"Get out of bond funds"

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ogd
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Re: "Get out of bond funds"

Post by ogd »

fd -- yes it's accurate, though the numbers are slightly off if we're still talking about a 5% / 7% scenario.

You must resist the temptation to go back to talk of "interest" and simplifications that deal with only the $2500 (which I will resist responding to). There is no interest and bond values are all that matter.

The pricing is like this: a $100 5yr zero coupon at 5% market yields costs $78.35. At 7% yields, it costs $71.30.

Once you run through the scenario, you will notice that inflows bring in a proportional number of bonds exactly identical to the bonds already in the fund, i.e. bonds maturing in 5 years worth $71.30 each. Therefore nothing changes per fund share.

The same happens with coupon bonds, although the math is a little harder and the bonds are superficially different from one another. Inflows don't matter, either to the existing investors or (another consequence of your overly simplified model) to the new investors, which don't see the 7% they're entitled to by market yields diluted by having to split it with the schmucks that bought in at 5%. Neither do outflows, or any kind of moves between bond funds depending on inflows and outflows. Which, of course, makes complete sense.
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Re: "Get out of bond funds"

Post by FinancialDave »

ogd wrote:fd -- yes it's accurate, though the numbers are slightly off if we're still talking about a 5% / 7% scenario.

You must resist the temptation to go back to talk of "interest" and simplifications that deal with only the $2500 (which I will resist responding to). There is no interest and bond values are all that matter.

The pricing is like this: a $100 5yr zero coupon at 5% market yields costs $78.35. At 7% yields, it costs $71.30.

Once you run through the scenario, you will notice that inflows bring in a proportional number of bonds exactly identical to the bonds already in the fund, i.e. bonds maturing in 5 years worth $71.30 each. Therefore nothing changes per fund share.
Ok, I'll resist talking interest if you resist talking bond "funds." I circle back to the funds later.

Investor 1 buys a 5% zero coupon for $78.35 at current rates. In 5 years he gets back $100 no matter where interest rates go.
Later in the day Investor #1 get's an inheritance of $71.30. (This is an inflow if you don't recognize it.) Before investor #1 can invest it, rates jump up so his new zero only costs $71.30. He buys the new zero. Rates go to 10%, but at the end of 5 years investor 1 still only has $200.

Investor 1 has improved his 5% return with the inflow of $71.30 to an actual return of 5.97%. If he has no inflow his return over the next 5 years is destined to be 5%, no matter where interest rates go.

Hopefully, you can agree to the above - I think it is just "bond basics."

If you can then just change the name of investor 1 to FD's intermediate bond fund, which either owns the one zero coupon bond, or get's some inflows to buy a second bond at a better rate.

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Re: "Get out of bond funds"

Post by ogd »

Well, of course he has. He invested new money at higher market yields. Good for him.

But look at the situation after the interest rate rise. The old money is due to make $100 on their current valuation $71.30. The new money is due to make ... $100 on $71.30. There is no difference between the old money and the new money. Their proportion doesn't matter. You could add a huge chunk of new money and it would make no difference, or you could have had much more old money and still no difference.

Yes, if you are both and old investor and a new investor, you'll make more money. If you are one or the other, it doesn't matter, you make as much money by joining a fund as you would by staying separate.
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Re: "Get out of bond funds"

Post by FinancialDave »

ogd wrote:Well, of course he has. He invested new money at higher market yields. Good for him.

The new money is due to make ... $100 on $71.30. There is no difference between the old money and the new money. Their proportion doesn't matter. You could add a huge chunk of new money and it would make no difference, or you could have had much more old money and still no difference.

Yes, if you are both and old investor and a new investor, you'll make more money. If you are one or the other, it doesn't matter, you make as much money by joining a fund as you would by staying separate.
You are really so close I can't give up now -- your problem is embedded in thinking like a bond fund investor rather that the bond fund manager - which in my case equals the investor #1.

<But look at the situation after the interest rate rise. The old money is due to make $100 on their current valuation $71.30>

Here you are thinking in terms of yield rather than the total return on the zero coupon, and you are thinking in terms of a bond fund not the bonds themselves -- the investor did NOT buy the zero coupon at 71.30, he paid $78.35 for it, just because the value he can sell it for is 71.30, makes no difference to him, because he is not going to sell it, as it won't help him to lose 10% of his investment.

The point is very simple - Once the zero is purchased the return on that investment is locked in - you can quote whatever yield to maturity you want to based on what the daily rates turn out to be, but it won't help out the investor, who above is going to get $100.

What you seem to be missing above in your old and new money "being equal" explanation, is that one investor lost 10% of his original investment on day 1 when the value of the investment dropped from $78.35 to $71.30. Investor #2 had no such problem with his "new" money, so his return is going to be much better. In this particular case - the "old money" investor makes a return of 5% on his money and the "new money" investor makes 7% return on his money. This is if they buy separate bonds.

Just to circle back to my point - which still is if no new money comes into a fund, there will be no change in the return over the 5 years in this simplified nominal bond fund scenario.

Instead of an investor we have a bond fund manager who buys the above bond for $78.35, puts it in his fund as 1 share and investor 1 comes along a buys the 1 share at cost for $78.35. If no one else decides to participate in this bond fund (no inflow) the return at the end of 5 years is going to be 5% on this zero no matter what yields on the fund look like on a day to day basis.

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Re: "Get out of bond funds"

Post by ogd »

FinancialDave wrote:Here you are thinking in terms of yield rather than the total return on the zero coupon, and you are thinking in terms of a bond fund not the bonds themselves -- the investor did NOT buy the zero coupon at 71.30, he paid $78.35 for it, just because the value he can sell it for is 71.30, makes no difference to him, because he is not going to sell it, as it won't help him to lose 10% of his investment.
No. The price that matters is the 71.30. This is the price at which new money comes in and the price at which the fund shares get divided up. It's the price that we're talking about, at which new inflows make a difference or not. The 78.35 is old news and no longer matters for anything other than the feelings of the old fund investors.

But listen, enough is enough. This discussion has been going nowhere for a while now. I've presented an example that I consider clear as day and reasonably complete in my post above, http://www.bogleheads.org/forum/viewtop ... 0#p2059475 , showing how old investors make the same return whether new investors come in or not. It needs no further simplification, what it needs is a 10 minute effort to understand rather than reframe endlessly. Your model is invalid and it leads to the preposterous conclusion that after interest rate moves one should choose and exchange bond funds depending on their net inflows or outflows, a conclusion that everyone who knows bonds will tell you is wrong.

That's all I have left to say on the topic. Good luck.
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Re: "Get out of bond funds"

Post by Doc »

I'm not following this thread very closely but try this thought process.

