The Risk of Short-term Bond Funds

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sleepysurf
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Re: The Risk of Short-term Bond Funds

Post by sleepysurf »

Kevin M wrote:I don't see much sense in short-term munis. SEC yield of Vanguard short-term tax-exempt is only 0.3%, so even if marginal tax rate is 50% you're better off in a savings account earning 0.9% pre-tax. Limited-term tax-exempt SEC yield is 0.8%, but you can still beat that after-tax with a 5-year direct CD @2.3%, and with less term risk and no credit risk. The distribution yield of limited-term tax exempt is 1.63%, but the CD even beats that at a marginal tax rate of 28% (after-tax yield of 1.66%).

Kevin
For me, as a physician practicing in FL, another consideration is asset-protection. I need my non-retirement accounts to be titled JTE (Joint Tenancy by the Entireties). The internet banks (offering such higher yields) do not offer JTE titled accounts, and my local banks offer meager interest rates on comparable products. I'm ~5 yrs from retirement, thus willing to "park" much of my taxable fixed income in Muni's that barely keep up with inflation. I'm more aggressive with my tax-sheltered 401k and IRA fixed income investments (40% Total Bond Market index).

If anybody knows of an internet bank offering JTE titling for CD's or MMA's, please share!
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Re: The Risk of Short-term Bond Funds

Post by Electron »

Short term bond funds will often outperform longer duration bond funds during periods of negative bond returns. They may indeed have their place in the period ahead.

There have been a number of articles recently stating that the Federal Reserve has discussed Exit Fees on bond funds. They are very concerned about bond fund redemptions once rates start rising since that selling would push rates up even farther.

Here are two recent articles:

http://www.cnbc.com/id/101764134#.

http://blogs.marketwatch.com/capitolrep ... ds-report/

Try an Internet search on "Federal Reserve" Bond Fund Exit Fee.

Lastly, note that the yield on short term government bonds is currently very low. Funds with a heavy concentration in short term government bonds may lag in performance as a result of the lower coupon income.
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Re: The Risk of Short-term Bond Funds

Post by Call_Me_Op »

The links above make me want to rush out and buy bond funds.
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Re: The Risk of Short-term Bond Funds

Post by Toons »

billyt wrote:Dollar cost averaging into a bond fund for 30 years and out for 30 years is essentially the same as holding for 60 years. Money you need this month to pay your bills should be in a bank account. Money you need to spend for the next few years should be in short term bonds or CD's. Match your duration to your investment horizon.
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Re: The Risk of Short-term Bond Funds

Post by Phineas J. Whoopee »

Electron wrote:...
Try an Internet search on "Federal Reserve" Bond Fund Exit Fee.
...
OK. I took the bait and read some links.

I'm willing to believe some people inside the Fed are discussing that, which is the extent of the claim. According to the CNBC link, the Fed can't impose it, but the SEC can.

If and when it gets to be a likely event I'll pay more attention.

It's the job of people in policymaking organizations to discuss options, likely and unlikely. Dig hard enough and I bet we could find a Pentagon plan for invading Canada. That's what they're supposed to do. It doesn't mean it's what we as a country are going to do.

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Re: The Risk of Short-term Bond Funds

Post by nisiprius »

Electron wrote:Short term bond funds will often outperform longer duration bond funds during periods of negative bond returns. They may indeed have their place in the period ahead.

There have been a number of articles recently stating that the Federal Reserve has discussed Exit Fees on bond funds. They are very concerned about bond fund redemptions once rates start rising since that selling would push rates up even farther.

Here are two recent articles:

http://www.cnbc.com/id/101764134#.

http://blogs.marketwatch.com/capitolrep ... ds-report/

Try an Internet search on "Federal Reserve" Bond Fund Exit Fee.
Thanks for posting. Interesting and sobering. Have you seen anything that gives a hint as to the size of the fees that are being considered?
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Re: The Risk of Short-term Bond Funds

Post by Electron »

nisiprius wrote:Thanks for posting. Interesting and sobering. Have you seen anything that gives a hint as to the size of the fees that are being considered?
None of the articles that I have seen mentioned anything about the size of possible exit fees. I would expect significant resistance to that kind of proposal from mutual fund companies. In addition, one wonders if the fees would even accomplish the stated goal.

