46%, at SEC yield 0.75%. I'm willing to ascribe some of that to older, higher interest rates, which is why I'm unsure that the stable period from last summer to April is a good indicator. This might also mean that 6 months of stability in the future is not enough proof...

The fact remains though, TBM (coming back to the poster's case) can return its SEC yield of 2% for the next 5.3 years while allowing portfolio duration to taper to zero. But of course it's not going to do that, it'll keep duration relatively constant (for which it gets ding'ed often enough on this forum, as too risky if the rates keep increasing), and duration seems well enough rewarded these days that it is likely to make quite a bit more.

Yes, we might be getting off-track. To summarize my opinion of joer1212's last question: it's possible or even likely that you'll get somewhat better returns with TBM than 2% if nothing else changes. I have a ballpark estimate based on treasury yields plus a credit quality adjustment that I'm not willing to either post or PM (because it's so ballpark) -- but you're definitely not getting 5-6% / year from this fund unless the interest rates go up significantly, which is gonna hurt in the short term. The period 2003-2007 (5 year yields 2 -> 5%) might be instructive as to how much / how hurt.

As for the bond bull market being over and heading down, remember that if bonds stayed at their all-time highs for a long time, instead of the recent drop / yield increase, you would have made peanuts in the long term. If they went even higher, then stayed there you would have made even less peanuts. Bonds are not like stocks. I would have been a happier bond investor if the yields stopped dropping and the prices stopped rising circa 2007. Yes we got ~40% returns on TBM since then with all the capital gains, but we would have got about the same and be sitting on a portfolio yielding 5.5% right now...
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Re: Isn't it a good thing if bond prices fall?

Postby joer1212 » Thu Jul 18, 2013 9:01 am

ogd wrote:As for the bond bull market being over and heading down, remember that if bonds stayed at their all-time highs for a long time, instead of the recent drop / yield increase, you would have made peanuts in the long term. If they went even higher, then stayed there you would have made even less peanuts. Bonds are not like stocks. I would have been a happier bond investor if the yields stopped dropping and the prices stopped rising circa 2007. Yes we got ~40% returns on TBM since then with all the capital gains, but we would have got about the same and be sitting on a portfolio yielding 5.5% right now...


I don't remember where I read that long-term bond returns (as in TBM) are about 8% annualized, whereas long-term stock returns have averaged 10%. I distinctly remember thinking that these returns were so close in terms of percentages (even though a 2% return difference will be significant in the long run). Is this accurate?
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Re: Isn't it a good thing if bond prices fall?

Postby ogd » Thu Jul 18, 2013 1:19 pm

joer1212 wrote:I don't remember where I read that long-term bond returns (as in TBM) are about 8% annualized, whereas long-term stock returns have averaged 10%. I distinctly remember thinking that these returns were so close in terms of percentages (even though a 2% return difference will be significant in the long run). Is this accurate?

8% is surely unrealistic. I took a look at Vanguard's numbers with 100% bond allocation and they're 5.5% annualized since 1926. Even that probably reflects some past periods that are not representative of the present, e.g. the 1970s - early 80s, when bonds were returning a lot but most of it got eaten up by inflation.

Their number for 100% stock allocation was indeed 10%, so maybe you got the number there but you got the 8% figure wrong; perhaps you're remembering the return for a 50/50 portfolio, which they quote at 8.3%.
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Re: Isn't it a good thing if bond prices fall?

Postby Phineas J. Whoopee » Thu Jul 18, 2013 2:20 pm

joer1212 wrote:...
I don't remember where I read that long-term bond returns (as in TBM) are about 8% annualized, ...

[Emphasis added.]

Hi joer1212,

It's been interesting to read this thread that you started. I'm only responding to point out that Total Bond Market is not a long-term fund. It's intermediate term. Even if long-term bonds returned around 8% for some period it wouldn't have much to do with TBM.

PJW
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Re: Isn't it a good thing if bond prices fall?

Postby ogd » Thu Jul 18, 2013 2:47 pm

Phineas J. Whoopee wrote:It's been interesting to read this thread that you started. I'm only responding to point out that Total Bond Market is not a long-term fund. It's intermediate term. Even if long-term bonds returned around 8% for some period it wouldn't have much to do with TBM.

Hmmm - I read that as "long-term returns of bonds". If the OP meant "returns of long-term bonds" then the number would indeed be higher at least in nominal terms. While you can look at long-term funds for the last 40 years or so, I don't know where you can get a number dating back to 1926 like Vanguard's.
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Re: Isn't it a good thing if bond prices fall?