You own a fund and the market interest rate changes so the NAV of the fund changes in the opposite direction.

Along comes a new investor and he buys some of the fund at the current NAV. The fund has to go out and buy more bonds for the new investor but these new bonds also reflect the market and therefore the new bonds are bought at the same NAV as the fund had before the purchase.

The new investor's purchase has no effect on the NAV of the fund and therefore has no effect on your future gains.
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FinancialDave
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Re: "Get out of bond funds"

Post by FinancialDave »

ogd wrote:

No. The price that matters is the 71.30. This is the price at which new money comes in and the price at which the fund shares get divided up. It's the price that we're talking about, at which new inflows make a difference or not. The 78.35 is old news and no longer matters for anything other than the feelings of the old fund investors.

showing how old investors make the same return whether new investors come in or not. It needs no further simplification, what it needs is a 10 minute effort to understand rather than reframe endlessly. Your model is invalid and it leads to the preposterous conclusion that after interest rate moves one should choose and exchange bond funds depending on their net inflows or outflows, a conclusion that everyone who knows bonds will tell you is wrong.

I agree, and I think I know why this has been going nowhere for 3 days now - it is this:
ogd, This all means that inflows and outflows don't matter for a fund's returns
Let me close this example to anyone who is still listening with the concrete 5 year "return" numbers for all involved in my simple 2 share FD bond fund that was built in the following way with two 5 year zero coupon bonds:
All transactions took place on day 1, to make calculating the returns easier:
Investor 1 comes in with $78.35, because that is what the bond fund is quoting as the cost of 1 share. Investor 1 buys 1 share.
Before the day is out, interest rates jump up and the new cost of 1 share drops to $71.30, investor 2 buys 1 share.

Nothing else happens for 5 years (at the end of 5 years each investor gets $100, because they own one share) - here are the returns reported:

Bond fund manager reports that the bond fund had a return of 5.97%.
Investor 1 reports that he had a return of 5%.
Investor 2 reports that he had a return of 7%.

So what happened -- nothing happened to either investors return once they bought in, their return was what they expected.
The bond fund itself however was able to report a higher return because of the new money that came in.

Let's change up the example a little. (no new money)
Investor 1 spends $78.35 for 1 share.
rates jump up right after he buys and so before the end of day one he sells the zero to investor #2 for $71.30, he then puts his money in a cookie jar.

Nothing else happens for 5 years. What are the returns at the end of 5 years.
Investor 1 reports he lost 1.87% per year.
Investor 2 reports he gained 7%
Bond fund manager reports the bond fund made 5% -- in this case there was no new money so the return over the 5 years was whatever the original bond that was first purchased was guaranteed to make.
The 78.35 is old news and no longer matters for anything other than the feelings of the old fund investors.
Is this correct? No --- the $78.35 matters to investor #1 because that is the cost (basis) of his investment - that is why he only makes 5% while his neighbor makes 7% in the first example.
showing how old investors make the same return whether new investors come in or not. It needs no further simplification
This is absolutely correct, as I have pointed out above.
Your model is invalid and it leads to the conclusion that after interest rate moves one should choose and exchange bond funds depending on their net inflows or outflows, a conclusion that everyone who knows bonds will tell you is wrong.
This was never my point, and it now seems clear that we were just not communicating. In fact I never really got to my full point due to our seeming communication issues.

Part of my point which I said many times was that once you buy into a bond fund your returns are essentially locked in. Many people can however "improve" their returns if rates go up by re-investing their dividends (new money). In other words THOSE that spend the new money are the ones that reap the benefits, not any of the current investors.

The aggregate of the bond fund investors will essentially make the returns that the bond fund manager reports - but some will have to lose money if others some how make more.

In a bond fund I also think it is very important to know what is under the hood - are the bonds all maturing at one time 5 years in the future, or are the maturity dates diversified. How is the duration of your fund changing over time.

"Get Out Of Bonds" -- Only you can answer that question -- but if you do invest in bonds you should only invest in a duration that is appropriate for when you want to use the money -- Don't invest in an Intermediate bond fund if you are taking money out on a monthly basis in retirement, unless the money is only the dividends and not the principal. Otherwise you could very much be that "investor 1" above with the loss on his balance sheet so others had a better return.

fd
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Re: "Get out of bond funds"

Post by longinvest »

fd,

Your example can't work, because funds are bought and sold once a day on market close at NAV price. So, if you want 2 investors to pay different prices, they need to buy on distinct days.

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Re: "Get out of bond funds"

Post by ogd »

Well fd -- the whole time I was arguing against this point from way earlier:
FinancialDave wrote:It is not really the inflows and outflows that matter it is the "Net" between the two:

Let's say on day 1 you buy a 5 year bond fund with one brand new 5 year 5% bond in it.
Day 2 interest rates jump to 7%.
Day 3 Investors pile into the bond fund and double it's size.
Day 4 fund managers invest the new money in 5 year 7% bonds, essentially increasing your income from 5% to 6%.

Neglecting of course the effect of the 4 days change, since it is small compared to the 5 year bond.

Forgetting that the above is highly unlikely, but the end result is that inflows (in excess of outflows) do matter as they will soon need to be invested in whatever is the current yield for this duration bond.
Whether I misread it or not, it seems that we're now in agreement:
FinancialDave wrote:Part of my point which I said many times was that once you buy into a bond fund your returns are essentially locked in. Many people can however "improve" their returns if rates go up by re-investing their dividends (new money). In other words THOSE that spend the new money are the ones that reap the benefits, not any of the current investors.
, which is correct. Inflows do not improve the returns of existing investors. More importantly, outflows do not diminish their returns; in both cases the returns are as if one's share of the fund was isolated from other investors. So the bond fund investor can feel comfortable that if interest rates go up, they won't be left holding the bag as others exit bonds, but they will get their fair share of both initial losses and eventual returns. Glad we agree on this.
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Re: "Get out of bond funds"

Post by FinancialDave »

ogd,
Thanks for pointing that out -- I corrected the original post to read that the bond Funds income improved from 5% to 6% with the inflows, not the investors.

In the original post I was referencing nominal bonds and how inflows will affect cash flows to investors, without thinking about the later hit to their "capital pocket."

Working it out on paper shows that inflows do improve the cash flow to the original investor, but when the capital loss is taken into account at the end of the 5 years, the total returns are still 5% & 7%, the same as in the zero coupon example.

What really happens on paper is that Investor 1 improves his cash flow during the 5 years to 5.74%, and investor 2 makes 6.26%, but Investor 1 has a capital loss at the end of the 5 years and investor 2 has a capital gain, mainly because the share price has dropped to $95.66 from an original base of $100, but investor 2 bought in at approximately $91.68.

