Danger in bond funds?

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Danger in bond funds?

Postby golfallday » Tue Jul 02, 2013 10:22 am

Newbie question here. The talking heads on CNBC and Bloomberg Radio incessantly rant that bonds are a terrible investment right now and a crash is coming. The problem is, they never explain why or how. Is the worry that when interest rates rise, a 10-year T-Note might yield 3% at a new auction; thereafter, bondholders who are holding bonds with a 2% coupon rate would immediately dump their bonds at a big discount below their par value to get the better coupon rate of 3%? These are all hypothetical values I'm putting out there. Am I missing something here? Thanks.
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Re: Danger in bond funds?

Postby G-Money » Tue Jul 02, 2013 10:28 am

CNBC is best watched with the volume off. :)

I *believe* most of the hand-wringing in the financial press about bonds has to deal with the certain/guaranteed/couldn't-happen-any-other-way [/sarcasm] chance of rising interest rates. So, no, you're not missing anything, IMO, other than the fact that the market's collective expectation of future interest rates is already priced into bonds.
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Re: Danger in bond funds?

Postby Call_Me_Op » Tue Jul 02, 2013 10:32 am

There is no question that the interest-rate risk associated with bonds is enormous right now. We had a taste last month of what can happen. That doesn't mean that bonds should be avoided. It does mean that you need to understand what you own and the risks.
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Re: Danger in bond funds?

Postby Ged » Tue Jul 02, 2013 10:34 am

If you are buying an investment grade bond to hold it to maturity there isn't much risk. You will get your principle and coupon as according to the contract unless there is a black swan event causing the issuer to be unable to pay. Whether or not the payment compensates for inflation is another risk to consider.

If you buy a bond fund of long term bonds there is a lot of risk, because the NAV of the fund will decline considerably if interest rates rise. The rule of thumb is for every 1% of rate increase the NAV will decline (duration) percent. So a fund with 10 yr duration may decline 10% for every percent rise in interest rates.

It isn't a matter of people selling bonds so much as it is a matter of the market price of the lower coupon bond dropping to yield comparable returns to the newly issued higher coupon bond.
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Re: Danger in bond funds?

Postby Chris M » Tue Jul 02, 2013 10:44 am

golfallday,

Yes, you're understanding this correctly. Basically, the price of your 2% bond will drop until the yield on the bond (for a new purchaser) matches the 3% yield for the new bond (assuming the two bonds are equal in all other respects).

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Re: Danger in bond funds?

Postby golfallday » Tue Jul 02, 2013 11:01 am

My only bond allocation is in my 457 plan: VBMPX. Would anybody suggest I break that up a bit?
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Re: Danger in bond funds?

Postby Harold » Tue Jul 02, 2013 11:24 am

Call_Me_Op wrote:There is no question that the interest-rate risk associated with bonds is enormous right now. We had a taste last month of what can happen.

To keep things in perspective, the drop in intermediate bonds over the last month was on the order of what stocks can drop in a typical trading day.

So if bond risk is enormous, stock risk must be something like ginormously collosal. :wink:
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Re: Danger in bond funds?

Postby ogd » Tue Jul 02, 2013 11:41 am

The dangers of higher interest rates, such as they are, are in bonds, not in bond funds only. The price declines that you see in bond funds are still there with individual bonds, although easier to ignore, and so are the higher interest payments that will eventually offset them.

It's generally a bad idea to shift your allocation in response to your guesses about interest rates, particularly in a direction opposite to the rewards that higher rates imply. The asset allocation should express your risk tolerance with respect to stocks, not your guesses about the bond market. This Vanguard paper has a good overview of the topic. Note that it's from 2010, when noise about interest rates was as high as it is today, while the rates themselves were 1% higher. Needless to say, those bond armageddon predictions didn't exactly pan out.
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Re: Danger in bond funds?

Postby G-Money » Tue Jul 02, 2013 11:49 am

golfallday wrote:My only bond allocation is in my 457 plan: VBMPX. Would anybody suggest I break that up a bit?

It's hard to give investment advice in a vacuum. We don't know what other fund options are in your 457, or if you have any 401(k), 403(b), IRAs, Roth IRAs, or if you're married and your spouse has similar accounts. We don't know the funds available in these other accounts, how much (on a relative basis) is in each account, or what your desired AA is.