Mutual fund redemption fees typically stay with the fund and are meant to compensate existing shareholders for the increased transaction costs to the fund. As many of us know Vanguard has used redemption fees in both equity and bond funds where liquidity is limited.
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Re: The Risk of Short-term Bond Funds

Post by midareff »

Electron wrote:
nisiprius wrote:Thanks for posting. Interesting and sobering. Have you seen anything that gives a hint as to the size of the fees that are being considered?
None of the articles that I have seen mentioned anything about the size of possible exit fees. I would expect significant resistance to that kind of proposal from mutual fund companies. In addition, one wonders if the fees would even accomplish the stated goal.

Mutual fund redemption fees typically stay with the fund and are meant to compensate existing shareholders for the increased transaction costs to the fund. As many of us know Vanguard has used redemption fees in both equity and bond funds where liquidity is limited.
A retiree who auto withdraws a fixed monthly amount from a bond fund for living expenses will enjoy that one.

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Re: The Risk of Short-term Bond Funds

Post by Kevin M »

billyt wrote:Match the duration of your holdings to your investment horizon.
Then anyone with an investment horizon of 15 years or more should own a long-term bond fund, not an intermediate-term bond fund.

As I said earlier, virtually the same article could have been written on "The risk of intermediate-term bond funds" in comparing 5-year returns for int-term and long-term bond funds. Or how about "The risk of bond funds" in comparing stocks to bonds over last five years?

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Re: The Risk of Short-term Bond Funds

Post by pascalwager »

Like others have pointed out, this study confuses strategy with outcome and should be of no interest to any serious investor, even if you do prefer to take term- and credit-risk.
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Re: The Risk of Short-term Bond Funds

Post by epilnk »

rleonardh wrote:So to keep your portifilo "safe" should one stick with short term or perhaps TBM and TIPS? If so what ratio should you have?
Short bonds are safer in the short term (lower risk of loss). Longer bonds are safer in the longer term (lower risk of erosion of purchasing potential). So you must choose what it is you most fear and want to stay safe from. If you want to buy a house soon, stay short. If you are 60 think you may live until 100, long may be more appealing.
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Re: The Risk of Short-term Bond Funds

Post by Jack »

midareff wrote:
[OT comments removed by admin LadyGeek]


I can't add anything to this - - - - I just can't.
[Response to OT comments removed by admin LadyGeek]
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Re: The Risk of Short-term Bond Funds

Post by epilnk »

Call_Me_Op wrote: The difference is that we expect high risk for the stock portion of our portfolio. Bonds are for safety.
For some people, sure; but if this is not in fact why you buy bonds it doesn't apply. I consider bonds safer, not safe. I expect the stock portion of my portfolio to go up and down. I expect the same for my bond portion. I hope for them not to go down at the same time but if they do I expect to ride it out. I also expect the bond portion to recover, which I am less confident of for the equity side.
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Re: The Risk of Short-term Bond Funds

Post by LadyGeek »

As a reminder, political comments are off-topic.
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Re: The Risk of Short-term Bond Funds

Post by hoops777 »

Like everything else in the market a lot of ifs....If rates had gone up substantially there would be a different tone here....but they did not so many have the hindsight of being very smart.It does go to show once again how the experts are not very good at predictions.
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Re: The Risk of Short-term Bond Funds

Post by livesoft »

hoops777 wrote:Like everything else in the market a lot of ifs....If rates had gone up substantially there would be a different tone here....but they did not so many have the hindsight of being very smart.It does go to show once again how the experts are not very good at predictions.
But hoops777, I showed in my first post in this thread that a short-term bond fund outperformed the intermediate-term bond fund just because rates did go up

I gotta ask, your GNMA fund has been doing OK though, right? I know mine has been just fine.
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Re: The Risk of Short-term Bond Funds

Post by Rick Ferri »

hoops777 wrote:Like everything else in the market a lot of ifs....If rates had gone up substantially there would be a different tone here....but they did not so many have the hindsight of being very smart. It does go to show once again how the experts are not very good at predictions.
Wait a minute hoops777. Maybe I'm confused by your post. I didn't make any prediction. I stayed in intermediate-term bonds. The people who switched out of intermediate-term bonds and into short-term bonds because they thought interest rates would rise made a prediction and acted on it. That's what you're saying, correct?

