Bond prices
Bond prices
I have 2 questions. 1--How does one determine if a TIPS bond is "correctly priced"? 2--What does it mean to say that a bond's (or bond mutual fund's) price includes interest rate increase projections? I hope I have posed these questions correctly.
Re: Bond prices
1. I don't mean to be needlessly semantic, but it really depends on what you think about what "correctly priced" might mean. Some people say that by definition, the current price—the one at which buyers and sellers currently agree to swap assets and money —is the correct one. It is the one that allows market participants to transact. Some stipulate that because the market contains knowledge about current conditions and collectively produces best guesses about future conditions, the current price reflects a market consensus about what the fair price might be. On the other hand, reflecting a variety of needs as well as opinions, there are many holders of that security that are not selling at the current price and prospective buyers who take a look and aren't interested. Some might have opinions and analyses that disagree with this market consensus and have some notion of a correct price that is different, but trivially you can see that a lot of these people are wrong. Historically, you can look back at the actual return, changes in interest rates, performance of other securities, and form an opinion about what the price should have been, but it is hard to distinguish from the market setting the wrong price a priori with information known at the time and just certain flukes and randomness. It's quite possible the price was right in some meaningful sense but certain unpredictable events happened to make it in the end a good deal or bad one.
2. It should be clear that a great number of market participants have notions about what future rates and conditions might look like. If the rate of a bond is 0.5% real but everyone somehow knows that it will be 0.6% tomorrow, nobody's going to want to buy at 0.5% today. As such, sellers will need to decrease the price until they can find buyers again, pushing the rate up. So it goes in the medium and long term. The rates reflect market consensus interest rate increase (and decrease, in general) projections to some degree. Participants also weigh how badly they need the income now and considerations besides interest rate projections. Again, you will find people who think the market is stupid and the rate too low and/or projected interest rate increases too high, and also people with the exact opposite opinion.
2. It should be clear that a great number of market participants have notions about what future rates and conditions might look like. If the rate of a bond is 0.5% real but everyone somehow knows that it will be 0.6% tomorrow, nobody's going to want to buy at 0.5% today. As such, sellers will need to decrease the price until they can find buyers again, pushing the rate up. So it goes in the medium and long term. The rates reflect market consensus interest rate increase (and decrease, in general) projections to some degree. Participants also weigh how badly they need the income now and considerations besides interest rate projections. Again, you will find people who think the market is stupid and the rate too low and/or projected interest rate increases too high, and also people with the exact opposite opinion.
Re: Bond prices
The simpler explanation you might be looking for is that "interest rates" (as seen on TV) are overnight Fed rates, i.e. zero duration, whereas "bond yields" (what is actually in the typical fund) are a different beast, typically much longer. Bond yields are already considerably higher than overnight rates, reflecting in some views the market's concrete expectations of future overnight rates, or in others at least the risk of such. For more on this see: https://en.wikipedia.org/wiki/Yield_cur ... hypothesisdachshund wrote: 2--What does it mean to say that a bond's (or bond mutual fund's) price includes interest rate increase projections? I hope I have posed these questions correctly.
It's very possible that short/zero rates increase while longer rates barely take notice. The clearer the future, the more you can expect this to be the case.
Re: Bond prices
Thank you for your replies. However, what I was really asking for (sorry I did not make myself clear) was not theoretical about efficient market theory but rather practical about when to buy TIPS funds/individual bonds and other bond funds based upon current low yields (which I expect to rise, lowering prices) and the forward-looking prognostications regarding inflation.
Re: Bond prices
Most people here suggest not trying to time purchases, which seems to be your aim. It's basically asking if someone knows what's going to happen in the near-term future. I don't.
If you want to play the guessing game and more actively trade, bonds have tended at times to do better more frequently in the short-mid term when
1. real yields are high
2. the yield curve is steep
3. rates have fallen recently (i.e. positive price momentum) (checking again, not sure this is true; all of this is period dependent, obviously)
among other things. Definitely with many exceptions, but more often than not. I'm not sure that leads to any positive trading strategies, though, especially since there are many times when multiple of the above are not true. And I would be especially scared of betting on momentum and hoping for rate declines given where rates are now.
