Bonds and Interest rates increase

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BogleAlltheWay
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Bonds and Interest rates increase

Post by BogleAlltheWay » Wed Aug 09, 2017 11:50 am

Hi all,

Why do bonds funds go down when interest rates rise? Why isn't the expected interest rate already priced into the fund?
For example, Amazon has growth priced into its stock.

livesoft
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Re: Bonds and Interest rates increase

Post by livesoft » Wed Aug 09, 2017 11:52 am

The expected interest rate rise is ALREADY priced into bond funds.

Here is a chart showing what VBTLX did since the first of 3 FFR increases back in December:

Image

To have a bond fund go up almost 4% in 8 months in the face of rising interest rates is amazing, isn't it?
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livesoft
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Re: Bonds and Interest rates increase

Post by livesoft » Wed Aug 09, 2017 12:04 pm

And here is a chart of VBTLX anticipating those 3 interest rate increases in the 6 months before the December increase:

Image
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BogleAlltheWay
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Re: Bonds and Interest rates increase

Post by BogleAlltheWay » Wed Aug 09, 2017 12:12 pm

livesoft wrote:The expected interest rate rise is ALREADY priced into bond funds.
I have been reading about the "bond bubble" and moving asset allocation into short term bonds or cds.
One example: viewtopic.php?f=10&t=224687

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Re: Bonds and Interest rates increase

Post by Sbashore » Wed Aug 09, 2017 1:02 pm

BogleAlltheWay wrote:
livesoft wrote:The expected interest rate rise is ALREADY priced into bond funds.
I have been reading about the "bond bubble" and moving asset allocation into short term bonds or cds.
One example: viewtopic.php?f=10&t=224687
If I had done that when I first started hearing about a "bond bubble" (years ago) I would be poorer. Match your bond duration to your needs and stop trying to anticipate the future.
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Re: Bonds and Interest rates increase

Post by mega317 » Wed Aug 09, 2017 1:10 pm

BogleAlltheWay wrote:Hi all,

Why do bonds funds go down when interest rates rise? Why isn't the expected interest rate already priced into the fund?
For example, Amazon has growth priced into its stock.
If you're just asking why, the idea is that when rates increase, people will not pay as much to buy bonds at lower rates.

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Re: Bonds and Interest rates increase

Post by DaftInvestor » Wed Aug 09, 2017 1:14 pm

Sbashore wrote:
BogleAlltheWay wrote:
livesoft wrote:The expected interest rate rise is ALREADY priced into bond funds.
I have been reading about the "bond bubble" and moving asset allocation into short term bonds or cds.
One example: viewtopic.php?f=10&t=224687
If I had done that when I first started hearing about a "bond bubble" (years ago) I would be poorer. Match your bond duration to your needs and stop trying to anticipate the future.
+1 Sbashore

BolgeAlltheWay - Since you believe we are in a "bond bubble" - based upon what you are reading - have you also been reading about the impending stock market crash and the fact that the bull-market will end soon and thus pulled out of stocks? BolgeAlltheWay is probably a bad username for you - I don't think Bogle is recommending pulling out of BND based upon "bond bubble" hype :happy
You have to learn to ignore all the financial hype.

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Re: Bonds and Interest rates increase

Post by BogleAlltheWay » Wed Aug 09, 2017 1:31 pm

DaftInvestor wrote:
Sbashore wrote:
BogleAlltheWay wrote:
livesoft wrote:The expected interest rate rise is ALREADY priced into bond funds.
I have been reading about the "bond bubble" and moving asset allocation into short term bonds or cds.
One example: viewtopic.php?f=10&t=224687
If I had done that when I first started hearing about a "bond bubble" (years ago) I would be poorer. Match your bond duration to your needs and stop trying to anticipate the future.
+1 Sbashore

BolgeAlltheWay - Since you believe we are in a "bond bubble" - based upon what you are reading - have you also been reading about the impending stock market crash and the fact that the bull-market will end soon and thus pulled out of stocks? BolgeAlltheWay is probably a bad username for you - I don't think Bogle is recommending pulling out of BND based upon "bond bubble" hype :happy
You have to learn to ignore all the financial hype.
I was trying to find out some information and I am made out to be a market timer who trades on every piece of news. After a few more posts, I will become a stock picker. :D

