Affect of Rising Interest Rates on Vanguard Total Bond Index

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Prudence
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Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Prudence » Thu Dec 21, 2017 10:51 pm

<t>Like many of you, I have some of my portfolio in Vanguard Total Bond Market Index (VBTLX). I heard a bond expert on Bloomberg today who was guessing that the yield on the 10 year Treasury note would end up in the range of 2.75 to 3.00% by the end of 2018. Who knows but this seems like a reasonable guess. The yield on the 10 year today is 2.48%. I am wondering about how this outcome, if realized, might impact VBTLX. The average yield to maturity, and average coupon are 2.7% and 2.75% respectively. Average duration and average effective maturity are 6.1 and 8.4 years. SEC Yield is 2.56%. Given these metrics, and assuming no other factors come into play (i.e. all things equal), I would think there might be some negative affect on price but this may be more than offset by the yield.</t>So an investor who maintains his position in the fund and reinvests the income may see some growth in the valuation of the investment. Is this reasonable (I know this is just a SWAG)?

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by stlutz » Fri Dec 22, 2017 12:43 am

In 2013, the 10 year treasury rate increased from 1.78% to 3.04%. The return of VG Total Bond that year was -2.15%. Unless you're watching the price on a daily basis, you won't really even be aware of a quarter point increase in rates.

In fact, rates *have* increased by a quarter of a point since Sept. 26th of this year. So you could look at what happened to the fund over that time period as well.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Prudence » Fri Dec 22, 2017 7:37 am

Prudence wrote:
Thu Dec 21, 2017 10:51 pm
<t>Like many of you, I have some of my portfolio in Vanguard Total Bond Market Index (VBTLX). I heard a bond expert on Bloomberg today who was guessing that the yield on the 10 year Treasury note would end up in the range of 2.75 to 3.00% by the end of 2018. Who knows but this seems like a reasonable guess. The yield on the 10 year today is 2.48%. I am wondering about how this outcome, if realized, might impact VBTLX. The average yield to maturity, and average coupon are 2.7% and 2.75% respectively. Average duration and average effective maturity are 6.1 and 8.4 years. SEC Yield is 2.56%. Given these metrics, and assuming no other factors come into play (i.e. all things equal), I would think there might be some negative affect on price but this may be more than offset by the yield.</t>So an investor who maintains his position in the fund and reinvests the income may see some growth in the valuation of the investment. Is this reasonable (I know this is just a SWAG)?
Given the average yield to maturity and average coupon of VBTLX today, it would seem to me that a move of the 10 year Treasury note to 3.00% by the end of 2018 could have a negative impact but not significant. Just wondering if this simple logic makes sense.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Call_Me_Op » Fri Dec 22, 2017 7:55 am

The effect of gradual increases in the Federal Funds Rate on an intermediate diversified bond fund cannot be predicted accurately. That's because there are factors other than short-term interest rates at play, such as the health of the economy.
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by livesoft » Fri Dec 22, 2017 8:09 am

morningstar.com reports the historical performance of the Vanguard Total Bond Index fund. It hasn't done too well.

2015 0.40%
2016 2.60%
2017 3.05% YTD

Here are the same time period for the Vanguard short-term corporate bond index fund:
2015 1.23%
2016 2.63%
2017 2.29% YTD

The 3-year returns are about the same for both of them: 2.06% and 2.10%. And the 5-year returns: 1.96% and 1.93%

So what's going to happen? Probably more of the same, say about 2% to 2.5% total return for 2018.
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by nisiprius » Fri Dec 22, 2017 8:10 am

Answer #1:

From 10/31/2010 to 2/8/2011 the 10-year Treasury yield rose from 2.48% to 3.72%. This is what the Treasury yield did:

Image

This is what three selected bond funds did. Vanguard Total Bond Market Index Fund, the one I use and the one you asked about, is in green. A pure Treasury bond fund is in dark blue, and an actively-managed bond fund that made headlines by getting completely out of Treasuries that year is in red.