I'm not sure what the track record for breakeven inflation rate vs. actual inflation rate seen is across countries and history. I would guess that frequently anticipated inflation has been overstated, but is that just a feature of the somewhat recent past and an era of falling rates, or something you can really expect to continue going forward?
And really, how much money (relatively, compared to other assets) is at stake here, and what would you be using instead of bonds? You better really know what you're doing and be prepared to be wrong if you want to deviate from a more strategic, long-term allocation (that is presumably properly diversified and more long-term optimal) in order to play timing games.
If you want to play the guessing game and more actively trade, bonds have tended at times to do better more frequently in the short-mid term when
1. real yields are high
2. the yield curve is steep
3. rates have fallen recently (i.e. positive price momentum) (checking again, not sure this is true; all of this is period dependent, obviously)
among other things. Definitely with many exceptions, but more often than not. I'm not sure that leads to any positive trading strategies, though, especially since there are many times when multiple of the above are not true. And I would be especially scared of betting on momentum and hoping for rate declines given where rates are now.
I'm not sure what the track record for breakeven inflation rate vs. actual inflation rate seen is across countries and history. I would guess that frequently anticipated inflation has been overstated, but is that just a feature of the somewhat recent past and an era of falling rates, or something you can really expect to continue going forward?
And really, how much money (relatively, compared to other assets) is at stake here, and what would you be using instead of bonds? You better really know what you're doing and be prepared to be wrong if you want to deviate from a more strategic, long-term allocation (that is presumably properly diversified and more long-term optimal) in order to play timing games.
Re: Bond prices
In theory, all bonds, including TIPS, are always priced correctly. They all factor in the yield curve and expected / probably inflation and rate changes. In practice this is hard but then again nobody has consistently beat the market so the theory holds.dachshund wrote:Thank you for your replies. However, what I was really asking for (sorry I did not make myself clear) was not theoretical about efficient market theory but rather practical about when to buy TIPS funds/individual bonds and other bond funds based upon current low yields (which I expect to rise, lowering prices) and the forward-looking prognostications regarding inflation.
There is are 2 issue with TIPS which makes them expensive.
The first is that they are relatively scarce to their straight brothers so you have to pay a bit of liquidity premium for them.
Second TIPS are priced like a long put derivative. Historically, on average, there are better ways to protect yourself from inflation. The medium average for expected inflation over the next 10 years is about 1.6%. The mean average is 2%. There is normally a spread. Thus the collective wisdom we will likely have about 1.6% inflation but there is a small chance it could be much higher. Only in the rare case where there is a big unexpected jump in inflation do TIPS pay off over other investments. You can figure this out but looking at call/put prices on Treasuries and by reading up on the volatility simile.
Now, what price are you willing to pay for that extra protection? Are you willing to give up .4% on a 10 year treasury for that extra protections? That will tell you if TIPS are priced high or low.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Re: Bond prices
Again, I apologize for not making myself clear. Currently I have a large cash position. The reasons are I subscribe to the Kitces and Pfau idea that in early retirement, sequence of returns risk is very important. I am starting with 35% equity mutual funds and 70% cash (33%) and short-/intermediate-term treasury funds (31%) (1% is missing I know.) I am going to follow K&P accelerated rising equity glide path by increasing equity part by 2%/yr X 15 yrs., mainly by withdrawing RMDs from cash. However, at any point in future time when it appears interest rate rises have probably (!) stabilized and when it appears inflation may be rising again, I would consider moving cash to bond funds/TIPS funds (or individual TIPS bonds.) I realize this is timing to some degree, but I'm not talking about huge moves. Anyway, some articles I've read note that interest rate hikes have already been "priced" into bonds. I want to understand what that phrase means. Also I want to understand what it means when some articles note that it is difficult to know whether a TIPS bond (or I guess any treasury) is "priced" correctly, by which I assume is meant it's a good buy.
Re: Bond prices
Dear responders: I am neither a mathematician nor an economist. That means for me to understand responses I need rather simple explanations. I don't know what a long put derivative is. I found it difficult to understand the Wikipedia reference. What is the source of "The medium average for expected inflation over the next 10 years" of 1.6%? I do not understand call/put prices or the volatility simile. Thanks for your patience and understanding.