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Re: Bonds and Interest rates increase

Post by DaftInvestor » Wed Aug 09, 2017 1:41 pm

BogleAlltheWay wrote:
DaftInvestor wrote:
Sbashore wrote:
BogleAlltheWay wrote:
livesoft wrote:The expected interest rate rise is ALREADY priced into bond funds.
I have been reading about the "bond bubble" and moving asset allocation into short term bonds or cds.
One example: viewtopic.php?f=10&t=224687
If I had done that when I first started hearing about a "bond bubble" (years ago) I would be poorer. Match your bond duration to your needs and stop trying to anticipate the future.
+1 Sbashore

BolgeAlltheWay - Since you believe we are in a "bond bubble" - based upon what you are reading - have you also been reading about the impending stock market crash and the fact that the bull-market will end soon and thus pulled out of stocks? BolgeAlltheWay is probably a bad username for you - I don't think Bogle is recommending pulling out of BND based upon "bond bubble" hype :happy
You have to learn to ignore all the financial hype.
I was trying to find out some information and I am made out to be a market timer who trades on every piece of news. After a few more posts, I will become a stock picker. :D
I was just asking the question - wasn't presuming :) I also now believe I completely misread what you said (and what I quoted). I actually read your statement as you were "moving asset allocation into short term bonds and cds" after "reading about bond bubble" - but now I see you may have been stating simply that you were reading about others that were "moving asset allocation into short term bonds and cds". I misread the sentence - thus my reaction - apologies.

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Re: Bonds and Interest rates increase

Post by dm200 » Wed Aug 09, 2017 1:46 pm

BogleAlltheWay wrote:Hi all,
Why do bonds funds go down when interest rates rise? Why isn't the expected interest rate already priced into the fund?
For example, Amazon has growth priced into its stock.
"Expectations" are not directly priced into a mutual fund. The price (NAV) of a mutual fund is the composite prices of its holdings.

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Re: Bonds and Interest rates increase

Post by Iczimek » Wed Aug 09, 2017 2:23 pm

mega317 wrote:
BogleAlltheWay wrote:Hi all,

Why do bonds funds go down when interest rates rise? Why isn't the expected interest rate already priced into the fund?
For example, Amazon has growth priced into its stock.
If you're just asking why, the idea is that when rates increase, people will not pay as much to buy bonds at lower rates.
To simplify, if interest rate is 2%, you get 2$ from 100$ bond. But if rates are higher, like 3%, everyone would like to have 3$ from this bond. But it pays fixed 2%, co how can we get it? We have to buy it cheaper!
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Re: Bonds and Interest rates increase

Post by BogleAlltheWay » Wed Aug 09, 2017 3:04 pm

dm200 wrote:
BogleAlltheWay wrote:Hi all,
Why do bonds funds go down when interest rates rise? Why isn't the expected interest rate already priced into the fund?
For example, Amazon has growth priced into its stock.
"Expectations" are not directly priced into a mutual fund. The price (NAV) of a mutual fund is the composite prices of its holdings.
For mutual funds the "expectations" are priced into the stocks, but are those same "expectations" priced anywhere into a bond fund?

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Re: Bonds and Interest rates increase

Post by livesoft » Wed Aug 09, 2017 3:21 pm

BogleAlltheWay wrote:..., but are those same "expectations" priced anywhere into a bond fund?
So the charts I posted were not convincing enough?
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Re: Bonds and Interest rates increase

Post by CantPassAgain » Wed Aug 09, 2017 3:27 pm

BogleAlltheWay wrote:
dm200 wrote:
BogleAlltheWay wrote:Hi all,
Why do bonds funds go down when interest rates rise? Why isn't the expected interest rate already priced into the fund?
For example, Amazon has growth priced into its stock.
"Expectations" are not directly priced into a mutual fund. The price (NAV) of a mutual fund is the composite prices of its holdings.
For mutual funds the "expectations" are priced into the stocks, but are those same "expectations" priced anywhere into a bond fund?
Read the replies to your own thread. The answer is "yes."

