Is Total Bond Market Performance Compromised By The Zero Int

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Is Total Bond Market Performance Compromised By The Zero Int

Postby BHChinook » Tue Jul 16, 2013 9:53 am

... or the title, "It Time For More Managed Funds"?

It seems like only a few years (but it's been over a decade) since Bill Bernstein's book, "The Intelligent Asset Allocator" came out and convinced many of us to convert from actively managed funds to index funds. Gone were the days of latching onto a fund manager who seemingly could do no wrong only to find he (or she) was falling from grace a year later. Gone were the days of high costs and constantly monitoring how accounts were doing. It was just buy and hold and sleep at night…

I still believe the basic principles so brilliantly described by BB, Vanguard and many others are sound. But… my concern is with funds like Target Retirement (VTINX), that hold a version of Total Bond Market, because of the presence of the zero interest floor.

In the ideal investment universe, interest rates can go up and down. They tend to move in cycles much like a sine curve. Over time, bond values in this environment go up and down but always equalize in a positive way. But when the interest rate cycle moves to the zero line, the normal sine curve motion becomes constrained; it comes down, hits zero, and can only go up. OK, it can go up a bit and then go back down but it still has than zero floor to constrain it.

So it makes sense, at times like this, to shorten bond durations. But an index fund like TBM (or TBM-II) can not do this; only a managed fund can do this. And funds like VTINX, that are based on TBM, are constrained by association.

Is it time to apportion some percentage of one's assets to managed funds now? Wellesley has a similar equity/bond ratio to Target Retirement but Wellesley is managed. Would it be wise to have some spilt between VTINX/Wellesley like, say, 60/40?

Please note I am not interested in going back in time to when I was "slicing and dicing" between a large number of funds. My goal, as much as possible, is to "keep it simple". Thanks
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby FNK » Tue Jul 16, 2013 10:08 am

BHChinook wrote:OK, it can go up a bit and then go back down but it still has than zero floor to constrain it.

So you get a clipped wave... so what?

If you are concerned about interest rate risk, you can buy a short-term index fund yourself. No need to hire a manager to do that for you.

The problem is that it's still market timing. Rates have been guaranteed to go up real soon for years now. People who chickened out missed out on a lot of interest in these years.

It's better to realize this:
- in a balanced portfolio something is always doing better than something else
- rates going up will probably follow stocks going up
- eventually, rates going up will pay you back.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby BHChinook » Tue Jul 16, 2013 10:14 am

- eventually, rates going up will pay you back.


I agree with this. My point was to question whether the zero interest floor has an impact on the "pay back relationship".

If you are concerned about interest rate risk, you can buy a short-term index fund yourself. No need to hire a manager to do that for you.


or I can move a percentage of assets to Wellesley, a lot cost managed fund. The question is, what is a reasonable distribution between say, VTINX and Wellesley?
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby thx1138 » Tue Jul 16, 2013 10:16 am

The zero interest floor only exists in nominal returns, in real returns there is no zero interest floor. However, there is the Fed and what it thinks of things and as they control monetary policy it is worth considering they have a target inflation number, which means all things are not equal in interest rates - either at zero or the high end.

Given the wide variety of bond index funds with selectable duration I fail to see the advantage of the high costs of a managed fund compared to moving from TBM to another or perhaps a split of two bond index funds. Yeah you might like "simple" but how is trying to find and evaluate (truthfully, blindly guess) a managed fund that does what you want simpler than doing what you want with two index funds? How on earth would you know that your chosen managed fund isn't going to suffer style drift and end up not doing what you assumed it was going to do in the first place?
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby FNK » Tue Jul 16, 2013 11:04 am

Chinook,

You do realize that the bonds in Wellesley have longer average duration than Total Bond Market, right?

What kind of magic are you expecting from Wellesley's manager?
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby BHChinook » Tue Jul 16, 2013 11:24 am

You do realize that the bonds in Wellesley have longer average duration than Total Bond Market, right?


Right, but they're pretty close. Big difference, of course, is Wellesley is investment grade corporate whilst TBM is everything.

What kind of magic are you expecting from Wellesley's manager?


No magic; must the ability to be more nimble if interest rate conditions warrant.

The zero interest floor only exists in nominal returns, in real returns there is no zero interest floor.


Hmmm, this may be true but surely the effect of a "clipped" function must have some effect somewhere???
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby FNK » Tue Jul 16, 2013 11:32 am

No magic; must the ability to be more nimble if interest rate conditions warrant.