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Re: The Risk of Short-term Bond Funds

Post by hoops777 »

I was not referring to you.You are very consistent with the advice you give.
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Re: The Risk of Short-term Bond Funds

Post by Ketawa »

epilnk wrote:
rleonardh wrote:So to keep your portifilo "safe" should one stick with short term or perhaps TBM and TIPS? If so what ratio should you have?
Short bonds are safer in the short term (lower risk of loss). Longer bonds are safer in the longer term (lower risk of erosion of purchasing potential). So you must choose what it is you most fear and want to stay safe from. If you want to buy a house soon, stay short. If you are 60 think you may live until 100, long may be more appealing.
By this logic, a 20 year old investor just starting out who doesn't plan to retire until after age 60 should be holding Vanguard Extended Duration Treasury ETF (EDV) with its 25 year duration. This probably isn't a good plan.

The important thing for any asset is how it impacts the overall portfolio, not how it performs in isolation. The volatility in EDV will be about 5x higher than Vanguard Intermediate-Term Treasury Fund Investor Shares (VFITX), which has a 5 year duration. It's not worth the extra 2% in yield. You would get much better results with similar overall portfolio volatility by holding VFITX and increasing the stock allocation.
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Re: The Risk of Short-term Bond Funds

Post by JoMoney »

Long-Term Bonds promise a more stable stream of income/coupon payments at the risk of higher price volatility as interest rates change over time.
Short-Term Bonds promise a more stable mark-to-market price at the risk of higher volatility in the coupon yields over time.
Equities promise nothing but a share of the uncertain future profits of the business, whatever those may be, at a price that is placed by a sometimes manic Mr.Market.

I have some savings in Short-Term bonds not because I'm trying to time when interest rates will rise, but because I might need this money for some short-term emergency, and I don't want to be forced to sell my equities in a "flash-crash" type of scenario. If I held long-term bonds, I wouldn't want to be forced to sell them at a loss either just because the current interest rate went up and I was in a situation that couldn't wait for the bonds to mature.

I'm still relatively young, with hopefully a long career ahead of me, I have no interest in locking in stable income from long-term bonds. I find the current rates especially unappealing relative to the hoped for long-term growth in equities. I'm willing to take the risk with a heavy equity position, and enough short-term savings to get me through any emergency situations.
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Re: The Risk of Short-term Bond Funds

Post by hoops777 »

Livesoft....Yes I have been happy with my GNMA and plan to keep it forever.Just a little tired of the market and all of the hype that is involved.
K.I.S.S........so easy to say so difficult to do.
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Re: The Risk of Short-term Bond Funds

Post by Call_Me_Op »

epilnk wrote:
Call_Me_Op wrote: The difference is that we expect high risk for the stock portion of our portfolio. Bonds are for safety.
For some people, sure; but if this is not in fact why you buy bonds it doesn't apply. I consider bonds safer, not safe. I expect the stock portion of my portfolio to go up and down. I expect the same for my bond portion. I hope for them not to go down at the same time but if they do I expect to ride it out. I also expect the bond portion to recover, which I am less confident of for the equity side.
I agree with this, because safety is never absolute. Maybe I can say that "I expect my bonds to experience much smaller nominal losses compared to my stocks."
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Re: The Risk of Short-term Bond Funds

Post by Leeraar »

I have short term VFSUX abd VBILX because I want them. I don't bother with their returns or price fluctuations.

Yesterday, in fact, I rebalanced by purchasing more of these. The target is 10% of my total portfolio in each.

