Short Terms vs Intermediate in Rising Rate Environment??

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longview
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Short Terms vs Intermediate in Rising Rate Environment??

Post by longview »

We've had lots of threads about bond/muni funds vs individual holdings in rising rate environments. Let's take for granted that funds are fine, and that they over the course of their duration then it's as though the NAV loss never occurred. Then the question is begged: short-term or intermediate??

Doesn't it make sense to go short-term during rising rates, so the NAV-loss is more quickly regained? Once rates are higher and more stable then transition to a longer term fund?

Muni situation:
.................................................................................. SEC Yield YTD 1 YR....
Intermediate-Term Tax-Exempt Admiral Shares VWIUX 2.63% A –3.87% –1.55% 4.68% 4.22% 4.30%
Limited-Term Tax-Exempt Admiral Shares VMLUX 0.98% A –0.56% 0.16% 2.76% 2.85% 3.16%
Short-Term Tax-Exempt Admiral Shares VWSUX 0.49% A 0.07% 0.39% 1.68% 2.22% 2.42%

So it seems pretty clearly NAV-loss vs yield. If you "know" interest rates are going up where do you put your money? OTOH, the only yield beating inflation is Intermediate. :oops:

Would love to see more discussion on this. Thanks for any and all info. (FWIW, I've been putting my money in VWIUX).
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
livesoft
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by livesoft »

Lots of folks agree with you. Many people went short-term starting already late last year. See, e.g., this poll from March: http://www.bogleheads.org/forum/viewtop ... 1&t=112412

Some prominent "stay-the-course" posters even noted they had exchanged all their intermediate-term TIPS fund shares into the newer short-term TIPS fund shares.

Full disclosure: Based on the linked poll, I went to shorter duration back then as well as I noted in this post: http://www.bogleheads.org/forum/viewtop ... 2#p1638192
Last edited by livesoft on Tue Sep 03, 2013 9:15 am, edited 1 time in total.
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dbr
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by dbr »

Two points:

1. Considering bonds in isolation a person holding bonds indefinitely in a retirement portfolio will probably find the sweet spot for return vs risk in the intermediate durations.

2. Doing what one should do and considering bonds as a part of an overall portfolio, bond duration probably does not matter very much. A little bit out on the yield curve might be a good thought, but it is a legitimate argument that bonds should be short and risk for return taken in stocks. The first step is to understand overall need, ability, and willingness to take risk.

0. PS It might be that CDs and Stable Value funds are a better choice than short bonds right now, but it will be interesting to see how fast that tune changes. Also, if in taxable at a high tax rate, it may be munis are the choice. Building a position in I bonds could be a thought.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by sport »

The problem with going short is that you don't know the timing of any rate increases. You don't know when rates will increase, nor how fast. Meanwhile, you are earning a significantly lower yield. If rates increase soon, going short was the right thing to do. On the other hand, if rates stay low for a while, you are paying a price for being short. I would suggest that since you do not know which scenario will play out, perhaps splitting between short and intermediate may be the most prudent.

Jeff
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Munir
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by Munir »

livesoft wrote:Lots of folks agree with you. Many people went short-term starting already late last year. See, e.g., this poll from March: http://www.bogleheads.org/forum/viewtop ... 1&t=112412

Some prominent "stay-the-course" posters even noted they had exchanged all their intermediate-term TIPS fund shares into the newer short-term TIPS fund shares.

Full disclosure: Based on the linked poll, I went to shorter duration back then as well as I noted in this post: http://www.bogleheads.org/forum/viewtop ... 2#p1638192
In going short term, is the investment grade fund (VFSUX) preferred to the bond index fund (VBIRX) since it has a shorter duration and a higher yield? Moreover, treasuries are supposed to be more sensitive to rising rates than corporates, but corporates have more credit risk. YTD, both of these funds have had a similar performance record.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by dphmd »

I may be wrong, but I think it depends on one's situation. In my case, I'm sticking with intermediate term funds, as I am in the accumulation phase with a 20+ year time horizon.

On the other hand, I am helping revamp my parent's portfolio after some large influxes of cash and have elected to go with short-term funds. They are already retired and are more interested in preserving their capital.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by dbr »

dphmd wrote:I may be wrong, but I think it depends on one's situation. In my case, I'm sticking with intermediate term funds, as I am in the accumulation phase with a 20+ year time horizon.

On the other hand, I am helping revamp my parent's portfolio after some large influxes of cash and have elected to go with short-term funds. They are already retired and are more interested in preserving their capital.
Your parents probably have a balanced portfolio and a life expectancy of 20+ years. Their preference in bonds is most likely not different from yours. If their circumstances are specific to something that dictates short bonds for a good reason, then so be it.