Postby Phineas J. Whoopee » Thu Jul 18, 2013 2:55 pm

ogd wrote:
Phineas J. Whoopee wrote:It's been interesting to read this thread that you started. I'm only responding to point out that Total Bond Market is not a long-term fund. It's intermediate term. Even if long-term bonds returned around 8% for some period it wouldn't have much to do with TBM.

Hmmm - I read that as "long-term returns of bonds". If the OP meant "returns of long-term bonds" then the number would indeed be higher at least in nominal terms. While you can look at long-term funds for the last 40 years or so, I don't know where you can get a number dating back to 1926 like Vanguard's.

[Emphasis added.]

Wouldn't that also have to be higher in real terms? More money is more money, after all, while inflation over any given period is always the same as: inflation over that period.

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Re: Isn't it a good thing if bond prices fall?

Postby Kevin M » Thu Jul 18, 2013 4:58 pm

I wanted to correct an erroneous statement I made earlier.

Kevin M wrote:SEC yield is based on average yield to maturity (YTM) over the previous 30 days. YTM is the return you will would earn on an individual bond, assuming no default and that interest is invested at the YTM as of the time of purchase, and that the bond is held to maturity, regardless of the current (distribution) yield. YTM factors in changes in bond price as the bond approaches maturity. Since a bond fund is made up of individual bonds, SEC yield, which is a form of YTM, is a better indicator than distribution yield of expected return over a period of time equal to the average maturity of the bonds in the fund.


The key point I missed is that interest must be reinvested at the YTM, which of course is unlikely for a coupon bond (with a zero coupon bond you will earn the YTM if held to maturity). Also, I was thinking it, but did not state explicitly that the bond must be held to maturity.

However, I still think the conclusion is valid, especially for the US aggregate bond market (as represented by TBM), and if the period is extended to 10 years. This is what Ken Volpert of Vanguard shows has been the case historically for the period covered in the chart below (from his presentation, which I linked to above):

Image

The blue line is YTM for Barclays US Aggregate Bond Index, and the orange line is the return for the following 10 years. Ken's words:

So what this graph is really communicating is that the yield to maturity right now is a really good estimate of what you're going to get over the next 10 years in this investment. It's really been a very reliable indicator. So it gives you a very good approximation of what the return is going to be.


As of Dec 31, the time mentioned in the presentation, the YTM for this index, which is the TBM benchmark index, was 1.74%, and Ken said:

So investors looking forward should expect that that's the kind of return you're going to get: 1.7% to 1.8% return over the next 10 years.


The SEC yield for TBM (admiral shares) on 12/31/12 was 1.58%, so 16 basis points below the YTM Ken mentioned. The most recent average YTM quoted for TBM was 2.3% as of June 30, and on 6/28 (last business day of month) SEC yield was 1.85% (admiral shares), so YTM was 45 basis points higher than SEC yield (distribution yield was 2.41%, so 11 basis points higher than YTM as of 6/30). SEC yield now is 2.00%, and the yields on treasuries haven't changed much this month, so it seems the current YTM should be in the ballpark of 2.3%. I don't think the YTM figure includes expenses, while the SEC yield does, and ER for TBM admiral is 10 basis points.

So based on the guidance from Vanguard, it seems that a reasonable estimate for TBM return over the next 10 years as of today is about 2.2%.

It's important to repeat that Vanguard is not recommending that investors abandon their allocation to fixed income, but instead that they have realistic expectations for bond fund returns going forward.

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Re: Isn't it a good thing if bond prices fall?

Postby billyt » Thu Jul 18, 2013 5:33 pm

Kevin: The most important words above are: "as of today". It is critical to note that this 10 year prediction changes on a daily basis. The shares I bought today are projected to return more than the shares I bought a month ago. Shares that were bought 10 years ago earned 4.5%. By continuing to invest according to your allocation, you are assured to earn the average market rate over your investing lifetime. The day to day changes are just noise, and rising rates will improve your returns.
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Re: Isn't it a good thing if bond prices fall?

Postby Kevin M » Thu Jul 18, 2013 7:21 pm

billyt wrote:Kevin: The most important words above are: "as of today". It is critical to note that this 10 year prediction changes on a daily basis.

That's because YTM and price (two sides of the same coin) change on a daily basis. No argument there. The reason your expected return is higher today than it was a month or two ago is that the prices of your bonds have fallen (as the yields have risen). The reason your expected return is lower than it was a few years ago is because the prices of your bonds have risen since then, and the yields have fallen.

billyt wrote:The shares I bought today are projected to return more than the shares I bought a month ago.