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Re: Bonds and Interest rates increase

Post by user76586 » Wed Aug 09, 2017 3:28 pm

Expectations are priced in, but expectations are not certainties. What gets priced in early are the 50 to 90% odds that the rates will change. On a Fed announcement, or other move, the odds become 100% and prices move the rest of the way.

BogleAlltheWay
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Re: Bonds and Interest rates increase

Post by BogleAlltheWay » Wed Aug 09, 2017 3:55 pm

livesoft wrote:
BogleAlltheWay wrote:..., but are those same "expectations" priced anywhere into a bond fund?
So the charts I posted were not convincing enough?
I am not disagreeing. Are the expectations priced into the individual bonds or the the price people are willing to pay for the fund?

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Re: Bonds and Interest rates increase

Post by dm200 » Thu Aug 10, 2017 8:18 am

BogleAlltheWay wrote:
dm200 wrote:
BogleAlltheWay wrote:Hi all,
Why do bonds funds go down when interest rates rise? Why isn't the expected interest rate already priced into the fund?
For example, Amazon has growth priced into its stock.
"Expectations" are not directly priced into a mutual fund. The price (NAV) of a mutual fund is the composite prices of its holdings.
For mutual funds the "expectations" are priced into the stocks, but are those same "expectations" priced anywhere into a bond fund?
Yes, I believe "expectations" are priced into bond prices.

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Re: Bonds and Interest rates increase

Post by dm200 » Thu Aug 10, 2017 8:20 am

BogleAlltheWay wrote:
livesoft wrote:
BogleAlltheWay wrote:..., but are those same "expectations" priced anywhere into a bond fund?
So the charts I posted were not convincing enough?
I am not disagreeing. Are the expectations priced into the individual bonds or the the price people are willing to pay for the fund?
Perhaps others could comment, but I do not believe purchases or sales of bond mutual funds are a significant influence on bond prices, but rather direct purchase or sales are.

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Re: Bonds and Interest rates increase

Post by Wakefield1 » Thu Aug 10, 2017 11:52 am

"Open end" Fund-price should mostly/only reflect the market value of the underlying assets?
"Closed end" Fund-price can trend well above or well below the market value of the underlying assets?

If lots of sales of mutual fund shares drive down the prices of the underlying assets(funds having to sell those assets to pay redemptions) then the price of the funds as well as the assets upon which the funds are based will drop-I think

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Re: Bonds and Interest rates increase

Post by dm200 » Thu Aug 10, 2017 2:13 pm

Wakefield1 wrote:"Open end" Fund-price should mostly/only reflect the market value of the underlying assets?
"Closed end" Fund-price can trend well above or well below the market value of the underlying assets?

If lots of sales of mutual fund shares drive down the prices of the underlying assets(funds having to sell those assets to pay redemptions) then the price of the funds as well as the assets upon which the funds are based will drop-I think
Just about all of the mutual funds discussed here are open end funds.

The relevant question (I think), then is how significant or influential mutual fund purchases and redemptions have on bonds. Although the information is probably available somewhere, I cannot cite anything. My guess is that the bond market is dominated by individual, corporate and organization purchases and sales - and not by mutual funds. In addition, there would need to be a significant diversion of the activities of mutual fund owners from that of others.

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Re: Bonds and Interest rates increase

Post by BogleAlltheWay » Thu Aug 10, 2017 2:18 pm

dm200 wrote:
Wakefield1 wrote:"Open end" Fund-price should mostly/only reflect the market value of the underlying assets?
"Closed end" Fund-price can trend well above or well below the market value of the underlying assets?

If lots of sales of mutual fund shares drive down the prices of the underlying assets(funds having to sell those assets to pay redemptions) then the price of the funds as well as the assets upon which the funds are based will drop-I think
Just about all of the mutual funds discussed here are open end funds.

The relevant question (I think), then is how significant or influential mutual fund purchases and redemptions have on bonds. Although the information is probably available somewhere, I cannot cite anything. My guess is that the bond market is dominated by individual, corporate and organization purchases and sales - and not by mutual funds. In addition, there would need to be a significant diversion of the activities of mutual fund owners from that of others.
Why do redemptions cause the mutual fund to be valued less? I thought it would only drop if the stocks in it did.

