struggling to understand "bond crash"

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mctot1234
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struggling to understand "bond crash"

Post by mctot1234 »

I continue to read about an impending "bond crash" . The articles are never ending. I apologize up front that I don't understand well what this means in practical terms.

Can someone explain in layman's terms (or point me to another posting) what would happen if U.S. Treasuries /Treasury Bond Funds "crashed"? Yields are so low...there isn't much room to go lower. What is the real world impact if China doesn't continue to purchase Treasuries for example (as I often read)? Does this precipitate such a "crash"?

I hold Fideltiy Spartan (FSBAX), Vanguard Short Term Treasury (VFISX) for principal preservation at this point...not yield. IF there are other bond funds that are better please suggest them.

Thank you.
jdilla1107
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Re: struggling to understand "bond crash"

Post by jdilla1107 »

mctot1234 wrote:I continue to read about an impending "bond crash" . The articles are never ending.
This is your problem. Stop reading the financial press and read something that is not trash. When you see at the grocery store that lizard people are taking over the US government, do you "struggle to understand it?" Same thing here. They sell fear.

Make sure you are doing this:

http://www.bogleheads.org/wiki/Getting_started

Then read some things here:

http://www.bogleheads.org/wiki/Books:_r ... nd_reviews
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DR
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Re: struggling to understand "bond crash"

Post by DR »

Yes, there's a lot of that kind of talk out there. But in this talk it's often easy to miss distinctions that these writers do not point out (because it would lower the scare factor in the narrative). For example, the concern we should have is holding long term bonds (in most but not all situations). A position in short term or intermediate term bonds is still a good position to have if the purpose of the bond position is to stabilize your portfolio. If you look at a "bad year" in an intermediate term bond fund such as FBIDX it's -2%. Compare that to a "bad year" in the S&P. But if you keep reading you'll see that Vanguard and others have put out some good papers that place all this scare talk into perspective and raise awareness of the distinction between bonds, bond funds, and the average maturity or duration of these funds.

You might enjoy Cullen Roche's "biggest myths" list and one of them has to do with so called "bond vigilantes." http://pragcap.com/biggest-myths-in-economics

There is a lot of stuff out there presented by experts--people that should know better--that is simply factually wrong. It can be pointed out to them in print with full refutation and they still will not change their point of view. This makes it very difficult for ordinary folks like us to separate the wheat from the chaff. But as you read you start to develop an opinion and you can hear when someone is being shrill. If anyone, for example, takes Peter Schiff seriously, then I guess they deserve to lose their money in the gold market. But he is not alone. He's not really an economist (though his followers call him that) but others of these types are really economists and they are still shrill, marketing fear just to get attention it appears.

Anyway, keep reading and good luck.
Dandy
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Re: struggling to understand "bond crash"

Post by Dandy »

crash is a relative term much more applicable to equities than most bonds. When interest rates rise people want the higher yielding Treasuries not the ones your fund holds. So the market value of the lower yielding Treasuries drops a bit. Fund have to reflect the lower value in their Net Asset Value. Now those "older" Treasury bonds that your fund owns will eventually get to their face value when they mature - if the fund holds them to maturity.

If you look at the duration of your fund it is the estimate of the impact of the interest rates going up 1 full percent.-- VG short term Treasury fund has a current duration of 2.1 years. That means if short term treasury rates go up 1% you fund will probably decline 2.1%. Hardly a crash. And, if that was the extent of the rise in interest rates, the fund would gradually replace the lower yielding bonds with the higher yielding and in a couple of years you should be at or close to the value before interest rose. This is a very rough, simple explanation. But the general idea is that the drop in bond value for a short term bond fund is likely nothing like the impact on equities. Unpleasant - yes but a disaster? Now interest rates may rise more than 1 percent over a few years but the same basic things happen. The higher the duration of your bond fund the more it will be impacted by a change in interest rates.

The duration does not take into account panic. When interest rates rise there could be a panic from bond holders as they see their "safe" money take a modest hit - amped up by the media hype. Panics are usually temporary and lower NAV and higher yields should be a buying opportunity.
Short Term Treasuries are also an excellent place to be when there is a flight to quality - e.g. when the economy goes into recession.

If a short term dip in your Short Term Treasury fund has you extra worried you might consider allocating part of that money to other government guaranteed products e.g. CDs, other bank products or I Bonds.
Boglegrappler
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Re: struggling to understand "bond crash"

Post by Boglegrappler »

Bond crash isn't referring to yields going lower (which is what actually has been happening since August of 1982). It refers to a dramatic increase in interest rates over some relatively short period of time. If this were to happen, a 30 year bond which was issued at a 3.5% yield, for example, would have a sharp drop in market price as a consequence of, for example, rates on 30 year paper moving to say 5.5% instead.