Hm... to be effective, that would require predicting the market, no?
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby G-Money » Tue Jul 16, 2013 11:36 am

BHChinook wrote:In the ideal investment universe, interest rates can go up and down.

They can now. Rate on the 7-year Treasury (average maturity of TBM) is right around 2%. Plenty of room to move up or down.

BHChinook wrote:They tend to move in cycles much like a sine curve.

I'll take your word for it. Remember, though, the human mind likes to find patterns where none exist.

BHChinook wrote:Over time, bond values in this environment go up and down but always equalize in a positive way.

I have no idea what this means. I agree with the general proposition that bonds have a positive expected return (at least nominally), if that's what you're saying.

BHChinook wrote:But when the interest rate cycle moves to the zero line, the normal sine curve motion becomes constrained; it comes down, hits zero, and can only go up. OK, it can go up a bit and then go back down but it still has than zero floor to constrain it.

I'm not sure this is true. Data to support this? Didn't T Bills go negative sometime in 2008 or 2009? Institutional investors can't literally put billions of dollars under a mattress, so they might be forced to accept sub-zero interest rates.

In any event, we're not there. Yields across the maturity spectrum are positive, so even if 0.000% is the lower bound, rates could still go lower. And, more importantly, the yield curve could certainly get flatter.

BHChinook wrote:So it makes sense, at times like this, to shorten bond durations.

No it doesn't. First, rates aren't actually at 0.000%, and the yield curve could still get much flatter, and that's assuming that 0.000% is actually the lower bound to where interest rates can go. Second, shortening durations now is a coin flip: maybe you'll time it right, and maybe you won't. Going short now is essentially a bet that rates will rise soon. Otherwise, you would benefit from the term premium (longer maturities are paying higher rates). If we're stuck at current interest rates for 20 years--which certainly could happen--you will have been better off in intermediate (or long) term bond funds, rather than short. The point is, you just don't know.

BHChinook wrote:But an index fund like TBM (or TBM-II) can not do this; only a managed fund can do this.

If you want to try to time the market and use a shorter-term bond fund, just buy a short-term bond fund. Vanguard has them. Fidelity has them. Just about every fund company has them. No active management required.

BHChinook wrote:And funds like VTINX, that are based on TBM, are constrained by association.

This is obvious. When you buy a fund-of-funds, your holdings are always constrained by whatever the fund-of-funds holds. Given that TBM tracks virtually the entire US bond market (except for TIPS, T Bills, munis and some others), that doesn't sound like a a bad fund to be "constrained" with.

BHChinook wrote:Is it time to apportion some percentage of one's assets to managed funds now?

No.

BHChinook wrote:Wellesley has a similar equity/bond ratio to Target Retirement but Wellesley is managed.

Only kinda. Target Retirement Income is 30/70 stocks/bonds. Wellesley is 40/60. Wellesley also holds longer-term corporate bonds, which seems to run against the premise you've been setting up in this thread. Those differences explain Wellesley's relative outperformance over the last 1-, 3-, and 5-years, which I'm sure has nothing to do with your proposal.

BHChinook wrote:Would it be wise to have some spilt between VTINX/Wellesley like, say, 60/40?

Since you haven't given a compelling reason to make this change, I'd say it would not be wise for you.
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Excellent post!

Postby Taylor Larimore » Tue Jul 16, 2013 11:56 am

G-Money:

I admire your excellent replies to the points raised by BHChinook .

Thank you and best wishes.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby BHChinook » Tue Jul 16, 2013 12:07 pm

I echo Taylor's "Thanks" to G-Money and all the other responders. As usual, the Bogleheaders have greatly helped!
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Ryan_in_Chi » Tue Jul 16, 2013 2:52 pm

If TBM were somehow allowed to morph into a short term bond fund, and all those Target funds that use TBM now had a short term bond fund instead of an intermediate, what do you think this would do to the bond market? Same with all the other intermediate index bond funds. ie, if there were no buyers for intermediate bonds?
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby tadamsmar » Tue Jul 16, 2013 3:13 pm

BHChinook wrote:I still believe the basic principles so brilliantly described by BB, Vanguard and many others are sound. But… my concern is with funds like Target Retirement (VTINX), that hold a version of Total Bond Market, because of the presence of the zero interest floor.