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Re: Bonds and Interest rates increase

Post by neurosphere » Thu Aug 10, 2017 2:28 pm

Sbashore wrote:
BogleAlltheWay wrote:
I have been reading about the "bond bubble" and moving asset allocation into short term bonds or cds.
One example: viewtopic.php?f=10&t=224687
If I had done that when I first started hearing about a "bond bubble" (years ago) I would be poorer. Match your bond duration to your needs and stop trying to anticipate the future.
What's interesting is that as talk of a rise in interest rates or a bond bubble increased a few years ago, I re-evaluated the role of bonds in my portfolio and actually decided to MOVE INTO long-term bonds from short and intermediate bonds. SO FAR, I don't regret the decision, and I am richer because of it. If the "bubble" bursts, I may yet end up a yield-chasing-casualty. :D
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Re: Bonds and Interest rates increase

Post by dm200 » Thu Aug 10, 2017 2:30 pm

BogleAlltheWay wrote:
dm200 wrote:
Wakefield1 wrote:"Open end" Fund-price should mostly/only reflect the market value of the underlying assets?
"Closed end" Fund-price can trend well above or well below the market value of the underlying assets?
If lots of sales of mutual fund shares drive down the prices of the underlying assets(funds having to sell those assets to pay redemptions) then the price of the funds as well as the assets upon which the funds are based will drop-I think
Just about all of the mutual funds discussed here are open end funds.
The relevant question (I think), then is how significant or influential mutual fund purchases and redemptions have on bonds. Although the information is probably available somewhere, I cannot cite anything. My guess is that the bond market is dominated by individual, corporate and organization purchases and sales - and not by mutual funds. In addition, there would need to be a significant diversion of the activities of mutual fund owners from that of others.
Why do redemptions cause the mutual fund to be valued less? I thought it would only drop if the stocks in it did.
Redemptions (net) of the shares of a mutual fund will not directly cause the NAV of the fund to drop. The value will be determined by the market value of its holdings (whether stocks or bonds).

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Re: Bonds and Interest rates increase

Post by Wakefield1 » Thu Aug 10, 2017 8:30 pm

BogleAlltheWay wrote:
dm200 wrote:
Wakefield1 wrote:"Open end" Fund-price should mostly/only reflect the market value of the underlying assets?
"Closed end" Fund-price can trend well above or well below the market value of the underlying assets?

If lots of sales of mutual fund shares drive down the prices of the underlying assets(funds having to sell those assets to pay redemptions) then the price of the funds as well as the assets upon which the funds are based will drop-I think
Just about all of the mutual funds discussed here are open end funds.

The relevant question (I think), then is how significant or influential mutual fund purchases and redemptions have on bonds. Although the information is probably available somewhere, I cannot cite anything. My guess is that the bond market is dominated by individual, corporate and organization purchases and sales - and not by mutual funds. In addition, there would need to be a significant diversion of the activities of mutual fund owners from that of others.
Why do redemptions cause the mutual fund to be valued less? I thought it would only drop if the stocks in it did.
If a mutual fund,because of redemptions,sells a lot of stock,it could cause those stock's prices to drop. That would be more apt to happen if lots of mutual funds were facing net redemptions at the same time. Perhaps a small mutual fund,that is one that held an insignificant fraction of all available shares,would not move the market very much if it had to sell as compared to a giant mutual fund. Of course in a correction or "bear",a lot of mutual funds and a lot of individual owners of stocks might be selling and driving the prices down,which then makes people panic and sell even more-until,if things work out like they usually have,some stocks and some funds become a real bargain.

I suppose tremendous selling pressure on a fund could cause its expenses to increase. But recently there was the case of ,I believe Pimco having its "Bond Guru" manager leave,a lot of investors sold,resulting in net outflow of money/fund assets,but if I am correct Pimco (its flagship bond fund) seems to have survived with continued competitive returns in its peer group,and is now attracting more money than is leaving.

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Re: Bonds and Interest rates increase

Post by grabiner » Thu Aug 10, 2017 8:42 pm

BogleAlltheWay wrote:Why do bonds funds go down when interest rates rise? Why isn't the expected interest rate already priced into the fund?
When the price of a bond falls, the yield on that bond rises; this is determined by a mathematical formula. If a bond with a 5-year duration and a 2% yield is worth $1000, then when its price drops to $950, the yield rises to 3%.