If they are withdrawing money from their portfolio then how well they preserve their capital will depend primarily on how much they withdraw and what luck they have with investment returns and inflation. How they invest will only have a small effect unless they make the mistake of having too little in stocks (such as less than 30% or a little more) or do something stupid such as sell out low in a panic.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by YDNAL »

longview wrote:Muni situation:
.................................................................................. SEC Yield YTD 1 YR....
Intermediate-Term Tax-Exempt Admiral Shares VWIUX 2.63% A –3.87% –1.55% 4.68% 4.22% 4.30%
Limited-Term Tax-Exempt Admiral Shares VMLUX 0.98% A –0.56% 0.16% 2.76% 2.85% 3.16%
Short-Term Tax-Exempt Admiral Shares VWSUX 0.49% A 0.07% 0.39% 1.68% 2.22% 2.42%

So it seems pretty clearly NAV-loss vs yield. If you "know" interest rates are going up where do you put your money? OTOH, the only yield beating inflation is Intermediate. :oops:

Would love to see more discussion on this. Thanks for any and all info. (FWIW, I've been putting my money in VWIUX).
Many things at play:
  1. Presumably you don't need the money in less than 5.6 years (VWIUX duration).
  2. And you accept all other associated risks with Munis.
  3. And you can rebalance with new money and existing Assets in non-Taxable.
  4. And since you "DON'T know" (nor I) where interest rates are going, then what's the problem, longview ??
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dphmd
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by dphmd »

dbr wrote:Your parents probably have a balanced portfolio and a life expectancy of 20+ years. Their preference in bonds is most likely not different from yours. If their circumstances are specific to something that dictates short bonds for a good reason, then so be it.

If they are withdrawing money from their portfolio then how well they preserve their capital will depend primarily on how much they withdraw and what luck they have with investment returns and inflation. How they invest will only have a small effect unless they make the mistake of having too little in stocks (such as less than 30% or a little more) or do something stupid such as sell out low in a panic.
Dad is 93 and Mom is 79 and in poor health (they had kids late in life), so their time horizon is <<20 years. Also, they both grew up during the Great Depression and are highly risk-averse, hence the decision for short-term bonds. Intermediate bonds would probably work fine, but they get really nervous with any drop in value (though they have done well with not reacting). FWIW, their new portfolio is 30% stock (50/50 domestic/international) and 70% bonds.

Honestly, the only real danger to their portfolio is something like a nursing home stay, but asset allocation will not protect against that. I'm just trying to strike a balance between some minor inflation protection and a portfolio that will let them sleep at night.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by garlandwhizzer »

In this bond environment some have moved to a combination of intermediate term, short term, and cash to cover all the bases rather than putting all the eggs into one basket. Cash has zero principal loss but zero return. Short term instruments have less risk of principal loss but lower interest rate returns relative to intermediate term. One thing that almost all agree on at present is reducing long term bond exposure, a class viewed as carrying too much principal risk going forward. At some point in the future due to widespread aversion from long term bonds, they will become undervalued bargains with generous yields and the herd which has galloped away from them will turn and rush back in.



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dbr
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by dbr »

dphmd wrote:
Dad is 93 and Mom is 79 and in poor health (they had kids late in life), so their time horizon is <<20 years. Also, they both grew up during the Great Depression and are highly risk-averse, hence the decision for short-term bonds. Intermediate bonds would probably work fine, but they get really nervous with any drop in value (though they have done well with not reacting). FWIW, their new portfolio is 30% stock (50/50 domestic/international) and 70% bonds.

Honestly, the only real danger to their portfolio is something like a nursing home stay, but asset allocation will not protect against that. I'm just trying to strike a balance between some minor inflation protection and a portfolio that will let them sleep at night.
That is probably very reasonable. You don't say what rate of withdrawal might be going on, as that is the only really important number in this case. CDs could be a good idea as well, depending on how much money is involved and how much managing assets they want to do.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by thx1138 »

The question isn't just will interest rates rise, but how fast will they rise. In a slowly rising environment intermediates will still out perform short term. In a very rapidly rising environment (assuming the yield curve hasn't already anticipated such an environment) short may out perform long.

And the parenthetical above already highlights the invalidity of nearly every Cassandra post on this forum about rising interest rates. Even if you know rates will rise that is insufficient information to choose a duration. You have to know how fast interest rates will rise and you have to somehow know better than the market the rate they will rise at since it is of course the market that sets the yield curve. I've only been on this forum for a short time, but the abject failure of a large proportion of its members to apply the same logic they do to equities to their bond portfolios is frankly amazing to behold. Some yell about the evil Fed tampering with the market as if they are the only people sage enough to realize this is happening, as if the market hasn't already been pricing the taper into the yield curve. (And of course not everyone here falls victim to this, there is plenty of steady and sound bond logic to be found too).

Now - one thing that is true of a bond allocation is a greater variety of non-marketable securities being available to individual investors. Things like savings bonds, various CDs and savings accounts, TSP G Fund, and in some 401k plans a SVF. These in fact may be better alternatives to certain marketable bond products and the advantage exists precisely because they are non-marketable. It is paramount to keep these two issues separate in your head - substituting an advantageous non-marketable security for a particular marketable bond is a completely different prospect than tinkering with your duration and credit exposure in marketable bond funds. The former is potentially a wise thing to do, the later is just as silly as any other form of market timing.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by dphmd »

thx1138 wrote:The question isn't just will interest rates rise, but how fast will they rise. In a slowly rising environment intermediates will still out perform short term. In a very rapidly rising environment (assuming the yield curve hasn't already anticipated such an environment) short may out perform long.