All the shares you own today, regardless of when you bought them, have the same expected return (looking forward), and will earn the same return going forward. The shares you bought a month ago have lost value, so some of the lower expected return as of a month ago already has been realized. Of course, the more shares you buy at lower prices, the higher your overall return will be going forward (assuming you don't sell shares at even lower prices); maybe this is what you mean to say.

billyt wrote:Shares that were bought 10 years ago earned 4.5%.

They may have earned 4.5% over the last 10 years, but that has no bearing on returns going forward. Thus it has no bearing on investment decisions you make today or return expectations you should have as of today. People who own shares today, regardless of when they bought them, should not be expecting to earn 4.5% over the next 10 years--that is the important point that some people don't seem to understand, and why looking at past returns can be very misleading.

billyt wrote:By continuing to invest according to your allocation, you are assured to earn the average market rate over your investing lifetime.

OK, no disagreement there, but again, what I earned earlier in my investment lifetime has no bearing on the decisions I make about and the expectations I have for my investments going forward. That's the point Vanguard is emphasizing--you should not expect bond returns over the next 10 years to be similar to those over the last 10 years.

billyt wrote:The day to day changes are just noise,

Agreed.
billyt wrote:and rising rates will improve your returns.
Agreed--eventually. The only question is how long you have to wait for those improved returns, which depends on a number of factors. According to the Vanguard presentation, a reasonable expectation, based on historical patterns, would be about 10 years, but of course we don't really know.

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Re: Isn't it a good thing if bond prices fall?

Postby ogd » Thu Jul 18, 2013 9:27 pm

Kevin: don't get too hung up on reinvested interest, the effect is very small: 3% of 3% is 0.09% which won't change much. If you just take the yield and don't reinvest it you will be close enough.

No, my entire argument is about holding to maturity vs rolling, and the reward for the extra credit risk that will exist, for example, 4 years from now: 1 more year in the YtM case, still 5 years in the rolling case. I understand Ken's historical perspective, it may well be that in the normal state of things SEC is all you get. I'm looking at that historical graph and then I'm looking at treasury yields and I can't help notice that for most of the interval the yield curve was much flatter than it is today. Put http://research.stlouisfed.org/fred2/data/GS5.txt and http://research.stlouisfed.org/fred2/data/GS10.txt and see how close they are most of the time. Today, we have 2.5% vs 1.35% so quite significant on a relative basis.

It's not accidental that I'm talking about these two Treasury points. Let's go back to VFITX which is much easier to analyze than VBTLX without those long bonds and MBS in the picture. Over the next 10 years, if you entered a 10 year treasury ladder and added cash to lower initial duration, you'd start by making about 1.3%, gradually going up to 2.5% as the cash diminishes to zero and the ladder is the appropriate 5 year -ish duration by itself. It is very reasonable to expect an intermediate fund like VFITX to make the same as a 10 year ladder, and the ending stable state is yielding much more than a 5 year treasury held to maturity, which is what VFITX's SEC yield is!

Perhaps the real lesson here is that the yield curve is expected to flatten as the market's predictions come to pass, i.e. Larry's future path of yields argument, which would bring the two numbers in-line and stop rewarding interest rate risk. So we should either be less worried about the extra interest rate risk from rolling, or expect there to be significant rewards, but it's unfair to deny both.

The real lesson for me would be that "the market is much smarter than you think". The more I learn the less it seems likely that I can make any kind of smart duration or timing decision...
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Re: Isn't it a good thing if bond prices fall?

Postby MitchC » Thu Jul 18, 2013 9:32 pm

Sure would be great if Taylor L, Larry S. or Rick Ferri would chime in here :sharebeer

In one of their books I read to only consider funds in your AA that AT LEAST earns inflation rate ( I think R. Ferri's Asset Allocation book ?). In my 401k I have Pimco Total Return and TBM... is either poised to earn over 3+% / year in the near term ? I dunno.. doesn't look like it. For now, my fixed income allocation stays in the Stable Value earning a no risk 2%. When things get sorted out, I'll add Pimco, TBM or both... but not right now.
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Re: Isn't it a good thing if bond prices fall?

Postby Kevin M » Thu Jul 18, 2013 11:38 pm

MitchC wrote:Sure would be great if Taylor L, Larry S. or Rick Ferri would chime in here :sharebeer

How about John Bogle?

