What the blank is going on with bonds?

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Calm Man
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What the blank is going on with bonds?

Post by Calm Man » Wed Jun 19, 2013 7:53 pm

I use the Intermediate term investment grade for IRAs and the NJ long term for taxable. These both have durations of about 5-6 years. I did anticipate as everybody did that rates would slowly rise eventually. When they started about a month ago, I figured it was all priced in. But we now have a weird situation where "everybody" is saying rates will keep going up and they do keep going up. Every day. Today was a bad one and NAVs are donw quite a bit today and over the last month or so. Could it be that these rates will just keep rising for years as they fell for years? I still have some more to put in as I didn't lump sum it all in and I know that if you hold for the duration, you are fine from the time of the LAST increase. Would it be over-reactive to just say it is too risky and just move all bonds to money markets and assume it is possible that rates will rise for years? I know I am not alone here but have a whole bunch of $ in bond funds. I am a 50/50 type of guy and stocks are getting shaky too but let's forget about them as I assume that they will grow over time.

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Re: What the blank is going on with bonds?

Post by Elbowman » Wed Jun 19, 2013 8:07 pm

Why are you watching interest rates and your fund values every day? Stop it. Nothing good will come of it. It is noise. You are not supposed to pay it any mind.

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Re: What the blank is going on with bonds?

Post by nisiprius » Wed Jun 19, 2013 8:11 pm

1) They certainly could keep rising for years. This is what it's done in the past:

Image

2) That probably doesn't mean what you think it means. It took me quite a while to figure this out and I haven't seen any place that explains it well, but bond prices do not simply mirror interest rates. If the interest rate jumps 1% and stays there, a 10-year bond's price will drop about 5%, but it does not stay down--it rises to its issue price at maturity.

This is an oversimplified approximate illustration, a computer simulation of what would happen to an imaginary bond fund consisting of a bond ladder. And it simulates a growth chart, i.e. assumes interest is invested.

But this is the general picture of what would happen if interest rates were to rise and just keep rising at 1% per year forever. First, rising rates would knock down the value of the bonds. When it had pushed them down to a certain level, there would be a balance between interest rates pushing them down and the upward "pull to maturity." The fund's price per share value would drop about 12% and then stabilize. But the bond fund would also be earning interest, and as interest rates rose that interest would grow, so the actual total value of the fund, including interest, would bottom, then rise, then rise faster and faster.

Image
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Frengo
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Re: What the blank is going on with bonds?

Post by Frengo » Wed Jun 19, 2013 8:12 pm

Calm Man wrote:I did anticipate as everybody did that rates would slowly rise eventually...
You probably anticipated too much. Had you left out the underlined part, your would have made an almost surely correct forecast. By taking a larger bite that chance has decreased a lot.

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Re: What the blank is going on with bonds?

Post by z3r0c00l » Wed Jun 19, 2013 8:25 pm

Bonds drop 2% in a month and people lose their minds, stocks drop 2% in a day and...?

"I am a 50/50 type of guy and stocks are getting shaky too but let's forget about them as I assume that they will grow over time."

If you have this faith in stocks, as I think we all do, then have the same in bonds. Bonds will grow over time. Ignore the noise, ignore the markets, they are a distraction from the real job of investing which is to own your slice of the market, the entire market, and ride the world economy into a secure future. Worst case scenario your bonds go down for a few years, you earn more monthly, and reinvest dividends at a cheaper NAV. Not so bad really.

I think lots of people were ignoring the very clear warnings on these investments:

"Conservative to moderate funds—Risk level 2
Vanguard funds classified as conservative to moderate are subject to low-to-moderate fluctuations in share prices. In general, such funds may be appropriate for investors with medium-term investment horizons (four to ten years)."
Last edited by z3r0c00l on Wed Jun 19, 2013 8:31 pm, edited 2 times in total.

Calm Man
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Re: What the blank is going on with bonds?