And the parenthetical above already highlights the invalidity of nearly every Cassandra post on this forum about rising interest rates. Even if you know rates will rise that is insufficient information to choose a duration. You have to know how fast interest rates will rise and you have to somehow know better than the market the rate they will rise at since it is of course the market that sets the yield curve. I've only been on this forum for a short time, but the abject failure of a large proportion of its members to apply the same logic they do to equities to their bond portfolios is frankly amazing to behold. Some yell about the evil Fed tampering with the market as if they are the only people sage enough to realize this is happening, as if the market hasn't already been pricing the taper into the yield curve. (And of course not everyone here falls victim to this, there is plenty of steady and sound bond logic to be found too).

Now - one thing that is true of a bond allocation is a greater variety of non-marketable securities being available to individual investors. Things like savings bonds, various CDs and savings accounts, TSP G Fund, and in some 401k plans a SVF. These in fact may be better alternatives to certain marketable bond products and the advantage exists precisely because they are non-marketable. It is paramount to keep these two issues separate in your head - substituting an advantageous non-marketable security for a particular marketable bond is a completely different prospect than tinkering with your duration and credit exposure in marketable bond funds. The former is potentially a wise thing to do, the later is just as silly as any other form of market timing.
I'm certainly no expert, though I generally agree with your post. That said, much like bear markets have a tendency to reveal an individual's true risk tolerance for stocks, the specter of a rate hike may be causing some individuals to rethink their risk tolerance for bonds. Intermediates may outperform, but only if you don't panic and sell at the bottom of the market, so just like with stocks it's important to decide where one's risk tolerance lies and adjust one's asset allocation accordingly.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by placeholder »

thx1138 wrote:highlights the invalidity of nearly every Cassandra post
I never believe Cassandra posts.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by thx1138 »

dphmd wrote: I'm certainly no expert, though I generally agree with your post. That said, much like bear markets have a tendency to reveal an individual's true risk tolerance for stocks, the specter of a rate hike may be causing some individuals to rethink their risk tolerance for bonds. Intermediates may outperform, but only if you don't panic and sell at the bottom of the market, so just like with stocks it's important to decide where one's risk tolerance lies and adjust one's asset allocation accordingly.
That's an excellent point - and I wasn't here to observe the 2008 panic and perhaps a similar re-evaluation on the equities side.

And I suppose to your point shortening duration would be a sensible reaction to deciding one prefers less risk in their bond portfolio and is certainly a far more sensible reaction than the opposite "chasing yield" behavior that is also prevalent in a low yield environment.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by livesoft »

Munir wrote:In going short term, is the investment grade fund (VFSUX) preferred to the bond index fund (VBIRX) since it has a shorter duration and a higher yield? Moreover, treasuries are supposed to be more sensitive to rising rates than corporates, but corporates have more credit risk. YTD, both of these funds have had a similar performance record.
Individuals may prefer any of the 4 or 5 Vanguard short-term bond funds based on the risk each of these funds presents and other factors.

For example, you have corporate index, investment grade, index, Treasury, and TIPS. There may be more. You have ETFs, actively-managed, and index funds. Some of the Admiral share class require $50K minimum and some $10K minimum. So there is no one single preferred fund for everybody.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by nisiprius »

The phrase "rising rate environment" isn't a very good one. It is heavily freighted with assumptions--that we are in some kind of stable, known, predictable trend. We don't know that.

What we do know is that interest rates have risen recently

Image

and in response bond funds such as Vanguard Total Bond Index Fund have fallen about 4% since May.

What happens in the future--how much farther interest rates might rise, how much farther intermediate-term high-grade bond funds might fall--nobody knows. It is not cut and dried, it is not certain. I know a lot of people are talking very confidently about the future for bonds but they are blowing smoke; they don't know.

Shortening the term reduces interest rate risk--shown by Vanguard Short-Term Bond Index dropping only 1% since May--

Image

but, of course, that is at the cost of lower long-term return.

Image

So there's no magic answer, it's just a straight risk/reward choice. Money market funds have no interest rate risk at all--and for the last few years, very close to zero return.

Some posters on this forum, notably tfb and kevin m, have made out a good case for bank CDs as being good alternatives to bond index funds, and this is definitely a possibility to be considered.

I happen to be sticking to the bonds I've held all along, not because I am convinced this is going to beat out other choices, but because I am pretty sure that nothing all that terrible is going to happen. The high-grade bonds in Vanguard Total Intermediate will approach their par value as they approach maturity. It may well turn out in hindsight that some other choice did better--or maybe not--but I think the stuff I'm holding now will do well enough.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by Munir »

I don't understand that statements that say no one knows anything on how interest rates will trend in the near or distant future, and that everything is already priced in the current values since the market is wiser than all of us. Then what's the use of making any decisions about investments since it's all que sera sera? The facts are that some people will be making money and others losing it. How do we choose sides :happy ?
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by Kevin M »

If you have a choice (i.e., outside of an employer sponsored retirement plan), I see no compelling reason to own a short-term bond fund rather than a good, directly-purchased CD.

SEC yield on the short-term treasury fund is 0.27%, while you can get 1.5% - 2% on a CD with an early withdrawal penalty (EWP) of 60 days to 180 days of interest.