John Bogle wrote:So, today, if you look at a 10-year Treasury bond, for example, at 1.6%--a hypothetic 1.6%--that's going to be your return in the next 10 years. Now, I don't think many people are going to be satisfied with that, and you can increase that return by taking a little more risk--investment-grade corporates, longer maturities, this is kind of a short-intermediate maturity, today, for 10 years, and you can go out to the 12- to 15-year range without getting into real volatility of a 25- to 30-year bond.

So, if you could get a 2.5% return or 3% return on bonds today, that would be the return for the next 10 years. Today's yield is the 10-year return, and the correlation between those two numbers is an incredible 91%, but of course, it has to be. It comports with your ideas of logic.

(Emphasis mine)

This is from: Bogle's Outlook for the Market, an interview with Christine Benz from M*.

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Re: Isn't it a good thing if bond prices fall?

Postby billyt » Fri Jul 19, 2013 5:39 am

The title of the thread is: "Isn't it a good thing if bond prices fall?" As the chart that Kevin posted very clearly shows, the answer to that question is a resounding yes. The bond fund 10 year returns are a smoothed version of what the SEC yield predicted 10 years ago. Bonds are a sleepy, boring investment. When you buy a fund, you buy into a bond ladder whose future returns are pretty well known. NAV changes are a distraction. The returns of a bond fund are determined by interest rates. The have been a lot of posters on this board lately who are worried about the 'risks' in bond funds. Looking at the chart Kevin posted, I don't see any risks, unless you mean that future returns might be a percent or two different from the SEC yield on the day you purchased the fund. The big problem with bond funds today is not that there is some unexpected risk lurking in there, but that today's yields are abysmally low. Increasing interest rates are the solution to that problem.

Now lets consider future fund returns from the perspective of the chart that Kevin posted. Notice that the orange return line is a smoothed version of the blue 'predicted return' (SEC) yield line line. It does not follow the short term fluctuations of the SEC yield (noise), but acts like some sort of moving average. If rates in the next couple of years return to the 4-5% level, which might be considered normal if inflation stays low, that orange line is going to skate right over those anomalously low recent rates and return something like 3-4%, not 1.74%. If, on the other hand rates stay in the sub 2% range, then you are going to have a 2% 10 year return 10 years from now. So there is no question that we should want rates to rise, or that rising rates improve your returns.
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Re: Isn't it a good thing if bond prices fall?

Postby YDNAL » Fri Jul 19, 2013 6:30 am

joer1212 wrote:
ogd wrote:As for the bond bull market being over and heading down, remember that if bonds stayed at their all-time highs for a long time, instead of the recent drop / yield increase, you would have made peanuts in the long term. If they went even higher, then stayed there you would have made even less peanuts. Bonds are not like stocks. I would have been a happier bond investor if the yields stopped dropping and the prices stopped rising circa 2007. Yes we got ~40% returns on TBM since then with all the capital gains, but we would have got about the same and be sitting on a portfolio yielding 5.5% right now...

I don't remember where I read that long-term bond returns (as in TBM) are about 8% annualized, whereas long-term stock returns have averaged 10%. I distinctly remember thinking that these returns were so close in terms of percentages (even though a 2% return difference will be significant in the long run). Is this accurate? (emphasis added)

Historical "long term bond returns" are irrelevant to future "long term bond returns." Same with Equity returns.
  • Your best indication is SEC and YTM yields.
  • A bond fund is a rolling ladder of bonds with certain coupon and certain maturity - that's ALL.
  • Of course, this assume no defaults, etc. - see my previous post on Bond risk.
Can we get lucky and make some timing moves ?... certainly (I'll leave it there).

Back to OP, increased rates are good in the sense that returns - over duration (I must emphasize) - is yield driven. The past 30 years have also shown significant capital appreciation as yields eroded. The opposite is also true. This doesn't mean that people - especially retirees on fixed income - are not uncomfortable seeing NAVs in bond funds decrease - human nature!... it shouldn't mean squat if they invest to hold through duration.
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Re: Isn't it a good thing if bond prices fall?

Postby billyt » Fri Jul 19, 2013 6:57 am

Landy: For the most part I agree with what you say, but a few details are not quite right.

[quote]Your best indication is SEC and YTM yields and everyone I've read seems to be in concensus to anticipate, in the near-term, about 2% per year on the 10-year Treasury.[/quote]

The SEC and YTM predict the future long term (duration +) returns for a particular bond fund, not the future interest on the 10 year treasury.

The future of interest rates is unknown, the future return on bond funds over the duration is much better constrained.

If you want to try timing the fund returns, the chart that Kevin posted indicates that it doesn't much matter if you buy at a short term high or low SEC yield, it is the average yield over some time window (the duration?) that determines your return.
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Re: Isn't it a good thing if bond prices fall?