Image

In context, this is how it appears in Total Bond's ten-year past history:

Source

Image
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by tibbitts » Fri Dec 22, 2017 8:20 am

Prudence wrote:
Fri Dec 22, 2017 7:37 am
Prudence wrote:
Thu Dec 21, 2017 10:51 pm
<t>Like many of you, I have some of my portfolio in Vanguard Total Bond Market Index (VBTLX). I heard a bond expert on Bloomberg today who was guessing that the yield on the 10 year Treasury note would end up in the range of 2.75 to 3.00% by the end of 2018. Who knows but this seems like a reasonable guess. The yield on the 10 year today is 2.48%. I am wondering about how this outcome, if realized, might impact VBTLX. The average yield to maturity, and average coupon are 2.7% and 2.75% respectively. Average duration and average effective maturity are 6.1 and 8.4 years. SEC Yield is 2.56%. Given these metrics, and assuming no other factors come into play (i.e. all things equal), I would think there might be some negative affect on price but this may be more than offset by the yield.</t>So an investor who maintains his position in the fund and reinvests the income may see some growth in the valuation of the investment. Is this reasonable (I know this is just a SWAG)?
Given the average yield to maturity and average coupon of VBTLX today, it would seem to me that a move of the 10 year Treasury note to 3.00% by the end of 2018 could have a negative impact but not significant. Just wondering if this simple logic makes sense.
Assuming a world of low-returns going forward, I'm not sure about the "not significant" part, but a lot of people have lost money anticipating rate increases that didn't happen (or didn't have the expected effects) in recent years.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by sadie wess » Fri Dec 22, 2017 8:25 am

Thanks Nis!

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Call_Me_Op » Fri Dec 22, 2017 8:30 am

tibbitts wrote:
Fri Dec 22, 2017 8:20 am
Prudence wrote:
Fri Dec 22, 2017 7:37 am
Prudence wrote:
Thu Dec 21, 2017 10:51 pm
<t>Like many of you, I have some of my portfolio in Vanguard Total Bond Market Index (VBTLX). I heard a bond expert on Bloomberg today who was guessing that the yield on the 10 year Treasury note would end up in the range of 2.75 to 3.00% by the end of 2018. Who knows but this seems like a reasonable guess. The yield on the 10 year today is 2.48%. I am wondering about how this outcome, if realized, might impact VBTLX. The average yield to maturity, and average coupon are 2.7% and 2.75% respectively. Average duration and average effective maturity are 6.1 and 8.4 years. SEC Yield is 2.56%. Given these metrics, and assuming no other factors come into play (i.e. all things equal), I would think there might be some negative affect on price but this may be more than offset by the yield.</t>So an investor who maintains his position in the fund and reinvests the income may see some growth in the valuation of the investment. Is this reasonable (I know this is just a SWAG)?
Given the average yield to maturity and average coupon of VBTLX today, it would seem to me that a move of the 10 year Treasury note to 3.00% by the end of 2018 could have a negative impact but not significant. Just wondering if this simple logic makes sense.
Assuming a world of low-returns going forward, I'm not sure about the "not significant" part, but a lot of people have lost money anticipating rate increases that didn't happen (or didn't have the expected effects) in recent years.
I do not consider "opportunity cost" lost money. I could have made millions if I invested in bitcoin in 2012, but I do not feel like I have lost millions.
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by nisiprius » Fri Dec 22, 2017 8:48 am

Answer #2. Gotta get through a quick bunch of disclaimers. This computer simulation does not even try to replicate the actual holdings of Total Bond or anything like that. It is showing the total value--market value plus accumulating reinvested coupon payments--of a rolling bond ladder of Treasury-like bonds that are assumed to be bought at issue at par, with a coupon rate equal to the interest rate used in the simulation, and held to maturity. The bond ladder has a duration of 6.33 years and is thus a rough match for Total Bond. The reason I wrote the simulation is that I got very tired of reading about, essentially, the instantaneous effect of an instantaneous interest rise. I wanted to see the effect of gradual rises and I wanted to see the future time course during and afterwards, including the effect of reinvested interest and the effect of the "pull to maturity" (a bond whose value is knocked down by an interest rate rise, is guaranteed to rise in value as it approaches maturity). The scales on the two graphs don't quite line up, by the way, which tells you that my program contains at least one bug.

So, here we have a hypothetical simulation showing a bond ladder with about the same duration as Total Bond, under conditions of an interest rate that holds level at 2.48%, then rises to 3.00% gradually over the course of one year, then holds level again.

Image

I can see in some numeric output (not shown) that the value is $1144.23 just before the interest rate starts rising, and is knocked down to $1136.88 at the end of the year, so, a loss of 0.64%. Notice that if you just multiply the interest rate rise (0.52%) by the duration (6.33) you get 3.29%. That's fairly accurate for price--the market value, assuming you throw away the interest or give it to charity or something, drops from $1,000 to $968.9, or a 3.11% loss.

Here's what happens if, instead of leveling off at one year, the interest continues to rise smoothly at a rate of 0.5% per year for three years.