To get a higher yield in short-term bonds, you have to take credit risk, and even then, SEC yield on short-term bond index fund is only 0.82% (admiral shares).

SEC yield on limited-term tax-exempt is 0.9%, so the after-tax yield on a 2% CD still is higher (although the distribution yield of LT TE is quite a bit higher, and has remained quite a bit higher for quite a long time). Of course you still have some interest-rate risk (and credit risk) with this fund, which has shown up lately as pretty close to 0% return for the past year.

So, I prefer direct CDs to short-term bond funds to mitigate interest-rate risk, and would rather take more interest-rate and credit risk for the higher yields in my bond funds, ala intermediate-term investment-grade and tax-exempt funds.

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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by Munir »

If one doesn't want the hassles of owning direct CDs, especially in an IRA, check the short term investment grade fund (VFSUX) with an SEC yield of 1.6% , duration of 2.4 years and ER of 0.1%.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by YDNAL »

Munir wrote:If one doesn't want the hassles of owning direct CDs, especially in an IRA, check the short term investment grade fund (VFSUX) with an SEC yield of 1.6% , duration of 2.4 years and ER of 0.1%.
Unlike CDs, VFSUX is not only exposed to interest rate risk, but exposed to credit risk as well, and you need $50K for that ER.

Code: Select all

Distribution (partial) by Credit Quality:
A2  13.5% 
A3  14.5% 
Baa1 7.0% 
Baa2 7.0% 
Baa3 4.7%
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by cflannagan »

YDNAL wrote:
Munir wrote:If one doesn't want the hassles of owning direct CDs, especially in an IRA, check the short term investment grade fund (VFSUX) with an SEC yield of 1.6% , duration of 2.4 years and ER of 0.1%.
Unlike CDs, VFSUX is not only exposed to interest rate risk, but exposed to credit risk as well, and you need $50K for that ER.

Code: Select all

Distribution (partial) by Credit Quality:
A2  13.5% 
A3  14.5% 
Baa1 7.0% 
Baa2 7.0% 
Baa3 4.7%
There are no true free lunches, but CDs come closest right now.
See nothing wrong with the credit quality there. Not everyone can have "perfect credit rating". Higher yields comes from those slighter-less-than-perfect credit ratings.

And because one is not invested into individual bonds when invested in a bond fund, but rather, many bonds over a range of the credit quality spectrum, one shouldn't really be worried about credit quality especially when those are "investment grade".
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by ruralavalon »

For years everyone has been predicting rising rates, and it will happen someday.

We are holding intermediate term bonds.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by longview »

YDNAL wrote: Many things at play:
  1. Presumably you don't need the money in less than 5.6 years (VWIUX duration).
  2. And you accept all other associated risks with Munis.
  3. And you can rebalance with new money and existing Assets in non-Taxable.
  4. And since you "DON'T know" (nor I) where interest rates are going, then what's the problem, longview ??
Well, I am early retiring -- so maybe I need to change my handle. ;) So, faced with the possibility of needing to transition money out in the next couple of years, principal loss has taken on some added pressure for me. But I admit there is also a market timing element -- or at least an element of not considering the return on intermediate worth the near-term principal loss. I could be wrong in the near term -- but that's the same kind of "wrong" that comes from having a small equity exposure. I am still "mostly" intermediate term.

You mention muni risk, but I do consider those pretty risk-free (relative to equity risk)... I consider it impossible/too-big-too-fail for a large percentage of the vanguard muni fund to default. If there were a good intermediate pre-funded muni fund I'd probably go with it.
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by longview »

Kevin M wrote:If you have a choice (i.e., outside of an employer sponsored retirement plan), I see no compelling reason to own a short-term bond fund rather than a good, directly-purchased CD.
...
SEC yield on limited-term tax-exempt is 0.9%, so the after-tax yield on a 2% CD still is higher
I just went to depositaccounts.com, CD-Rates, 2-Years the top is 1.3%. 3-years 1.5% (1.7% with active checking, so that doesn't scale). Limit-Term Tax-Exempt is average duration 2.5 years, with .99 SEC, so ~1.52% after tax. So the 3-year CD is < 1% after-tax, vs Limited-Term 1.52% after-tax. So I still don't think it's fair to say CDs are better for people in the top tax bracket.

If you aren't in the top tax bracket, or you aren't all in taxable, then that's a different story.
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by longview »

One more thought/question for those that call all this so much pure market timing:

- There is the issue that NAV responds proportional to the change in interest rates, not the percentage change in interest rates. ie, if rates go from 1%->2%, it's similar to if they go from 9%->10%.

- But in the case of 9%->10%, the NAV loss is regained much quicker since you're getting 10%... vs the case where you are getting 2% (but you are trying to recover an ~equivalent loss). Let's call this NAV-recoverability.

So, what is really going on, is limiting downside (and upside) until rates increase a bit and enter a zone where NAV-recoverability is higher.

