Bogleheads

[Padlin]

I believe Bond mutual funds drop in value as interest rates rise, is there something that goes the opposite way? Attempting to determine how the "Bond" funds in my 401K would react to interest rates rising. Would I be correct in assuming that the only real bond fund I have (Fidelity US Bonds) would see a hit or are there others from the below possibles?

Vanguard Inflation Protection Securities VIPSX
Fidelity US (intermediate) Bond Fund FBIDX
GIC (insurance guaranteed mortgage fund)
Fidelity Money Market Trust
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Regards
Bob

[livesoft]

VIPSX would also see a hit. And so would a mortgage fund of GNMAs.

If you read the prospectus of each fund, it will usually tell you risks involved and how interest rates could affect the NAV and your investment in the fund.

[Call_Me_Op]

Money market funds are about the only thing I can think of that are guaranteed to provide an immediate hedge against rising rates. Second in line are short-term bonds and a short-term CD ladder.

Note that inflation and interest rates are not the same thing, although generally they tend to go together.
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Best regards,

-Op

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"In the midst of difficulty lies opportunity."

Albert Einstein

[grabiner]

[retcaveman]

I Bonds (opposed to TIPS) will not drop in value like the NAVs of bond funds. The fixed component would generally go up with increasing rates but the value won"t fall.
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"The wants of mortals are containers that can never be filled." (Socrates)

[Juan]

[retcaveman]

From the Treasury Direct Website: "The I Bond earnings rate is a combination of two separate rates; a fixed rate and an inflation rate:

The fixed rate will always be greater than or equal to 0.00%.

In certain deflationary situations, the semiannual inflation rate may be negative. However, if the semiannual inflation rate is negative to the extent that it completely offsets the fixed rate of return, the redemption value of a Series I bond for any particular month will not be less than the value for the preceding month.

Composite rates are never less than zero. "

So while the 6 mos rate may be zero, the value of the bond never declines.
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"The wants of mortals are containers that can never be filled." (Socrates)

[tetractys]

Retcaveman is correct. I bonds never go down in value. They can sit at 0% interest for a while, like they are doing now because of deflation; but they can never go down. They are a type of savings bond. Also i bonds have a put. So if i bond rates rise greater than the i bonds you hold, you can simply trade them in dollar for dollar, for new i bonds of a higher rate. The only penalty is a few months interest if they are under 5 years old, and there is a $5,000 limit on new i bond purchases.

So i bonds do protect against rising interest rates. -- Tet
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[TT]

My question on all this is if I have an IRA 50% Vanguard Total Bond Index fund and 50% Vanguard Inflation Protection Securities which I intend to hold at least 10 years possibly longer are interest rate changes a concern?
Thanks in advance.

[Juan]

[dbr]

[retcaveman]

TT, I will try to explain my laymans understanding.

The return for bond funds is a combination of interest/yield and changes in the NAV (like stocks, this goes up and down). The NAV is the value of each share in the fund, point in time.

So if interest rates go up, the current yield shouldn't change much but the NAV will go down. Bond prices move opposite to yields...when rates go up, the price of existing bonds, including the NAV of bond funds, goes down. This is because a higher yielding bond today is more valuable than an existing bond yielding less. Anyone with new money to invest would buy the new, higher yielding bond rather than buy a bond yielding less. To sell the lower yielding bond, you would have to sell it for less.

Over time though, the mangers of a bond fund will be redeeming maturing bonds and/or selling and reinvesting money from existing bonds in the fund into new, presumably higher yielding bonds. So while there will be an initial hit to the NAV, over time, as new, higher yielding bonds are added to the fund, the NAV should increase.

Interest rates have been declining since the 1980's and as a result, the NAV's of bond funds have benefited. With rates so low right now, many feel there is only one way for rates to move - up. So you risk declining NAV's going forward. And longer term bonds carry more risk because it will take longer for them to mature/turn over freeing up funds to invest in new, presumable higher paying isuues. This is why so many, including myself are keeping their bond holdings in short or maybe intermediate term funds.

The two funds you mention seem reasonable, especially if you are going to keep them for a while. My bond holdings are mostly in Short Term Bond Index, I Bonds (not in an IRA) and the Stable Value Option in my 401k (which is like a short term bond fund but will not go down in value like the NAV of a bond fund).

I hope that helps. I am sure other more experienced investors will be able to offer you additional advice/perspective.

Good luck.

[plats]

[retcaveman]

Thanks. I agree with your second point. Re the first point, won't the yield remain fairly steady until the current bonds begin to be replaced with new, higher yielding bonds? The yields on the bonds already in the fund won't change, will they?
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"The wants of mortals are containers that can never be filled." (Socrates)

[plats]

[Taylor Larimore]

Hi Padlin:

[Padlin]

Excellent Taylor, believe it or not I was wondering where I could turn up historical returns from the 80's for this reason. If I recall correctly we were too interested in the Magellan fund to think about how the bond funds were doing. I've occasionally wished I had kept my statements from back then...
Thanks
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Regards
Bob