More Bond Questions?

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Topic Author
Funkey
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Joined: Tue Aug 12, 2014 8:58 am

More Bond Questions?

Post by Funkey »

Ok. If I buy the Total Bond market index fund. It contains Longer Term Bonds and Short Term bonds. The total of this is an intermediate term bond fund?

If view of the Government saying that interest rates are going to rise in the future. Is it wise to hold Short Term Government Bond funds as well as the Total Bond Market fund. To cover the interest rate increase risk? Or does holding the Total Bond Market fund which includes STB's. Cover the risk?

If STB's are needed what percentage of my bond funds should be STB's?

If I understand from my reading. TBM value may decrease with rising interest rates. But if you hold it for 5 years or so the value will come back as the fund replaces lower interest rate bonds?

Thanks
livesoft
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Re: More Bond Questions?

Post by livesoft »

It is a lot more complicated than that. First of all, I will note that Total Bond Market Index fund also have intermediate-term bonds in it. Why did you leave those out?

There is no bond fund that "covers the risk" of rising interest rates, so I am not sure what you mean by that. All bond funds will drop in value if interest rates rise. Did you see that interest rates rose since the end of August? What has happened to the NAV of your favorite bond fund? See how that works?
Suzanne Walker at Bloomberg usually has good reports about the bond market, here is today's:
http://www.bloomberg.com/news/2014-09-1 ... -week.html
Her article from last Friday or Saturday was particularly good since it mentioned how short-term bonds are reacting to FOMC stuff. It is not what you might expect. This might be that article: http://www.bloomberg.com/news/2014-09-1 ... -u-s-.html
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Topic Author
Funkey
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Re: More Bond Questions?

Post by Funkey »

livesoft wrote:It is a lot more complicated than that. First of all, I will note that Total Bond Market Index fund also have intermediate-term bonds in it. Why did you leave those out?
My thinking was that Long term and short term combined would equate to intermediate term. The intermediate term just fit in. I knew it was included in TBM.

When I used the word risk not the right word. I'm new to this and still learning. I was thinking that STB was less likely to lose NAV with rising interest rates. Because of the shorter term.

Thanks for the link. Guess I need to read some more not sure I'm understanding bond concepts.
livesoft
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Re: More Bond Questions?

Post by livesoft »

Funkey wrote:I was thinking that STB was less likely to lose NAV with rising interest rates. Because of the shorter term.
That's the theory at least, but it may not turn out to be true. For instance, it is possible that the NAV of intermediate-term bond funds are suppressed in anticipation of interest rate increases that have not happened yet, but the NAVs of short-term bond fund have not had the corresponding anticipatory decreases. So when the yield curve changes, interesting things can happen: It may get steeper or not. Short-term bond funds may take a bigger hit than expected.

Who knows?

In any event, if you are worried, then wait until the minutes of this week's FOMC meeting are announced and digested before making any major speculatory moves with your bond funds.
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Topic Author
Funkey
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Re: More Bond Questions?

Post by Funkey »

livesoft wrote:it is possible that the NAV of intermediate-term bond funds are suppressed in anticipation of interest rate increases that have not happened yet,
livesoft is this EMT in action? So in effect the loss of NAV in TBM may have already incurred.
livesoft wrote:In any event, if you are worried, then wait until the minutes of this week's FOMC meeting are announced and digested before making any major speculatory moves with your bond funds.
Yes I'm watching this. :shock:

Thanks
abyan
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Re: More Bond Questions?

Post by abyan »

I suspect this is probably a bigger question than I mean it to be, but, how many of your answers deal with owning individual bonds vs a bond fund? I get how individual bonds work, but start to get a bit more confused when we're talking about a fund, as the fund is always buying new bonds when old bonds are due. But I'm assuming the same logic applies - that you buy a bond fund, and interest rates go up, so the nav of all the bonds in the fund goes down. So if you sell immediately, you lose money (if the current nav is below what you bought it at, and depending, I suppose on how long you've held the fund and thus how much interest you've earned over the years.) So, the interest rates of the existing bonds in the fund don't change, but as the bonds in the fund come due, the fund buys new bonds at the higher interest rate, so eventually the average yield of the overall bond fund rises and makes up for the decrease in nav. Yes?