Post by Calm Man » Wed Jun 19, 2013 8:28 pm

Elbowman, I actually haven't been following too closely. I just was jogging today and turned on bloomberg radio and they discussed it so I looked tonight and saw the recent significant decline in NAV> For example, my NJ long term bund fund has gone from about 12.40 or so to 11,90 which I guess is 2,5% in about 6 or so weeks I think as I made a purchase in April.
Nsis - very interesting analysis. Thank you. I guess if one can hold his/her nose, it will all be OK particularly if you get through the first 5 or so years. Psychologically I can probably just hang out as is but I have been DCAing quarterly for 2 years and still have a little over half to go in. I am debating whether I should stick to the plan or slow it down by half per quarter maybe. As Mike Tyson said: everybody has a plan until they get punched in the mouth.
Frengo, fortunately there is a lot of fresh cash to put in, more luck than skill.
zscr - it is more than 2% I think. It's not the 2%, it's more the realization sinking in that they could keep going up indefinitely--nisi has helped quell the angst on that.

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Re: What the blank is going on with bonds?

Post by z3r0c00l » Wed Jun 19, 2013 8:34 pm

Calm Man wrote:Psychologically I can probably just hang out as is but I have been DCAing quarterly for 2 years and still have a little over half to go in. I am debating whether I should stick to the plan or slow it down by half per quarter maybe.
If it was good at the all time high NAV, why not good now 2.5% lower? The lower it goes, the better your deal, no?

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momar
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Re: What the blank is going on with bonds?

Post by momar » Wed Jun 19, 2013 8:38 pm

nispirius with a fantastic post illustrating that it's not just the change in rates, it's the relative change in rates that matters.
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Re: What the blank is going on with bonds?

Post by BolderBoy » Wed Jun 19, 2013 8:40 pm

nisiprius wrote:This is an oversimplified approximate illustration, a computer simulation of what would happen to an imaginary bond fund consisting of a bond ladder. And it simulates a growth chart, i.e. assumes interest is invested.
An "imaginary bond fund consisting of a bond ladder"?

I wonder if all bond funds are bond ladders of a sort. Not so? I'd not thought of them that way until you mentioned it above.

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Re: What the blank is going on with bonds?

Post by Novine » Wed Jun 19, 2013 9:06 pm

Thanks nisiprius. I have to admit that the functioning of bonds generally and the various bond funds is a bit of a mystery to me. I think I understand the basics but I've had a hard time making sense of much of the recent commentary and whether it would make sense to make some adjustments in my bond holdings. Your post helps make it a little less of a mystery.

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Re: What the blank is going on with bonds?

Post by ogd » Wed Jun 19, 2013 9:30 pm

BolderBoy wrote:
nisiprius wrote:This is an oversimplified approximate illustration, a computer simulation of what would happen to an imaginary bond fund consisting of a bond ladder. And it simulates a growth chart, i.e. assumes interest is invested.
An "imaginary bond fund consisting of a bond ladder"?

I wonder if all bond funds are bond ladders of a sort. Not so? I'd not thought of them that way until you mentioned it above.
They are all bond ladders, except they generally prefer a more complex curve of maturities instead of an equal distribution. The latter is what an individual investor would normally do, purchasing bonds of, say, 5 years and holding all to maturity.

Take a look at http://portfolios.morningstar.com/fund/ ... ture=en-us for an example. VFICX is actively managed with the 5-10 year duration as a constraint, so it looks like a bell curve. Total Bond Market is more complicated, because it doesn't commit itself to an "intermediate" or "long" term but it tries to represent the market, which is mostly driven by bond issuance.

It's important to recognize that the "imaginary fund" / straight ladder is not like the Carnot cycle in thermodynamics (a theoretical optimum impossible to achieve by any real engine). The funds could very easily do it that way if they wanted, but instead every fund seems to pick a point or two on the yield curve and stay with it. Some of them have to do it because of the prospectus (like VFICX) and the role it implies in their investors' portfolios. The more flexible ones (example: MWTIX) presumably have an opinion on which 2-3 points are the best values. E.g. bonds approaching maturity are almost equivalent to cash and the fund manager may not see much point holding them in their final year. As to why the bonds are "smeared" around the preferred maturity point, that's probably for liquidity / turnover reasons.

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Re: What the blank is going on with bonds?