Re: Bond prices
Given your expressed parameters, you would be well-served by investing in a total bond market fund. Trillions of investor dollars have already determined this is the place to be. If you know more than millions of other investors who have invested their hard-earned money, congratulations.dachshund wrote:Dear responders: I am neither a mathematician nor an economist. That means for me to understand responses I need rather simple explanations. I don't know what a long put derivative is. I found it difficult to understand the Wikipedia reference. What is the source of "The medium average for expected inflation over the next 10 years" of 1.6%? I do not understand call/put prices or the volatility simile. Thanks for your patience and understanding.
Re: Bond prices
A short answer is to take the yield on the 10 year treasury and subtract the yield on a 10 year TIPS – or any other time span. This will give you the approximate mean of inflation. For the mode, the short answer is: Black Scholes option pricing model, or some other option pricing model. Long answer: lots of math.dachshund wrote:Dear responders: I am neither a mathematician nor an economist. That means for me to understand responses I need rather simple explanations. I don't know what a long put derivative is. I found it difficult to understand the Wikipedia reference. What is the source of "The medium average for expected inflation over the next 10 years" of 1.6%? I do not understand call/put prices or the volatility simile. Thanks for your patience and understanding.
Think of long puts as insurance, which is what they are.
For the volatility smile, I am saying that the inflation risk is not symmetrical. We can guess that inflation will be 1.6%. Is the chance of a 1% up / down error equal? That is 2.6% or .6%, I would say about the same. What about a 5% swing, or 6.6% or - 3.4%? I could see a low chance were inflation is 6.6%, but I have a very hard time seeing a world were we see average deflation of 3.4%. Up / Down chances are not equal. TIPS are priced as insurance in a world of 6% inflation, not for a world with 3% deflation.
Which takes me back to your original question – which I am not sure what it is. Why do you want to know if TIPS are trading at the "correct" price. I am not quite making the jump with Kitces and Pfau (which I am not familiar with). What do you mean by "correct". I am assuming you are looking for some type of input for the retirement model but I don't exactly know what you are searching for.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Re: Bond prices
Have you considered using CDs purchased directly from banks or credit unions instead of cash, and even instead of the intermediate-term Treasury fund?dachshund wrote:Currently I have a large cash position. <snip> I am starting with 35% equity mutual funds and 70% cash (33%) and short-/intermediate-term treasury funds (31%) (1% is missing I know.)
The yield (APY) on a good direct CD is 2.25%, with an early withdrawal penalty of six months of interest. The early withdrawal option limits your downside to about 1.13% if you do an early withdrawal to invest at higher rates. This is a very limited downside compared to the Treasury fund, which has an SEC yield of 1.64% (Admiral shares); SEC yield is commonly used as an estimate for expected annualized return over the subsequent 5-10 years. So the CD provides a higher expected return with less risk.
The CD has only slightly more risk than cash, but offers a higher yield than the intermediate-term Treasury fund, compared to 1% or so you can earn on cash in an online savings account.
I have about 70% of my fixed income in direct CDs, 25% in bond funds, and 5% in cash. I don't use Treasury bond funds since CDs offer higher yields at lower risk, unless you go long-term. I use at minimum intermediate-term investment-grade bond fund, with a current SEC yield of 2.82% (Admiral shares). There is an argument for keeping some in Treasuries for the flight-to-safety potential in a financial crisis, but you get more bang for the buck with a long-term Treasury fund if you want this. So an alternative to what I do might be to combine mostly direct CDs with a little long-term Treasury fund.
Kevin
If I make a calculation error, #Cruncher probably will let me know.
Re: Bond prices
You should determine if you need TIPS in the first place. If you hold >=60% equities then I say NO.
KISS & STC.
-
- Posts: 48944
- Joined: Fri May 11, 2007 11:07 am
Re: Bond prices
To price the TIP bond, the market takes a view as to likely inflation "the breakeven inflation rate". That's usually quoted along with the TIPS price.dachshund wrote:I have 2 questions. 1--How does one determine if a TIPS bond is "correctly priced"? 2--What does it mean to say that a bond's (or bond mutual fund's) price includes interest rate increase projections? I hope I have posed these questions correctly.