Interest can drop by half, drop by half, drop by half again, so on, to infinity. Seems that the important math of interest rates works like this, in relation to the log transform. So I am not so impressed as you by the notion that they have zero as a floor. The log has no floor.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby G-Money » Tue Jul 16, 2013 3:14 pm

Ryan_in_Chi wrote:If TBM were somehow allowed to morph into a short term bond fund

That could only happen if the entire bond market had a fundamental change. Essentially, it would require the Treasury department, federal agencies, corporations to stop issuing new long-term debt. I don't think this is likely.

TBM is an index fund, and it has rules governing which securities it is allowed to buy. The long and short of it is that TBM must buy the bonds in the underlying index (the Barclays Aggregate), and the fund's entire purpose is to mirror the essential characteristics of the underlying index (average maturity, duration, credit quality, bond type, yield, etc.).

Ryan_in_Chi wrote:and all those Target funds that use TBM now had a short term bond fund instead of an intermediate, what do you think this would do to the bond market?

You have it backwards. TBM doesn't do anything to the bond market. The bond market does things to TBM. TBM just tracks the market. So the bond market would be the dog wagging the TBM tail.

Ryan_in_Chi wrote:Same with all the other intermediate index bond funds.

Same as above.

Ryan_in_Chi wrote:ie, if there were no buyers for intermediate bonds?

For every seller, there is a buyer. Bonds are created at issuance. They can increase or decrease in value before maturity, but they can't disappear (barring default). Someone must hold them until maturity.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby FNK » Tue Jul 16, 2013 3:57 pm

tadamsmar wrote:Interest can drop by half, drop by half, drop by half again, so on, to infinity. Seems that the important math of interest rates works like this, in relation to the log transform. So I am not so impressed as you by the notion that they have zero as a floor. The log has no floor.

I think the relationship between yield and price is linear, not logarithmic, so this observation is not very relevant. The observation that the price can go above zero yield is relevant though.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Kevin M » Tue Jul 16, 2013 4:30 pm

OP, I agree with your premise, but not with your conclusion.

The way I state it is that interest-rate risk is asymmetrical, and the closer rates get to 0%, the more asymmetrical it is. No, intermediate-term rates are not 0% now, so there is still some potential upside in taking interest-rate risk from rates decreasing, but there is much more downside risk from rates increasing.

However, my conclusion is not to use actively managed bond funds, but instead to favor non-brokered CDs with favorable early withdrawal terms, which can provide a higher yield compared to a bond (or a bond fund) with comparable credit risk (treasuries, up to about 5-year maturities anyway) or a yield that is comparable to a bond fund with more credit risk (like TBM, for example), and in both cases with much less interest-rate risk (limited to the early withdrawal penalty, which would be about 1% for the CD I bought most recently).

As I've stated in other threads, one can construct a TBM-like portfolio, but with higher yield and lower risk, by replacing the treasury/agency/MBS portion (about 70%) with good non-brokered CDs, and use intermediate-term investment-grade and/or muni bond funds to get comparable risk/expected-return for the other 30%. This is a very rough approximation of course, but it's good enough for me.

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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Ryan_in_Chi » Tue Jul 16, 2013 7:24 pm

G-Money wrote:
Ryan_in_Chi wrote:If TBM were somehow allowed to morph into a short term bond fund

That could only happen if the entire bond market had a fundamental change. Essentially, it would require the Treasury department, federal agencies, corporations to stop issuing new long-term debt. I don't think this is likely.

TBM is an index fund, and it has rules governing which securities it is allowed to buy. The long and short of it is that TBM must buy the bonds in the underlying index (the Barclays Aggregate), and the fund's entire purpose is to mirror the essential characteristics of the underlying index (average maturity, duration, credit quality, bond type, yield, etc.).
....


Yes, yes yes. I agree with your whole post. The OP was opining that TBM is at a disadvantage to managed funds because it isn't allowed to shorten it's duration. I am posing the question, that say TBM was a managed fund - a very very very big managed fund. What do you suppose would happen to the market if TBM managers decided as the OP suggested that now is the time to shorten the funds duration and acted by dumping most of it's intermediate duration bonds. And, lets says that all the other index bond funds somehow gained this magical ability also to shorten their duration.