Post by grabiner » Wed Jun 19, 2013 9:31 pm

BolderBoy wrote:
nisiprius wrote:This is an oversimplified approximate illustration, a computer simulation of what would happen to an imaginary bond fund consisting of a bond ladder. And it simulates a growth chart, i.e. assumes interest is invested.
An "imaginary bond fund consisting of a bond ladder"?

I wonder if all bond funds are bond ladders of a sort. Not so? I'd not thought of them that way until you mentioned it above.
The difference between most bond funds and ladders is that funds sell bonds before maturity. A typical intermediate-term bond fund holds bonds of maturities 5-10 years, and sells bonds 5 years from maturity to buy new 10-year bonds. A typical 10-year ladder holds bonds of maturities 0-10 years, and sells maturing bonds to buy new 10-year bonds.

Short-term funds are more like ladders, as they usually hold bonds until about a year before maturity, when bonds are essentially cash. Total Bond Market Index doesn't sell bonds until a year from maturity, but it behaves more like a combination of ladders. It holds bonds up to 30 years, but has only 15% of its value in bonds more than 10 years from maturity, while a true 30-year ladder would have 2/3 of its value in bonds more than 10 years from maturity.
Wiki David Grabiner

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BolderBoy
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Re: What the blank is going on with bonds?

Post by BolderBoy » Wed Jun 19, 2013 9:36 pm

ogd wrote:
BolderBoy wrote:
nisiprius wrote:This is an oversimplified approximate illustration, a computer simulation of what would happen to an imaginary bond fund consisting of a bond ladder. And it simulates a growth chart, i.e. assumes interest is invested.
An "imaginary bond fund consisting of a bond ladder"?

I wonder if all bond funds are bond ladders of a sort. Not so? I'd not thought of them that way until you mentioned it above.
They are all bond ladders, except they generally prefer a more complex curve of maturities instead of an equal distribution. The latter is what an individual investor would normally do, purchasing bonds of, say, 5 years and holding all to maturity.

Take a look at http://portfolios.morningstar.com/fund/ ... ture=en-us for an example. VFICX is actively managed with the 5-10 year duration as a constraint, so it looks like a bell curve. Total Bond Market is more complicated, because it doesn't commit itself to an "intermediate" or "long" term but it tries to represent the market, which is mostly driven by bond issuance.

It's important to recognize that the "imaginary fund" / straight ladder is not like the Carnot cycle in thermodynamics (a theoretical optimum impossible to achieve by any real engine). The funds could very easily do it that way if they wanted, but instead every fund seems to pick a point or two on the yield curve and stay with it. Some of them have to do it because of the prospectus (like VFICX) and the role it implies in their investors' portfolios. The more flexible ones (example: MWTIX) presumably have an opinion on which 2-3 points are the best values. E.g. bonds approaching maturity are almost equivalent to cash and the fund manager may not see much point holding them in their final year. As to why the bonds are "smeared" around the preferred maturity point, that's probably for liquidity / turnover reasons.
To say this is way over my head is a vast understatement, but thank you! :happy Grabiner's explanation was down on my level a bit more.

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Re: What the blank is going on with bonds?

Post by ogd » Wed Jun 19, 2013 9:43 pm

BolderBoy wrote:To say this is way over my head is a vast understatement, but thank you! Grabiner's explanation was down on my level a bit more.
Sorry :? I was trying to make the point that many funds out there have the freedom to hold bonds to maturity. The fact that they don't (and they show a marked dislike of the very short term) tells us something.

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Re: What the blank is going on with bonds?

Post by etarini » Wed Jun 19, 2013 9:56 pm

I've been focusing on increasing my investment in bonds for a few years now, somewhat bemused to see the bond and bond fund prices going up so much (I wasn't at all happy to see the NAV climbing at multiples of the underlying dividend rate; it just increased my purchase costs.) Now that they're coming back down to their intrinsic value, am I surprised? No. I bought them with an expectation of a certain bond return, and that expectation has been satisfied, though I won't mind if the underlying coupons grind higher over the next few years.

Baird Intermediate Municipal (BMBIX) is down 3.2% compared to 52-week high.

Vanguard Intermediate-Term Tax Exempt (VWIUX) is down 4.0% compared to 52-week high.