As you say, using a zero coupon reference makes it a lot easier to see what happens.

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Re: "Get out of bond funds"

Post by ogd »

fd -- yay! Same page.

This is why I like using SEC yield, it tells the combined story of capital gains and cash flows. Moreover, it can't be gamed -- while a manager could today give you cash flows of 10% using nothing more than Treasuries, they'd be doing so at the expense of about 8% capital loss per year. Hence the SEC mandate to provide that yield. It's like the forward looking version of total return (which also can't be gamed by switching bond vintage).

In the example, the fund yielding 5% SEC immediately jumps to 7% after the rate increase, making old and new shares no different. The old shareholders still have to contend with the capital loss of course, but it's now in the past. Moreover, the 7% is not just a number but it has a concrete realization: assuming a flat or flattening yield curve (which is the expectation), the fund will make 7% total return every year after the rise. And it works just as well with zero coupons.
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Re: "Get out of bond funds"

Post by Doc »

ogd wrote:This is why I like using SEC yield, it tells the combined story of capital gains and cash flows. Moreover, it can't be gamed -- while a manager could today give you cash flows of 10% using nothing more than Treasuries, they'd be doing so at the expense of about 8% capital loss per year. Hence the SEC mandate to provide that yield. It's like the forward looking version of total return (which also can't be gamed by switching bond vintage).
It's not just "like the forward version" it's exactly the same equation. The math doesn't know or care that the starting point is ten years ago and ends today or starts today and ends ten years in the future.
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Re: "Get out of bond funds"

Post by ogd »

Doc wrote:It's not just "like the forward version" it's exactly the same equation. The math doesn't know or care that the starting point is ten years ago and ends today or starts today and ends ten years in the future.
"Expected total return" is how I'd call it. For a bond, it can't be otherwise, but for a fund it only gets realized if certain expectations about the yield curve are met -- specifically, that it flattens according to its own shape. I've been raving on and on about how funds have greatly exceeded their SEC yields over the past year (since market yields moved up to current levels) because of the ongoing steepness of the yield curve. On the other side of the coin, if the yield curve flattened faster than its own prediction or even became inverted, you'd make less. The shape of a fund's portfolio adds an additional complication, sometimes positive but usually neutral.

Even "expected" is not necessarily true if you subscribe to alternative views about the yield curve. Then the best you can do at a time like today is something like "total return if yield curve flattens".
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Re: "Get out of bond funds"

Post by Doc »

ogd wrote:Even "expected" is not necessarily true if you subscribe to alternative views about the yield curve. Then the best you can do at a time like today is something like "total return if yield curve flattens".
I think the math works out such that "expected" is really only true if the fund self liquidates by not rolling maturing bonds. So since the fund is not going to self liquidate the future shape of the yield curve introduces the "expected" concept.

This discussion is getting too far into the weeds to be of much more use. :|
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Re: "Get out of bond funds"

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Doc wrote:This discussion is getting too far into the weeds to be of much more use. :|
I've been trying to keep up with the latest posts but most of it went way over my head (beginner bond investor here). If I remember right basic bottom line is either way is ok way to invest (bond index fund vs individual bonds) depending on personal preference.
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Re: "Get out of bond funds"

Post by Doc »

ginmqi wrote:
Doc wrote:This discussion is getting too far into the weeds to be of much more use. :|
I've been trying to keep up with the latest posts but most of it went way over my head (beginner bond investor here). If I remember right basic bottom line is either way is ok way to invest (bond index fund vs individual bonds) depending on personal preference.
As long as you are talking about Treasuries there is very little difference between a fund and a rolling ladder. And which of those minor differences is meaningful to any one of us is highly dependent on the rest of our portfolio and what the main reason is for each of us to invest in bonds in the first place.

And "bonds are for safety" is not a meaningful reason because "safety" also means different things to different people depending on each individuals risk/reward/age/ability/access and on and on.
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Re: "Get out of bond funds"

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Doc wrote:
ginmqi wrote:
Doc wrote:This discussion is getting too far into the weeds to be of much more use. :|
I've been trying to keep up with the latest posts but most of it went way over my head (beginner bond investor here). If I remember right basic bottom line is either way is ok way to invest (bond index fund vs individual bonds) depending on personal preference.
As long as you are talking about Treasuries there is very little difference between a fund and a rolling ladder. And which of those minor differences is meaningful to any one of us is highly dependent on the rest of our portfolio and what the main reason is for each of us to invest in bonds in the first place.

And "bonds are for safety" is not a meaningful reason because "safety" also means different things to different people depending on each individuals risk/reward/age/ability/access and on and on.
Good point. Yes for me I am so far only interested in investing in US treasuries and TIPS. And so as I read more on bond index funds and also a rolling ladder of short-intermediate Treasuries, personally I did not feel as comfortable investing in that bond fund and so far I am leaning towards individual, laddered treasuries.
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Re: "Get out of bond funds"

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ginmqi wrote:Good point. Yes for me I am so far only interested in investing in US treasuries and TIPS. And so as I read more on bond index funds and also a rolling ladder of short-intermediate Treasuries, personally I did not feel as comfortable investing in that bond fund and so far I am leaning towards individual, laddered treasuries.
1) TIPS are US Treasuries. After all it is Treasury Inflation Protected Securities. :D

2) Most people that are still learning and/or have small portfolios will probably be better off with a fund at least in a taxable account. The bookkeeping involved with secondary market sales/purchases can become burdensome. The new tax reporting rules are in effect for nominal Treasuries. Schwab and I think Fidelity are reporting adjusted amounts on your account cost basis screen daily but Vanguard is "still working on it". TIPS don't get covered for another 2 years. If you are still trying to get a handle on funds versus ladders you are not yet ready to tackle bond amortization/accretion issues in a taxable account. If you only buy at auction and hold until maturity or have your bonds in a tax advantaged account these accounting problems do not occur.
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Re: "Get out of bond funds"

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Doc wrote:
ginmqi wrote:Good point. Yes for me I am so far only interested in investing in US treasuries and TIPS. And so as I read more on bond index funds and also a rolling ladder of short-intermediate Treasuries, personally I did not feel as comfortable investing in that bond fund and so far I am leaning towards individual, laddered treasuries.
1) TIPS are US Treasuries. After all it is Treasury Inflation Protected Securities. :D

2) Most people that are still learning and/or have small portfolios will probably be better off with a fund at least in a taxable account. The bookkeeping involved with secondary market sales/purchases can become burdensome. The new tax reporting rules are in effect for nominal Treasuries. Schwab and I think Fidelity are reporting adjusted amounts on your account cost basis screen daily but Vanguard is "still working on it". TIPS don't get covered for another 2 years. If you are still trying to get a handle on funds versus ladders you are not yet ready to tackle bond amortization/accretion issues in a taxable account. If you only buy at auction and hold until maturity or have your bonds in a tax advantaged account these accounting problems do not occur.
Ah I see so TIPS are under the umbrella of government treasuries. Indeed I will need to continue my learning and understanding of bonds. My plan so far is to buy at auction (not secondary market) and hold until maturity, basically avoiding the seemingly complex secondary market maze and then replace outgoing bond with new bond of same maturity as the ladder rolls over time for a very long-investment horizon.