Postby billyt » Fri Jul 19, 2013 6:59 am

hmmm... it is clear that I don't know how to use the quote function. Is there a tutorial somewhere?

Thanks
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Re: Isn't it a good thing if bond prices fall?

Postby YDNAL » Fri Jul 19, 2013 7:05 am

billyt wrote:Landy: For the most part I agree with what you say, but a few details are not quite right.

Your best indication is SEC and YTM yieldsand everyone I've read seems to be in concensus to anticipate, in the near-term, about 2% per year on the 10-year Treasury.

The SEC and YTM predict the future long term (duration +) returns for a particular bond fund, not the future interest on the 10 year treasury.

I was in the processing to fix the first bullet when you posted because I thought it may be confusing. You guys are too fast to post even at 6:57 AM EDT. :beer

Anyways, the quote you show is a bullet to expand on the first sentence - take out the sentence, and that's when "details" may be misinterpreted.
Historical "long term bond returns" are irrelevant to future "long term bond returns." Same with Equity returns.
• Your best indication [referring to future "long term bond returns"] is SEC and YTM yields.
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Re: Isn't it a good thing if bond prices fall?

Postby billyt » Fri Jul 19, 2013 7:16 am

Thanks Landy, that is much clearer, and we are in agreement. I misinterpreted what you were trying to say.
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Re: Isn't it a good thing if bond prices fall?

Postby YDNAL » Fri Jul 19, 2013 7:31 am

billyt wrote:Thanks Landy, that is much clearer, and we are in agreement. I misinterpreted what you were trying to say.

No problem.. I knew that !

On this subject, perhaps it is only me, but more and more I find quotations get chopped-up to the point where the initial thought-process is actually out of the picture - creating the confusion or more confusion when something may not be totally clear. I opted a "bullet point" approach to post in an effort to make things as clear as possible to me (as I post) and to readers. That also can backfire when one particular bullet point is extracted from the overall message. Some posters are quicker to extract one point to highlight an unclear statement to "correct it," than they are quicker to post to provide input to an OP, for instance. I'm not talking about our discussion, just saw the opportunity to vent. :D :beer

LadyGeek does a good job monitoring and I recall seeing a few (very few) instances where she steps-in to discuss "surgical" quotes - as I like to refer to them - BUT we shouldn't expect a moderator to fix posters' posts (try saying that 3 times fast).
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Re: Isn't it a good thing if bond prices fall?

Postby blueridge » Fri Jul 19, 2013 8:05 am

billyt wrote:The title of the thread is: "Isn't it a good thing if bond prices fall?" [...] the answer to that question is a resounding yes.

Thank you for cutting through the noise. This is the most important point, especially for less experienced investors, to understand.
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Chiming in.

Postby Taylor Larimore » Fri Jul 19, 2013 2:50 pm

MitchC wrote:Sure would be great if Taylor L, Larry S. or Rick Ferri would chime in here :sharebeer

Hi Mitch:

I am not sure if there is much I can add except to remind everyone that bonds are primarily for safety, not high return.

Vanguard experts recently gave us their opinion about bonds which seems reasonable to me. I posted their interview here:

"Answers to your questions about bonds."

Best wishes.
Taylor
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Re: Isn't it a good thing if bond prices fall?

Postby rob777 » Fri Jul 19, 2013 3:04 pm

If you already own bonds, then no it's a bad thing, especially if long term bonds. On the other hand if you are sitting on cash or other liquidable assets than yes, it's great, you can make more on your money, however usually this also indicates inflation is setting in.
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Re: Isn't it a good thing if bond prices fall?

Postby joer1212 » Fri Jul 19, 2013 3:15 pm

Phineas J. Whoopee wrote:
joer1212 wrote:...
I don't remember where I read that long-term bond returns (as in TBM) are about 8% annualized, ...

[Emphasis added.]

Hi joer1212,

It's been interesting to read this thread that you started. I'm only responding to point out that Total Bond Market is not a long-term fund. It's intermediate term. Even if long-term bonds returned around 8% for some period it wouldn't have much to do with TBM.

PJW


Oh, yes, I know that TBM is intermediate (averaged out; in fact there are, both long and short term bonds in the fund). I meant the long-term returns of TBM, not the duration of TBM.
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Re: Isn't it a good thing if bond prices fall?