Or so my introspection/rationalization leads me to believe. Please let me know if there is a flaw there.
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by billyt »

I don't know how many times this needs to be repeated. NAV changes have no impact on your long term returns. The best predictor of your long term returns is the yield of the fund when you buy the shares. NAV just goes up and down over a limited range that is related to the duration. Bond fund NAV's did not continuously increase over the last 30 years of falling rates, and they are not going to continuously decrease in the face of rising rates if that comes to pass. If you are accumulating over 20 years and decumulating over 20 years, NAV changes will average out to near zero, and have negligible impact on your returns. Almost all of your bond fund return comes from the interest, which is why low interest rates are a big problem. Default and inflation are legitimate things to worry about for your bond funds, NAV changes are not, if you are a long term investor. You are going to earn the average of the interest rates over your investing lifetime. Shortening the duration, unless you need the money in the short term, will do nothing but reduce your returns. If you are a bond market genius, and know exactly what the rates and the shape of the yield curve will be in advance, better than all the other bond market experts, then you might make a small amount of extra money. It is not worth the effort.

NAV changes might be a consideration if you are going to withdraw all of your bond fund money all at once at some specific future date. Then, you will want to shorten duration as the day of reckoning approaches. This is the only situation where NAV changes should be a concern.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by YDNAL »

cflannagan wrote:
YDNAL wrote:
Munir wrote:If one doesn't want the hassles of owning direct CDs, especially in an IRA, check the short term investment grade fund (VFSUX) with an SEC yield of 1.6% , duration of 2.4 years and ER of 0.1%.
Unlike CDs, VFSUX is not only exposed to interest rate risk, but exposed to credit risk as well, and you need $50K for that ER.

Code: Select all

Distribution (partial) by Credit Quality:
A2  13.5% 
A3  14.5% 
Baa1 7.0% 
Baa2 7.0% 
Baa3 4.7%
See nothing wrong with the credit quality there. Not everyone can have "perfect credit rating"....
No one said there is anything "wrong" (subject to opinion), just that ~50% of holdings are below 'A' rating and there's added credit risk.
cflannagan wrote:Higher yields comes from those slighter-less-than-perfect credit ratings.
And.... that is EXACTLY the point made to poster Munir.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by IlliniDave »

I'm no expert on bonds. I really don't consider the direction of interest rates. My horizon is relatively long, full retirement in 15 years, so for what I consider my "investment" bonds I've stuck with and continue to buy intermediate-term bond funds. The backup layer of my emergency fund I keep in short-term bond funds. At some point I'll probably considering lengthening the term of those, when my total invested assets hit a certain threshold. At some point staving off inflation over time will be more important than short-term NAV fluctuations.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by YDNAL »

longview wrote:
YDNAL wrote:Many things at play:
  1. Presumably you don't need the money in less than 5.6 years (VWIUX duration).
  2. And you accept all other associated risks with Munis.
  3. And you can rebalance with new money and existing Assets in non-Taxable.
  4. And since you "DON'T know" (nor I) where interest rates are going, then what's the problem, longview ??
Well, I am early retiring -- so maybe I need to change my handle. ;)
"Shorthandle" :?: LOL
So, faced with the possibility of needing to transition money out in the next couple of years, principal loss has taken on some added pressure for me. But I admit there is also a market timing element -- or at least an element of not considering the return on intermediate worth the near-term principal loss. I could be wrong in the near term -- but that's the same kind of "wrong" that comes from having a small equity exposure. I am still "mostly" intermediate term.

You mention muni risk, but I do consider those pretty risk-free (relative to equity risk)... I consider it impossible/too-big-too-fail for a large percentage of the vanguard muni fund to default. If there were a good intermediate pre-funded muni fund I'd probably go with it.
Capital preservation is quite important during withdrawal phase.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by rkhusky »

nisiprius wrote:
I happen to be sticking to the bonds I've held all along, not because I am convinced this is going to beat out other choices, but because I am pretty sure that nothing all that terrible is going to happen. The high-grade bonds in Vanguard Total Intermediate will approach their par value as they approach maturity. It may well turn out in hindsight that some other choice did better--or maybe not--but I think the stuff I'm holding now will do well enough.
Bond funds have a healthy turnover and, in order to maintain the duration distribution, usually don't hold their bonds to maturity (especially the intermediate and long term funds).
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by ogd »

longview wrote:One more thought/question for those that call all this so much pure market timing:

- There is the issue that NAV responds proportional to the change in interest rates, not the percentage change in interest rates. ie, if rates go from 1%->2%, it's similar to if they go from 9%->10%.

- But in the case of 9%->10%, the NAV loss is regained much quicker since you're getting 10%... vs the case where you are getting 2% (but you are trying to recover an ~equivalent loss). Let's call this NAV-recoverability.

So, what is really going on, is limiting downside (and upside) until rates increase a bit and enter a zone where NAV-recoverability is higher.

Or so my introspection/rationalization leads me to believe. Please let me know if there is a flaw there.
longview: while it's true that bonds will recover the NAV loss faster at higher yields, this is true of any absolute point of return: at 10% yield you get there faster, whether +50% or +0%.

If, instead, you express the expectation to be relative to the initial yield -- how fast will my bond fund absorb the NAV loss as if it hadn't happened, meaning I get the initially promised yield -- then the recovery time is actually independent of the initial yield. It is equal to the fund duration (this is called the point of indifference).