(check Larry Swedroe's books I am sure he has a chapter on TIPS? Also ?Annette Thau? has a book on bonds).
If inflation over the time to maturity of the TIPS is higher than BEIR, then you have 'won'-- the TIPS protected you against the unexpected inflation that occurred over that time. If lower than BEIR you would have been better off in the conventional Treasury Bond of the same maturity.
You also get a real yield figure with a TIPS bond price quote, and AFAIK that's prepared on the same basis ie if inflation is as the market expects over the remaining life of the bond, then that's the real return you would get for holding it (could be negative).
(Don't forget ibonds in your investment strategy, as they can actually be more attractive than TIPS at times)
2. whenever you buy a bond (straight or TIPS) the return (Yield to Maturity) it offers you combines a number of factors:
- expected inflation
- liquidity (TIPS should have a premium yield because they are illiquid compared to ordinary treasuries)
- credit risk (usually assumed to be 0 for US Treasury securities)
- real return (ie after inflation)
The first and last of those factors are priced into the yield curve (the plot with time to maturity on the x axis, yield of bond with that maturity on the y axis, normally upward sloping).
So when you buy a bond, its place on the yield curve, and therefore the market's expectation of future interest rates, is "priced in".
What happens is the value of the bond fluctuates as the market changes its view over these factors.
As an investor, I would suggest:
- you can't time bonds, you don't sit in on the meetings of the Fed that decides interest rates, you have no insider advantage
- you can decide whether TIPS are offering sufficient reward for the inflation protection (remember unexpected inflation only) you are buying. As that is quite a valuable protection, it's usually fairly expensive (TIPS were arguably underpriced for their first 10 years of existence)
- you can really only protect yourself against interest rate moves by shortening the duration of your portfolio. For example using ST bond funds rather than total bond market. It's the very long maturity bonds (more than 10 years) which are most sensitive to interest rate moves
At current yields, I have hazarded the guess that TIPS and ST bond funds are going to offer very similar returns-- if inflation rises (good for TIPS) then so will interest rates, and ST bond funds will take relatively little loss.
A good test is always to check the bond market returns for 1994, and then subtract 4%. 1994 was the worst year for bonds since about 1981, and reflected a sudden Fed tightening after a long period of very low interest rates, that caught everyone by surprise.
minus 4% because going into 1994, yields on bonds were quite a bit higher than now. So since we are looking at total return, we could see price movements down like 1994, but in 1994 we also got coupons from the bonds which were much higher than they are now. So as a rough rule of thumb you could expect things to be significantly worse, by about 4% on total return.
Note in 2008-9 corporate bonds underperformed, especially high yield. And TIPS did badly for what we think were technical market factors: they were used as collateral for other transactions (Repos) and when Lehman failed, the transactions were unwound and the TIPS just dumped into an illiquid market. Hence big price falls and yield rises. It was in retrospect the deal of the century.
-
- Posts: 48944
- Joined: Fri May 11, 2007 11:07 am
Re: Bond prices
I should note the suggestion to use CDs is a good one. Especially v. ST bonds and ST bond funds.
Because of the need to increase their deposit base, financial institutions have been offering better yields on CDs than risk free Treasury bonds offer in the market. As a small investor you can exploit the FDIC guarantee, whereas large investors cannot. One of the very few instances in finance where retail wins over wholesale.
Because of the need to increase their deposit base, financial institutions have been offering better yields on CDs than risk free Treasury bonds offer in the market. As a small investor you can exploit the FDIC guarantee, whereas large investors cannot. One of the very few instances in finance where retail wins over wholesale.