If it helps, all of my fixed income is in Total Bond and the Vanguard TIPS fund (the original, not the short-term one). I'm not planning on making any changes. You're very fortunate to have access to the Institutional class of Total Bond. But I'm a long way from retirement, have an equity-heavy portfolio, and, in general, am completely unconcerned about the prospect of rising interest rates. So what works for me may not work for you.

If you want a more comprehensive recommendation, I'd recommend starting a new thread, following this template: viewtopic.php?t=6212
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Re: Danger in bond funds?

Postby Call_Me_Op » Tue Jul 02, 2013 11:57 am

Harold wrote:
Call_Me_Op wrote:There is no question that the interest-rate risk associated with bonds is enormous right now. We had a taste last month of what can happen.

To keep things in perspective, the drop in intermediate bonds over the last month was on the order of what stocks can drop in a typical trading day.

So if bond risk is enormous, stock risk must be something like ginormously collosal. :wink:


Let's see. My TIPS fund lost over 7%. That was for a 1% increase in the 10-year rate. It could easily rise another 2% - for a > 20% loss. That's pretty enormous for one's safe allocation. And that's for an intermediate duration.

We expect stocks to be very risky - and allocate accordingly. Few of us have experienced a period where there was this much interest rate risk pent-up in our bonds.
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Re: Danger in bond funds?

Postby MnD » Tue Jul 02, 2013 12:17 pm

Harold wrote:
Call_Me_Op wrote:There is no question that the interest-rate risk associated with bonds is enormous right now. We had a taste last month of what can happen.

To keep things in perspective, the drop in intermediate bonds over the last month was on the order of what stocks can drop in a typical trading day.

So if bond risk is enormous, stock risk must be something like ginormously collosal. :wink:


It's curious that the standard response to bond fund risk concerns is now "but stocks are riskier!".
Bond funds with considerable interest rate risk have been promoted here as the "safe" portion of your portfolio. How many times have we heard the line "take your risk on the equity side". Many long term total return charts encompassing all or some of the past 30 year bull market for bonds (when rates went from ~16% to ~1.4% on the ten-year) have been posted to reassure investors that bond funds are wonderful things that march upward in return steadily _except_ when stocks fall, when they reliably operate as financial versions of Monroe Platinum Premium shock absorbers to alleviate a portion of the stock decline by a "flight to safety" price spike.

Bonds have a purpose but I believe they have been over-promoted based on the past 30 years where their yields were nothing like what they have been the recent past. Bond funds starting from 1.5% a few months back are simply not going to behave like bond funds starting at 8, 15% or even 4%.

Bogle with his comments on the Total Bond index composition being "broken" along with urging investors to consider Social security as part of their fixed income portfolio was in my opinion, warning on bonds as directly as possible using indirect means. Excellent timing on those warnings along with the more direct comments by Buffet on March 6, 2013 regarding bonds being a terrible investment at that time. Pretty much nailed the bottom on that one.
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Re: Danger in bond funds?

Postby G-Money » Tue Jul 02, 2013 12:18 pm

Call_Me_Op wrote:Few of us have experienced a period where there was this much interest rate risk pent-up in our bonds.

I disagree. The interest rate risk is always there, and it's always the same. Interest rates could rise 1%, 5%, 10%, etc., regardless of where current interest rates are. If you have a bond fund with a duration of 5 years, it's exposure to interest rate risk is the same when interest rates are 1% as when they are 10%. I'm not aware of any research showing that interest rates revert to any particular mean, so the idea that bonds are riskier at low interest rates is really a manifestation of anchoring bias.

If you meant to say that few of us have experienced a period where the interest rate risk showed up, that may be true. Of course, anyone invested in bonds back in the late 70s would probably disagree. But even if that is what you meant, interest rates have only risen about 75 bp for the 10-year Treasury over the last 3 months. The same thing happened as recently as the spring of 2009, with much less wailing and gnashing of teeth. (Source: http://www.federalreserve.gov/releases/h15/data.htm).
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Re: Danger in bond funds?

Postby ogd » Tue Jul 02, 2013 12:22 pm

G-Money wrote:But even if that is what you meant, interest rates have only risen about 75 bp for the 10-year Treasury over the last 3 months. The same thing happened as recently as the spring of 2009, with much less wailing and gnashing of teeth. (Source: http://www.federalreserve.gov/releases/h15/data.htm).

I think that at the time it was abundantly clear which risks are truly worth losing sleep about. How quickly we forget.
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Re: Danger in bond funds?

Postby G-Money » Tue Jul 02, 2013 12:31 pm

MnD wrote:It's curious that the standard response to bond fund risk concerns is now "but stocks are riskier!".
Bond funds with considerable interest rate risk have been promoted here as the "safe" portion of your portfolio.