Vanguard Total Bond (VBTLX) isdown 3.8% compared to 52-week high.

If stocks fall 4% compared to their 52-week high, no one even notices. Their fall would have to be 5 times larger to even qualify as a "correction."

I realize that relatively few people can rely on the returns of today's bonds to meet their needs, and must take more risk in stocks.

But all the gnashing of teeth and rending of cloth seems out of proportion, at least for those who have been paying attention to bonds' excessive total returns over the past few years.

Did people really think that bonds and bond funds would continue to outperform their coupons?

Eric

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Re: What the blank is going on with bonds?

Post by Calm Man » Thu Jun 20, 2013 7:50 pm

I posted this originally yesterday (Wed). Only because while listening to the radio while jogging (Bloomberg) I heard that some muni etf had the biggest decline in years did I decide to check prices tonight. All the prices were down with long treasuries real bad. But the muni funds seem to have been hit a lot more than intermediate bonds. Are people worried about defaults or just that they have overperformed for so long? Or am I seeing something not even there?

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Re: What the blank is going on with bonds?

Post by gerrym51 » Thu Jun 20, 2013 8:06 pm

ogd wrote:
BolderBoy wrote:To say this is way over my head is a vast understatement, but thank you! Grabiner's explanation was down on my level a bit more.
Sorry :? I was trying to make the point that many funds out there have the freedom to hold bonds to maturity. The fact that they don't (and they show a marked dislike of the very short term) tells us something.
not if they have to sell to pay for redemptions

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Re: What the blank is going on with bonds?

Post by surfer1 » Thu Jun 20, 2013 8:07 pm

Calm Man wrote:But the muni funds seem to have been hit a lot more than intermediate bonds.
Municipals carry more risk than plain bonds. This is the reason I never understood that people can move all of their money into muni bonds in a taxable account, without the thought of the increase in volatility, compared to plain bonds.

-> Risk ->
Bonds -> Munis -> Junk

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Re: What the blank is going on with bonds?

Post by Rainier » Thu Jun 20, 2013 8:12 pm

surfer1 wrote:
Calm Man wrote:But the muni funds seem to have been hit a lot more than intermediate bonds.
Municipals carry more risk than plain bonds. This is the reason I never understood that people can move all of their money into muni bonds in a taxable account, without the thought of the increase in volatility, compared to plain bonds.

-> Risk ->
Bonds -> Munis -> Junk
What would that be? Many are insured and are backed by a legal obligation to raise taxes to cover principal and interest.

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Re: What the blank is going on with bonds?

Post by gerrym51 » Thu Jun 20, 2013 8:24 pm

surfer1 wrote:
Calm Man wrote:But the muni funds seem to have been hit a lot more than intermediate bonds.
Municipals carry more risk than plain bonds. This is the reason I never understood that people can move all of their money into muni bonds in a taxable account, without the thought of the increase in volatility, compared to plain bonds.

-> Risk ->
Bonds -> Munis -> Junk

when you say plain bonds what are you talking about. of course treasury bonds have no risk.

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Re: What the blank is going on with bonds?

Post by linuxizer » Thu Jun 20, 2013 8:56 pm

It's been a year or two since I read Bogleheads every day, and posted a lot, but back then everyone was wishing for higher rates. Now that they've come, there are a bunch of threads fretting about rates going up!

And regarding ladder vs. fund: http://www.bogleheads.org/wiki/Individu ... _Bond_Fund

Almost all bond funds work like *rolling* bond ladders. See the constant vs. declining duration section of the wiki article.

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Re: What the blank is going on with bonds?

Post by Scooter57 » Thu Jun 20, 2013 9:00 pm

Detroit?

The Detroit bankruptcy and the story that bondholders are going to get screwed has been in the news the past few days.

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Re: What the blank is going on with bonds?

Post by ofcmetz » Thu Jun 20, 2013 9:00 pm

Calm Man, with yields rising the expected returns on your new purchases is increasing. You decision to slowly DCA seems to be working out.

I would actually feel better about continuing with your type of plan now as the new money is getting better yields with less downside.

Nobody seems to consider that yields could crash again with a new recession and these current ones may be the best we get.
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Re: What the blank is going on with bonds?