The interest rates which the Fed targets are short-term rates. Bond funds hold longer-term bonds, and long-term rates don't always move at the same time as short-term rates. If bond investors expect short-term rates to rise, they will demand higher yields on long-term bonds than on short-term bonds. If the rises match their expectations, the yields on long-term bonds will not change. If short-term rates rise faster than expected, or if investors' expectations of future rate increases change (for example, because of rising inflation), then the yields on long-term bonds will be affected.
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Re: Bonds and Interest rates increase

Post by BogleAlltheWay » Thu Aug 10, 2017 9:50 pm

grabiner wrote:
BogleAlltheWay wrote:Why do bonds funds go down when interest rates rise? Why isn't the expected interest rate already priced into the fund?
When the price of a bond falls, the yield on that bond rises; this is determined by a mathematical formula. If a bond with a 5-year duration and a 2% yield is worth $1000, then when its price drops to $950, the yield rises to 3%.

The interest rates which the Fed targets are short-term rates. Bond funds hold longer-term bonds, and long-term rates don't always move at the same time as short-term rates. If bond investors expect short-term rates to rise, they will demand higher yields on long-term bonds than on short-term bonds. If the rises match their expectations, the yields on long-term bonds will not change. If short-term rates rise faster than expected, or if investors' expectations of future rate increases change (for example, because of rising inflation), then the yields on long-term bonds will be affected.
I am confused as to where the price of the bond comes in. Is the buying and selling of the bonds in the fund that causes the adjustment?

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Re: Bonds and Interest rates increase

Post by grabiner » Thu Aug 10, 2017 10:03 pm

BogleAlltheWay wrote:
grabiner wrote:When the price of a bond falls, the yield on that bond rises; this is determined by a mathematical formula. If a bond with a 5-year duration and a 2% yield is worth $1000, then when its price drops to $950, the yield rises to 3%.
I am confused as to where the price of the bond comes in. Is the buying and selling of the bonds in the fund that causes the adjustment?
It's a mathematical relationship. The yield of a bond is the interest rate at which you would need to invest your money in order to get all the bond payments.

For the simplest example, consider a zero-coupon bond. If a five-year zero-coupon bond will pay you $1000 at maturity, and the bond is currently worth $906, then the bond yield is 2%, because $906 invested for five years at 2% interest would become $1000. If the bond price drops to $863, then the bond yield becomes 3%, because $863 needs a 3% interest rate to become $1000 in five years. The math works similarly for bonds with coupons, but you have to consider all of the coupon payments.

The bond price will drop because bond traders set bond prices; even if you don't sell this bond, other traders have bought and sold similar bonds, which determines what this bond is worth. It makes more sense to say the yield rose because the price fell than the other way around.

But why did the price fall? Probably because rates in general rose. If other five-year bonds are yielding 3%, nobody will buy your bond at a price which gives it a 2% yield, but they may buy it at a price which gives it a 3% yield.

Another possibility is that the risk of your bond increased. If your bond was downgraded, it may be that high-quality bonds are still yielding 2%, but your bond lost value because of the risk it will default, and the decreased value increased its yield. This is why high-yield bonds have their high yields; investors demand those yields as compensation for the risk that they will not receive their payments.
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Re: Bonds and Interest rates increase

Post by BogleAlltheWay » Fri Aug 11, 2017 8:24 am

grabiner wrote:
For the simplest example, consider a zero-coupon bond. If a five-year zero-coupon bond will pay you $1000 at maturity, and the bond is currently worth $906, then the bond yield is 2%, because $906 invested for five years at 2% interest would become $1000. If the bond price drops to $863, then the bond yield becomes 3%, because $863 needs a 3% interest rate to become $1000 in five years. The math works similarly for bonds with coupons, but you have to consider all of the coupon payments.

The bond price will drop because bond traders set bond prices; even if you don't sell this bond, other traders have bought and sold similar bonds, which determines what this bond is worth. It makes more sense to say the yield rose because the price fell than the other way around.
So the value of a bond fund is determined by how much the bonds can be sold for as opposed to their value at maturity? Therefore, if investors expect interests rates to rise 1/2%, they will only pay $884 for the $906 bond?

