Vanguard Bond question

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Vanguard Bond question

Postby FamilyMan » Fri Feb 12, 2010 10:46 pm

I recently converted my IRA to a Roth IRA which I plan on contributing to until I retire in about 25 years. In this Vanguard Roth IRA, I chose to use Total Bond Market Index Fund (VBMFX) as my bond choice. Today, I received the Vanguard Bond Prospectus and have been reading through it. I am starting to wonder if I should have chosen Vanguard Long-term Bond Index fund (VBLTX) for the following reasons:

1. Over 10 years, the long-term bond return is 6.65% vs. total bond is 5.37% (obviously, doesn't predict future returns)

2. The risk of the fund is almost the same except that long-term bonds have a higher risk with interest rates.

3. The Total bond index is 40% mortgage-backed bonds vs. 0% of long-term bonds. Is this more risky for the total bond index?

In summary, the benefits seem to be advantage Long-term bonds. What am I missing that most people on this site recommend the Total Bond Market Index vs. Long-term bonds for a 25 year time frame?

Your opinions are always appreciated

FM
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Postby dm200 » Fri Feb 12, 2010 11:18 pm

2. The risk of the fund is almost the same except that long-term bonds have a higher risk with interest rates.


This reminds me of the line:

Other than that, Mrs. Lincoln, how was the play?
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Re: Vanguard Bond question

Postby linuxizer » Fri Feb 12, 2010 11:49 pm

FamilyMan wrote:I recently converted my IRA to a Roth IRA which I plan on contributing to until I retire in about 25 years. In this Vanguard Roth IRA, I chose to use Total Bond Market Index Fund (VBMFX) as my bond choice. Today, I received the Vanguard Bond Prospectus and have been reading through it. I am starting to wonder if I should have chosen Vanguard Long-term Bond Index fund (VBLTX) for the following reasons:

1. Over 10 years, the long-term bond return is 6.65% vs. total bond is 5.37% (obviously, doesn't predict future returns)

2. The risk of the fund is almost the same except that long-term bonds have a higher risk with interest rates.

3. The Total bond index is 40% mortgage-backed bonds vs. 0% of long-term bonds. Is this more risky for the total bond index?

In summary, the benefits seem to be advantage Long-term bonds. What am I missing that most people on this site recommend the Total Bond Market Index vs. Long-term bonds for a 25 year time frame?

Your opinions are always appreciated

FM


The past 2-3 decades have seen rates falling considerably. This boosted bond returns. Since rates are now at historic lows, using the past returns to justify your decision seems a bad idea.

Read this part of the wiki:
http://www.bogleheads.org/wiki/Bond_Bas ... short-term

Reading the wiki page on duration and convexity sounds like it might be beneficial as well (under Bonds:Advanced Topics).
Last edited by linuxizer on Sat Feb 13, 2010 6:05 am, edited 1 time in total.
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Re: Vanguard Bond question

Postby FamilyMan » Sat Feb 13, 2010 12:24 am

The past 2-3 decades have seen rates falling considerably. This boost bond returns. Since rates are now at historic lows, using the past returns to justify your decision seems a bad idea.

Read this part of the wiki:
http://www.bogleheads.org/wiki/Bond_Bas ... short-term

Reading the wiki page on duration and convexity sounds like it might be beneficial as well (under Bonds:Advanced Topics).[/quote
]


Thank you linuxizer. After reading the wikipedia article, I should have done more research into which bond index to buy. I guess TIPS and intermediate bond index might have been my better choice, even with a longer time until retirement (25 years)
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Postby linuxizer » Sat Feb 13, 2010 6:22 am

There are, of course, other opinions. Sticking to short-term or intermediate-term seems to be the general recommendation around these parts, though, and it was on that basis that I gave that guidance in the wiki. Bernstein's analysis in The Intelligent Asset Allocator is pretty good, though.
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Postby Dude2 » Sat Feb 13, 2010 10:07 am

TBM contains 31.6% Mortgage Backed Securities which are now government backed and 3.4% commercial MBS.