At the same time, do we expect that the nav eventually rises back to its previous level? (I believe it has after last year's big drop.) Or do you just have to hang on to the fund long enough for the increased interest to make up for the nav decrease, if you ever want to sell?

And trust me, I've read everything in the wiki about bonds, a few times over. I just still find this entire area somewhat confusing. Though I'm getting there ;-)
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Phineas J. Whoopee
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Re: More Bond Questions?

Post by Phineas J. Whoopee »

abyan wrote:...
At the same time, do we expect that the nav eventually rises back to its previous level? (I believe it has after last year's big drop.)
No, that's not a realistic expectation, even though it can happen of course.
abyan wrote:Or do you just have to hang on to the fund long enough for the increased interest to make up for the nav decrease, if you ever want to sell?
...
Yes, that's it exactly. If you reinvest the dividends then it takes the number of years expressed as the fund's average duration for your wealth to get back to where you would have been if a single interest rate change in either direction hadn't occurred.

In reality, of course, interest rates change all the time. The media is breathless about what the Fed will say tomorrow, but while the Fed has influence it doesn't directly set very much of anything. Most rates are determined by a continuous, ongoing auction, among fixed income market participants who take all sorts of things, including past and potential future Fed actions, into account.

PJW
abyan
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Re: More Bond Questions?

Post by abyan »

Okay, so bottom line, things can correct themselves over time, but it might take time, thus the reason bonds are not a sure-deal, though, your market value should drop less with bonds than stocks, so they do serve their purpose. The only question is whether to play the bond game at all, nowadays, and simply use money markets and CDs.
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Phineas J. Whoopee
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Re: More Bond Questions?

Post by Phineas J. Whoopee »

abyan wrote:Okay, so bottom line, things can correct themselves over time, but it might take time, thus the reason bonds are not a sure-deal, though, your market value should drop less with bonds than stocks, so they do serve their purpose. The only question is whether to play the bond game at all, nowadays, and simply use money markets and CDs.
That's not an unreasonable statement, but I'd like to embellish a little.

Bonds are not a sure deal, I agree. They have risk. All of them have risk. In Modern Portfolio Theory there's a fundamental concept of a risk-free rate, but that's hypothetical. In the real world, however, we have to plug some number into MPT's formulas. One-month T-bills are a good proxy. The risk is negligible in an engineering sense, but not zero in a mathematician sense.

The timing of bond cash flows can differ from what an investor ends up needing. That's a risk. If they're too far away the investor could fail to meet a need, and if they're too close the decreased risk most likely will decrease returns.

We have some weird thing about the number zero. I get it, because I used to have it, but it's just another number. One could do well even if prices of one's assets dropped; or poorly even if they increased. There's a lot more context around the zero or less or more question.

On an absolute basis, yes, the difference between a, say, money market fund yielding 0.01% and a 10-year treasury at 2.6% is pretty small by historical standards. Today MidFirst Direct will pay 3% on a 10-year FDIC-insured CD. Make of it what you will.

PJW
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ogd
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Re: More Bond Questions?

Post by ogd »

abyan wrote:Okay, so bottom line, things can correct themselves over time, but it might take time, thus the reason bonds are not a sure-deal, though, your market value should drop less with bonds than stocks, so they do serve their purpose. The only question is whether to play the bond game at all, nowadays, and simply use money markets and CDs.
The biggest reason by far is if you can't get your money to a CD. Think 401k's, i.e. most of most people's money. Even if you can roll over to an IRA, that move has huge consequences and it should never be done for the sake of a CD.

A smaller one is if you don't want to because you're quite happy exchanging funds with one click. Particularly if the money is earmarked for exchanging back into stocks during declines.

Yet another one is if you're counting on bonds to often go up during a crash, improving the efficiency of your portfolio. This is most applicable to Treasuries.

That said, I like CDs currently.
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