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Re: Bonds and Interest rates increase

Post by grabiner » Fri Aug 11, 2017 8:47 am

BogleAlltheWay wrote:
grabiner wrote:For the simplest example, consider a zero-coupon bond. If a five-year zero-coupon bond will pay you $1000 at maturity, and the bond is currently worth $906, then the bond yield is 2%, because $906 invested for five years at 2% interest would become $1000. If the bond price drops to $863, then the bond yield becomes 3%, because $863 needs a 3% interest rate to become $1000 in five years. The math works similarly for bonds with coupons, but you have to consider all of the coupon payments.

The bond price will drop because bond traders set bond prices; even if you don't sell this bond, other traders have bought and sold similar bonds, which determines what this bond is worth. It makes more sense to say the yield rose because the price fell than the other way around.
So the value of a bond fund is determined by how much the bonds can be sold for as opposed to their value at maturity? Therefore, if investors expect interests rates to rise 1/2%, they will only pay $884 for the $906 bond?
Mutual funds are priced at "net asset value"; this means that the price is determined by the current value of the assets. If you withdraw $884 from the mutual fund (which is the correct value of this bond if its yield is 2.5%), then the mutual fund must sell assets for $884 to pay you. With the fund priced at net asset value, it will sell one bond for $884, so all the other fundholders break even; fundholders have $884 less and the fund has $884 less in assets.
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Re: Bonds and Interest rates increase

Post by BogleAlltheWay » Fri Aug 11, 2017 9:08 am

grabiner wrote: Mutual funds are priced at "net asset value"; this means that the price is determined by the current value of the assets. If you withdraw $884 from the mutual fund (which is the correct value of this bond if its yield is 2.5%), then the mutual fund must sell assets for $884 to pay you. With the fund priced at net asset value, it will sell one bond for $884, so all the other fundholders break even; fundholders have $884 less and the fund has $884 less in assets.
Is it the redemptions of the bonds that causes the bond fund's price to drop or rise?
Why does it matter what people will currently pay for the bond? For example, say my car is worth 10K. If I don't sell it, why does it matter?

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Re: Bonds and Interest rates increase

Post by grabiner » Fri Aug 11, 2017 9:21 am

[example of a five-year zero-coupon bond]
BogleAlltheWay wrote:
grabiner wrote: Mutual funds are priced at "net asset value"; this means that the price is determined by the current value of the assets. If you withdraw $884 from the mutual fund (which is the correct value of this bond if its yield is 2.5%), then the mutual fund must sell assets for $884 to pay you. With the fund priced at net asset value, it will sell one bond for $884, so all the other fundholders break even; fundholders have $884 less and the fund has $884 less in assets.
Is it the redemptions of the bonds that causes the bond fund's price to drop or rise?
Why does it matter what people will currently pay for the bond? For example, say my car is worth 10K. If I don't sell it, why does it matter?
The fund quotes a price because that is the price at which anyone can buy or sell.

You are correct that you don't really care about the price other than when you buy or sell. If you will need $1000 in five years, then you can buy this bond, and you will have your $1000 five years from now no matter what happens to interest rates along the way.

However, the price is relevant to you because you probably don't know that you will need exactly $1000 in exactly five years. If inflation causes your need to increase and also drives up interest rates, the reduced value of the bond confirms that you are worse off. If you need the money before the five years are up, you may have to sell the bond before maturity, and it is likely to be worth less than you expected.

The difference between the bond and your car or house is that the car or house is bought for its use, rather than for money. If your car increases in value, it still gets you to work; you don't care about the increase unless you sell the car (or are forced to convert it to cash, such as if the car is totaled in an accident and insurance pays you the current value). If your house declines in value, it still provides you the same place to live.
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Re: Bonds and Interest rates increase

Post by Wakefield1 » Fri Aug 11, 2017 9:36 am

I guess buying and selling individual bonds is different than investing in bond mutual funds
I wonder if anyone has any thoughts about the Vanguard GNMA fund? (A couple of years ago I moved some money from that into the Wellesley Fund) of course that is not a pure bond fund

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Re: Bonds and Interest rates increase

Post by longinvest » Fri Aug 11, 2017 9:46 am

For those interested, we have a Bond-Fund Simulator spreadsheet available to play with.