By the way, I notice the Vanguard frequent trading restriction is now explained differently, in that restricted transactions can be done by mail

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Re: The Risk of Short-term Bond Funds

Post by Hopeful »

This bond stuff makes my head spin, and I can see both sides of the argument. I am just glad that I have a Stable Value fund in my 403b that is currently paying 3%. That is where I am keeping my fixed income allocation until interest rates normalize more.
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Re: The Risk of Short-term Bond Funds

Post by Call_Me_Op »

Hopeful wrote:This bond stuff makes my head spin, and I can see both sides of the argument. I am just glad that I have a Stable Value fund in my 403b that is currently paying 3%. That is where I am keeping my fixed income allocation until interest rates normalize more.
Are you able to switch out of the stable value fund when you want?
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Re: The Risk of Short-term Bond Funds

Post by Hopeful »

Call_Me_Op wrote:Are you able to switch out of the stable value fund when you want?
Fortunately, Yes.
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Re: The Risk of Short-term Bond Funds

Post by hoops777 »

Got so frustrated with the back and forth on interest rates and bond funds that I plucked down a good amount on 10 year brokered CD's at Vanguard a few months ago at 3.4 in my IRA acct.It is strange to say this but I hope that it was a mistake in hindsight down the road,but I can live with 3.4 in a tax free acct.
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Re: The Risk of Short-term Bond Funds

Post by Kevin M »

hoops777 wrote:Got so frustrated with the back and forth on interest rates and bond funds that I plucked down a good amount on 10 year brokered CD's at Vanguard a few months ago at 3.4 in my IRA acct.It is strange to say this but I hope that it was a mistake in hindsight down the road,but I can live with 3.4 in a tax free acct.
You do understand that a 10-year brokered CD has the same interest-rate risk as a 10-year bond, right? Perhaps a bit more because the bid/ask spread is likely to be quite a bit higher than for a treasury, so if you sell before maturity you'll take more of a haircut. Of course you're being paid nicely to compensate for the higher bid/ask spread because the CD rate is much higher than the 10-year treasury rate (currently 2.65%, but was 3% at beginning of year, so your premium depends on when you bought).

The modified duration of the CD, assuming bought at par, is about 8.4, so quite a bit more term risk than an intermediate-term bond fund with duration of 5. Of course the duration declines over time, so in about four years you'll be approaching the duration of an intermediate-term bond fund, and in the meantime you're earning a nice premium. If you want to go longer term, a CD is a nice way to earn the term-risk premium.

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Re: The Risk of Short-term Bond Funds

Post by Call_Me_Op »

hoops777 wrote:Got so frustrated with the back and forth on interest rates and bond funds that I plucked down a good amount on 10 year brokered CD's at Vanguard a few months ago at 3.4 in my IRA acct.It is strange to say this but I hope that it was a mistake in hindsight down the road,but I can live with 3.4 in a tax free acct.
Would you buy some of these in a taxable account? If not, what would you buy instead - assuming you wanted a bond position?
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Re: The Risk of Short-term Bond Funds

Post by epilnk »

Ketawa wrote:
epilnk wrote:
rleonardh wrote:So to keep your portifilo "safe" should one stick with short term or perhaps TBM and TIPS? If so what ratio should you have?
Short bonds are safer in the short term (lower risk of loss). Longer bonds are safer in the longer term (lower risk of erosion of purchasing potential). So you must choose what it is you most fear and want to stay safe from. If you want to buy a house soon, stay short. If you are 60 think you may live until 100, long may be more appealing.
By this logic, a 20 year old investor just starting out who doesn't plan to retire until after age 60 should be holding Vanguard Extended Duration Treasury ETF (EDV) with its 25 year duration. This probably isn't a good plan.
Why not? Volatility is less of a consideration with a long event horizon, or even a positive for those who like to rebalance non correlating assets. I would probably have considered this had it been around when I was younger (and if I had access to a corresponding mutual fund, since I don't use ETFs).
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Re: The Risk of Short-term Bond Funds

Post by Kevin M »

A long-term nominal bond would only make sense to me if I had a matching long-term nominal liability, and then only an individual bond, not a bond fund, since the remaining maturity of the fund doesn't decrease as the date of the liability approaches. Not only does a long-term nominal bond fund have huge term risk (nominal interest-rate risk), but it also has huge inflation risk (real interest-rate risk). I think most people's future liabilities are real, not nominal.

Holding a long-term bond fund just because one has a long-term investment horizon doesn't make sense to me, but it makes about as much sense as holding an intermediate-term bond fund for the same reason (if that is the only reason). Holding period is only one consideration.