To understand this, you have to view bonds as rented money. If you hold a bond it is a promise to repay your $1000 principal at the maturity date, and the interest payment yearly (or semi-annually) until then. The payment amount (coupon) and the principal never change in response to interest rate movements. But the market price of the bond does. If rates rise, the bond price falls, because that's the only way that the yield on the bond can rise to equal the market rate. A short term bond is like selling a house with a tenant in it for a short term at a fixed rent. A long term bond is like selling a house with a tenant in it for a long term, but also at a fixed rent that cannot be raised. If market rents change, the value of the house with the long term tenant is affected more. It rises as rents fall, and it falls as rents rise, because you're stuck with the original rent agreement. Lending is renting money.

IF the bond matures tomorrow, then there isn't much price adjustment no matter how rates move today. But if the $1000 principal isn't due for another 29 or 30 years, then the price of the bond moves a lot more for a given change in interest rates.

Bond investment is very important in the insurance industry....especially for annuities. Also in the pension investment business. You can read Warren Buffetts letter from two years ago and read the section titled "The choices available to investors......" for Buffetts view on bond investing for the long term.
livesoft
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Re: struggling to understand "bond crash"

Post by livesoft »

I think we need to cue a nisiprius bond crash chart here. Let me see if I can find one ….

Wow, there are so many many threads on this going back to the start of the forum. Apparently, bonds threatening to crash is a perpetual problem even when they are going up.

Here's a thread
http://www.bogleheads.org/forum/viewtop ... &p=1925934

And another
http://www.bogleheads.org/forum/viewtop ... 0&t=108382

And another
http://www.bogleheads.org/forum/viewtop ... 1#p1916591

And another
http://www.bogleheads.org/forum/viewtop ... 9#p2001479
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John3754
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Re: struggling to understand "bond crash"

Post by John3754 »

The articles you're reading are just noise, ignore the noise and you'll be better off.
Call_Me_Op
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Re: struggling to understand "bond crash"

Post by Call_Me_Op »

2.5% loss per year of duration,as a first-order estimate.
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ObliviousInvestor
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Re: struggling to understand "bond crash"

Post by ObliviousInvestor »

livesoft wrote:I think we need to cue a nisiprius bond crash chart here.
I recently noticed the signature of Boglehead member sharke: "I survived the Great Bond Crash of 2013!" Hehe. Reminded me of Nisi's charts. :)
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BolderBoy
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Re: struggling to understand "bond crash"

Post by BolderBoy »

mctot1234 wrote:I continue to read about an impending "bond crash" . The articles are never ending. I apologize up front that I don't understand well what this means in practical terms.

Can someone explain in layman's terms (or point me to another posting) what would happen if U.S. Treasuries /Treasury Bond Funds "crashed"?
You need to quit reading this slop.

If U S Treasuries crashed you'd have nothing to worry about (assuming you can grow your own food, take out your own appendix and defend perpetually against the raging hordes.)

There is a greater chance that an escaped African wildebeest will trample you in your backyard after swimming across the Atlantic.
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LadyGeek
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Re: struggling to understand "bond crash"

Post by LadyGeek »

This thread is now in the Investing - Theory, News & General forum (general question).
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YDNAL
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Re: struggling to understand "bond crash"

Post by YDNAL »

mctot1234 wrote:I continue to read about an impending "bond crash" . The articles are never ending. I apologize up front that I don't understand well what this means in practical terms.
Well, "in practical" terms, when interest rates increase, Bond prices decrease. Suggestion: read THIS.
mctot1234 wrote:I hold Fideltiy Spartan (FSBAX), Vanguard Short Term Treasury (VFISX) for principal preservation at this point...not yield.
FSBAX shows an average effective duration of 2.57% (currently). Roughly speaking, every 1% in higher interest rates, means -2.57% in FSBAX price, while shares you own would pay higher future dividends.
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Topic Author
mctot1234
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Re: struggling to understand "bond crash"

Post by mctot1234 »

Thank you all for the levelheaded replies.

DR and Dandy...thanks for the explanation of "duration"...that was new to me and very helpful.

Boglegrappler...the analogy to "rented money" was very helpful.

I appreciate the collected insight...thank you for taking time to share it. (and apologies for my lag in responding this week...not a lack of interest but a heavy travel schedule)
z3r0c00l
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Re: struggling to understand "bond crash"

Post by z3r0c00l »

A bad year for bonds = a bad day for stocks. Something to keep in mind.
70% Global Stocks / 30% Bonds
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