A while ago, I did an experiment, looking at what would happen if the decreasing interest rates of the last years were to play in reverse, going up. Here's what I found:

viewtopic.php?f=1&t=168007#p3073222
longinvest wrote:Using our Bond Fund Simulator, I ran a simulation to see what would happen if historical yields from 1999 to 2016 (based on FRED data) were to play in reverse.

But, before I run the "reverse yield sequence" simulation, here's the result of a bond fund simulation using (normal sequence) historical yields compared to Vanguard's Total Bond Market index fund:
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I hope you'll agree that our simulator seems good enough to get a rough idea of what happens to bonds given a sequence of annual yields.

So, what would happen if in 2017, yields were identical to 2015, yields in 2018 identical to 2014, and so on? Here's the result of the simulation:
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In the reverse simulation, most annual returns were positive. The worst annual return was -3.46 in 2023 (2009), followed by another negative return of -3.20 in 2024 (2008), for a cumulative 2-year drawdown of -6.54%, which is recovered from in 2027 (2005). On the positive side, from 2025 (2007) to 2027 (2005), there was a three-year sequence of returns higher than +6%. There were various years with returns of +7.17%, +8.80%, and even +15.60%.

That's what a bear market could look like, in bonds.
I really encourage curious readers to download the spreadsheet and play with it. One can see how the loss in value of some bonds, when interest rates go up, is mostly compensated by the coupons thrown by all the bonds, as well as the recovery in value of bonds approaching maturity.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

BogleAlltheWay
Posts: 300
Joined: Mon May 15, 2017 5:25 pm

Re: Bonds and Interest rates increase

Post by BogleAlltheWay » Fri Aug 11, 2017 10:07 am

grabiner wrote:
BogleAlltheWay wrote:
grabiner wrote: Mutual funds are priced at "net asset value"; this means that the price is determined by the current value of the assets. If you withdraw $884 from the mutual fund (which is the correct value of this bond if its yield is 2.5%), then the mutual fund must sell assets for $884 to pay you. With the fund priced at net asset value, it will sell one bond for $884, so all the other fundholders break even; fundholders have $884 less and the fund has $884 less in assets.
Is it the redemptions of the bonds that causes the bond fund's price to drop or rise?
Why does it matter what people will currently pay for the bond? For example, say my car is worth 10K. If I don't sell it, why does it matter?
The fund quotes a price because that is the price at which anyone can buy or sell.

You are correct that you don't really care about the price other than when you buy or sell. If you will need $1000 in five years, then you can buy this bond, and you will have your $1000 five years from now no matter what happens to interest rates along the way.

However, the price is relevant to you because you probably don't know that you will need exactly $1000 in exactly five years. If inflation causes your need to increase and also drives up interest rates, the reduced value of the bond confirms that you are worse off. If you need the money before the five years are up, you may have to sell the bond before maturity, and it is likely to be worth less than you expected.

The difference between the bond and your car or house is that the car or house is bought for its use, rather than for money. If your car increases in value, it still gets you to work; you don't care about the increase unless you sell the car (or are forced to convert it to cash, such as if the car is totaled in an accident and insurance pays you the current value). If your house declines in value, it still provides you the same place to live.
That makes sense that bond fund's price is what the bonds can be brought or sold out.
If you sell a bond that loses value before maturity, you are not losing any value(minus transaction costs). You can take that money and buy the newer bond.
When interest rates rise, the $1000 won't buy what it used to.

not4me
Posts: 105
Joined: Thu May 25, 2017 3:08 pm

Re: Bonds and Interest rates increase

Post by not4me » Sat Aug 12, 2017 9:35 am

user76586 wrote:
Wed Aug 09, 2017 3:28 pm
Expectations are priced in, but expectations are not certainties. What gets priced in early are the 50 to 90% odds that the rates will change. On a Fed announcement, or other move, the odds become 100% and prices move the rest of the way.
Thanks for making an important point that is often forgotten, glossed over, or misunderstood/misrepresented. Can't the same be said in general terms for stocks/bonds at most times? Some trades may be made because they have to. But usually buy/sale transaction reflect whatever expectations are present at the time of transaction. Markets are forward looking. I don't get the 'past performance is evidence of future performance' line of thinking.

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