It also has approx 12% long term. You do get a piece of long term there. You also get approx 25% of short term.

Since it is a "total" bond fund, you some of everything, and that's good.
I think we all wish that it also had TIPS in it. Not a bad idea to hold some TIPS too.

On this forum, from my observations, I do not believe that anyone has any real problem with TBM. It's a great fund choice. Don't even worry about it.
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Postby tibbitts » Sat Feb 13, 2010 11:15 am

After reading the wikipedia article, I should have done more research into which bond index to buy. I guess TIPS and intermediate bond index might have been my better choice, even with a longer time until retirement (25 years)

I think if you do still more (and more, and more) research, you'll probably conclude that it isn't likely to matter much in any predictable way.

By far the biggest risk is that you won't have 25 years until retirement. That's something you need to worry about more than the makeup of your bond fund.

Paul
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Postby MickeyBoy » Sun Feb 14, 2010 6:46 pm

I just reread Larry Swedroe's book on bonds. He specifically advises against the Vanguard Total Bond Market fund because of the large percentage of mortgage-backed securities. He pointed out that when interest rates move outside of a narrow band, the value of these securities changes in unfavorable ways. This is particularly the case with rising interest rates, just what we are very likely to see. In other words, falling or rising rates hurt the interests of the borrower. If I remember correctly, in an earlier book he recommended the Vanguard intermediate-term bond fund, which is free of MBS. Or perhaps now a mixture of intermediate and short-term bond funds giving you the appropriate duration for your needs.

I have a large holding of Total Bond Market I am strongly thinking of selling in favor of IT and ST funds. Can anyone come up with strong arguments against this?
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Postby mickeyd » Sun Feb 14, 2010 7:55 pm

MickeyBoy wrote: He specifically advises against the Vanguard Total Bond Market fund because of the large percentage of mortgage-backed securities. He pointed out that when interest rates move outside of a narrow band, the value of these securities changes in unfavorable ways.


One of the reasons that I have selected my FI bond fund to be the I-T Bond Index rather than the TBM is that I was trying to stay away from GNMA bonds and I-T fits the bill, but it does have a longer duration than does the TBM if I recall correctly. The I-T, mixed 50/50 with TIPS, seems to work pretty well.

Like all investments, time will tell.
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Postby rick51 » Sun Feb 14, 2010 9:00 pm

You might find this week's discussion on wealthtrack.com re: fixed investments interesting regarding long bonds as a contrarian investment, but for me its TBM.
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Total Bond Market Index Fund

Postby Taylor Larimore » Sun Feb 14, 2010 9:53 pm

Hi MickeyBoy:

Welcome to the Bogleheads Forum!

I have a large holding of Total Bond Market I am strongly thinking of selling in favor of IT and ST funds (to avoid GNMAs). Can anyone come up with strong arguments against this?


The strongest argument for Total Bond Market Index Fund is its bond diversification (over 3,000 bonds). This advantage was demonstrated in the bear market of 2008 when Vanguard's Intermediate-Term Investment Grade Bond Fund fell -6.2% and Short-Term Investment Grade Bond Fund fell -4.7%.

Meanwhile, the GNMA Fund gained +7.2% which helped Total Bond Market gain 5.1%. Total Bond Market holds GNMAs, Short-Term, Intermediate-Term, and Long-Term high-quality bonds with an average intermediate-term duration.

No one can forecast bond returns in advance. This is why we diversify in stocks. Bonds are primarily for safety, and this is why you should also diversify in bonds. Diversification is our friend.

Total Bond Market Index Funds are recommended by Jack Bogle. TBM has served you well.