Yes, you are just rationalizing. It's a bad habit to "discover your risk tolerance" or "understand the true risk of your investments" right after a large loss. Well, to be precise, it's a bad habit to act on it. In the stocks world, this has lead to people still waiting for "the stock market to stabilize" after selling out in March 2009.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by ogd »

rkhusky wrote:
nisiprius wrote:
I happen to be sticking to the bonds I've held all along, not because I am convinced this is going to beat out other choices, but because I am pretty sure that nothing all that terrible is going to happen. The high-grade bonds in Vanguard Total Intermediate will approach their par value as they approach maturity. It may well turn out in hindsight that some other choice did better--or maybe not--but I think the stuff I'm holding now will do well enough.
Bond funds have a healthy turnover and, in order to maintain the duration distribution, usually don't hold their bonds to maturity (especially the intermediate and long term funds).
Nevertheless, the bonds in the fund advance towards maturity at the steady aggregate pace of 1 year per year :) Principal recovery occurs throughout the lifetime of the bond; in fact, it's more pronounced in the earlier years.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by longview »

ogd wrote: longview: while it's true that bonds will recover the NAV loss faster at higher yields, this is true of any absolute point of return: at 10% yield you get there faster, whether +50% or +0%.

If, instead, you express the expectation to be relative to the initial yield -- how fast will my bond fund absorb the NAV loss as if it hadn't happened, meaning I get the initially promised yield -- then the recovery time is actually independent of the initial yield. It is equal to the fund duration (this is called the point of indifference).

Yes, you are just rationalizing. It's a bad habit to "discover your risk tolerance" or "understand the true risk of your investments" right after a large loss. Well, to be precise, it's a bad habit to act on it. In the stocks world, this has lead to people still waiting for "the stock market to stabilize" after selling out in March 2009.
Well said. I think it's natural for people to have more of an aversion to NAV-loss in their safe investment than they would have an aversion to a lower yield in their safe investment. And that is basically the difference between starting at record low rates, or higher rates. Technically, if you aren't selling and are reinvesting, there really isn't a difference though.

As for discovering the risk tolerance... to be fair I was aware and wary of this going in, which is why I've been DCAing my lump sum. ;) In my dream world my FI is maximally safe and tax-free, interest rates are high, and my chunk of equities is a roller coaster with an upward trajectory. :beer I wouldn't say I'm risk averse, I'd say I want all my risk in equities and outside investments.
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by ogd »

longview: the self-doubting is only human, the key is to learn not to act rashly on it.

FYI I'm in the same boat with you, when it comes to taxable bonds, and frankly I'm worried about doing the opposite: I find VCLAX (long-term CA munis) absolutely irresistible right now, at 7.5% pretax-equivalent yield (Cali brackets are what they are). Trying hard to resist pumping more (new) money in there. The voice of reason reminds me that I don't like what munis do when the economy goes south. The voice of greed is on the verge of winning right now.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by Kevin M »

ruralavalon wrote:For years everyone has been predicting rising rates, and it will happen someday.

We are holding intermediate term bonds.
It already has been happening. 10-year treasury hit a low of 1.43% in July last year, and as of yesterday was 2.86%--that's a 100% increase.

For me, the issue doesn't involve predicting changes in rates, but how much of what types of risk you want to take relative to the expected returns.

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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by Kevin M »

longview wrote:
Kevin M wrote:If you have a choice (i.e., outside of an employer sponsored retirement plan), I see no compelling reason to own a short-term bond fund rather than a good, directly-purchased CD.
...
SEC yield on limited-term tax-exempt is 0.9%, so the after-tax yield on a 2% CD still is higher
I just went to depositaccounts.com, CD-Rates, 2-Years the top is 1.3%. 3-years 1.5% (1.7% with active checking, so that doesn't scale). Limit-Term Tax-Exempt is average duration 2.5 years, with .99 SEC, so ~1.52% after tax. So the 3-year CD is < 1% after-tax, vs Limited-Term 1.52% after-tax. So I still don't think it's fair to say CDs are better for people in the top tax bracket.

If you aren't in the top tax bracket, or you aren't all in taxable, then that's a different story.
I don't pay much attention to CDs with maturities of less than five years since the early withdrawal option usually makes a 5-year CD a better deal. That's why I used the 2% 5-year CD with an EWP of 180 days of interest as a comparison (and why I actually sold all of my Limited Term TE to buy a 5-year CD last year). For this CD, your downside risk is limited to 1%. With a duration of 2.5, a rate increase of one percentage point results in a loss of 2.5%. So, more risk, lower after-tax yield.

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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by longview »

Kevin M wrote: I don't pay much attention to CDs with maturities of less than five years since the early withdrawal option usually makes a 5-year CD a better deal. That's why I used the 2% 5-year CD with an EWP of 180 days of interest as a comparison (and why I actually sold all of my Limited Term TE to buy a 5-year CD last year). For this CD, your downside risk is limited to 1%. With a duration of 2.5, a rate increase of one percentage point results in a loss of 2.5%. So, more risk, lower after-tax yield.