Image

I've been scratching my head for almost a decade now at expectations of something apocalyptic happening to ordinary investors in ordinary "core" bond funds--intermediate-term or shorter, investment grade--the instant "the Fed raises rates." I just can't bridge the gap between the rhetoric and the actual scale of the problem. There is certainly what I will call "ego risk," the concern that it might be stupid to just hold onto a bond fund when some alternative might arguably do better. There is certainly a possibility of a bond fund being driven back by a headwind, or failing to keep up with inflation. But I just don't think stock-market-type losses are likely.

My theory is that the financial sophisticates, the actual people on "Wall Street," take advantage of the supposed predictability of bonds--during "normal" times. On that foundation of predictability, they build elaborate, complicated, houses of cards, using leverage, short positions, derivatives or whatever, to create exquisite balances between one bunch of bonds that does one thing and another bunch of bonds that does something just a bit different, and make money on that difference. And that when interest rates tremble, those houses of cards can fall. Because in the past, when interest rates have trembled, all that has happened to bond funds like Total Bond is that they, too, have... trembled.
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by nisiprius » Fri Dec 22, 2017 9:11 am

Here's an interesting one. Suppose the interest rate starts at 2.48% and then rises gradually at 0.50% per year and never stops. What happens? Again, this is total return... a growth chart... assuming that you keep the interest payments (i.e. the fund dividends) and reinvest them.

Image

As old bonds mature and are replaced with new bonds that have higher interest rates, the bond ladder starts to overcome the headwind of rising interest rates. I'm not saying it's a great situation, but, yes, a bond ladder (or bond fund) can make money in the face of continuously rising interest rates if the rise is gradual and not too fast. 0.5% per year is not an unrealistically low number, either--from about 1940 to 1980 the ten-year yield rose from about 2% to 15%, so, 13% over forty years or an average of less than 0.5%/year.

However, if the reason for rising interest rates was inflation, as it was during 1940-1980, then the situation, expressed in inflation-adjusted "real" dollars is bad.
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Da5id » Fri Dec 22, 2017 9:32 am

nisiprius wrote:
Fri Dec 22, 2017 9:11 am
However, if the reason for rising interest rates was inflation, as it was during 1940-1980, then the situation, expressed in inflation-adjusted "real" dollars is bad.
Yep. I personally have the "feeling" that when stock prices fall it is bad (as they are mostly capital gain dependent) and when bond prices fall it is good (yay higher yields). Neither is exactly right or a guide to anything, just how it "feels", so I don't do anything based on that :) Stocks falling is the price of doing business, if equities were not a risky asset which can sometimes fall they wouldn't command the equity risk premium. Bond yields rising as you say may be due to inflation, it is the real yield that ultimate matters...

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Prudence » Fri Dec 22, 2017 11:35 am

nisiprius wrote:
Fri Dec 22, 2017 9:11 am
Here's an interesting one. Suppose the interest rate starts at 2.48% and then rises gradually at 0.50% per year and never stops. What happens? Again, this is total return... a growth chart... assuming that you keep the interest payments (i.e. the fund dividends) and reinvest them.

Image

As old bonds mature and are replaced with new bonds that have higher interest rates, the bond ladder starts to overcome the headwind of rising interest rates. I'm not saying it's a great situation, but, yes, a bond ladder (or bond fund) can make money in the face of continuously rising interest rates if the rise is gradual and not too fast. 0.5% per year is not an unrealistically low number, either--from about 1940 to 1980 the ten-year yield rose from about 2% to 15%, so, 13% over forty years or an average of less than 0.5%/year.

However, if the reason for rising interest rates was inflation, as it was during 1940-1980, then the situation, expressed in inflation-adjusted "real" dollars is bad.
Nisi, thanks for all of your replies especially this one. BTW, in my OP I did not intend to imply that 2017 and 2018 Fed rate increases would drive the increase, if any, in the 10-year. In fact, I see other drivers of higher market rates that may be more important such as perceptions regarding the growth of the economy, jobs, wages etc. and inflation.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Copernicus » Tue Dec 26, 2017 8:51 pm

nisiprius,
Thank you for the amazing clarity and detailed explanation of the hidden facts! Always a pleasure to lean from your posts! Happy New Year to you, and all!

With the stock market rise, the allocations made couple of years ago are now out-of-whack. I wonder whether members are now making rebalancing adjustments to the portfolio to buy more bonds, in spite of the rising rates?

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by soter » Thu Dec 28, 2017 1:19 pm

nisiprius wrote:
Fri Dec 22, 2017 9:11 am
Here's an interesting one. Suppose the interest rate starts at 2.48% and then rises gradually at 0.50% per year and never stops. What happens? Again, this is total return... a growth chart... assuming that you keep the interest payments (i.e. the fund dividends) and reinvest them.