Arguments that I'm concerned about regarding individual bonds is the fact that as interest rates move say in a year, it may not be able to take advantage of a favorable move (ie, low rates going up) as quick as say a bond fund where the daily value of the fund seems to be constantly changing and reacting to interest rate changes.

My basic question is this:
Over a long investment horizon (>30 years), only comparing bought at auction US treasuries held to maturity using a intermediate duration rolling ladder VS a passive treasury bond index. Which would have less risk, less cost, and provide upkeep with inflation so as to generate "riskless" returns?
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Re: "Get out of bond funds"

Post by Doc »

ginmqi wrote:Arguments that I'm concerned about regarding individual bonds is the fact that as interest rates move say in a year, it may not be able to take advantage of a favorable move (ie, low rates going up) as quick as say a bond fund where the daily value of the fund seems to be constantly changing and reacting to interest rate changes.

My basic question is this:
Over a long investment horizon (>30 years), only comparing bought at auction US treasuries held to maturity using a intermediate duration rolling ladder VS a passive treasury bond index. Which would have less risk, less cost, and provide upkeep with inflation so as to generate "riskless" returns?
You can take advantage of a favorable move with a bond any minute of the market day while the bond fund is accessible only at the end of the day.

As long as the bond fund and the ladder have similar duration and you never sell on the secondary market the ladder will win because you avoid the e/r of the fund. Even if you do have to sell the cost is very low and the fund is buying and selling all the time anyway so it too has some transaction costs. The real question is whether the e/r savings is worth the extra time it will take to manage the ladder.

As an example of the cost: right now on Vanguard to buy 1 ten year Treasury the price is 99.667 while to buy 250 the price is still 99.675. That's not much of a transaction cost difference.
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Re: "Get out of bond funds"

Post by ginmqi »

Doc wrote:You can take advantage of a favorable move with a bond any minute of the market day while the bond fund is accessible only at the end of the day.

As long as the bond fund and the ladder have similar duration and you never sell on the secondary market the ladder will win because you avoid the e/r of the fund. Even if you do have to sell the cost is very low and the fund is buying and selling all the time anyway so it too has some transaction costs. The real question is whether the e/r savings is worth the extra time it will take to manage the ladder.

As an example of the cost: right now on Vanguard to buy 1 ten year Treasury the price is 99.667 while to buy 250 the price is still 99.675. That's not much of a transaction cost difference.
Indeed, I am not sure if the ER of a bond fund is worth the time and by default the knowledge gained by learning how bonds and bond markets work if one were to learn to invest in treasuries bought at auction and held at maturity and rolling this ladder.

The other thing is that to me and from what I've read (and no doubt I will continue to read/learn) is that a bond index fund is not the same animal as individual bonds. I've read Thau's Bond Book and from other sources it appears bond funds are of course mutual bonds where pool of investors hand money over to a manager that buys a bunch of bonds that is satisfactory for the characteristic/goal of that fund (ie, bond type or duration, etc.) Big difference is that funds do not have a set maturity date and principal is not 'guaranteed' on the maturity date. And with fluctuating NAV of the fund, it's not as "guaranteed" as an "actual" bond that has a maturity date with promise for principal + any coupons (barring deflation I guess or if you invest in inflation protected security)
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Re: "Get out of bond funds"

Post by ogd »

ginmqi: I say this sympathetically because none of us were born into bond knowledge, so don't take it the wrong way -- but if you had any trouble following the admittedly length discussions about bond pricing above, you would be much better served with a fund. In addition to the complications, it would give you the opportunity to invest in the larger universe of corps and munis without undue concentration into a single instance of default risk.

There are superficial differences between a fund and a ladder, but really what the fund does is two things: prices everything to market (which you should anyway, the ostrich approach won't serve you well) and it maintains a constant shape of the portfolio, which you also will be doing although probably in the least labor-intensive way which involves waiting till maturity -- something I've repeatedly argued is right now a money loser compared to alternatives. None of these activities adds losses or additional risk of loss, the same risk is there in the same instruments. There are no additional guarantees. One way you can possibly convince yourself of this is to track the price of a fund and a ladder through simulated interest rate moves and realize that they are still interchangeable, as long as they were comparable to begin with. If A and B lose the same value when a particular risk shows up then they are similarly risky in that regard, whether you choose to ignore the value or not.

Take the advice of Doc above, who is doing this because he likes the opportunity to sculpt the edges and look for tax advantages, but he's under no illusion that it lowers his risk. Or take the advice of Rick Ferri that I've quoted you in another thread I believe, based on his experience managing a much larger bond portfolio (well, unless Doc turns out to be my secret billionare online acquaintance, which could probably get me a book deal -- but I digress).
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Re: "Get out of bond funds"

Post by abuss368 »

I still have not hit the exits! Actually I am looking into the possibility of diversifying our bonds with the addition of one more bond fund! Two total bonds funds!
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Re: "Get out of bond funds"

Post by jackpullo997 »

Manks wrote:For example, how exactly will the 'impending interest rises' affect bond funds influencing people to shy away from or leave this asset class.
Bond prices move inversely with interest rates.
Longer maturity is even more sensitive.

Also, if the economy slows, default risk increases.
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Re: "Get out of bond funds"

Post by Phineas J. Whoopee »

jackpullo997 wrote:
Manks wrote:For example, how exactly will the 'impending interest rises' affect bond funds influencing people to shy away from or leave this asset class.
Bond prices move inversely with interest rates.
Longer maturity is even more sensitive.

Also, if the economy slows, default risk increases.
The people who allow themselves to be frightened and exploited by others who cynically encourage and take advantage of their anchoring cognitive biases will sell their bond holdings at reduced prices to new owners who will collect the increased yields.

Others will stay the course, including both those who ignore the noise, and those who listen but have adopted rational and appropriate asset allocations they can stick with and who realize each day is a new day for their portfolios.

I suppose we total market indexers in stocks will benefit in minuscule ways from the bottom line effects on those public companies which successfully exploit the fear.