Post by etarini » Thu Jun 20, 2013 9:26 pm

Scooter57 wrote:The Detroit bankruptcy and the story that bondholders are going to get screwed has been in the news the past few days.
Yes, we are all Detroit now. Or Stockton. Or Harrisburg. Or something. That's like saying every stock is Enron.

Those who hold long term bonds or low-quality (high-yield) bonds shouldn't be surprised.

Top-rated municipals have a better credit quality and lower default rate than corporate bonds, no?

BTW, I was born in Detroit, and I'm a product of the Detroit Public School system.

But that was a long time ago.

Eric

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Re: What the blank is going on with bonds?

Post by jdb » Fri Jun 21, 2013 8:02 am

As an investor with muni bond ladder the publicity about Detroit and Stockton etc. will present buying opportunities. These are outliers in huge universe of muni bonds. Most investment grade GOs are probably safer than most corporates. Just need to be careful in what you buy and learn to use EMMA.

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Re: What the blank is going on with bonds?

Post by Scooter57 » Fri Jun 21, 2013 8:23 am

As I understand it, Municipal bonds don't get reviewed and rerated. They trade infrequently and may only be rated when issued. So it is quite possible for a bond rated investment quality to deteriorate without it showing up on the rating. I also read that WorldCom bonds were rated as very high quality weeks before the company went bankrupt. (They were corporate, not muni, but the principle is the same.)

Munis are mostly held by wealthy individuals rather than institutions, since the tax free facet applies to individuals, so it is also possible that wealth managers are polishing up their or monthly (or quarterly) statements by removing poorly performing assets. Bonds of all types have been very poorly performing this past month. Though fee-only managers are supposed to not churn accounts, when my parents' money was being managed I saw an awful lot of selling of poorly performing assets. So that could also explain changes beyond what you expected to see.

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Re: What the blank is going on with bonds?

Post by Gauntlet » Fri Jun 21, 2013 8:25 am

For the heck of it, I went to Vanguard's website and filtered all the bonds with a risk level of 1 and 2. Besides, the inflation-protection securities, nothing is down YTD much more than 3%. Intermediate-term tax exempt is down 2.13% and Total Bond is down 2.27. I guess what I'm saying is that if you don't take much risk with your bonds, even after all this craziness, not much has happened.

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Re: What the blank is going on with bonds?

Post by surfer1 » Fri Jun 21, 2013 10:30 am

Rainier wrote:What would that be? Many are insured and are backed by a legal obligation to raise taxes to cover principal and interest.
Munis tend to have a lower credit quality than treasury bonds. Comparing a chart of MUB (muni) vs AGG (total bond), you can see the sharp contrast in spikes. Munis are fine for the tax advantage, but I just think it's important to note their additional risk. Myself, I find munis too volatile (drops of 1%+ a day for a bond fund).

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Re: What the blank is going on with bonds?

Post by allsop » Fri Jun 21, 2013 10:40 am

Calm Man wrote:But we now have a weird situation where "everybody" is saying rates will keep going up and they do keep going up. Every day.
Since the beginning of the Lesser Depression many, very many, have claimed that interest rates will rise and, if not hyperinflation, very high inflation.

They have all been very, very wrong, not that they will admit it, ever. Doubling down is more like it.

I myself was not immune to this and avoided bond funds, but on the other had I live in Sweden and FDIC insured CD's have a positive after inflation and tax a positive yield. Lucky me.

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Re: What the blank is going on with bonds?

Post by nisiprius » Fri Jun 21, 2013 11:09 am

Gauntlet wrote:For the heck of it, I went to Vanguard's website and filtered all the bonds with a risk level of 1 and 2. Besides, the inflation-protection securities, nothing is down YTD much more than 3%. Intermediate-term tax exempt is down 2.13% and Total Bond is down 2.27. I guess what I'm saying is that if you don't take much risk with your bonds, even after all this craziness, not much has happened.
+1. Hear, hear.