As you said, every seller needs a buyer. I believe the bond market is extremely efficient. If everyone shifts strategies, prices will shift and equalizes things. In a few years, I personally don't think switching to a short term will make a significant difference.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby dumbmoney » Tue Jul 16, 2013 7:41 pm

I disagree with the premise that a lower bound on rates automatically makes bonds a bad deal. They are only a bad deal if expected to return less than cash.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Kevin M » Tue Jul 16, 2013 9:14 pm

dumbmoney wrote:I disagree with the premise that a lower bound on rates automatically makes bonds a bad deal. They are only a bad deal if expected to return less than cash.

That assumes bonds and cash are the only fixed income alternatives, which is not the case (although I wouldn't use the term "bad deal"); did you read my post above?

But let's just stick with bonds. A retail investor can get a higher return on cash (say about 1%) than on a 3-year treasury (about 0.64% as of today), or a short-term treasury bond fund (SEC yield = 0.37%). Even the SEC yield for the short-term bond index fund is only 0.82% as of today. So a retail investor actually can get a higher expected return on cash with less risk (you need to look at risk too--not just expected return).

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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Epsilon Delta » Wed Jul 17, 2013 12:18 pm

Kevin M wrote:But let's just stick with bonds. A retail investor can get a higher return on cash (say about 1%) than on a 3-year treasury (about 0.64% as of today), or a short-term treasury bond fund (SEC yield = 0.37%). Even the SEC yield for the short-term bond index fund is only 0.82% as of today. So a retail investor actually can get a higher expected return on cash with less risk (you need to look at risk too--not just expected return).

Kevin

The risk with cash is that the interest rate could go to zero next month and stay there. So by going from 3-year to cash you are trading one risk for another. Deciding which of these risks the investor wants to take is a matter of opinion, preference and circumstances. The risks are different and there is no universal framework to say which is smaller, just as there is no universal frame work to say how much risk should be traded for a particular expected return.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Phineas J. Whoopee » Wed Jul 17, 2013 1:17 pm

BHChinook wrote:...
because of the presence of the zero interest floor.
...

Hi BHChinook,

I realize I'm adding my voice to others, but I'd like to (wait for it .......) add my voice to others.

By no means is zero the floor for even nominal interest rates. T-bills briefly traded above par in 2009. Bank of New York / Mellon charges large corporate customers a percentage-based fee for deposits over a few tens of millions. Denmark treasuries had a negative interest rate recently, set by auction. The European Central Bank has threatened negative interest rates on banks' reserves if they don't start lending more. The Federal Reserve System has spoken of modifying its auction procedures to allow for negative interest rate bids from the primary dealers.

Not only do I agree it is possible (I make no statement regarding likelihood) for interest rates to drop further; but there is no physical bar to them becoming negative. An individual might be able to get stacks of $100 bills (the largest current denomination) from the bank teller, but who can store anything so valuable without cost? Large corporations which need to make payroll every couple of weeks certainly can't.

There is no lower interest rate bound, other than -100%, or close enough to it that a lot of people decide to take their chances.

How did bondholders do after the October Revolution (which took place in November)?

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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Kevin M » Wed Jul 17, 2013 1:23 pm

Epsilon Delta wrote:The risk with cash is that the interest rate could go to zero next month and stay there. So by going from 3-year to cash you are trading one risk for another.

True, but again, the retail investor has alternatives, which is my main point. For example, to get a higher yield and hedge against interest-rate declines, yet retain immediate access to your money, you can earn 0.85% on an Ally 11-month no-penalty CD. You can also earn about 1% on a 1-year CD, or even more with an Ally 1.5% CD if you do an early withdrawal after one year (earn about 1.25%).

Looking at 3-years, you can get a 3-year CD earning about 1.5%, vs. the 0.6x% for a 3-year treasury and the less than 1% SEC yield for the short-term bond funds I mentioned.

So, CDs and savings accounts give the retail investor alternatives, other than bonds, to use in constructing the fixed income portion of their portfolio to provide, IMO, a superior blend of risk and return. Bonds can be part of that as well, as they are for me.

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Re: Is Total Bond Market Performance Compromised By The Zero

Postby BHChinook » Wed Jul 17, 2013 1:42 pm

Hi PJW... thanks for adding your voice...

True, but again, the retail investor has alternatives, which is my main point. For example, to get a higher yield and hedge against interest-rate declines, yet retain immediate access to your money, you can earn 0.85% on an Ally 11-month no-penalty CD. You can also earn about 1% on a 1-year CD, or even more with an Ally 1.5% CD if you do an early withdrawal after one year (earn about 1.25%).