Image

As old bonds mature and are replaced with new bonds that have higher interest rates, the bond ladder starts to overcome the headwind of rising interest rates. I'm not saying it's a great situation, but, yes, a bond ladder (or bond fund) can make money in the face of continuously rising interest rates if the rise is gradual and not too fast. 0.5% per year is not an unrealistically low number, either--from about 1940 to 1980 the ten-year yield rose from about 2% to 15%, so, 13% over forty years or an average of less than 0.5%/year.

However, if the reason for rising interest rates was inflation, as it was during 1940-1980, then the situation, expressed in inflation-adjusted "real" dollars is bad.
Thanks Nisiprius for building great charts.

I would like to add one note here regarding ETF bond funds as mutual funds are allowed to US citizens only. Let's take a look at BND ETF - VG analogue of VBTLX mutual fund. Last dividend paid on 12/27 was $0.17422 with NAV=$81.14; given dividends tax rate (15% in my case), it would need to own 81.14/(0.17422 * 0.85) = 548 shares (that is $44,465) to be able to reinvest the received dividend as most ETFs do not offer DRIP (in opposite to most mutual funds).

So, it would be great to have results of such computer simulation for condition when dividends are not reinvested and interest rate rises gradually for, lets say, 5 years. How much will it take for the fund to recover its NAV taking into account "pull to maturity" effect only?

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Gauntlet » Thu Dec 28, 2017 1:34 pm

Copernicus wrote:
Tue Dec 26, 2017 8:51 pm
nisiprius,
Thank you for the amazing clarity and detailed explanation of the hidden facts! Always a pleasure to lean from your posts! Happy New Year to you, and all!

With the stock market rise, the allocations made couple of years ago are now out-of-whack. I wonder whether members are now making rebalancing adjustments to the portfolio to buy more bonds, in spite of the rising rates?
For me the answer is a resounding yes. In fact, my portfolio has grown so much that I am thinking about making a permanent allocation change towards an increased percentage in fixed income.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by saltycaper » Thu Dec 28, 2017 2:39 pm

soter wrote:
Thu Dec 28, 2017 1:19 pm

I would like to add one note here regarding ETF bond funds as mutual funds are allowed to US citizens only. Let's take a look at BND ETF - VG analogue of VBTLX mutual fund. Last dividend paid on 12/27 was $0.17422 with NAV=$81.14; given dividends tax rate (15% in my case), it would need to own 81.14/(0.17422 * 0.85) = 548 shares (that is $44,465) to be able to reinvest the received dividend as most ETFs do not offer DRIP (in opposite to most mutual funds).
Fractional share purchases are possible for ETFs in the case of re-investing dividends. At least, that has been my experience at Fidelity and Vanguard. (Some brokers even allow you to purchase fractional shares of ETFs directly.) Do you have experience where your dividends were not reinvested because you could not purchase a full share? I would be curious what broker that was.
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Tyler Aspect » Thu Dec 28, 2017 6:06 pm

Prudence wrote:
Thu Dec 21, 2017 10:51 pm
Like many of you, I have some of my portfolio in Vanguard Total Bond Market Index (VBTLX). I heard a bond expert on Bloomberg today who was guessing that the yield on the 10 year Treasury note would end up in the range of 2.75 to 3.00% by the end of 2018. Who knows but this seems like a reasonable guess. The yield on the 10 year today is 2.48%. I am wondering about how this outcome, if realized, might impact VBTLX. The average yield to maturity, and average coupon are 2.7% and 2.75% respectively. Average duration and average effective maturity are 6.1 and 8.4 years. SEC Yield is 2.56%. Given these metrics, and assuming no other factors come into play (i.e. all things equal), I would think there might be some negative affect on price but this may be more than offset by the yield. So an investor who maintains his position in the fund and reinvests the income may see some growth in the valuation of the investment. Is this reasonable (I know this is just a SWAG)?
The duration of the Total Bond Market Index is currently 6.1 years. The effect of a yield increase has an immediate negative impact to the net asset value. For example, a one percent yield jump results in 6.1% drop in net asset value. If the yield then stays unchanged, then the net asset value will fully recover. The enhanced yield means the initial lost money is recovered after holding the fund for 6.1 years (the duration).