"Safe" and "risky" are typically used in relative terms. I don't recall many people here suggesting intermediate or long-term Treasuries were riskless, except in the context of matching assets to known fixed or real liabilities far into the future. If you want absolute safety (i.e., value can never decrease), you're stuck with MM accounts (withing FDIC/NCUA limits) and T bills. That's always been the case.

MnD wrote:Many long term total return charts encompassing all or some of the past 30 year bull market for bonds (when rates went from ~16% to ~1.4% on the ten-year) have been posted to reassure investors that bond funds are wonderful things that march upward in return steadily _except_ when stocks fall, when they reliably operate as financial versions of Monroe Platinum Premium shock absorbers to alleviate a portion of the stock decline by a "flight to safety" price spike.

I didn't see a "smiley," so I can't tell if you're being ironic. The value of high quality, investment grade bonds is that they typically have displayed low correlation to stocks, have exhibited much less volatility than stocks, and still offer a positive expected return* (although, usually, less than stocks). That is the explanation I've read repeatedly on this forum for owning bonds. And those reasons still hold true today.

* at least in nominal terms, except for a brief period for T Bills. But I don't think too many Bogleheads were loading up on negative-nominal-yielding T Bills, so I'm going to leave this statement as-is.
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Re: Danger in bond funds?

Postby Call_Me_Op » Tue Jul 02, 2013 12:32 pm

G-Money wrote:
Call_Me_Op wrote:Few of us have experienced a period where there was this much interest rate risk pent-up in our bonds.

I disagree. The interest rate risk is always there, and it's always the same. Interest rates could rise 1%, 5%, 10%, etc., regardless of where current interest rates are. If you have a bond fund with a duration of 5 years, it's exposure to interest rate risk is the same when interest rates are 1% as when they are 10%. I'm not aware of any research showing that interest rates revert to any particular mean, so the idea that bonds are riskier at low interest rates is really a manifestation of anchoring bias.

If you meant to say that few of us have experienced a period where the interest rate risk showed up, that may be true. Of course, anyone invested in bonds back in the late 70s would probably disagree. But even if that is what you meant, interest rates have only risen about 75 bp for the 10-year Treasury over the last 3 months. The same thing happened as recently as the spring of 2009, with much less wailing and gnashing of teeth. (Source: http://www.federalreserve.gov/releases/h15/data.htm).


If you are suggesting that the past few years have been normal times for bonds, I must respectfully disagree. The massive flight to quality and residual fear (as well as Fed policy) have held rates at never-before seen lows. What has really changed is that there is little benefit gained by holding intermediate bonds, and arguably greater-than-normal risk. Why greater-than-normal risk? Just the fear the people have of rising rates (because rates are so low) is making the bond market extremely volatile and there is a danger of massive selling at the drop of a hat. Fear of stocks has driven the masses to the bond market - producing (what is in effect) a bubble. Fear of bonds threatens to burst it.
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Re: Danger in bond funds?

Postby MnD » Tue Jul 02, 2013 12:36 pm

G-Money wrote:
Call_Me_Op wrote:Few of us have experienced a period where there was this much interest rate risk pent-up in our bonds.

I disagree. The interest rate risk is always there, and it's always the same. Interest rates could rise 1%, 5%, 10%, etc., regardless of where current interest rates are. If you have a bond fund with a duration of 5 years, it's exposure to interest rate risk is the same when interest rates are 1% as when they are 10%.
...snip...
The same thing happened as recently as the spring of 2009, with much less wailing and gnashing of teeth. (Source: http://www.federalreserve.gov/releases/h15/data.htm).


Barclays aggregate bond index had positive nominal returns every year 1977-1981 because the yield was starting at something like 7% (on the road to something like 15%).
The real return was awful (-35%) but it never experienced an actual price decline on an annual basis.
A bond fund starting from 1.5% yield will not have the cushion of high coupons to offset bond price declines.
In 2009 total bond funds did relatively well in the immediate post-crash rate increase because of the simultaneous strong recovery in the price of the corporate bond portion of the indices - when it became apparent that capitalism wasn't in fact going to go out of business.
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Re: Danger in bond funds?

Postby G-Money » Tue Jul 02, 2013 12:43 pm

Call_Me_Op wrote:If you are suggesting that the past few years have been normal times for bonds, I must respectfully disagree.