And now for the chorus of "What are you saying? 2% is huge. It's enormous, I'm telling you. Why, that's two whole years' fund earnings, gone, vaporized, poof, down the tubes, shot to hell. If a 2% loss isn't a good reason to panic, nothing is. The sky has fallen 20 feet, and it might well fall another 20 feet before it's over."
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Re: What the blank is going on with bonds?

Post by mrwalken » Fri Jun 21, 2013 11:49 am

nisiprius wrote:
Gauntlet wrote:For the heck of it, I went to Vanguard's website and filtered all the bonds with a risk level of 1 and 2. Besides, the inflation-protection securities, nothing is down YTD much more than 3%. Intermediate-term tax exempt is down 2.13% and Total Bond is down 2.27. I guess what I'm saying is that if you don't take much risk with your bonds, even after all this craziness, not much has happened.
+1. Hear, hear.

And now for the chorus of "What are you saying? 2% is huge. It's enormous, I'm telling you. Why, that's two whole years' fund earnings, gone, vaporized, poof, down the tubes, shot to hell. If a 2% loss isn't a good reason to panic, nothing is. The sky has fallen 20 feet, and it might well fall another 20 feet before it's over."
VIPSX, which is one of the two bond funds that are by far the most advocated on this site, has been hammered pretty hard. Especially considering that it has negative yield. Losing 10% in a fund that wasn't even expected to outpace inflation is pretty rough.

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Re: What the blank is going on with bonds?

Post by Tom_T » Fri Jun 21, 2013 12:10 pm

If someone can give me the name of a bond fund that is guaranteed never to go down in value, I'm all ears. ;)

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Re: What the blank is going on with bonds?

Post by zaboomafoozarg » Fri Jun 21, 2013 12:31 pm

Tom_T wrote:If someone can give me the name of a bond fund that is guaranteed never to go down in value, I'm all ears. ;)
I-Bonds! :D That's all I've used for inflation protection. But I started buying shortly after I started investing... with the $10k yearly limit (or I guess $30k if you have 2 people + a trust), it would be hard for financially established people to get any meaningful amount of them.

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Re: What the blank is going on with bonds?

Post by MnD » Fri Jun 21, 2013 12:59 pm

Tom_T wrote:If someone can give me the name of a bond fund that is guaranteed never to go down in value, I'm all ears. ;)
Thrift Savings Plan G Fund. Hits an all time record high every day.
I suppose it could go down, but If the weighted yield of all Treasuries with 4 or more years to maturity drops below 0 we probably have bigger problems to worry about. :mrgreen:

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Re: What the blank is going on with bonds?

Post by Rainier » Fri Jun 21, 2013 1:48 pm

zaboomafoozarg wrote:
Tom_T wrote:If someone can give me the name of a bond fund that is guaranteed never to go down in value, I'm all ears. ;)
I-Bonds! :D That's all I've used for inflation protection. But I started buying shortly after I started investing... with the $10k yearly limit (or I guess $30k if you have 2 people + a trust), it would be hard for financially established people to get any meaningful amount of them.
There was a time when you could buy $30k worth of I-Bonds per person....with a credit card. And they had an interest rate attached to them, not just inflation.

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Re: What the blank is going on with bonds?

Post by gerrym51 » Fri Jun 21, 2013 1:51 pm

Rainier wrote:
zaboomafoozarg wrote:
Tom_T wrote:If someone can give me the name of a bond fund that is guaranteed never to go down in value, I'm all ears. ;)
I-Bonds! :D That's all I've used for inflation protection. But I started buying shortly after I started investing... with the $10k yearly limit (or I guess $30k if you have 2 people + a trust), it would be hard for financially established people to get any meaningful amount of them.
There was a time when you could buy $30k worth of I-Bonds per person....with a credit card. And they had an interest rate attached to them, not just inflation.

even better i remember when you could do it with a credit card that gave you 1 percent cash back. after i did it once as a test then the government shortly after closed this loophole. oh well

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Re: What the blank is going on with bonds?

Post by mrwalken » Fri Jun 21, 2013 2:22 pm

Tom_T wrote:If someone can give me the name of a bond fund that is guaranteed never to go down in value, I'm all ears. ;)
Sometimes going down is one thing. When a fund with negative yield drops over 3 percent in 3 days, that's another thing.

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