Kevin
I gotcha. Even still, 2% at top rate is 1.3% after-tax (even lower if you take into account state tax). Meanwhile, limited-term is .99% SEC, 1.52% after-tax (more counting state). So, you are still getting paid a premium in the high tax bracket to avoid CDs right now.
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by nisiprius »

rkhusky wrote:
nisiprius wrote:
I happen to be sticking to the bonds I've held all along, not because I am convinced this is going to beat out other choices, but because I am pretty sure that nothing all that terrible is going to happen. The high-grade bonds in Vanguard Total Intermediate will approach their par value as they approach maturity. It may well turn out in hindsight that some other choice did better--or maybe not--but I think the stuff I'm holding now will do well enough.
Bond funds have a healthy turnover and, in order to maintain the duration distribution, usually don't hold their bonds to maturity (especially the intermediate and long term funds).
Yes, but if there is anyone with real insight into what bond funds actually do, and what the management strategy is, they haven't been posting in this forum. (And it's not in Thau's "The Bond Book," and it's not in Fabrozzi's "Handbook of Fixed Income," or at least I haven't been able to find it.). I don't think that this changes things much, except to add a dollop of manager risk to the equation.

The central fact, which is different for bonds than it is for stocks, is that there is a fixed principal value, even though it is locked inside the bond and can't be released until maturity, and that--barring default, which is reasonable to do for high-grade bonds--everyone knows that value to the penny, and the moment it will be released to the day. So the market value is attached by a Bungee cord that is anchored at one end to that fixed point. This is just plain different from stocks.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by rkhusky »

nisiprius wrote:
rkhusky wrote:
nisiprius wrote:
I happen to be sticking to the bonds I've held all along, not because I am convinced this is going to beat out other choices, but because I am pretty sure that nothing all that terrible is going to happen. The high-grade bonds in Vanguard Total Intermediate will approach their par value as they approach maturity. It may well turn out in hindsight that some other choice did better--or maybe not--but I think the stuff I'm holding now will do well enough.
Bond funds have a healthy turnover and, in order to maintain the duration distribution, usually don't hold their bonds to maturity (especially the intermediate and long term funds).
Yes, but if there is anyone with real insight into what bond funds actually do, and what the management strategy is, they haven't been posting in this forum. (And it's not in Thau's "The Bond Book," and it's not in Fabrozzi's "Handbook of Fixed Income," or at least I haven't been able to find it.). I don't think that this changes things much, except to add a dollop of manager risk to the equation.

The central fact, which is different for bonds than it is for stocks, is that there is a fixed principal value, even though it is locked inside the bond and can't be released until maturity, and that--barring default, which is reasonable to do for high-grade bonds--everyone knows that value to the penny, and the moment it will be released to the day. So the market value is attached by a Bungee cord that is anchored at one end to that fixed point. This is just plain different from stocks.
It seems like stocks should also have a floor to them based on the amount of cash and other hard assets they have, which varies greatly on the industry.

Bond funds would be looked at quite differently if there were wild swings in interest rates over short periods of time, like there can be for stocks.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by Phineas J. Whoopee »

placeholder wrote:
thx1138 wrote:highlights the invalidity of nearly every Cassandra post
I never believe Cassandra posts.
Good one!
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by Phineas J. Whoopee »

rkhusky wrote:...
It seems like stocks should also have a floor to them based on the amount of cash and other hard assets they have, which varies greatly on the industry.
...
Indeed, there is often press about stocks which are trading below book. Investors from time to time vote with their dollars that a business's prospects are it will likely destroy value.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by Ged »

I'm in the process of transitioning from working to retirement - I'm leaving my job by the end of this year if not the end of this month, and my wife will be retiring in a year or so. After she retires we will be converting a lot of our tIRAs to Roth. So we will be selling a lot of stuff.

I'm short on my bonds based not so much on planning but just from reading somewhere that the risk/return for intermediate was questionable. Now that I'm here though it seems to be a good place to be given what we are going to be doing in the near term.

The funds that remain in my tIRA will be used either to pay LTC or go into my legacy. So after I convert I'll probably go to intermediate bonds.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by Kevin M »

longview wrote:
Kevin M wrote: I don't pay much attention to CDs with maturities of less than five years since the early withdrawal option usually makes a 5-year CD a better deal. That's why I used the 2% 5-year CD with an EWP of 180 days of interest as a comparison (and why I actually sold all of my Limited Term TE to buy a 5-year CD last year). For this CD, your downside risk is limited to 1%. With a duration of 2.5, a rate increase of one percentage point results in a loss of 2.5%. So, more risk, lower after-tax yield.

Kevin
I gotcha. Even still, 2% at top rate is 1.3% after-tax (even lower if you take into account state tax). Meanwhile, limited-term is .99% SEC, 1.52% after-tax (more counting state). So, you are still getting paid a premium in the high tax bracket to avoid CDs right now.
No! You are double-counting the tax savings. The yield on a TE fund is the after-tax yield, not including state taxes, so about 1% for LT TE for SEC yield. Also, there is no state tax benefit for the national muni funds--at least not in my state of CA, for which the fund must have at least 50% of its assets in CA to provide any tax benefit. The Vanguard CA TE funds are the only ones that qualiify. So the after-tax yield of LT TE is actually lower than the distribution yield in a state like CA.