Postby joer1212 » Fri Jul 19, 2013 3:25 pm

MitchC wrote:Sure would be great if Taylor L, Larry S. or Rick Ferri would chime in here :sharebeer

In one of their books I read to only consider funds in your AA that AT LEAST earns inflation rate ( I think R. Ferri's Asset Allocation book ?). In my 401k I have Pimco Total Return and TBM... is either poised to earn over 3+% / year in the near term ? I dunno.. doesn't look like it. For now, my fixed income allocation stays in the Stable Value earning a no risk 2%. When things get sorted out, I'll add Pimco, TBM or both... but not right now.


This is exactly what I did in my portfolio last week. If and when the dust settles, I will overweigh my fixed income allocation back to TBM. Right now I am 20% stable value; 10% TMB. It used to be the opposite.
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Re: Isn't it a good thing if bond prices fall?

Postby joer1212 » Fri Jul 19, 2013 3:32 pm

billyt wrote:The title of the thread is: "Isn't it a good thing if bond prices fall?" As the chart that Kevin posted very clearly shows, the answer to that question is a resounding yes. The bond fund 10 year returns are a smoothed version of what the SEC yield predicted 10 years ago. Bonds are a sleepy, boring investment. When you buy a fund, you buy into a bond ladder whose future returns are pretty well known. NAV changes are a distraction. The returns of a bond fund are determined by interest rates. The have been a lot of posters on this board lately who are worried about the 'risks' in bond funds. Looking at the chart Kevin posted, I don't see any risks, unless you mean that future returns might be a percent or two different from the SEC yield on the day you purchased the fund. The big problem with bond funds today is not that there is some unexpected risk lurking in there, but that today's yields are abysmally low. Increasing interest rates are the solution to that problem


Very well said.
But I guess I should reframe my question this way: should I place most of the fixed income portion of my portfolio in stable value, wait for interest rates to rise over the next couple (?) of years, and then shift that money back into TBM, or should I just hold my TBM index fund as interest rates drop, and keep dollar-cost-averaging into it? Which option would win in, say, 5 years from now?
By the way, I chose the former. I shifted my fixed income allocation to 20% stable, and 10% TBM. It used to be the reverse.
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Re: Isn't it a good thing if bond prices fall?

Postby joer1212 » Fri Jul 19, 2013 3:36 pm

YDNAL wrote:The past 30 years have also shown significant capital appreciation as yields eroded. The opposite is also true. This doesn't mean that people - especially retirees on fixed income - are not uncomfortable seeing NAVs in bond funds decrease - human nature!... it shouldn't mean squat if they invest to hold through duration.


Excellent point.
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Re: Isn't it a good thing if bond prices fall?

Postby blueridge » Fri Jul 19, 2013 3:37 pm

joer1212 wrote:
billyt wrote:The title of the thread is: "Isn't it a good thing if bond prices fall?" As the chart that Kevin posted very clearly shows, the answer to that question is a resounding yes. The bond fund 10 year returns are a smoothed version of what the SEC yield predicted 10 years ago. Bonds are a sleepy, boring investment. When you buy a fund, you buy into a bond ladder whose future returns are pretty well known. NAV changes are a distraction. The returns of a bond fund are determined by interest rates. The have been a lot of posters on this board lately who are worried about the 'risks' in bond funds. Looking at the chart Kevin posted, I don't see any risks, unless you mean that future returns might be a percent or two different from the SEC yield on the day you purchased the fund. The big problem with bond funds today is not that there is some unexpected risk lurking in there, but that today's yields are abysmally low. Increasing interest rates are the solution to that problem


Very well said.
But I guess I should reframe my question this way: should I place most of the fixed income portion of my portfolio in stable value, wait for interest rates to rise over the next couple (?) of years, and then shift that money back into TBM, or should I just hold my TBM index fund as interest rates drop, and keep dollar-cost-averaging into it? Which option would win in, say, 5 years from now?
By the way, I chose the former. I shifted my fixed income allocation to 20% stable, and 10% TBM. It used to be the reverse.

If you time it right, then the market-timing strategy will win. If you don't, just holding TBM will win. Note though that neither will win by very much, since as Taylor reminded us, bonds are for safety.
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Re: Isn't it a good thing if bond prices fall?

Postby Kevin M » Fri Jul 19, 2013 3:40 pm

We've covered lots of ground in this thread. If we want to go back to the OP, well that was pretty much answered in the first reply. What we've been exploring since are the nuances, which the first reply mentioned it was ignoring.

Yes, it's good for novice investors to understand that falling bond prices and rising yields are good if one continues to buy bonds and/or reinvest dividends--eventually. That last word is important. We must be patient.