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Re: "Get out of bond funds"

Post by ginmqi »

ogd wrote:ginmqi: I say this sympathetically because none of us were born into bond knowledge, so don't take it the wrong way -- but if you had any trouble following the admittedly length discussions about bond pricing above, you would be much better served with a fund. In addition to the complications, it would give you the opportunity to invest in the larger universe of corps and munis without undue concentration into a single instance of default risk.

There are superficial differences between a fund and a ladder, but really what the fund does is two things: prices everything to market (which you should anyway, the ostrich approach won't serve you well) and it maintains a constant shape of the portfolio, which you also will be doing although probably in the least labor-intensive way which involves waiting till maturity -- something I've repeatedly argued is right now a money loser compared to alternatives. None of these activities adds losses or additional risk of loss, the same risk is there in the same instruments. There are no additional guarantees. One way you can possibly convince yourself of this is to track the price of a fund and a ladder through simulated interest rate moves and realize that they are still interchangeable, as long as they were comparable to begin with. If A and B lose the same value when a particular risk shows up then they are similarly risky in that regard, whether you choose to ignore the value or not.

Take the advice of Doc above, who is doing this because he likes the opportunity to sculpt the edges and look for tax advantages, but he's under no illusion that it lowers his risk. Or take the advice of Rick Ferri that I've quoted you in another thread I believe, based on his experience managing a much larger bond portfolio (well, unless Doc turns out to be my secret billionare online acquaintance, which could probably get me a book deal -- but I digress).
No offense taken and I thank you for your honesty and opinion. As someone who is always curious and wanting to learn more, what do you think would be good resources (books, websites, videos, seminars/conferences, etc.) that can really educate someone into the basics and intermediate level knowledge about bonds? I've read through Thau's Bond Book once and have been browsing some articles on the Bogleheads wiki, both of which I need to revisit but I was wondering what other resources would you recommend? And how DO people become well-versed in the fine aspects of bonds?

One can certainly do alot worse than a Vanguard index bond fund. But for me I am also following Buffett's advice that: "don't invest in anything you do not understand." And so while I have some basic understanding (basic nature of a bond, interest rate changes affecting valuation of current bonds, etc.) of what a bond is I do not feel like I have enough grasp and understanding to know exactly what my money is doing inside a bond or bond fund and how that money/investment will do going forward and how exactly that bond or bond fund contributes to a personal investment portfolio besides what the very basics of what people say bonds are (ie, risk-mitigation and the ad-nausea repeated phrase of "You should invest in 100-(100-age) in bonds!"
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Re: "Get out of bond funds"

Post by ogd »

ginmqi: the Thau book is a definitive guide; the only other one that I'd recommend is Larry's "The Only Guide to a Winning Bond Strategy You'll Ever Need".

Both of these books give you the fundamentals. The next step IMHO is to work things out for yourself, like a homework of sorts, not stopping on a single quote that agrees with something you believe, for example that bond funds have no defined maturity like Thau says. This is true, but it's important to understand exactly how it affects you and what are your alternatives to achieving the same goals (or what are the goals in the first place).

For example, you could take a ladder and a fund through a scenario that worries you, like an interest rate increase, pricing it at all times. Then you quickly see that they both lose the same value through that one event; then ask yourself, is it possible that going forward one does better than the other? Why would that be the case and when exactly do they begin to diverge? And why don't market traders pounce on this difference to make free money? Resist the temptation to take shortcuts like "the value doesn't matter", just work it out, because the mere act of marking to market cannot lose you money. There will be scenarios when a ladder does better, like a ladder that you stop rolling while rates continue to increase, but the reason for that is merely that you take less and less interest risk approaching cash, whereas if you continue to run your ladder or if you hold a fund you are always exposed to the same interest rate risk (but also the associated rewards of the longer bonds). When you hit upon such a scenario, ask yourself if this is what you would have actually done not knowing in advance what the interest rates will do, or rather you'd be on the other side of the comparison with your ongoing bond position; and also, if there are alternative ways to get to the same place, for example by switching to shorter and shorter funds as you approach the date when you need the money and you'd have exited the ladder.

A good approximation of a bond fund is 1-3 bonds traded every year for the maturities they started out with, to counter the passage of that year. Calculators for bond value and duration are available online or in Excel.

An example of an apples to apples comparison, i.e. a fund-based strategy where you'll be hard pressed to find any difference at any point in time vs a ladder, is this: while investor A runs a ladder, investor B sits on a fund with the same duration. At the exact moment in time when A decides to take advantage of his "guaranteed value at maturity" by stopping reinvestment and exiting the ladder within the next N years, investor B sells out of his fund and buys A's position, taking advantage of the fact that the value of his fund has stayed the same to A's ladder up to that point; at the "due date" N years later, they both have the same amount of money. B's advantage is that he didn't have to babysit the ladder throughout the reinvestment years, and by being willing to trade he can more precisely target the due date by using zero coupon bonds, for example.

Anyway, hope this helps. Fundamentally, we're talking about investments made of the same stuff and trading in a market that does not ignore obvious things about the lifecycle of a bond, such as the par value which is always factored in the price.
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Re: "Get out of bond funds"

Post by Bustoff »

nisiprius wrote:
staythecourse wrote:
nisiprius wrote:just the way they (DIDN'T) do 1940-1980
Nisi,

Do you have an article or data talking about this. I do remember a post of Rick Ferri's on his website talking about that period and remember it showed zero return for bonds during that period (I believe long term treasuries). No loss and no gain.

Thanks in advance.

Good luck.
Long discussion here:91% real loss in bonds--is this accurate? The actual number is very endpoint-sensitive, but it in the ballpark of 50% real loss for long-term and considerably less for intermediate-term.

And the loss is an inflation effect, not an interest-rate effect.
According to Annette Thau, it appears to have been both interest rate effect and inflation. See The Bond Book:
The period between 1950 and 1982 represents a bear market in bonds that lasted well over 30 years. During many of those years, bonds were said not to “have earned their coupon", meaning that the principal value of bonds declined by more than the interest income received. During the disastrous 1970’s, the worst of those three decades, satirists described long-term bonds as “fixed rate instrument(s) designed to fall in price” and “certificates of confiscation.” Bondholders suffered staggering losses as bonds purchased in the 1960’s and 1970’s with coupons of 4% to 6% declined by 50% or more ($500 per $1,000 bond) as interest rates approached 15% on the long bond.
Note further that these bondholders suffered a double whammy. Not only was the value of their bonds sharply down, but to add insult to injury, they were earning meager returns of 4% to 6% while interest rates went into the double digits even on short-term and tax-exempt securities. The final blow was that during that period double-digit inflation was eroding the purchasing power of every dollar.
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Re: "Get out of bond funds"

Post by ginmqi »

ogd: Thanks a bunch for your insight and opinion. I'm in the process of getting the winning bond strategy book and will continue to read and work through bond homework, as you say. Have a good holiday weekend!
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Re: "Get out of bond funds"

Post by Doc »

ogd wrote:ginmqi: the Thau book is a definitive guide; the only other one that I'd recommend is Larry's "The Only Guide to a Winning Bond Strategy You'll Ever Need".
Ditto.
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Re: "Get out of bond funds"

Post by HardKnocker »

Ok, I've decided to liquidate all my bond holdings.