If it takes 5 years for the total bond market's yield to reach top water mark in this economic cycle, then you need to hold about 11.1 years (5 + 6.1) for the accumulated negative hits to be cleared. Usually the losses are small, and it is just a patient waiting game for the hits to go away.
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by triceratop » Thu Dec 28, 2017 6:13 pm

saltycaper wrote:
Thu Dec 28, 2017 2:39 pm
soter wrote:
Thu Dec 28, 2017 1:19 pm

I would like to add one note here regarding ETF bond funds as mutual funds are allowed to US citizens only. Let's take a look at BND ETF - VG analogue of VBTLX mutual fund. Last dividend paid on 12/27 was $0.17422 with NAV=$81.14; given dividends tax rate (15% in my case), it would need to own 81.14/(0.17422 * 0.85) = 548 shares (that is $44,465) to be able to reinvest the received dividend as most ETFs do not offer DRIP (in opposite to most mutual funds).
Fractional share purchases are possible for ETFs in the case of re-investing dividends. At least, that has been my experience at Fidelity and Vanguard. (Some brokers even allow you to purchase fractional shares of ETFs directly.) Do you have experience where your dividends were not reinvested because you could not purchase a full share? I would be curious what broker that was.
I cannot reinvest dividends in VGIT [ Vanguard Intermediate Treasury Index ETF ] at Merrill Edge. I think I could reinvest dividends in VCIT, the intermediate corporate fund. Just an anecdote. Not that I want to, receiving in cash is fine with me.
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by saltycaper » Thu Dec 28, 2017 6:15 pm

triceratop wrote:
Thu Dec 28, 2017 6:13 pm

I cannot reinvest dividends in VGIT [ Vanguard Intermediate Treasury Index ETF ] at Merrill Edge. I think I could reinvest dividends in VCIT, the intermediate corporate fund. Just an anecdote. Not that I want to, receiving in cash is fine with me.
Interesting. I wonder what the determining factors are.
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by inbox788 » Thu Dec 28, 2017 7:42 pm

Gauntlet wrote:
Thu Dec 28, 2017 1:34 pm
Copernicus wrote:
Tue Dec 26, 2017 8:51 pm
With the stock market rise, the allocations made couple of years ago are now out-of-whack. I wonder whether members are now making rebalancing adjustments to the portfolio to buy more bonds, in spite of the rising rates?
For me the answer is a resounding yes. In fact, my portfolio has grown so much that I am thinking about making a permanent allocation change towards an increased percentage in fixed income.
Me too. A few years ago, I was heavily in stocks in my 401k, and was adding 60/40 with new additions, but with rising stocks, that didn't do much towards rebalancing, so I went 100% into bonds. Despite not participating in the growth the last couple of years, the automatic rebalancing from 100% bonds have been a welcome stabilizing risk reducing measure. I'm making progress towards reaching my desired AA, which due to personal glidepath is a moving target. As long as stocks don't crash, I don't foresee ever allocating any more stock to the additions. Because this plan is averaged out over years rising rates aren't necessarily that bad.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by jalbert » Fri Dec 29, 2017 12:50 am

If, hypothetically, all US interest rates rose by 50 basis points on Jan 2, and then stayed flat the rest of the year, then on Jan 2, VBTLX would fall about 3% and it’s yield would rise to about 3%. It would then make back the loss with interest received the rest of the year to finish the year with a zero return, ie no loss or gain. A 50 bp rise in rates is not very scary for a bond fund with a current yield that is close to half its duration in magnitude.

For VBTLX to get hammered by rising rates in 2018 would require the collective bond market to have significantly underestimated forecasted inflation in aggregate for 2018.
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by soter » Fri Dec 29, 2017 12:53 pm

saltycaper wrote:
Thu Dec 28, 2017 2:39 pm
soter wrote:
Thu Dec 28, 2017 1:19 pm

I would like to add one note here regarding ETF bond funds as mutual funds are allowed to US citizens only. Let's take a look at BND ETF - VG analogue of VBTLX mutual fund. Last dividend paid on 12/27 was $0.17422 with NAV=$81.14; given dividends tax rate (15% in my case), it would need to own 81.14/(0.17422 * 0.85) = 548 shares (that is $44,465) to be able to reinvest the received dividend as most ETFs do not offer DRIP (in opposite to most mutual funds).
Fractional share purchases are possible for ETFs in the case of re-investing dividends. At least, that has been my experience at Fidelity and Vanguard. (Some brokers even allow you to purchase fractional shares of ETFs directly.) Do you have experience where your dividends were not reinvested because you could not purchase a full share? I would be curious what broker that was.
It's Interactive Brokers in my case:
12. What happens to cash from dividends that is insufficient to purchase a whole share?
Only in limited instances does IB facilitate the holding of fractional shares in an account. Any account not eligible to hold fractional shares will have the portion of the cash dividend insufficient to purchase a whole share credited to the account in the form of cash.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by saltycaper » Fri Dec 29, 2017 1:05 pm