Stay-the-course.
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Postby DaveS » Mon Feb 15, 2010 2:10 am

The last place I would want to throw money now is a long term bond fund. Over the last ten years interest rates have trended lower. At present they are at historic lows. While its impossible to time interest rate increases, they are not likely to stay at historic lows indefinitely. Recall that for each increase in rates of one percent, the NAV of a bond fund will go down by its duration. Pick your poison.
Vanguard Total Bond Market. Duration 4.5.
Vanguard Intermediate Term Investment Grade. Duration 5.2
Vanguard Intermediate Term Index. Duration 6.3
Vanguard Long Term Investment Grade. Duration 12.

I would sure prefer a decline of 4.5% with total bond, than 12% decline from the long term fund. If you don't want a fund with a significant mortgage bond component then I would pick either Int. Term Investment Grade an active fund, but a very inexpensive one, or Intermediate index. Dave
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Postby TJAJ9 » Mon Feb 15, 2010 5:10 am

Stick with Total Bond Market Index. Easy choice. Great fund.

MickeyBoy wrote:I just reread Larry Swedroe's book on bonds. He specifically advises against the Vanguard Total Bond Market fund because of the large percentage of mortgage-backed securities.


I like Total Bond. Jack Bogle likes it. Many other investors like it. It has performed great. It holds high-quality bonds. It's extremely diversified.

Total Bond, it is.
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Postby MickeyBoy » Mon Feb 15, 2010 3:17 pm

Mr Larimore, TJAJ9, and others who replied to my post: Thank you very much. I respect your opinions and experience; you have given me much to think about, particularly regarding diversification of one's bond holdings.

As it happens, Larry Swedroe has a new column today in the CBS MoneyWatch entitled, 'Why ginnie maes may not be right for your portfolio." In it he recommends avoiding bonds with 'optionality,' i.e., of uncertain maturity. In his book he stated that if you insist on having MBS in your portfolio, you should consider ginnie maes only. In today's column he cites evidence that ginnie maes don't earn higher returns, despite their higher yields.

At the risk of hijacking this thread, I would like to ask your opinion of the idea of creating a diversified bond portfolio by means of separate funds or ETFs. E.g. one could combine VBISX, VBIIX, and other funds, perhaps along with an international bond fund. Such a group of funds would be just as diversified as Total Bond, but shorn of questionable bond types such as MBS.

Let me add that I have been searching the literature for good articles on diversifying one's bond holdings, but to no avail. Larry's book has some good information. Do you know of other sources?

TIA.
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Postby Roy » Mon Feb 15, 2010 9:40 pm

MickeyBoy wrote:As it happens, Larry Swedroe has a new column today in the CBS MoneyWatch entitled, 'Why ginnie maes may not be right for your portfolio." In it he recommends avoiding bonds with 'optionality,' i.e., of uncertain maturity. In his book he stated that if you insist on having MBS in your portfolio, you should consider ginnie maes only. In today's column he cites evidence that ginnie maes don't earn higher returns, despite their higher yields.

At the risk of hijacking this thread, I would like to ask your opinion of the idea of creating a diversified bond portfolio by means of separate funds or ETFs. E.g. one could combine VBISX, VBIIX, and other funds, perhaps along with an international bond fund. Such a group of funds would be just as diversified as Total Bond, but shorn of questionable bond types such as MBS.

Let me add that I have been searching the literature for good articles on diversifying one's bond holdings, but to no avail. Larry's book has some good information. Do you know of other sources?
TIA.


Note that while Jack Bogle likes VBMFX he also had this to say about it:

"The Total Bond Market Index Fund is fine, but I vaguely wonder about a bond fund that has 35% of its portfolio in non-bonds (i.e., GNMA securities, with their risk of being prepaid early, when interest rates tumble).

That said, TBMF happens to have a maturity profile that is intermediate-term on balance, and so differs from IT largely in its holdings of GMNAs and Treasurys. Their ten-year records are similar, based on the tabulation I’m sending separately (IT 6.49%, TBM 5.96%, which included a single year–2002–in which we sort of forgot to stick to index principles, costing 2.00%, or about 0.20% per year. I’m assured by management that such an aberration will not recur.)"