Uhm...now what? :confused
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Re: "Get out of bond funds"

Post by FinancialDave »

Doc wrote:
ogd wrote:ginmqi: the Thau book is a definitive guide; the only other one that I'd recommend is Larry's "The Only Guide to a Winning Bond Strategy You'll Ever Need".
Ditto.
And you can get it on Amazon for 48 cents (plus shipping)!

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Re: "Get out of bond funds"

Post by Doc »

FinancialDave wrote:
Doc wrote:
ogd wrote:ginmqi: the Thau book is a definitive guide; the only other one that I'd recommend is Larry's "The Only Guide to a Winning Bond Strategy You'll Ever Need".
Ditto.
And you can get it on Amazon for 48 cents (plus shipping)!

fd
I would definitely upgrade to the Used-Very Good one for 51 cents. :D

(I must not be a very good bargain hunter. I paid full (Amazon) price for myself.)
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Re: "Get out of bond funds"

Post by Kevin M »

HardKnocker wrote:Ok, I've decided to liquidate all my bond holdings.

Uhm...now what? :confused
If in an IRA, I'd recommend a 5-year CD from GE Capital Retail Bank, yielding 2.25-2.30% with an early withdrawal penalty (EWP) of six months of interest. Higher yield than Total Bond Market, no credit risk, and much less interest-rate risk. Even in a taxable account the after-tax yield is higher than the SEC yield of Vanguard short-term or limited-term tax-exempt bond funds.

If in a 401k, then perhaps you have access to a good stable value fund. Otherwise, you're stuck with whatever bond and money market funds are available in your plan.

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Re: "Get out of bond funds"

Post by Johno »

Money market accounts and CD's at the best yields usually beat treasuries and muni's nowadays out to 5 yrs, especially the latter given the risk difference, if CD early withdrawal penalty isn't a concern. The worst case scenario for more and more municipal issuers is public pension blow ups, which are going to be worst if the stock market crashes or under performs, so IMO muni's are now questionable as the 'safe' part of a portfolio heavily invested in stocks otherwise, even though their after tax yields are relatively attractive compared to treasuries by historic measures.

On treasury bonds v funds I agree that ladder v fund is just a matter of whether one has the knowledge or time (including to gain the knowledge, though it's not rocket science) to do the trading and book keeping for the individual issues and therefore avoid the fund Expense Ratio, plus the market movement effect on whatever difference in duration you allow in the ladder over time compared to the fund. If anyone convinces themselves there's any fundamental value difference otherwise, they need to go back and review, because that's not correct.

I do individual issues for the TIPS portion of my portfolio (I don't have any fixed rate treasuries): not worth paying even Vanguard's modest ER on their TIP fund, to me. However if you venture beyond treasuries it's a different story. Nobody AFAIK, Vanguard or even the more trading oriented brokers, offers bid offer spreads on corporate (investment grade), junk or muni bonds narrow enough for constructing your own portfolio to make any sense, especially also considering you have to have more issues in a non-treasury portfolio to diversify credit risk among issuers, and as compared to Vanguard's level of bond fund ER's.
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Re: "Get out of bond funds"

Post by Kevin M »

Johno wrote:Money market accounts and CD's at the best yields usually beat treasuries and muni's nowadays out to 5 yrs, especially the latter given the risk difference, if CD early withdrawal penalty isn't a concern.
Actually, brokered CDs beat treasuries as far out as you can find them. Can get 3.4% or better on a 10-year brokered CD, while a 10-year treasury is 2.54%, and a 30-year T is 3.4%. Direct CDs is where you can't find much better yields beyond five years, for which 2.3% is the best for a nationally-available CD, which of course is much better than the 1.55% yield for a 5-year treasury.

The early withdrawal option ("penalty") isn't a concern, but a huge benefit of direct CDs, as it limits the interest-rate risk to the EWP, so about 1.15% on a CD earning 2.3% with an EWP of six months of interest. Of course a valid concern is that an early withdrawal will be disallowed, but I personally don't worry much about that. Brokered CDs, on the other hand, have essentially the same interest-rate risk as treasuries, except that treasuries are more liquid, so perhaps better in a crisis.

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Re: "Get out of bond funds"

Post by HardKnocker »

Kevin M wrote:
HardKnocker wrote:Ok, I've decided to liquidate all my bond holdings.

Uhm...now what? :confused
If in an IRA, I'd recommend a 5-year CD from GE Capital Retail Bank, yielding 2.25-2.30% with an early withdrawal penalty (EWP) of six months of interest. Higher yield than Total Bond Market, no credit risk, and much less interest-rate risk. Even in a taxable account the after-tax yield is higher than the SEC yield of Vanguard short-term or limited-term tax-exempt bond funds.

If in a 401k, then perhaps you have access to a good stable value fund. Otherwise, you're stuck with whatever bond and money market funds are available in your plan.

Kevin
Thanks, Kevin, but I was joking. Those are good ideas though. :sharebeer
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Re: "Get out of bond funds"

Post by Doc »

Kevin M wrote: The early withdrawal option ("penalty") isn't a concern, but a huge benefit of direct CDs, as it limits the interest-rate risk to the EWP ...
Interest rate risk means that the price of a bond goes up and down as interest rates go down and up. It's a two way street. Depending on if and when you need your money early that "risk" can help you as well as hurt. In a flight to quality situation when you also want to sell FI it's nice to have the price be the 120 of the Treasury and not the 100 of the CD.

If all you are concerned about is the money you make from your fixed income portfolio without any regard to your portfolio as a whole a CD may come out on top. But if you take the Boglehead view based on looking at your portfolio as a whole to obtain total return and not just "income" and rebalancing as needed you may come out with a different result.
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Re: "Get out of bond funds"

Post by Johno »

Kevin M wrote:
Johno wrote:Money market accounts and CD's at the best yields usually beat treasuries and muni's nowadays out to 5 yrs, especially the latter given the risk difference, if CD early withdrawal penalty isn't a concern.
1. Actually, brokered CDs beat treasuries as far out as you can find them.