I think the only thing that supports using Limited Term TE over CDs is that the distribution yield is much higher than the SEC yield (most recently 1.66%/1.74% (investor/admiral)), and has been consistently so for a very long time. There doesn't seem to be the convergence of distribution yield and SEC yield that one would expect over a couple of years in a fund of such short duration. On the other hand, you still have the interest rate risk, which recently has manifested as a YTD return of -0.7% and a one-year return of -0.3%.

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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by longview »

Kevin M wrote: No! You are double-counting the tax savings. The yield on a TE fund is the after-tax yield, not including state taxes, so about 1% for LT TE for SEC yield. ...

I think the only thing that supports using Limited Term TE over CDs is that the distribution yield is much higher than the SEC yield (most recently 1.66%/1.74% (investor/admiral)), and has been consistently so for a very long time. There doesn't seem to be the convergence of distribution yield and SEC yield that one would expect over a couple of years in a fund of such short duration. On the other hand, you still have the interest rate risk, which recently has manifested as a YTD return of -0.7% and a one-year return of -0.3%.
Kevin
:oops: Yep, you're right. Intermediate wins, but not Limited Term. Why is the distribution yield not going to SEC yield on limited?

Regarding CDs, in another thread I saw the issue that many banks (ie, Ally) have in their small print that they don't need to let you early redeem -- which would really hurt if interest rates spiked quickly and you had a few million in 5-year CDs. Seems like the other side of the interest-rate-risk coin. Thoughts on that? And, somewhat related, is FDIC insurance on CDs per CD or per person/per bank -- because when talking about big numbers it becomes very annoying to spread a bunch of CD buckets around a bunch of banks.

Thanks for the correction.
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by Kevin M »

longview wrote: Regarding CDs, in another thread I saw the issue that many banks (ie, Ally) have in their small print that they don't need to let you early redeem -- which would really hurt if interest rates spiked quickly and you had a few million in 5-year CDs. Seems like the other side of the interest-rate-risk coin. Thoughts on that?
Yes, there often is such a term, like you may do an early withdrawal with their permission. There also is often a term that allows them to change the terms, so they could always use that loophole. Personally, I don't worry much about it, but even if they were to disallow an early withdrawal, CDs are better than treasuries of comparable maturity as long as the rates are higher, which they still are, and if liquidity isn't an issue for your CD holdings. For good direct CDs this is true up to maturities of 5 years, and it's true for some brokered CDs of longer maturities. To get higher yield for comparable maturity, you must take some credit risk.
longview wrote:And, somewhat related, is FDIC insurance on CDs per CD or per person/per bank -- because when talking about big numbers it becomes very annoying to spread a bunch of CD buckets around a bunch of banks.
It's per ownership category per institution. So I have all my taxable CDs and savings held as POD or in trust for four beneficiaries, so total insurance for all accounts held in the POD/trust ownership category is $1M. Then I get another $250K coverage for an IRA account, since that's a different ownership category. I could get more if I wanted to hold an individual account or a joint account, but I don't for probate-avoidance purposes.

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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by sport »

Kevin M wrote:It's per ownership category per institution. So I have all my taxable CDs and savings held as POD or in trust for four beneficiaries, so total insurance for all accounts held in the POD/trust ownership category is $1M. Then I get another $250K coverage for an IRA account, since that's a different ownership category. I could get more if I wanted to hold an individual account or a joint account, but I don't for probate-avoidance purposes.

Kevin
Kevin,
What if an FDIC account is in a revocable trust, and the trust names a spouse as successor trustee and two children as secondary trustees. Is the FDIC limit 250K, 500K, or 1M?
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by Kevin M »

jsl11 wrote: Kevin,
What if an FDIC account is in a revocable trust, and the trust names a spouse as successor trustee and two children as secondary trustees. Is the FDIC limit 250K, 500K, or 1M?
Jeff
It's not the trustees or successor trustees that matter--it's the beneficiaries. The trustees are responsible for administering the trust; the beneficiaries are the ones who inherit the trust assets. Of course they could be some of the same people. In my case, I am the trustee, and two of my four beneficiaries are co-successor trustees. It's the four beneficiaries that gets me the $1M in coverage.

In the case of alternate beneficiaries, I don't know the answer, but I assume only the primary beneficiaries would count unless one of them died before you died. You can read what the FDIC says about it here: FDIC: Your Insured Deposits, and as they say, if you have questions, you can contact them.

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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by Jebediah »

Does swapping out one's Intermediate bonds for short bonds or CDs now count as A) TLHing or B) 'selling low'? I'm curious what people think.
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Re: Short Terms vs Intermediate in Rising Rate Environment??

Post by livesoft »

Jebediah wrote:Does swapping out one's Intermediate bonds for short bonds or CDs now count as TLHing or 'selling low'? I'm curious what people think.
That's selling low in my book. Or more properly: "Strange" because one shouldn't have bonds in taxable anyways, so one cannot TLH them.

OTOH, if you have munis in taxable, then I'd try to stick to the same duration at this point.
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