It's also important for novice investors not to think that future returns are likely to be like past returns, which clearly is one misunderstanding some have. Some of the posts here and in other bond threads show that some folks are just looking at historical returns of 5%/year or more, and expecting that going forward. This is not realistic. Don't listen to me and other anonymous posters, listen to the experts at Vanguard.

Here's another Vanguard paper that's worth reading: Vanguard - The challenges ahead for the bond market (Part 1)

Here's a quote from the article from Bill McNabb, Vanguard chairman and CEO:

The one thing we can be fairly confident about is that the next ten years of bond returns aren't going to be what the last ten years have been, when the broad bond market returned about 5% a year. It's almost mathematically impossible because yields currently are so low.

The current yield of a bond is one of the best predictors of its future returns. So, logically, with yields near historical lows, investors should have much more modest expectations for bond returns. I'm not saying to investors that they should abandon a sensible allocation to bonds. I'm just trying to help set realistic expectations.


He goes on to explain what we're all agreeing on here:

And if interest rates rise, we'll see a decline in bond prices, but over the long term, a rising-rate environment is not a bad thing for people who are in it for income. If you're reinvesting part of the dividend, you'll reinvest at a higher rate and that will compound over time.


Since many people are mislead by historical returns, the following quote also is important to understand. After discussing how bonds had a bad year in 1994 after rates spiked, Bob Auwaerter, head of the Vanguard Fixed Income Group said:

But it's also very important to look at these historical examples in context. A big difference between now and, say, 1994 is that yields are much lower than they were then. In the past, yields have helped offset declines in bond prices. But today we don't have that yield cushion. We are in a unique historical situation with bonds. I've worked in investment management since 1978, and I've never experienced yields this low. You have to go back to the 1950s to find yields at this level.


So, although the duration concept still applies, and after a period, after the last rate increase, equal to duration, we will start earning higher returns than if rates had not risen, we might have to be more patient to recover from losses than in the past.

I also think it's important for folks to understand the words above in bold. For a bond fund with a duration of five years, if rates were to increase tomorrow, you will not end up the same return in five years (as if rates had not increased) if rates increase again next year--you must restart your duration clock after the next rate increase. And that's just fine as long as we're patient. If rates increase for the next five years and then stay flat for the following five years, we will be better off in 11 years than if rates had not risen.

Of course I think (and I don't think you'll hear this from Vanguard) that those of us who are using fixed-income alternatives, such as non-brokered CDs and stable value funds, for a portion of our fixed income allocation are likely to be even better off as we gradually shift from assets that have not lost any value into higher yielding bond funds (or CDs or SV funds). Sorry, I couldn't resist squeezing that in. :wink:

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Re: Isn't it a good thing if bond prices fall?

Postby ogd » Fri Jul 19, 2013 3:45 pm

joer1212 wrote:
MitchC wrote:Sure would be great if Taylor L, Larry S. or Rick Ferri would chime in here :sharebeer

In one of their books I read to only consider funds in your AA that AT LEAST earns inflation rate ( I think R. Ferri's Asset Allocation book ?). In my 401k I have Pimco Total Return and TBM... is either poised to earn over 3+% / year in the near term ? I dunno.. doesn't look like it. For now, my fixed income allocation stays in the Stable Value earning a no risk 2%. When things get sorted out, I'll add Pimco, TBM or both... but not right now.


This is exactly what I did in my portfolio last week. If and when the dust settles, I will overweigh my fixed income allocation back to TBM. Right now I am 20% stable value; 10% TMB. It used to be the opposite.

Joer1212: stable value funds are usually a good deal so it's hard to argue against this particular move. Just don't let it become a habit: the market tends to make things expensive by the time "the dust settles".
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Re: Chiming in.

Postby MitchC » Fri Jul 19, 2013 4:28 pm

Taylor Larimore wrote:
MitchC wrote:Sure would be great if Taylor L, Larry S. or Rick Ferri would chime in here :sharebeer

Hi Mitch:

I am not sure if there is much I can add except to remind everyone that bonds are primarily for safety, not high return.

Vanguard experts recently gave us their opinion about bonds which seems reasonable to me. I posted their interview here:

"Answers to your questions about bonds."

Best wishes.
Taylor


Thanks for the reply Taylor ! Much appreciated.

Admitedly I'm a newbie investor trying to get my head around things. I totally understand the concept of diversification in the AA strategy. I guess I'm not understanding the 'safety' or 'ballast' aspect as you cite. By safety, are you referring to the fact that my FI portion of my AA (let's assume 50% FI), will not LOSE money as that 40-50% is diverted away from (not allocated to) falling equity markets ? If so, it seems to me I'd rather have it in my stable value fund earning less than inflation rather than earing nothing or perhaps losing ?