2. The early withdrawal option ("penalty") isn't a concern, but a huge benefit of direct CDs,
1. Thanks for adding that. My statement was perhaps too tunnel visioned to my own view of today's fixed income market, where I don't see value and am not looking to go long any (direct) fixed rate interest rate risk past 5 yrs, not on the 'investment side' anyway, maybe in my limited partly-for-fun trading, via bond futures.

2. As Doc pointed out, and again something more important when the max maturity you consider is beyond short-medium term, it's not a benefit to be able to withdraw at 98.3 (say 3.4% 10yr 180 days interest) par if the instrument is theoretically worth 110, though it is a benefit to be able to withdraw at 98.3 if the instrument is theoretically worth 90. An argument could be made that the former is less likely given today's starting curve I suppose, though OTOH if it's safe money for times of distress, then the scenario of not getting the capital gain from a rate decline is arguably the more important.

I bought a 5yr CD from Penfed earlier this year at 3%, remarkable deal, last I looked they'd pulled back to 1.75. And that was before some of the recent rally in bonds. But it was by far the longest CD I've ever bought. I don't think I'd park money that relatively illiquidly for 10yrs, just me.
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Re: "Get out of bond funds"

Post by Kevin M »

Sure, interest-rate risk works both ways. If you want to maximize it, and the potential for upside in a crisis (when stocks are way down) as well as big losses if rates increase a lot, then go with long-term treasuries. I believe Larry Swedroe coauthored a paper that indicated that long-term treasuries actually made sense for an equity-heavy portfolio, although he generally recommends staying on the short end of the yield curve--at least for nominal bonds.

Total Bond Market didn't do much more than hold steady during the last financial crisis, especially compared to long treasuries, so direct CDs are a good alternative to consider if you would otherwise use something like TBM, and especially so if you would otherwise stick with short-term bond funds.

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Re: "Get out of bond funds"

Post by Kevin M »

Johno wrote: I bought a 5yr CD from Penfed earlier this year at 3%, remarkable deal, last I looked they'd pulled back to 1.75. And that was before some of the recent rally in bonds. But it was by far the longest CD I've ever bought. I don't think I'd park money that relatively illiquidly for 10yrs, just me.
I loaded up on the 3% deal too, but stuck with 5-year instead of the 7-year 3% they also offered, so am kind of with you on not going longer term (although we may live to regret it). I don't think of my CDs as highly illiquid; I actually did early withdrawals from a couple of 2% CDs at Barclays to buy the 3% CDs at PenFed--this is a perfect example of the value of the early withdrawal option. Of course it's not the same as a bank account or bond fund where you can exchange into stocks with a few mouse clicks, which is one reason I keep about 1/3 of my fixed income in bond funds.

EDIT: come to think of it, it really wasn't that much more work to do the early withdrawal and buy the new CD. A quick phone call for the early withdrawal, funds transferred into online savings at same place (Barclays), and purchase at PenFed with ACH from Barclays (no trial deposits or anything like that required), all within a day or two. However, this was in a taxable account, and it is more work and more time consuming if in an IRA, due to the IRA transfer process, which can take 2-3 weeks.

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Re: "Get out of bond funds"

Post by Bustoff »

Doc wrote:If all you are concerned about is the money you make from your fixed income portfolio without any regard to your portfolio as a whole a CD may come out on top. But if you take the Boglehead view based on looking at your portfolio as a whole to obtain total return and not just "income" and rebalancing as needed you may come out with a different result.
What if you're retired and have significantly more in fixed-income than stocks ? Moreover, what if, because the portfolio is the only source of income, you're not reinvesting those portfolio returns ?
How does "total return investing" work for a retired investor with a one million dollar portfolio that is 70% Total Bond fund and 30% Total Stock fund but has annual expenses of $40,000 per year ? Under that scenario, what's the best bond fund ?
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Re: "Get out of bond funds"

Post by Doc »

Bustoff wrote:
Doc wrote:If all you are concerned about is the money you make from your fixed income portfolio without any regard to your portfolio as a whole a CD may come out on top. But if you take the Boglehead view based on looking at your portfolio as a whole to obtain total return and not just "income" and rebalancing as needed you may come out with a different result.
What if you're retired and have significantly more in fixed-income than stocks ? Moreover, what if, because the portfolio is the only source of income, you're not reinvesting those portfolio returns ?
How does "total return investing" work for a retired investor with a one million dollar portfolio that is 70% Total Bond fund and 30% Total Stock fund but has annual expenses of $40,000 per year ? Under that scenario, what's the best bond fund ?
He uses what ever income he has to meet his $40k needs. If he comes up short he sells both stocks and bonds to make up the difference while trying to keep his AA constant. If he has enough income to meet his income requirements from interest then he is making his AA increase more rapidly and he has to sell FI to rebalance. So now that he has a need to sell FI maybe a CD that matures in five or ten years is not the best alternative.

As I've said repeatedly If you don't care about your AA then your FI portfolio is based on the return from the FI alone and the CD may be your best alternative. But most Bogleheads would say "stay the course and rebalance". In which case you have other criteria that you would like your FI to meet.

You don't need to do one or the other. You can do both. Part of your FI portfolio can be geared to high income and part can be geared toward AA concerns in market stress situations.

Our situation is not that dissimilar to your example. I keep enough money in short term Treasuries to cover rebalancing a ~40% stock market decline. If you have a very low stock allocation the amount needed is not that much.The rest is invested in FI with higher return, lower liquidity and less favorable correlation with equities. (I use an intermediate corporate fund instead of a CD for added flexibility but the yield is similar for either.)
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Re: "Get out of bond funds"

Post by Bustoff »

Doc wrote:
Bustoff wrote:
Doc wrote:If all you are concerned about is the money you make from your fixed income portfolio without any regard to your portfolio as a whole a CD may come out on top. But if you take the Boglehead view based on looking at your portfolio as a whole to obtain total return and not just "income" and rebalancing as needed you may come out with a different result.
What if you're retired and have significantly more in fixed-income than stocks ? Moreover, what if, because the portfolio is the only source of income, you're not reinvesting those portfolio returns ?
How does "total return investing" work for a retired investor with a one million dollar portfolio that is 70% Total Bond fund and 30% Total Stock fund when that retiree has annual expenses of $40,000 per year ? Under that scenario, what's the best bond fund ?
He uses what ever income he has to meet his $40k needs. If he comes up short he sells both stocks and bonds to make up the difference while trying to keep his AA constant. If he has enough income to meet his income requirements from interest then he is making his AA increase more rapidly and he has to sell FI to rebalance. So now that he has a need to sell FI maybe a CD that matures in five or ten years is not the best alternative.