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Re: The Risk of Short-term Bond Funds

Post by hoops777 »

Call me op....I have very little in taxable money....most in my SEP.What I do have is in two 30 year Muni's yielding 5.1 and the rest mostly in Vang intermediate muni fund.I am in full protection mode and have given up a lot of gains but feel at peace with my decision.I own a small mom and pop business which hopefully will allow me to work as long as I want and I consider that my investment gain without stock market risk and stress.That could change if my business went seriously down.I do not want commit to a 10 year CD in taxable because of the taxes and the inability to get the money out safely because they are brokered.
K.I.S.S........so easy to say so difficult to do.
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Re: The Risk of Short-term Bond Funds

Post by Call_Me_Op »

Hi hoops,

Thanks for the feedback. We are all struggling with what to do in this ultra-low yield environment.
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Re: The Risk of Short-term Bond Funds

Post by Doc »

Call_Me_Op wrote:We are all struggling with what to do in this ultra-low yield environment.
Hi young'n,

The high yield environment leading up to the S&L crisis was a lot more of a struggle for us old fogies. :P
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Re: The Risk of Short-term Bond Funds

Post by JoMoney »

Doc wrote:...The high yield environment leading up to the S&L crisis was a lot more of a struggle for us old fogies. :P
It is interesting that the "real" yield isn't so bad compared to some times in the past, in 1980 inflation was about 13% with 10yr Treasuries yielding around 10%
In 2013 inflation was about 1.5% and treasuries yielded almost 2%.
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Re: The Risk of Short-term Bond Funds

Post by Doc »

JoMoney wrote:
Doc wrote:...The high yield environment leading up to the S&L crisis was a lot more of a struggle for us old fogies. :P
It is interesting that the "real" yield isn't so bad compared to some times in the past, in 1980 inflation was about 13% with 10yr Treasuries yielding around 10%
In 2013 inflation was about 1.5% and treasuries yielded almost 2%.
When making investment decisions I concentrate on the norms more often than on the tails of the metric under consideration.

There was a thread recently containing an historic real yield chart. I always believed based on Swedroe's bond book that the "normal" real yield range was 2% to 3% for the ten. Based on comments and other date from that thread which I can't find right now it may be that the the lower "normal" range may be somewhat lower. Perhaps 1.5% or 1.75%. The data covered some 30 to 40 years not just a 1980 anomaly.

In any case I would consider the current 0.4% very low.
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Re: The Risk of Short-term Bond Funds

Post by mptfan »

billyt wrote:This thread (and almost all the bond-panic threads) repeatedly miss the central point. All the worry is over interest rate risk (or duration risk). If you start investing at age 30 and die at 90, your holding period is 60 years, or something like 20x the duration of an intermediate bond fund. In such a situation, your duration risk is zero. Changes in NAV with changes in interest rates have absolutely no impact on your lifetime returns. Your returns are determined by the average interest rate over your holding period. The higher the average rate, the higher your return. In such a situation, an investor in an intermediate bond fund will always have higher returns that an investor in short term bond funds, because of the interest rate difference. This is just a fact. Match the duration of your holdings to your investment horizon. If you need the funds in a few years, sure, put them in a short term bond fund. Why are people worried about the short-term price volatility of a bond fund? Look at the volatility of your overall portfolio. If that is too much to stomach, simply add more bonds. If that is still too much then you need to be in cash.
:thumbsup Very wise words.
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Re: The Risk of Short-term Bond Funds

Post by dbr »

mptfan wrote:
billyt wrote:This thread (and almost all the bond-panic threads) repeatedly miss the central point. All the worry is over interest rate risk (or duration risk). If you start investing at age 30 and die at 90, your holding period is 60 years, or something like 20x the duration of an intermediate bond fund. In such a situation, your duration risk is zero. Changes in NAV with changes in interest rates have absolutely no impact on your lifetime returns. Your returns are determined by the average interest rate over your holding period. The higher the average rate, the higher your return. In such a situation, an investor in an intermediate bond fund will always have higher returns that an investor in short term bond funds, because of the interest rate difference. This is just a fact. Match the duration of your holdings to your investment horizon. If you need the funds in a few years, sure, put them in a short term bond fund. Why are people worried about the short-term price volatility of a bond fund? Look at the volatility of your overall portfolio. If that is too much to stomach, simply add more bonds. If that is still too much then you need to be in cash.
:thumbsup Very wise words.
Exactly. It is so simple I don't understand all the sturm and drang.