Re: Bond prices
Apparently I am not asking my questions well. I am not at all saying I "know more than millions of other investors" as per kenner's response nor am I trying to time the market in a major way. My thinking is that the bond market is currently low yield and high-priced. Correct me if I'm wrong. I am in early retirement and believe sequence of returns risk is very significant to me at my stage and given the current market situations. I have a relatively large cash position with my portfolio being 35% equity mutual funds, 33% cash and 32% short-/intermediate-term treasury bond funds. I think I should move some of cash to bonds, but I am reluctant to do so in a chunk at this time because of my concerns as above. My original 2 questions where meant to elicit explanations about bond attributes I do not fully understand. First, and as alex_686 stated, "...all bonds...are always priced correctly. They all factor in the yield curve and expected/probably [?sic] inflation and rate changes. My first question is how is that done. Again, a complex mathematical answer or one with abbreviations a layman won't understand won't help me. If this is an impossible question, let me know. My second question regards TIPS prices. You all may have convinced me not to go that route, but I've read somewhere that one of the problems in buying an individual TIPS bond (and I suppose that goes for other treasuries as well) is trying to determine if it's price is right (not in an efficient market sense, but in a good deal sense). I may well have that all wrong, but that's what I'm trying to understand. BTW there was an article posted on MSN homepage by Jeremy Josse of The Street "What the Chinese market crash is trying to tell you" which states "Robert Shiller...argues the Internet...generate significant misinformation and bias, rendering many participants...not very rational at all....How can you have the rational market of 'efficient market theory' if so many of the participants in the market are not rationally informed."
Re: Bond prices
Dear Kevin M: Where do you have your CDs at 2.25%? Thanks.
Re: Bond prices
Dear Valuethinker: I'm sorry. My last 2 posts were made before I read your post entirely. First, what's AFAIK? Second, so the answer to my first question is that expected inflation and real return are used to determine the stated yield on a bond? But then what is meant when writers state that anticipated interest rate hikes have been "priced in"? Does that mean the same; i.e. that the current yield reflects the expected rate hikes? Third, what do you mean when said "TIPS were arguably underpriced for their first 10 years of existence." Fourth, aren't they underpriced now if inflation takes off in the future? Fifth, I sorta get the idea of matching portfolio withdrawal needs with fund average duration. Butwhat happens when the interest rate hikes occur over a long period of time? In other words, if a fund with a 5-yr duration experiences a 0.5% hike and loses 2.5% in price but recovers in 5 years (or less), what happens if the 0.5 % hike occurs not once but each year for 5 yrs? LAST, regarding your advice of CDs vs ST bond, what about my intermediate treasury bond fund and which financial institution(s) for the CDs? Thank you.
Re: Bond prices
Dachshund
First, I think as a board we are getting confused because the question you are asking is so basic. It is like asking why Google is trading at $600 per share. We can point to dozens of different reasons but in the end it is because what the market says it is.
Second you ask how people determine the bond price. Models, math, gut instinct, etc. The bond market relies much more heavily on math and models than equities because the cash flows are much more predictable. To boil it down in lay terms, what is the chance that real interest rates will rise and what happens then? What happens if long term rates rise but not short term rates? What are the various chances of inflation? Oil shock? etc. Take a weighted average and there you go. Does the level of return offset the risk? Which kind of takes us back to the Google example.
Third, I hope I did not dissuade you from buying TIPS. The fact that I can't tell if they are cheap or expensive does not mean that they are wrong for you. Part of being a Bogglehead is that we can't predict the future so we can't tell if any asset class, stock or bond, is cheap or expensive. What we can do is determine if the asset's risk / reward profile fits your needs.
Fourth, I think you are going a little astray on your analysis of TIPS and inflation. The beauty of buying TIPS is that you take most of that risk off of the table. Inflation may be high or low but you don't care. Your real rate of returns are locked in. You might be a little sad if real rates increase because you would be under-performing the market but you would not be losing anything. With fixed rate bonds, inflation could eat away your real returns.
5th, you say “My thinking is that the bond market is currently low yield and high-priced. Correct me if I'm wrong.” OK, you are wrong – kind of. 10 year treasury bonds are at historic lows. However, if we enter a Japaneses decade of deflation those returns are going to be juice. More importantly, you pointed out that the nominal rate of a bond is equal to the expected real rate but the expected inflation. While nominal rates may be at all time lows, real rates are mealy low.
Which takes us lastly to your sequence of returns. If you invest in a portfolio which has some portion of TIPS will you be able to generate sufficient returns to meet your retirement needs? This should be the central question you have.