soter wrote:
Fri Dec 29, 2017 12:53 pm

It's Interactive Brokers in my case:
12. What happens to cash from dividends that is insufficient to purchase a whole share?
Only in limited instances does IB facilitate the holding of fractional shares in an account. Any account not eligible to hold fractional shares will have the portion of the cash dividend insufficient to purchase a whole share credited to the account in the form of cash.
Well that's interesting too. "Any account not eligible..." Why would one account be eligible and another not? Some searching around indicates others have not been able to reinvest for fractional shares depending on the ETF. Someone speculated it had to do with how the broker purchases the shares that are then made into fractional shares for all customers, and that perhaps there is not a sufficient number of shares held by customers for certain ETFs. In other words, certain ETFs at certain brokers might not be eligible. Oh, well. I've gotten sufficiently off topic.
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by boyntonstu » Fri Dec 29, 2017 1:19 pm

How does 1.75% in a non penalty FDIC insured banks sound?

As interest rates rise in 2018, I expect ALLY to follow as they have done this year.

(I expect that ALLY will pay 2.5% by this time next year.)

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by ReformedSpender » Wed Mar 21, 2018 7:59 am

Great posts by nisiprius in this thread. Consider this a free 'bump'


:beer
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billyt
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by billyt » Wed Mar 21, 2018 8:55 am

Yes, well-done, very clear explanation by Nisi. It shows very clearly that rising rates lead to rising returns (with a lag of approximately the duration) for bond fund investors. In other words: a rising rate environment is a bull market for bond fund investors, not the other way around, as has been so often repeated. Bond traders and bond fund market timers may experience different results.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Da5id » Wed Mar 21, 2018 9:10 am

billyt wrote:
Wed Mar 21, 2018 8:55 am
Yes, well-done, very clear explanation by Nisi. It shows very clearly that rising rates lead to rising returns (with a lag of approximately the duration) for bond fund investors. In other words: a rising rate environment is a bull market for bond fund investors, not the other way around, as has been so often repeated. Bond traders and bond fund market timers may experience different results.
Hmm. We aren't getting the same message apparently. I think he was showing it wasn't so bad, not quite what you said.

3funder
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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by 3funder » Wed Mar 21, 2018 9:15 am

Negligible, in my opinion, provided that you won't need the money for the length of the duration. I haven't lost one wink of sleep.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by triceratop » Wed Mar 21, 2018 9:17 am

Da5id wrote:
Wed Mar 21, 2018 9:10 am
billyt wrote:
Wed Mar 21, 2018 8:55 am
Yes, well-done, very clear explanation by Nisi. It shows very clearly that rising rates lead to rising returns (with a lag of approximately the duration) for bond fund investors. In other words: a rising rate environment is a bull market for bond fund investors, not the other way around, as has been so often repeated. Bond traders and bond fund market timers may experience different results.
Hmm. We aren't getting the same message apparently. I think he was showing it wasn't so bad, not quite what you said.
Isn't that what billyt paraphrased nisi as saying?
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Da5id » Wed Mar 21, 2018 9:22 am

triceratop wrote:
Wed Mar 21, 2018 9:17 am
Da5id wrote:
Wed Mar 21, 2018 9:10 am
billyt wrote:
Wed Mar 21, 2018 8:55 am
Yes, well-done, very clear explanation by Nisi. It shows very clearly that rising rates lead to rising returns (with a lag of approximately the duration) for bond fund investors. In other words: a rising rate environment is a bull market for bond fund investors, not the other way around, as has been so often repeated. Bond traders and bond fund market timers may experience different results.
Hmm. We aren't getting the same message apparently. I think he was showing it wasn't so bad, not quite what you said.
Isn't that what billyt paraphrased nisi as saying?
"Rising rate environment is a bull market for bond fund investors". Hmm. That asserts that the total real return of a bond fund during a rising rate environment is generally better than the return during a falling rate environment. That isn't what I read Nisi to be saying at all. And as total real returns depend on a number of things (capital appreciation, dividends/interest, inflation rate, defaults, ?), it kind of depends anyway.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by triceratop » Wed Mar 21, 2018 9:25 am

I don't disagree at all, but I read billyt a bit differently in intent, in that rising rates are a good thing for bondholders, which was nisi's point. In any case, your clarification is welcome.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by billyt » Wed Mar 21, 2018 11:27 am

It is very clear from the examples Nisi posted that the rate of return (slope of the line) is greater after the interest rate increase. First, you lose a little from NAV going down, then you get back to even (no net loss), then back to where you expected to be before the rate increase. After that you are making more than you expected to before the rate increase. Returns have improved!