As to how you manage "this current interest rate environment," you don't. It just comes with the territory. Life happens.
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Re: The Risk of Short-term Bond Funds

Post by hoops777 »

These last couple of posts should be automatically posted on every bond thread talking about the dreaded interest rate risk.I cannot believe how much time is wasted and stress created by this subject.I have been guilty of not seeing the simplicity of the facts and invested too heavily in short term corp......another bone headed maneuver by yours truly. :D
K.I.S.S........so easy to say so difficult to do.
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Re: The Risk of Short-term Bond Funds

Post by billyt »

Thanks. I have basically been saying this over and over again to little avail. After a while, I get to exhausted to respond anymore.
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Re: The Risk of Short-term Bond Funds

Post by Munir »

billyt wrote:Thanks. I have basically been saying this over and over again to little avail. After a while, I get to exhausted to respond anymore.
If you are a retiree in his mid-seventies, you do not know how long you will live- could be three years or 20 years. My conclusion is to own bond funds of varying duration (short and intermediate) to cover all possibilities, plus a continuous source of income like an SPIA (and Soc. Sec.).
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Re: The Risk of Short-term Bond Funds

Post by livesoft »

So to summarize: The risk of short-term bond funds is that one could have used the money to invest in something riskier. I get it.
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Re: The Risk of Short-term Bond Funds

Post by Rick Ferri »

Opportunity cost is the risk of being in short-term bond funds when you don't need short-term bonds.

I understand the need for emergency money. That's different. If your liabilities are intermediate- long-term, why put your investment portfolio in short-term bonds?

Opportunity cost is real - it's a risk - and it should be part of your decision-making process.

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Re: The Risk of Short-term Bond Funds

Post by livesoft »

^I completely agree. Somehow I think I see the start of another blog article in that post. :)

BTW, this is the same argument used to validate not paying off a low-interest fixed rate mortgage.
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Re: The Risk of Short-term Bond Funds

Post by ML 59 »

billyt wrote:Thanks. I have basically been saying this over and over again to little avail. After a while, I get to exhausted to respond anymore.
But please do continue to respond...you and several others, including Rick, have been a great help in my basic understanding of all of the talk of bonk risks.
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Re: The Risk of Short-term Bond Funds

Post by zeugmite »

Rodc wrote:
richard wrote:
Dandy wrote:<snip>I do find it hard to accept that any bond fund or fixed income product is the only or best choice for every age, goal or risk tolerance. Maybe that is my blind spot :oops:
Standard theory is that the market portfolio is appropriate for the representative investor and that, if you are meaningfully different, something else may be appropriate for you.
Diluted with "riskless asset" generally held to be "cash", no?

Ie the Market Portfolio itself is not the best choice for every age, goal or risk tolerance; it is the right choice in a mix of risky and riskless assets (absent being significantly different from most people).

As an aside, I have never seen an explanation of why in practice this seems to almost never be recommended by pretty much anybody, any book, etc.
These are quite confused statements. Standard (well, a 40-year-old, simplistic) theory says that there is some portfolio that produces the best risk-return over a closed pool of assets (under some specific model of risk-return), and if everybody were rational (under some specific model of utility), they should all hold that portfolio in combination with some cash, and therefore let's just call that the market portfolio as short-hand. This has little to do with the actual composition of the total market portfolio, the actual behavior of the representative investor, or anything to do with reality.