FYI, I prefer using portfolio immunization. You may want to read up on that. It requires more math than your approach but it should be accessible to anybody who has access to basic math skills and a Excel worksheet. It is a conservative approach that will help you determine what type of risks you can take.
First, I think as a board we are getting confused because the question you are asking is so basic. It is like asking why Google is trading at $600 per share. We can point to dozens of different reasons but in the end it is because what the market says it is.
Second you ask how people determine the bond price. Models, math, gut instinct, etc. The bond market relies much more heavily on math and models than equities because the cash flows are much more predictable. To boil it down in lay terms, what is the chance that real interest rates will rise and what happens then? What happens if long term rates rise but not short term rates? What are the various chances of inflation? Oil shock? etc. Take a weighted average and there you go. Does the level of return offset the risk? Which kind of takes us back to the Google example.
Third, I hope I did not dissuade you from buying TIPS. The fact that I can't tell if they are cheap or expensive does not mean that they are wrong for you. Part of being a Bogglehead is that we can't predict the future so we can't tell if any asset class, stock or bond, is cheap or expensive. What we can do is determine if the asset's risk / reward profile fits your needs.
Fourth, I think you are going a little astray on your analysis of TIPS and inflation. The beauty of buying TIPS is that you take most of that risk off of the table. Inflation may be high or low but you don't care. Your real rate of returns are locked in. You might be a little sad if real rates increase because you would be under-performing the market but you would not be losing anything. With fixed rate bonds, inflation could eat away your real returns.
5th, you say “My thinking is that the bond market is currently low yield and high-priced. Correct me if I'm wrong.” OK, you are wrong – kind of. 10 year treasury bonds are at historic lows. However, if we enter a Japaneses decade of deflation those returns are going to be juice. More importantly, you pointed out that the nominal rate of a bond is equal to the expected real rate but the expected inflation. While nominal rates may be at all time lows, real rates are mealy low.
Which takes us lastly to your sequence of returns. If you invest in a portfolio which has some portion of TIPS will you be able to generate sufficient returns to meet your retirement needs? This should be the central question you have.
FYI, I prefer using portfolio immunization. You may want to read up on that. It requires more math than your approach but it should be accessible to anybody who has access to basic math skills and a Excel worksheet. It is a conservative approach that will help you determine what type of risks you can take.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Re: Bond prices
Really quickly:
If you keep the portfolio at 5 year duration, you'll get something like 5.4% returns over 5 years for a fund like TBM starting at 2.15%. So less than what was promised, but not a disaster. But another couple of years at those yields (4.65%) and your returns jump to something like 15.4%, already better than your starting yield over the 7 years. The nice thing about losses to interest rate risk is they bring with them commensurate future rewards, and in the long term you're better off.
Another option though, if the horizon is actually 5 years, is to reduce duration along the way to match the approaching horizon [*], e.g. by mixing cash. If you do it often enough (so as to be precise), you'll end up with something close to the known return that you expect from individual bonds, even if rates do go up. If the cash is a very good deal like can be found presently (~1% savings accounts), you'll probably do quite a bit better.
Edit: to elaborate: the reason you didn't get the yield you expected in the first scenario (holding the fund, unchanged) is that e.g. in the final year you were holding a 5 year instrument when your horizon was 1 year away or less. So no wonder you got bit. Mixing with cash is one way to reduce duration; you could also hop between funds or any number of things that should still be less complex than managing a portfolio of bonds.
Yes. Price and yield are two aspects of the same thing. For a given bond, one can compute one from the other. So if I've set my required yield to account for something, I've also set the price. Hence, "priced in".dachshund wrote:Second, so the answer to my first question is that expected inflation and real return are used to determine the stated yield on a bond? But then what is meant when writers state that anticipated interest rate hikes have been "priced in"? Does that mean the same; i.e. that the current yield reflects the expected rate hikes?
Nothing that horrible.dachshund wrote:Fifth, I sorta get the idea of matching portfolio withdrawal needs with fund average duration. Butwhat happens when the interest rate hikes occur over a long period of time? In other words, if a fund with a 5-yr duration experiences a 0.5% hike and loses 2.5% in price but recovers in 5 years (or less), what happens if the 0.5 % hike occurs not once but each year for 5 yrs?