Higher interest rates mean more return on your bond fund, lower rates mean less return on your bond fund. Of course you have to wait out the duration lag, which is why you don't put money you need next year in an intermediate term bond fund. Match your duration to your spending timeline!

For a real life illustration, go to Morningstar and chart the returns of Vanguard Total Bond Market. Look at the 60 month (5 year) rolling returns. Since the mid-eighties, the return on this fund has dropped steadily. In my opinion, anyone who refers to this period of falling rates as a bond bull market has their head on backwards.

Rising rates mean better returns for bond fund investors.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Da5id » Wed Mar 21, 2018 11:53 am

billyt wrote:
Wed Mar 21, 2018 11:27 am
It is very clear from the examples Nisi posted that the rate of return (slope of the line) is greater after the interest rate increase. First, you lose a little from NAV going down, then you get back to even (no net loss), then back to where you expected to be before the rate increase. After that you are making more than you expected to before the rate increase. Returns have improved!

Higher interest rates mean more return on your bond fund, lower rates mean less return on your bond fund. Of course you have to wait out the duration lag, which is why you don't put money you need next year in an intermediate term bond fund. Match your duration to your spending timeline!

For a real life illustration, go to Morningstar and chart the returns of Vanguard Total Bond Market. Look at the 60 month (5 year) rolling returns. Since the mid-eighties, the return on this fund has dropped steadily. In my opinion, anyone who refers to this period of falling rates as a bond bull market has their head on backwards.

Rising rates mean better returns for bond fund investors.
Bear in mind the difference between nominal and real returns, and that only real returns matter...

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Riley15 » Wed Mar 21, 2018 1:25 pm

Any discussion on bonds and interest rate is incomplete without considering underlying inflation. While those charts above seem impressive they are missing a critical piece of information which is the inflation graph. Sure you may lose and gain back nominal dollar amounts without realizing what's going on in the background. Interest rates rarely rise in a bubble and are almost always correlate with higher inflation. So no this would not be a bull market for bonds or even stocks. Inflation is a drag on most asset classes. You can hope to get lucky with TIPS or commodities maybe.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by blackcat allie » Wed Mar 21, 2018 1:45 pm

So it looks like BND not going down below earlier lows this year. Is that because only 3 (not 4) rate increases planned this year, from meeting today?
(Pardon simplistic question)

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by saltycaper » Fri Mar 23, 2018 1:25 pm

Da5id wrote:
Wed Mar 21, 2018 11:53 am

Bear in mind the difference between nominal and real returns, and that only real returns matter...
Riley15 wrote:
Wed Mar 21, 2018 1:25 pm
Any discussion on bonds and interest rate is incomplete without considering underlying inflation. While those charts above seem impressive they are missing a critical piece of information which is the inflation graph. Sure you may lose and gain back nominal dollar amounts without realizing what's going on in the background. Interest rates rarely rise in a bubble and are almost always correlate with higher inflation. So no this would not be a bull market for bonds or even stocks. Inflation is a drag on most asset classes. You can hope to get lucky with TIPS or commodities maybe.
I agree.

The graphs are interesting as a mathematical exercise, but they don't tell us whether an investor is better or worse off because in real life inflation rates will be changing along with the yields.
Quod vitae sectabor iter?

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by dbr » Fri Mar 23, 2018 1:42 pm

saltycaper wrote:
Fri Mar 23, 2018 1:25 pm
Da5id wrote:
Wed Mar 21, 2018 11:53 am

Bear in mind the difference between nominal and real returns, and that only real returns matter...
Riley15 wrote:
Wed Mar 21, 2018 1:25 pm
Any discussion on bonds and interest rate is incomplete without considering underlying inflation. While those charts above seem impressive they are missing a critical piece of information which is the inflation graph. Sure you may lose and gain back nominal dollar amounts without realizing what's going on in the background. Interest rates rarely rise in a bubble and are almost always correlate with higher inflation. So no this would not be a bull market for bonds or even stocks. Inflation is a drag on most asset classes. You can hope to get lucky with TIPS or commodities maybe.
I agree.

The graphs are interesting as a mathematical exercise, but they don't tell us whether an investor is better or worse off because in real life inflation rates will be changing along with the yields.
Yes, investors have to keep in mind that all this mathematics is just a translation of unpredictable variations in interest rates and inflation into bond price movements, which therefore are themselves unpredictable -- in spite of any amount of mathematical tautology.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by john4546 » Tue Apr 03, 2018 7:31 pm

Interest rates going up: Should you be concerned?:

https://mythfighter.com/2018/03/27/inte ... concerned/

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by michaeljc70 » Sat Jun 30, 2018 10:45 pm

I often hear this argument that if rates rise quicker than the bond market expects, not to worry. You'll make it up as bonds mature and they buy new bonds with a higher yield. I think I understand the argument. However, two things strike me:

1) That this is like buying a stock at $50. It goes to $40. Say it paid a 2% dividend. Now it pays a ~2.4% dividend. You are buying new shares at a lower price with the dividend yield is higher! But that is putting lipstick on the pig. If the stock does go back up and you sell it, great. But it might not. There are also timing issues (it might bounce around).