Looking at 3-years, you can get a 3-year CD earning about 1.5%, vs. the 0.6x% for a 3-year treasury and the less than 1% SEC yield for the short-term bond funds I mentioned.

So, CDs and savings accounts give the retail investor alternatives, other than bonds, to use in constructing the fixed income portion of their portfolio to provide, IMO, a superior blend of risk and return. Bonds can be part of that as well, as they are for me.


Kevin,

Can you point me to a study that compares past returns from your type fixed-income ladder with the fixed income parts of VTINX? What you describe may make all kinds of sense but the effort required can be daunting to someone who likes to keep things simple. Just putting assets into VTINX (which has the equity ratio I'm comfortable with) has served me well for several years and I'm hesitant to change; especially after getting the other advice in this thread. In other words, is there really enough in it to justify the added effort?
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Kevin M » Wed Jul 17, 2013 1:50 pm

Phineas J. Whoopee wrote:By no means is zero the floor for even nominal interest rates.

Granted, there have been examples of nominal interest rates going slightly negative. Here's a paper from the St Louis FRB that discusses it: How Low Can You Go? Negative Interest Rates and Investors’ Flight to Safety

Nevertheless, I think 0% is a practical nominal interest-rate lower limit for retail investors. Despite the examples cited, I personally have never accepted less than 0% yield on fixed-income investments, and other than money market funds, which may the the only option in a 401k or in an IRA, I don't recall having had to accept less than about 1% (I might accept a bit less for convenience and out of laziness, but not much less). Even an Ally checking account earns 0.4% (0.75% if > $15K), and my reward checking account earns much more than that.

I just calculated that $1M in $100 dollar bills is about 22 pounds, which I could store in a safe deposit box for about $100/year. OK, a little negative, but pretty close to 0%. I'm sure you can come up with a scenario that would poke holes in anything I come up with--there's always Armageddon, but my investment policy doesn't account for that.

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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Phineas J. Whoopee » Wed Jul 17, 2013 1:57 pm

Kevin M wrote:...
there's always Armageddon, but my investment policy doesn't account for that.
...

Nor should it.

I was responding to a claim that interest rates can't go below zero; and I specifically disclaimed any predictions.

PJW

P.S. Thanks for the posts about nonbrokered CDs. I have more in them now (and am doing better now) than I would have hadn't you posted. PJW
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby billyt » Wed Jul 17, 2013 2:00 pm

In June of 2010, Ally Bank 5 year CDs were available for 2.99% and Vanguard Total Bond Market had an SEC yield of 2.96%. Through June 2013, TBM has returned 3.40%. No real difference, and this comparison could have easily gone the other way, depending on starting and ending points. On the other hand, a 5 year ladder of Ally CDs purchased in 2010 would have earned more like 1.5% annual through today.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Kevin M » Wed Jul 17, 2013 2:16 pm

BHChinook wrote:Kevin,

Can you point me to a study that compares past returns from your type fixed-income ladder with the fixed income parts of VTINX? What you describe may make all kinds of sense but the effort required can be daunting to someone who likes to keep things simple. Just putting assets into VTINX (which has the equity ratio I'm comfortable with) has served me well for several years and I'm hesitant to change; especially after getting the other advice in this thread. In other words, is there really enough in it to justify the added effort?

First, simplicity may be an overriding factor for you, and if so, I won't try to talk you out of VTINX. I think the Target Retirement and LifeStrategy funds are great for folks who want to keep things simple, although I personally wouldn't use VTINX or any of the funds that have a high allocation to fixed income.

No, I can't point you to any studies, and I'd be wary of them anyway, since you have to compare the conditions during the time period covered by any study to the present conditions. For example, bonds will have done better over any period of declining interest rates, which is what we've had for most of the last 30 years. Those results cannot be duplicated starting at rates of 2%.

Just consider that Ken Volpert, head of the fixed income group at Vanguard, says that YTM (roughly the SEC yield for a bond fund) represents the annualized return one should expect over the next 10 years; this isn't guaranteed, but historically it has worked out pretty much that way:
Ken Volpert on the current bond landscape

So, as long as you're comfortable with the roughly 2% nominal the fixed income portion of VTINX (70% fixed income) is likely to return over the next 10 years, you're fine.

Interestingly, my AA is the same as VTINX at the top level: 30/70 stocks/fixed-income. I just happen to believe that by using CDs for 2/3 of my fixed income and intermediate-term investment-grade and muni bond funds for the other 1/3, my expected return is higher and my risk is lower. Reasonable minds may differ.