No. I am saying the risk of interest rates rising x% in the next y period of time is the same. That's what interest rate risk is. I'm not aware of any magical "normal" interest rate, above which interest rate risk is lower and below which interest rate risk is higher.

Call_Me_Op wrote:What has really changed is that there is little benefit gained by holding intermediate bonds, and arguably greater-than-normal risk.

The market (i.e., buyers and sellers) have always determined how much expected benefit (yield) is required to compensate for the risks of owning bonds of any particular maturity and credit risk. What do you know that the market doesn't?

Call_Me_Op wrote:Why greater-than-normal risk? Just the fear the people have of rising rates (because rates are so low) is making the bond market extremely volatile and there is a danger of massive selling at the drop of a hat. Fear of stocks has driven the masses to the bond market - producing (what is in effect) a bubble. Fear of bonds threatens to burst it.

It's a nice story, perhaps even plausible, but I don't invest based upon stories. And I am always loathe to believe anyone who says "this time it's different." That's why I stay the course and recommend others do the same.
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Re: Danger in bond funds?

Postby G-Money » Tue Jul 02, 2013 12:47 pm

MnD wrote:Barclays aggregate bond index had positive nominal returns every year 1977-1981 because the yield was starting at something like 7% (on the road to something like 15%).
The real return was awful (-35%) but it never experienced an actual price decline on an annual basis.
A bond fund starting from 1.5% yield will not have the cushion of high coupons to offset bond price declines.
In 2009 total bond funds did relatively well in the immediate post-crash rate increase because of the simultaneous strong recovery in the price of the corporate bond portion of the indices - when it became apparent that capitalism wasn't in fact going to go out of business.

So what do you recommend to dampen the volatility of stocks?
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Re: Danger in bond funds?

Postby Call_Me_Op » Tue Jul 02, 2013 12:48 pm

G-Money wrote:It's a nice story, perhaps even plausible, but I don't invest based upon stories. And I am always loathe to believe anyone who says "this time it's different." That's why I stay the course and recommend others do the same.


My point is this time it is not different. Real rates will return to levels where investors are rewarded for investing and taking the associated risks. When that happens (it has already started) bonds will suffer.
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Re: Danger in bond funds?

Postby ogd » Tue Jul 02, 2013 12:53 pm

MnD wrote:It's curious that the standard response to bond fund risk concerns is now "but stocks are riskier!".
Bond funds with considerable interest rate risk have been promoted here as the "safe" portion of your portfolio. How many times have we heard the line "take your risk on the equity side".


1) The fact that you talk about bond fund risk and not simply bonds does not lend credibility to your arguments.
2) The bond allocation of a portfolio has always been about smoothing out the risks of stocks rather than the yields of bonds themselves. Stocks are always assumed to eventually return more than bonds regardless of the interest rates.
3) The "risk on the equity side" dictum is about credit risk, which is correlated with equity risk and thus defeats the primary reason for holding bonds.
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Re: Danger in bond funds?

Postby G-Money » Tue Jul 02, 2013 12:56 pm

Call_Me_Op wrote:Real rates will return to levels where investors are rewarded for investing and taking the associated risks.

As Larry Swedroe explained far more cogently than I can:
long-term bond yields are basically the average of expected future short rates.

http://www.cbsnews.com/8301-505123_162- ... investors/

So the market's estimation of where interest rates are heading is already priced in. So it again boils down to: What do you know that the market doesn't?
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Re: Danger in bond funds?

Postby golfallday » Tue Jul 02, 2013 1:18 pm

Thanks to all for the informative responses and replies. Indeed, Mr Swedroe and Dr Bernstein have written about this very topic. I'll keep peeling away at the onion for a while. Best to all.
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Re: Danger in bond funds?

Postby Call_Me_Op » Tue Jul 02, 2013 1:27 pm

G-Money wrote:
Call_Me_Op wrote:Real rates will return to levels where investors are rewarded for investing and taking the associated risks.

As Larry Swedroe explained far more cogently than I can:
long-term bond yields are basically the average of expected future short rates.

http://www.cbsnews.com/8301-505123_162- ... investors/

So the market's estimation of where interest rates are heading is already priced in. So it again boils down to: What do you know that the market doesn't?


The same thing I knew back in 2000; that people invest based upon two emotions - greed and fear - and these emotions often result in irrational behavior that mis-prices markets significantly with respect to underlying fundamental factors.
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Re: Danger in bond funds?