As I've said repeatedly If you don't care about your AA then your FI portfolio is based on the return from the FI alone and the CD may be your best alternative. But most Bogleheads would say "stay the course and rebalance". In which case you have other criteria that you would like your FI to meet.

You don't need to do one or the other. You can do both. Part of your FI portfolio can be geared to high income and part can be geared toward AA concerns in market stress situations.

Our situation is not that dissimilar to your example. I keep enough money in short term Treasuries to cover rebalancing a ~40% stock market decline. If you have a very low stock allocation the amount needed is not that much.The rest is invested in FI with higher return, lower liquidity and less favorable correlation with equities. (I use an intermediate corporate fund instead of a CD for added flexibility but the yield is similar for either.)
Thanks Doc!
When you mention keeping enough short-term treasuries to cover equity declines, are you figuring the amounts in dollars? In other words, using my portfolio amounts above, would you calculate 40% of the $300,000 in equities and put $120,000 of the $700,000 allocated to fixed income in a short-term bond index and then the remaining $580,000 of fixed income in an intermediate corporate fund?
Regarding the corporate bond fund, aren't those positively correlated with equities. I thought we wanted a negative correlation between stocks and bonds ?
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Re: "Get out of bond funds"

Post by Kevin M »

Bustoff wrote:How does "total return investing" work for a retired investor with a one million dollar portfolio that is 70% Total Bond fund and 30% Total Stock fund but has annual expenses of $40,000 per year ? Under that scenario, what's the best bond fund ?
There is no one answer. I think in terms of total return, I am retired, my allocation is 30/70 stocks/FI, but my withdrawal rate is much lower than 4%.

I have about 2/3 of my fixed income in direct CDs, earning 2% or more, and about 1/3 in mostly intermediate-term investment-grade and tax-exempt bond funds. In my view this gives me a higher overall yield than Total Bond, but with comparable if not lower risk. The CDs take the place of the no-credit-risk government bonds in TBM, but with less interest-rate risk, and the int-term bond funds take the place of the higher-yield, higher-risk corporate bonds.

If one wants more crisis-protection-juice, one could easily include a slice of long-term treasuries in this mix. I have about 5% in cash, which is available for rebalancing into stocks, and would tap the CDs and/or bond funds if I needed more. I'm not going to worry about a 1% dip in fixed income to buy into a 40% drop in equities.

Note that with fixed income yielding 2.25% and stocks yielding 2%, you meet more than half of your 4% expenses with dividends and interest on the $1M portfolio. The other half has to come from selling assets (considering cash from a maturing CD as selling an asset), unless you annuitize. I sell assets when necessary from whatever asset class is above its target allocation.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
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ogd
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Re: "Get out of bond funds"

Post by ogd »

Kevin M wrote:There is no one answer. I think in terms of total return, I am retired, my allocation is 30/70 stocks/FI, but my withdrawal rate is much lower than 4%.
Yes, it's worth remembering how different the tradeoffs can be at high fixed income allocations. For example, Kevin can under any conceivable scenario rebalance entirely from bond funds, taking full advantage of the liquidity and the possible value increase, if breaking CDs is not worth it, e.g. they become more "valuable" (without directly having a market value) if yields head lower during a crash. Moreover, optimizing FI as much as possible is a good use of his time.

I'd probably do something very similar if I was 70% fixed income; perhaps even venturing into the 10-15 yr fund duration ranges for that portion, balanced out by the near zero duration of the CDs. It's quite possible I would want a significant amount of TIPS too. Not so at my current 40%, where the equity portion is first on my mind.
Bustoff wrote:How does "total return investing" work for a retired investor with a one million dollar portfolio that is 70% Total Bond fund and 30% Total Stock fund but has annual expenses of $40,000 per year ?
Bustoff: one big reason to think total return is because dividends and capital appreciation / depreciation are quite interchangeable when it comes to bonds. For example, 700k bonds could easily generate 60k of income from Treasuries today, using old bonds bought at premiums, at the cost of massive capital depreciation later on when the bonds return to par. So whether you spend that income or sell some bonds to supplement lower yields, it makes no difference.

Basically, at a time when market yields are X% for your chosen duration / risk composure, spending $Y from bonds means you are giving up Y x X% in future return, as compared to the total return of a portfolio without withdrawals. No more, no less, regardless of how premium or depreciated the bonds are. It doesn't matter (except to taxes) if the $Y came from dividends not reinvested or bonds or fund shares sold. I know you're worried about the X% going up a lot, which means the $Y is costing you more future returns than it would right now, but the upside (barring inflation) is that there are all of a sudden bonds available that make much higher returns, which should eventually be good for a fixed income portfolio.

The tradeoffs really have more to do with risk taken and time spent / liquidity issues. You can take more risk and get more money, but your portfolio gets more volatile. Credit risk is something that puts more of your portfolio into equity territory. Interest rate risk makes your portfolio more volatile and slower to adapt to inflation. Which is why spending some time dealing with multiple CD accounts while having an easily accessible "rebalancing stash" seems like such a good idea, at least until interest rates on bank instruments get more in line with the market.
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Doc
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Re: "Get out of bond funds"

Post by Doc »

Bustoff wrote: Thanks Doc!
When you mention keeping enough short-term treasuries to cover equity declines, are you figuring the amounts in dollars? In other words, using my portfolio amounts above, would you calculate 40% of the $300,000 in equities and put $120,000 of the $700,000 allocated to fixed income in a short-term bond index and then the remaining $580,000 of fixed income in an intermediate corporate fund?

Regarding the corporate bond fund, aren't those positively correlated with equities. I thought we wanted a negative correlation between stocks and bonds ?
You need to do the arithmetic. My mind's asleep so let me use a more simple example. Assume a 50/50 AA and a 50% decline in stocks. Your $1,000K portfolio becomes $750K. You want 50/50 so you need $375 in equities but you now have only $250k so you need to have only $125k in short term liquid bonds to rebalance. That's much less than what your calculation would imply.

On the second part. You already have the rebalancing issue covered so the you can afford to take on more credit risk or liquidity risk with the rest and get a little more return. Neither a CD or corporate bonds help mitigate the stock downturn but since you have the short term crisis already covered you don't care that much about the correlation with the rest. Unless there is a lot of default corporate bond prices as well as CDs will recover at the duration even if stock prices haven't. Don't forget that banks can default also and it is only the principal and accrued interest that is insured.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
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Bustoff
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Re: "Get out of bond funds"

Post by Bustoff »

Kevin M, ogd and Doc,

Thank you so much for your help in clarifying this total return approach. Too often I fall into the mental habit of examining things in isolation rather than a complete package. Thank you for the reminders.

Bustoff
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