Ready to give up on bond fund, Lost 2.25% past 6 months

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itstoomuch
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by itstoomuch » Mon Jan 22, 2018 7:43 pm

OP,
the issue with today's bonds is that rates are at lows and there is an effort by federal and private banks, governments to raise rates->which means current bond prices will go down.

Owning bonds may reduce the volatility against stocks, but not always. Bonds is supposed to be non-correlative low-correlative to Stocks which gives the reduced volatility in a combined equity/bond portfolio.

Disclaimer: Our retirement & asset portfolios no longer have bonds directly (small amount in managed portfolio) nor do we have a great deal of equity (small amount in managed portfolio). Our Discretionary Accts (much reduced) is entirely equity and cash. We have transitioned to GLWB Annuities (2008-2012) and high quality/low leverage Rentals. In a way we substituted Annuities for Bonds and substituted RE rentals for Equity. The Annuities and Rentals are Income producers. In Retirement, we want Income from secure sources not necessarily a pile of stocks and bonds funds that must be periodically liquidated to provide income.
YMMV
Last edited by itstoomuch on Fri Jan 26, 2018 12:49 am, edited 1 time in total.
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo

RRAAYY3
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by RRAAYY3 » Mon Jan 22, 2018 8:09 pm

Admiral wrote:
Mon Jan 22, 2018 4:07 pm
RRAAYY3 wrote:
Mon Jan 22, 2018 1:48 pm
and this is why i'm probably never owning bonds

cash to buy dips/ CD's to actually lock in savings ... someone convince me otherwise, as I really struggle to see the appeal of bonds [i understand, less volatile]
Because cash loses value to inflation and CDs have early withdrawal penalties. That's why. Also, if you're holdings are with Vanguard, then having CDs held outside your VG portfolio is just another/step hassle in terms of rebalancing, should you want to.
Cash loses value to inflation, bonds apparently lose value to cash

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whodidntante
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by whodidntante » Mon Jan 22, 2018 8:17 pm

My butchered, hack explanation of MPT is that you want to own assets that have similar expected returns but low correlation or less than perfect correlation, in order to improve risk adjusted return. I don't think bonds have great expected returns right now. In fact, bonds look pretty awful with a mix of low yields and upward pressure on interest rates. This may be why we are seeing more offerings in the alternative space right now. I will probably sell AQR Market Neutral myself once bonds yield 6%.

GibsonL6s
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by GibsonL6s » Mon Jan 22, 2018 8:25 pm

ruralavalon wrote:
Mon Jan 22, 2018 7:30 pm
metalworking wrote:
Mon Jan 22, 2018 6:44 pm
GibsonL6s wrote:
Mon Jan 22, 2018 6:38 pm
visualguy wrote:
Mon Jan 22, 2018 5:02 pm
GibsonL6s wrote:
Mon Jan 22, 2018 4:06 pm
I don't consider bonds volatile, but to put it simply your cash does not go up when your stocks go down. So unless you like another hedge better than bonds, this is their use in my simplistic view.
You can't have it both ways. It's either not volatile, in which case it won't do much as a hedge for stock, or it's volatile. In reality, it's somewhat volatile, but nothing compared to stock. I don't see how it acts as a meaningful hedge, and I don't see a good reason to tolerate the volatility.

You're also likely to get a lower total return when compared to a CD ladder in a period of rising interest rates because the "double duration" rule will bite you. Regardless of whether this happens or not, no point in playing this game when there's no win, so I stay away from these funds as much as possible, and stick to other fixed income.
Volatility and correlation in my mind are two different concepts. Securities and be both volatile and correlated or non-correlated with stocks. Again CDs and Cash are not going to rise when stocks fall, bonds generally will so CDs are not a hedge against stocks. I am not suggesting that one may not prefer to hold CDs or cash as opposed to fixed income, just that they behave differently as opposed to bonds.
It sounds like you are saying bonds generally rise when stocks fall but in other post i read that they are not correlated at all. Which is it? thanks
Bonds and stocks do not have a negative correlation.