Problem is it's the 'it seems to me' thinking that is the hard part of a simple concept. Rebalancing is really counter-intuitive but I understand why it leads to higher over-all return. Just 'boggles' the brain to get rid of great performers to buy bad performers... but I guess we do it because the bad performers can be had CHEAP !.. then we train them to perform better (wait for the recovery).

Set me straight here please ? I really want to learn to use my 401k to my full advantage in the 10-15 years we have left to invest.

Thanks again !
Mitch
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Re: Isn't it a good thing if bond prices fall?

Postby joer1212 » Sat Jul 20, 2013 3:11 am

Here's another Vanguard paper that's worth reading: Vanguard - The challenges ahead for the bond market (Part 1)


Oops! I'm wondering now, did I make a bad move by suddenly overweighing stable value over TBM? Maybe I should have let it ride a while longer? Wish I had read this sooner.
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Re: Isn't it a good thing if bond prices fall?

Postby blueridge » Sat Jul 20, 2013 8:09 am

joer1212 wrote:
Here's another Vanguard paper that's worth reading: Vanguard - The challenges ahead for the bond market (Part 1)


Maybe I should have let it ride a while longer?

"let it ride"
"maybe I should have"

You're talking like a market timer. Believe me, you don't want to go there.

When it comes to investing, the best advice is - "Don't do something, just stand there!"
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Re: Isn't it a good thing if bond prices fall?

Postby Kevin M » Sat Jul 20, 2013 4:35 pm

joer1212 wrote:
Here's another Vanguard paper that's worth reading: Vanguard - The challenges ahead for the bond market (Part 1)


Oops! I'm wondering now, did I make a bad move by suddenly overweighing stable value over TBM? Maybe I should have let it ride a while longer? Wish I had read this sooner.

Joe, I don't know how you got that impression from the paper. It just emphasizes that one should expect low returns from bonds going forward, and not think that one will earn returns similar to those over the last 10 years or so (which was one of your misunderstandings).

I think you made a rational choice, and that it is most likely to work out well for you. You have access to a type of fixed-income investment that many of us don't. Vanguard doesn't offer us a stable value fund. Your SV fund provides a yield that is in the ballpark of TBM, perhaps higher, but with less risk. For those who say "bonds are for safety", it is an excellent choice. If it were me, I probably would have put 100% of my fixed income in the plan into the SV fund.

The message from Vanguard, which is consistent with most of what is being said here, is that although rising interest rates would result in temporary losses (and we've recently seen an example of that), eventually it will result in higher long-term returns. By using the SV fund, you can avoid the losses, and then gradually move back into TBM as the rates increase more and more above the SV fund (if that happens). I simply ignore those who deride this as market timing, since I'm confident that the trade off between expected return and risk makes this a rational decision.

Simply consider the following three basic scenarios.

  1. Interest rates remain flat. Your SV fund provides a higher return because the yield is higher.
  2. Interest rates increase signficantly. Your SV fund provides an even higher return as rate rise, since it does not experience the loss in NAV. You can establish a policy for shifting back into TBM gradually as rates increase. I would think of this as rebalancing, not market timing.
  3. Interest rates fall significantly (although they can't fall much further than 2 percentage points). This would result in an increase in NAV for TBM, providing even more "up front interest payments", further lowering the TBM yield and expected return. In this case, I would have a policy to shift even more into the SV fund. Remember, the closer rates get to 0%, the less upside potential from further declines in rates.
You have a great deal going. Be happy you have access to this choice that many of us don't! You made the decision, so just relax for awhile and don't second guess yourself.

In terms of policy, maybe set your "rebalancing" triggers at 0.5 percentage point increments. For example, if TBM SEC yield (or average YTM) increases to 0.5 pp above the SV yield move 25% of your SV fund into TBM. If TBM yield decreases by 0.5 pp below the SV fund yield, move 25% of your TBM into the SV fund. Assuming the SV yield remained relatively stable, this would put you all into the SV fund if TBM were to hit 0% yield, and all into TBM if yield were to get to 4%. This way, no matter what happens, one of the components in your fixed income portfolio is winning, helping smooth out your overall fixed income return.

Finally, remember that the risk of your fixed income, whether TBM or SV, is very small compared to the risk of your stocks. If you want to worry about something, worry about a 50% decline in the stock portion of your portfolio. That's not going to happen with your fixed income. This is one reason many here are simply content to stick with TBM or some other investment-grade bond fund, and not worry about tweaking their fixed income.

Kevin
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