Postby G-Money » Tue Jul 02, 2013 1:30 pm

Call_Me_Op wrote:
G-Money wrote:
Call_Me_Op wrote:Real rates will return to levels where investors are rewarded for investing and taking the associated risks.

As Larry Swedroe explained far more cogently than I can:
long-term bond yields are basically the average of expected future short rates.

http://www.cbsnews.com/8301-505123_162- ... investors/

So the market's estimation of where interest rates are heading is already priced in. So it again boils down to: What do you know that the market doesn't?


The same thing I knew back in 2000; that people invest based upon two emotions - greed and fear - and these emotions often result in irrational behavior that mis-prices markets significantly with respect to underlying fundamental factors.

Well, there you have it. I'm not smart enough to know when the market is irrational. I should subscribe to your newsletter. :beer
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Re: Danger in bond funds?

Postby MnD » Tue Jul 02, 2013 2:23 pm

G-Money wrote:The market (i.e., buyers and sellers) have always determined how much expected benefit (yield) is required to compensate for the risks of owning bonds of any particular maturity and credit risk. What do you know that the market doesn't?


When the federal reserve has committed to holding short-term interest rates at zero until such time that certain economic conditions are met, and likewise for committing $85 billion dollars per month to longer-term bond purchases, you have to call into question the efficiency of "The Market". Recall that just a few years ago the efficient "market" (mortgage credit market specifically) facilitated tree trimmers and house-cleaners in purchasing $800K homes with "zero down" and we all know how that turned out.

We are much closer now to meeting the economic benchmarks that will trigger fed policy changes. It's no secret and the fed has been explicit and open about the policy and thresholds for change to it. If people understand the risks of the bond funds they hold and what price changes under various reasonable future rate scenarios will be, and aren't going to panic sell after sustaining significant losses, then fine. Hopefully these bond positions were established long ago and the owners who 'rode them up" during declining rates are well-prepared to "ride them down" in the event of rate increases. I perceive a systematic lack of understanding with regards to bond and bond fund price changes. When retail investors do not understand the characteristics of the financial products they hold, they tend to head for the exits at the worst possible times. I expect we'll see some of that at least in the months and years to come.
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Re: Danger in bond funds?

Postby ogd » Tue Jul 02, 2013 2:28 pm

MnD wrote:We are much closer now to meeting the economic benchmarks that will trigger fed policy changes. It's no secret and the fed has been explicit and open about the policy and thresholds for change to it.

Bingo. Everyone can see this one coming. Fed buying or not (the Fed is actually focused on MBS right now), the market knows better than to get run over by the train it sees coming ten miles away. Which is why bonds have done what they have despite no actual changes having occured yet.
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Re: Danger in bond funds?

Postby Call_Me_Op » Tue Jul 02, 2013 2:45 pm

G-Money wrote:Well, there you have it. I'm not smart enough to know when the market is irrational. I should subscribe to your newsletter. :beer


Average PE north of 40 is a hint. :beer

Don't confuse an efficient market (one that incorporates all publicly-available information) with a rational market.
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Re: Danger in bond funds?

Postby MnD » Tue Jul 02, 2013 3:31 pm

ogd wrote:Bingo. Everyone can see this one coming. Fed buying or not (the Fed is actually focused on MBS right now), the market knows better than to get run over by the train it sees coming ten miles away. Which is why bonds have done what they have despite no actual changes having occured yet.


Bingo - which is why I exited TBM in late 2012 and Int-term Corporate and high yield in spring 2013. The appeal of standing on the tracks and getting run over (likely but not assured) when you can see the train now (10 miles away but closing) lacks a certain appeal. Also with so many on the tracks you don't want to be in danger of there not being a spot to jump off too - or trip in the crush of everybody getting off the tracks at the same time.

The train might derail I suppose, or the train could still stop within 10 miles. But chances are if you are standing on the tracks and watching an approaching freight train and you can now hear the whistle and the tracks start to shake a little suggests that a step to either side is prudent. :happy Easy for me to say of course, having access to the soft warm landing spots off the track of both the G Fund and a 3% stable value 529 fund and two kids in college.
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Re: Danger in bond funds?

Postby ogd » Tue Jul 02, 2013 3:40 pm

So that has worked out for you, but it's undoubtedly a worse time to quit now than 6 months ago.

If I had 3% stable value funds available, I would take them even now (and so should the OP). But as it is, I'd have to accept 1% yield in a savings account, or go hunt for CDs and hope I'm allowed to break them, and I'm not willing to do that based on guessing interest rates beyond what the market has already priced in. And even that would be far better than increasing one's stock allocation, like a poster in another thread was considering.