The complexity of implementing something like what I have depends on the size of your portfolio, the split between tax-advantaged and taxable accounts, and other factors specific to you. This determines, for example, whether you could get by with one CD at one institution or would need to use multiple CDs at multiple institutions to stay within federal insurance limits. Since you are using VTINX, I assume you don't need to consider whether or not to consider tax-exempt funds vs. taxable bond funds.

I personally have multiple CDs at multiple institutions and a variety of bond funds, but it doesn't seem that complicated to me. I am not a typical Boglehead, and do not worship the "majesty of simplicity" (although I understand the appeal).

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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Electron » Wed Jul 17, 2013 2:19 pm

Attached is a chart showing the NAV and SEC yield for the Vanguard Total Bond Market Index fund going back to 1993. One can see the rise in NAV since 2008 as a result of cuts in the Federal Funds rate and Quantitative Easing. One would hope that the NAV would remain in the range shown on the chart if rates head back up to earlier levels.

A lot can be learned from the chart by looking at specific periods such as 1994.

The SEC yield had a short but significant dip in the summer of 2003. Does anyone recall what was going on in the bond market at that time? Data is from the Vanguard site using the Price History Search tool.

Here is another interesting question. I wonder if NAV would revert to the previous trading range after Quantitative Easing ends. If so, one might benefit by shortening duration until that time. After the end of QE, increases in the Federal Funds rate would also impact the bond market.

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Re: Is Total Bond Market Performance Compromised By The Zero

Postby billyt » Wed Jul 17, 2013 2:23 pm

Kevin, I think there is nothing wrong with your approach, but the thing that you are missing is that most of the time CD rates are significantly below comparable Treasuries. The present situation is an anomaly, which it is reasonable to take advantage of, if you are so inclined. However, it is doubtful that this can be a long term investing approach.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby billyt » Wed Jul 17, 2013 2:27 pm

Electron: Could you post the TMB rolling returns for the same period. That is what is really relevant to the discussion.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Phineas J. Whoopee » Wed Jul 17, 2013 2:30 pm

Vanguard [reference to a fastener in the past tense]-up TBM in the early 2000s, because everybody knew the index was bad and anyone with half a brain could do better.

[Please forgive the anachronism] NOT!

I think the answer to the scared-about-the-bond-market dilemma is answered by: are you a short- (1 - 3 years); intermediate- (4 - 10 years); or long-term (10 years+) investor?

If the first, TBM is the wrong vehicle. If the second, it's appropriate. If the third, what are you doing in bonds?

For many investors a combination of maturities plus a healthy dollop of stocks is the answer. Notice I didn't say the best answer, because best is unknowable.

Even for retirement-oriented investors, unless their plan is to sell everything the day they get their gold watch and buy an SPIA, time horizons are often much greater than 10 years.

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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Kevin M » Wed Jul 17, 2013 2:31 pm

billyt wrote:In June of 2010, Ally Bank 5 year CDs were available for 2.99% and Vanguard Total Bond Market had an SEC yield of 2.96%. Through June 2013, TBM has returned 3.40%. No real difference, and this comparison could have easily gone the other way, depending on starting and ending points. On the other hand, a 5 year ladder of Ally CDs purchased in 2010 would have earned more like 1.5% annual through today.

I like to remember Larry Swedroe's caution not to confuse strategy with outcome. It's easy to develop strategies that look better or worse in the past. This post by forum member tfb may be of interest: CD vs Bond Fund: A Case Study.

We both own CDs and bond funds; I just happen to own more of the former and less of the latter than you. I haven't sold any of my bond funds or bought any CDs since interest rates bottomed, and I don't plan to do so unless rates drop a fair amount below the lows. No matter what happens with rates, I have something to feel good about.

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Re: Is Total Bond Market Performance Compromised By The Zero

Postby billyt » Wed Jul 17, 2013 2:34 pm

OK, I just looked up the rolling returns on Morningstar. For the period covered by Electrons charts the 2 year returns ranged from about 3% to 10%. A few extremes lower and higher. So even if you held the fund for just 2 years over this period, you did OK. No negative returns.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby billyt » Wed Jul 17, 2013 2:36 pm

Kevin: The basic strategy of using something like TBM for fixed income is certainly not based on outcome. Your strategy appears to be based on market timing.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Phineas J. Whoopee » Wed Jul 17, 2013 2:37 pm

billyt wrote:OK, I just looked up the rolling returns on Morningstar. For the period covered by Electrons charts the 2 year returns ranged from about 3% to 10%. A few extremes lower and higher. So even if you held the fund for just 2 years over this period, you did OK. No negative returns.