If you keep the portfolio at 5 year duration, you'll get something like 5.4% returns over 5 years for a fund like TBM starting at 2.15%. So less than what was promised, but not a disaster. But another couple of years at those yields (4.65%) and your returns jump to something like 15.4%, already better than your starting yield over the 7 years. The nice thing about losses to interest rate risk is they bring with them commensurate future rewards, and in the long term you're better off.
Another option though, if the horizon is actually 5 years, is to reduce duration along the way to match the approaching horizon [*], e.g. by mixing cash. If you do it often enough (so as to be precise), you'll end up with something close to the known return that you expect from individual bonds, even if rates do go up. If the cash is a very good deal like can be found presently (~1% savings accounts), you'll probably do quite a bit better.
Edit: to elaborate: the reason you didn't get the yield you expected in the first scenario (holding the fund, unchanged) is that e.g. in the final year you were holding a 5 year instrument when your horizon was 1 year away or less. So no wonder you got bit. Mixing with cash is one way to reduce duration; you could also hop between funds or any number of things that should still be less complex than managing a portfolio of bonds.
Explore http://depositaccounts.com.dachshund wrote: LAST, regarding your advice of CDs vs ST bond, what about my intermediate treasury bond fund and which financial institution(s) for the CDs? Thank you.
- abuss368
- Posts: 27850
- Joined: Mon Aug 03, 2009 2:33 pm
- Location: Where the water is warm, the drinks are cold, and I don't know the names of the players!
- Contact:
Re: Bond prices
Hi galeno,galeno wrote:You should determine if you need TIPS in the first place. If you hold >=60% equities then I say NO.
I would agree. In terms of TIPS an investor must determine if they have a higher risk to unexpected inflation (which is calculated and paid by the federal government) or not.
One item I do not see mentioned enough, if ever, in terms of inflation and investing in bonds. I always read about unexpected inflation and the "need" for inflation bonds. What about the opposite or flip side of that coin? Inflation is less than expected and your bonds are paying more than inflation! Now that is a good thing!
Vanguard experts recommend Total Bond Index and Total International Bonds Index. Short Term TIPS (which have a negative yield if I am correct and guarantee a real loss over time - who would invest in that?) are in the Vanguard Target Funds (not LifeStrategy Funds) close to retirement. The Intermediate Term TIPS fund is no longer recommended or included in Vanguard funds.
Keep investing simple.
John C. Bogle: “Simplicity is the master key to financial success."
Re: Bond prices
One last thought on how bond prices incorporate future rate changes using laymen's terms. Let us say I have 2 options.
I can buy the 2 year Treasury.
I can buy a 1 year Treasury and in one year roll that Treasury into a new 1 Year Treasury.
In either case I am buy an equivalent product – 2 years of risk free government debt. The yield I get from either should be the same. If they are not there is an arbitrage situation – a situation where I can make money risk free and prices get pushed to where they are the same.
From this I can extract the market's expectation of price and yield of a 1 year treasury in 1 year – adjusted for risk, of course. There is math behind this but this is the basic concept. We can see this in the price of a 1 year futures contract to buy a 1 year Treasury.
I hope this helps.
I can buy the 2 year Treasury.
I can buy a 1 year Treasury and in one year roll that Treasury into a new 1 Year Treasury.
In either case I am buy an equivalent product – 2 years of risk free government debt. The yield I get from either should be the same. If they are not there is an arbitrage situation – a situation where I can make money risk free and prices get pushed to where they are the same.
From this I can extract the market's expectation of price and yield of a 1 year treasury in 1 year – adjusted for risk, of course. There is math behind this but this is the basic concept. We can see this in the price of a 1 year futures contract to buy a 1 year Treasury.
I hope this helps.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Re: Bond prices
Thanks to valuethinker and ogd for trying to answer my BASIC questions. Apologies to all the rest for asking such basic questions. You all are much wiser in investment matters than I. I have read a great deal including both Bogleheads books, a number of For Dummies books, and a great number of Internet articles, but I still find bonds to be difficult to understand. I thought this website would be the place to acquire better understanding, but I guess I need to have that understanding in order to ask the RIGHT questions. I guess there are stupid questions after all.