I think staying the course is a good default choice for everyone. Interest rate risk is not as bad as it sounds, with the proper horizon and expectations.

Edit: by the way MnD, why did you wait until last year to switch to stable value? I'm curious. I'd have been in them for at least four years (I don't believe in timing the bond market in the other direction either...).
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Re: Danger in bond funds?

Postby MnD » Tue Jul 02, 2013 4:12 pm

ogd wrote:Edit: by the way MnD, why did you wait until last year to switch to stable value? I'm curious. I'd have been in them for at least four years (I don't believe in timing the bond market in the other direction either...).


The first switch I made was to go G Fund from TBM (F Fund) in 2012. Roughly same yield at the time so elimination of interest risk seemed like a no-brainer. Dropping VCIT and high yield was tougher. At the time the G fund was still ~1.75% while VCIT was 3% and high yield was 6%. A real cut in yield for cutting interest risk (and reducing some credit risk).

I was unaware that the Colorado 529 stable value option fund existed, let alone at at 3% until I saw something here this spring. I'm in the Vanguard Colorado 529 and the stable value option is a separate fund under different management. So it did not show up even when logging into my account. So the short answer - ignorance on my part.

I do like a nice mix of G Fund, TBM, a corporate tilt with VCIT and a smattering of high yield for flavor. I expect to return to that within a few years time, perhaps when the kids are done with college and the 529 Stable Value Fund is no longer an option. So yes, the moves above were temporary "market timing" type moves albeit with decent alternatives and no change to my overall equity/fixed income AA. Me bad!
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Re: Danger in bond funds?

Postby ogd » Tue Jul 02, 2013 4:26 pm

MnD wrote:Dropping VCIT and high yield was tougher. At the time the G fund was still ~1.75% while VCIT was 3% and high yield was 6%. A real cut in yield for cutting interest risk (and reducing some credit risk).

I think that one was mostly about credit risk, since the folks at TSP appear happy to take on your interest rate risk for free. Credit risk is a different type of foe: when a bond defaults, your money is gone. And to make matters worse, the share price of that company and everything connected to it aren't going to react very well either. I demand to be very well paid for that risk (I take it with munis).
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Re: Danger in bond funds?

Postby Kevin M » Tue Jul 02, 2013 4:47 pm

Golfallday,

A good concept to learn about is duration, which is an approximation of the sensitivity of bond price to bond yield. Duration is related to maturity, so basically bonds that mature further in the future change more in price (in the opposite direction) to changes in interest rates.

Bond price and bond yield are actually two ways to measure the same thing, and for an individual bond there is a mathematical formula that relates the two. So price and yield will change in the opposite direction in a precisely determined way. You can either think of it as change in yield causing change in price, or vice versa. I think most people think of it as interest rates affecting bond prices, but bonds actually are bought and sold at prices that determine yields.

It's more complicated for a bond fund, since the bonds in the fund typically are not held to maturity, but the same basic principle holds. The duration of a bond or bond fund indicates its sensitivity to interest rates. A bond fund with a duration of 5 will decrease in value about 5% for every 1 percentage point increase in yield, and vice versa.

Those who say individual bonds are safer are buying into what Vanguard refers to as the "principal at maturity myth". Here is a quote from A topic of current interest: Bonds or bond funds?/pdf/s354.pdf

Holding an individual bond to maturity primarily
confers an emotional, rather than economic, benefit
and tends to be most practical for funding of nearterm liabilities with highly predictable values. When
the principal paid at maturity is reinvested—as it
often is in laddered individual bond strategies—the
resulting portfolio is functionally similar to a mutual
fund but is likely to incur greater costs and have less
diversification.


In answer to the question, "so what are you going to use to dampen the volatility of stocks instead?", one answer is non-brokered CDs, which provide a higher yield with less risk than a comparable bond.

Kevin
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Re: Danger in bond funds?

Postby SVariance1 » Tue Jul 02, 2013 7:05 pm

The main issue for bonds is that he risk/reward framework is not very good. Most of the return you get from bonds is in coupons and with rates so low, your returns will low. Yet, you still have to take risk to get a very low return.
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Re: Danger in bond funds?

Postby patrick » Tue Jul 02, 2013 7:35 pm

If you're going to hold for longer than the fund's duration, you will end up with more money at the end if interest rates increase now. For the long-term bond investor the nightmare scenario is not that interest rates might increase, but rather that interest rates might fail to increase.
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