The portfolios recommended in practice are based on a different idea, which can be called the "mediocre retail investor" proposition, which says that within a closed pool of assets, retail investors are not in a position to extract excess risk-return over the long term compared to the average risk-return that a market of participants operating over the same pool of assets achieve. Since most people take "investment" to be simply in US stocks, the total stock market portfolio was recommended. A bond allocation was slapped on to serve approximately the role of the cash portion of "standard" theory, purely as a heuristic.
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Re: The Risk of Short-term Bond Funds

Post by Kevin M »

Rick Ferri wrote:If your liabilities are intermediate- long-term, why put your investment portfolio in short-term bonds?
A typical Boglehead reason could be that you're expecting your long-term liabilities to be met with your overall portfolio, which includes stocks, and you believe in taking risk in equities and not bonds.

Thinking along these lines, another good thing to point out is that the higher the stock allocation, the less difference it makes. Below are 5-year returns for various combinations of US stocks and US bonds (using treasuries to eliminate the credit-risk component).

Code: Select all

                    5-yr return
                    -----------
short-term treasury 1.37%
int-term treasury   4.08%
total US stock     19.44%

stock allocation       50%    60%    70%    80%    90%
----------------       -----  -----  -----  -----  -----
with short-term bonds  10.4%  12.2%  14.0%  15.8%  17.6%
with int-term bonds    11.8%  13.3%  14.8%  16.4%  17.9%
difference              1.4%   1.1%   0.8%   0.5%   0.3%
So for an 80/20 portfolio, the annualized difference in 5-year returns was only 0.5 percentage points. Or to put it another way, the 80/20 portfolio with short-term bonds earned 97% of the return of the portfolio with intermediate-term bonds.

Again, one also could use the above data to show the opportunity cost of owning any bonds at all over the last five years.

Here's another one. With 30% of stocks in international, the 5-year return with intermediate-term treasuries for the 80/20 portfolio was 14.3%, so 1.5 percentage points less than the 80/20 portfolio with US stocks and short-term bonds (15.8%). So using the same logic, there was more opportunity cost of including the Vanguard-recommended allocation to international stocks than of using short-term bonds.

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Re: The Risk of Short-term Bond Funds

Post by Electron »

billyt wrote:This thread (and almost all the bond-panic threads) repeatedly miss the central point. All the worry is over interest rate risk (or duration risk). If you start investing at age 30 and die at 90, your holding period is 60 years, or something like 20x the duration of an intermediate bond fund. In such a situation, your duration risk is zero. Changes in NAV with changes in interest rates have absolutely no impact on your lifetime returns. Your returns are determined by the average interest rate over your holding period. The higher the average rate, the higher your return. In such a situation, an investor in an intermediate bond fund will always have higher returns that an investor in short term bond funds, because of the interest rate difference. This is just a fact. Match the duration of your holdings to your investment horizon. If you need the funds in a few years, sure, put them in a short term bond fund. Why are people worried about the short-term price volatility of a bond fund? Look at the volatility of your overall portfolio. If that is too much to stomach, simply add more bonds. If that is still too much then you need to be in cash.
As mentioned by several others, this is excellent advice. One thing not mentioned in this thread is that many investors have difficulty with volatility and maintaining the proper long term perspective. These investors seem willing to accept lower returns for less volatility. The net result is less stress. A year such as 1994 in the bond market may not look all that threatening on a 25 year Morningstar Total Return chart, but in real time it is a different situation.

I also recall periods of time where short term bonds provided most of the return from longer term bonds but with much less volatility. Those periods may have been when rates were much higher than today. It may also depend on the shape of the yield curve.
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Re: The Risk of Short-term Bond Funds

Post by CWRadio »

Just a implementation question.
How is the dividend of a bond fund calculated?
Is the dividend of the bond fund calculated on the NAV of the fund or the total number of shares you have of the bond fund? Thanks
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Re: The Risk of Short-term Bond Funds

Post by Kevin M »

CWRadio wrote:Just a implementation question.
How is the dividend of a bond fund calculated?
Is the dividend of the bond fund calculated on the NAV of the fund or the total number of shares you have of the bond fund? Thanks
The dividend is declared as an amount per share. The amount you get depends on how many shares you own. The amount you get does not depend on the NAV. The distribution yield depends on the per share dividend and the NAV.

EDIT: And the total return, which is what Rick's article focuses on, is composed of the distributions (dividends and capital gain distributions) and the change in NAV during the holding period. So if in one year you receive 2% in distributions and the NAV increases by 2%, your total return is 4%.

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