2) Rates may be rising due to inflation (of course there can be other reasons too). Any future increase in interest you get may be only nominal.

All that being said, I don't worry about rising interest rates affecting the NAV significantly in BND as rising rates are baked into the price and I don't foresee any crazy unexpected spikes (though I don't have a crystal ball).
Last edited by michaeljc70 on Sun Jul 01, 2018 8:53 am, edited 5 times in total.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by Cyclesafe » Sat Jun 30, 2018 11:35 pm

Understanding bonds is not easy.

Please disregard your analogy with stocks.

1) Market decides it needs a higher interest rate (return) to invest in bonds.
2) Market offers and the market accepts a lower price for bonds.
3) Owners of bonds spend interest gained elsewhere (it leaves the picture) and they buy no more bonds.

Time passes

4) Bonds mature and the owners receive their principal back - the same amount they would have received before #1 above. Whether or not "interest rates have increased" the owners are always assumed here to get their money back. At what price? The value of the principal.

So between the time of the lower purchase price at #2 and the maturity of the bond at time #4, the price the market is willing to pay for the bond changes (up, or down depending on the value of the bond prior to #1).

Keep things simple and understanding will follow.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by michaeljc70 » Sun Jul 01, 2018 8:16 am

Cyclesafe wrote:
Sat Jun 30, 2018 11:35 pm
Understanding bonds is not easy.

Please disregard your analogy with stocks.

1) Market decides it needs a higher interest rate (return) to invest in bonds.
2) Market offers and the market accepts a lower price for bonds.
3) Owners of bonds spend interest gained elsewhere (it leaves the picture) and they buy no more bonds.

Time passes

4) Bonds mature and the owners receive their principal back - the same amount they would have received before #1 above. Whether or not "interest rates have increased" the owners are always assumed here to get their money back. At what price? The value of the principal.

So between the time of the lower purchase price at #2 and the maturity of the bond at time #4, the price the market is willing to pay for the bond changes (up, or down depending on the value of the bond prior to #1).

Keep things simple and understanding will follow.
The thread is about a bond fund. You don't control when a bond is sold so 4 is not necessarily true. Funds sell bonds before maturity for less than face sometimes.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by petulant » Sun Jul 01, 2018 9:25 am

Copernicus wrote:
Tue Dec 26, 2017 8:51 pm
nisiprius,
Thank you for the amazing clarity and detailed explanation of the hidden facts! Always a pleasure to lean from your posts! Happy New Year to you, and all!

With the stock market rise, the allocations made couple of years ago are now out-of-whack. I wonder whether members are now making rebalancing adjustments to the portfolio to buy more bonds, in spite of the rising rates?
That's exactly how it should be, if you think about it. Yields rise, prices for bonds go down, rebalancing is triggered. But yields are higher, meaning you have higher expected returns (assuming no change in inflation expectations). In other words, your rebalancing system will automatically tell you that returns from bonds are expected to be better, so invest more in those bonds! And you don't have to do any kind of active or complicated analysis.

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Re: Affect of Rising Interest Rates on Vanguard Total Bond Index

Post by dbr » Sun Jul 01, 2018 9:28 am

petulant wrote:
Sun Jul 01, 2018 9:25 am
Copernicus wrote:
Tue Dec 26, 2017 8:51 pm
nisiprius,
Thank you for the amazing clarity and detailed explanation of the hidden facts! Always a pleasure to lean from your posts! Happy New Year to you, and all!

With the stock market rise, the allocations made couple of years ago are now out-of-whack. I wonder whether members are now making rebalancing adjustments to the portfolio to buy more bonds, in spite of the rising rates?
That's exactly how it should be, if you think about it. Yields rise, prices for bonds go down, rebalancing is triggered. But yields are higher, meaning you have higher expected returns (assuming no change in inflation expectations). In other words, your rebalancing system will automatically tell you that returns from bonds are expected to be better, so invest more in those bonds! And you don't have to do any kind of active or complicated analysis.
Right, and the reason for that is that the investor is now taking too much stock risk and should cut that risk. Rebalancing is for the purpose of controlling risk.

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