May I borrow the keys to your time machine so I can invest two years ago?
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby billyt » Wed Jul 17, 2013 2:44 pm

Exactly my point. You should have been invested 2 years ago, 5 years ago, 10 years ago. You should be invested today. You are certainly not going to lose your shirt by switching to CD's, but the strategic reasons for allocating a chunk of your portfolio to an intermediate bond fund are clear and compelling, as you just pointed out.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby billyt » Wed Jul 17, 2013 2:47 pm

Looking back at Electrons NAV chart, it is important to recall that there are capital gains distributions that prevent the NAV from growing too much. I suspect that if you add those distribution of capital gains (not interest) back in, the chart might look quite different.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Kevin M » Wed Jul 17, 2013 2:49 pm

billyt wrote:Kevin, I think there is nothing wrong with your approach, but the thing that you are missing is that most of the time CD rates are significantly below comparable Treasuries. The present situation is an anomaly, which it is reasonable to take advantage of, if you are so inclined. However, it is doubtful that this can be a long term investing approach.

Hmmm, I recall seeing a Wiki article that indicated otherwise, but I don't really care, since what I've been doing is based on the situation at the time. It doesn't seem that long ago when I was earning 5% in money market accounts, and was quite happy to hold large amounts in them, but I certainly am not doing that today at close to 0%.

I didn't even start buying non-brokered CDs until late 2010, when as I recall I learned about the approach from Allan Roth's blog.

I fully intend to start shifting some fixed income back into bond funds if/when interest rates increase enough (and my fund values drop enough). I was eyeing my Long-Term Investment-Grade bond fund earlier this month as SEC yield was approaching 5%, but things have turned around since then. I seem to be anchored on 5% yields. :wink:

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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Epsilon Delta » Wed Jul 17, 2013 2:57 pm

billyt wrote:In June of 2010, Ally Bank 5 year CDs were available for 2.99% and Vanguard Total Bond Market had an SEC yield of 2.96%. Through June 2013, TBM has returned 3.40%. No real difference, and this comparison could have easily gone the other way, depending on starting and ending points. On the other hand, a 5 year ladder of Ally CDs purchased in 2010 would have earned more like 1.5% annual through today.

A five year ladder has a duration of about 2.5 years compared to TBM 5.5 years. Given the steepness in the yield curve you have to be careful when comparing these two investments.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Kevin M » Wed Jul 17, 2013 2:58 pm

billyt wrote:Kevin: The basic strategy of using something like TBM for fixed income is certainly not based on outcome. Your strategy appears to be based on market timing.

I was just referring to your use of past results in comparing bond funds and CDs, and as the tfb blog post points out, we're not done yet.

You can call it market timing if you want. I don't give it a name, other than maybe optimizing my perception of expected return and risk (but that's not as catchy as "market timing"). Sometimes I think of it as rebalancing between bonds and CDs. As I've watched the value of my bond funds go up, I view that as prepaid interest, and I'd rather take some of that off the table rather than risk giving it all back, so I move some from bond funds to CDs. Doesn't seem that different to me than rebalancing between stocks and bonds.

I think of market timing more as moves based on a belief about what will happen in the future. Instead, I try to consider possibilities and probabilities about what might happen in the future, and adjust my risk accordingly. Maybe it won't turn out to do as well as just sticking with TBM (which I've never owned anyway), but I sleep well at night.

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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Kevin M » Wed Jul 17, 2013 3:16 pm

billyt wrote:Exactly my point. You should have been invested 2 years ago, 5 years ago, 10 years ago. You should be invested today. You are certainly not going to lose your shirt by switching to CD's, but the strategic reasons for allocating a chunk of your portfolio to an intermediate bond fund are clear and compelling, as you just pointed out.

Well, although I disagree that past results are a good reason to invest in something today, I do agree there are reasons to allocate a chunk of fixed income to intermediate-term bond funds. Specifically, rates can go lower, they could stay low for a long time, and by taking some credit risk, as well as interest-rate risk, I can actually earn higher yields. But, it depends on the fund (type of bonds).