Larry is an excellent source of information on any investing topic, especially fixed income. The best diversifier for your purposes might be TIPS, and Larry certainly has a lot to say about those and CCFs as diversifiers, (CCFs enabling one to go longer in bond maturity). Some dislike TIPS and others dislike CCFs. There are lots of relevant discussions here in past threads.

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Postby TJAJ9 » Tue Feb 16, 2010 4:55 am

MickeyBoy wrote:At the risk of hijacking this thread, I would like to ask your opinion of the idea of creating a diversified bond portfolio by means of separate funds or ETFs. E.g. one could combine VBISX, VBIIX, and other funds, perhaps along with an international bond fund. Such a group of funds would be just as diversified as Total Bond, but shorn of questionable bond types such as MBS.

Let me add that I have been searching the literature for good articles on diversifying one's bond holdings, but to no avail. Larry's book has some good information. Do you know of other sources?

TIA.


As long as you're using high-quality, short-term and/or intermediate-term bonds, you should be just fine. You could also use TIPS if that's what you like. A bond portfolio doesn't need to be complicated.

The simplest thing would be to hold Total Bond or Total Bond/TIPS. What you're proposing is also good albeit slightly more complicated. Either way is fine.
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Postby nisiprius » Tue Feb 16, 2010 8:32 am

You need to think about the fundamentals of what kind of stuff is in a fund and how it behaves, not just whether it's going up or down or how much it went up in the last ten years.

I'm honestly not sure what the proper role of long-term bonds is in an ordinary investor's portfolio. They seem to me to be a specialty item.

Think about what a 30-year bond is. Let's say it pays 5% interest per year, just for round numbers. You give the issuer $100,000 now. Every year they give you $5,000 and then thirty years from now you get your $100,000 back. If that is a pattern that fits a plan, great. If it's just part of an amorphous blob of stuff in a mutual fund that you will be buying and selling at random times on the market, it's not good, because a lot can happen in thirty years and the value that the market places on that bond can change drastically with interest rates. If it's a nominal (fixed-rate) bond and not a TIPS, thirty years gives inflation an awful lot of time to chew away at it, and presents a long window of vulnerability for a high-inflation episode.

One use I can see for long-term bonds would be a rich family, that believes they can live comfortably off the interest only, doesn't care what the market value is, because they're not going to sell them, and doesn't care when they mature because they're just going to replace them with new bonds when that happens. They just keep getting passed on to the next generation. If inflation hits, the family business takes care of that, daddy just builds some more railroads or sells some more software or something.

Long-term bonds seem to be the flavor-of-the-month because of big numbers, and because everything looks lousy and people are flailing around looking at new stuff they've never looked at before, and anything with recent big numbers attracts attention.

The last thirty years have been an absolutely unprecedented time for them. Unfortunately, the forty years that preceded them were nothing but a long steady relentless decline.

Vanguard puts Total Bond Market, VBMFX, at a "2" on their risk scale; Long-Term Bond Index Fund gets a "3;" and Total Stock Market Index a "4." That tells you that the long-term bond index is pretty darn risky for bonds.
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Postby brick-house » Tue Feb 16, 2010 9:10 am

Nisiprius wrote:

I'm honestly not sure what the proper role of long-term bonds is in an ordinary investor's portfolio. They seem to me to be a specialty item.


Long Term Treasuries provide deflation protection, provide an income stream, and serve as a safe haven in a global crisis (2008). One investing strategy, The Permanent Portfolio, dedicates 25% to Long Term Treasuries for these reasons.

Total Bond pays a 3.3% yield with a duration of 4.4 years. PenFed offers a 7 year CD with 3.75% yield that can be broken for six months of interest (1.875). I know that market timing is forbidden, but why take the interest rate risk of the Total Bond when CDs are offering a higher yield, federal government insurance, and the ability to break the CD for a defined amount (1.875%).
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