  • SEC yield of VG Int-Term Treasury is only 1.39%; I can earn 2% on a 5-year CD with essentially same credit risk and much less interest-rate risk, so no thanks.
  • SEC yield of CA Int-Term Tax-Exempt is 2.43%. Hmm, since I'm in CA, it looks interesting. I continue to own some in taxable.
  • SEC yield of Int-Term Tax-Exempt is 2.40%. Hmm, not as good as the CA fund, but since I don't want to put too many eggs in the CA basket, I continue to own some in taxable.
  • SEC yield of Int-Term Inv-Grade is 2.9%. OK, I'll continue to own a bit of that too, in my tax-advantaged account.
  • SEC yield of TBM is 2%, but 70% of that is treasury/agency/MBS, which I can beat with CDs, and the other 30% I essentially get with other bond funds with higher yields, so no thanks.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby billyt » Wed Jul 17, 2013 3:27 pm

I agree that one should compare based on yields, and select based on individual taste for risk/return. Any differences between bond/CD outcomes due to future rate changes are likely to be small in the context of larger portfolio.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby rj49 » Wed Jul 17, 2013 4:00 pm

Those who follow Bill Bernstein will have been aware of his warnings against stretching for yield, and his recommendation to stay short, even with T-Bills, to avoid pain from interest rate rises. A lot of the recent bond panic is from people who didn't follow his advice.

Wellesley will never follow such a path, because they are an income fund that people are drawn to by a high yield, which requires going out in duration and emphasizing corporate bonds. So even if they have managerial expertise, they're hemmed in by the nature of their fund and the lust for yield from its investors. Besides, managed funds can make bad moves as well as timely ones, such as Bill Gross's retreat from Treasuries just as they were about to take off, and most bond managers looked like stars in a 30-year bull market, just as many amateurs felt like expert stock market pickers and sophisticated day traders in the late 1990s.

There are good arguments for staying with VTINX, particularly in a retirement account with reinvested dividends. It's also a good way to get a generous TIPS coverage and some inflation protection. Personally, I'd be against any balanced fund now for the distribution phase of retirement, since coupling bonds and stocks limits your withdrawal flexibility, as well as all the arguments about tax efficiency and fund placement. Separating stocks and bonds also gives you the option to add other fixed income options, such as ibonds and CDs, as well as to ladder bond funds (short-term for near-term needs, etc.). Even mimicking the VTINX allocation would give me more comfort, since I could withdraw from which fund is up and avoid reverse dollar-cost-averaging.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby Electron » Wed Jul 17, 2013 4:26 pm

billyt wrote:Looking back at Electrons NAV chart, it is important to recall that there are capital gains distributions that prevent the NAV from growing too much. I suspect that if you add those distribution of capital gains (not interest) back in, the chart might look quite different.

I was just about to point out that capital gain distributions were not reflected in the chart. However, it appears that capital gains were not distributed in most years. There were several capital gain distributions in recent years but they were relatively small.

After doing a web search, it appears that there was a deflation scare in 2003 which is the likely cause of the spike down in SEC yield shown in the chart. The 10 year Treasury dropped from roughly 4% to 3% in the first half of 2003. Comments from the Federal Reserve apparently added to the concern. Regardless, it's surprising to see the SEC yield drop that much. Perhaps other factors were involved.
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Re: Is Total Bond Market Performance Compromised By The Zero

Postby BHChinook » Wed Jul 17, 2013 4:58 pm

There are good arguments for staying with VTINX, particularly in a retirement account with reinvested dividends. It's also a good way to get a generous TIPS coverage and some inflation protection. Personally, I'd be against any balanced fund now for the distribution phase of retirement, since coupling bonds and stocks limits your withdrawal flexibility, as well as all the arguments about tax efficiency and fund placement.


I can see the arguments here but I'm still a fan of VTINX for its simplicity. I'm 70, retired, and just started taking RMDs. I did some Roth conversions between age 65 and 70 to get to a roughly 1/3 Roth and 2/2 TIRA (circa $0.5M and $1.0M). In my early investment life, I was engrossed with slicing and dicing and had lots of different funds. Now, I just don't want to fool with it. My desired AA (where I sleep nicely) is 30/70 and VTINX matches that to perfection. I have VTINX in Roth, TIRA and even some in a modest $200k non-qualified account. I do have some Wellesley and Wellington (roughly 14%) and the thought of increasing that percentage is what prompted this thread. In keeping with my motto ("It's always easier to do nothing than to do something"), I'll probably make no changes...
It's always easier to do nothing than to do something.
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