Bonds and stocks have a low correlation. Total Stock Market ETF and Total Bond Market ETF have a correlation of 4, where 100 equals a perfect correlation.
I am getting Negative .17

https://www.portfoliovisualizer.com/ass ... ingDays=60

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randomizer
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by randomizer » Mon Jan 22, 2018 8:32 pm

Bonds are simple investments but widely misunderstood. Whole books written on them. Maybe start with Larry Swedroe’s bond book. It explains more than you will ever need to know.
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by stocknoob4111 » Mon Jan 22, 2018 8:52 pm

I had similar concerns, i've invested quite a bit into a bond fund and i'm sticking to it. I think long term it isn't an issue. Based on a lot of reading i've done and also a lot of info from this forum there are a couple of points:
- interest rates are not going to zoom up from here, they are forecasting .5-.75 by end of 2018 perhaps less, the reason is that Germany is at 0.4% and Japan is almost at zero so US 10Y returns are still very high in comparison to elsewhere making these instruments still attractive to buyers worldwide at current yields.
- The economy is strong but the Fed has no intention of unraveling things suddenly - higher interest rates will also kill the stock market and may start a recession.
- The fund has some management to balance it by selling lower yielding bonds at a loss and acquiring newer bonds, may drop the NAV in the interim but long term returns will be higher.

I like this video: https://www.youtube.com/watch?v=GuJoojyOvMg
This one too: https://www.youtube.com/watch?v=znZohOFDvj4

Finally, I think a ton of people still have bonds as part of their allocation so all of them can't be crazy, at least I hope not!! :D

RRAAYY3
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by RRAAYY3 » Mon Jan 22, 2018 9:12 pm

In this environment, what bond ffund/type would actually make sense ?

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arcticpineapplecorp.
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by arcticpineapplecorp. » Mon Jan 22, 2018 9:28 pm

The Wizard wrote:
Mon Jan 22, 2018 10:31 am
Over last six months from 7/22/17, $10,000 of swagx has "grown" to $9963.79, per M* charts.
This is a decline of 0.36%, not 2%+...
as was said above...but here's a picture to prove it. Also, if you don't want as much volatility why not invest in shorter term bonds? You understand the tradeoff? That's right, less risk, less return. Below is the chart for the last 6 months for the fund swagx which is intermediate (in blue). For fun I threw in a short term bond fund (in orange) and an ultra short bond fund (in green). Most Intermediate bond funds have a 5-7 year duration. The short term bond fund has a 2.7 year duration and the ultra short has a 0.9 year duration. The higher the duration the more interest rate sensitivity. Interestingly the short term bond fund actually did worse than the intermediate. The ultra short held up the best, but that really tells you nothing. Because 6 months is a sprint, whereas investing is a marathon (best done over decades).

Image

source:
http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by visualguy » Tue Jan 23, 2018 3:08 am

itstoomuch wrote:
Mon Jan 22, 2018 7:43 pm
OP,
the issue with today's bonds is that rates are at lows and there is an effort by federal and private banks, governments to raise rates->which means current bond prices will go down.

Owning bonds may reduce the volatility against stocks, but not always. Bonds is supposed to be non-correlative to Stocks which gives the reduced volatility in a combined equity/bond portfolio.

Disclaimer: Our retirement & asset portfolios no longer have bonds directly (small amount in managed portfolio) nor do we have a great deal of equity (small amount in managed portfolio). Our Discretionary Accts (much reduced) is entirely equity and cash. We have transitioned to GLWB Annuities (2008-2012) and high quality/low leverage Rentals. In a way we substituted Annuities for Bonds and substituted RE rentals for Equity. The Annuities and Rentals are Income producers. In Retirement, we want Income from secure sources not necessarily a pile of stocks and bonds funds that must be periodically liquidated to provide income.
YMMV
Just curious - in what area are these income-producing rentals located? My area is good for appreciation, but very bad for income (lousy rent-to-price ratio). Just wondering where people are owning these days to enable them to rely on rental income without having to sink too much money into it.

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WpgGuy
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by WpgGuy » Tue Jan 23, 2018 3:23 am

Milo953 wrote:
Mon Jan 22, 2018 3:34 am
Novice here. I have small part of my retirement portfolio in the bond fund of SWAGX, an intermediate bond fund from Schwab. It’s been losing money ever since I bought it 6 months ago. I want to just give up and invest in a 2% cd at synchrony instead. I thought bonds were supposed to be the stablizing force in a portfolio ? My other bond investments are mixed in with a 2035 target date fund and vanguard’s wellsley mutual fund. Should I stay the course or bail now on the SWAGX ?
Hang in there, I own 3 intermediate bond funds (vteb, vwitx and vcaix), like yours, they are all down :). Not to worry though, the dividend fairy will make us whole after a while, just set Schwab to reinvest dividends and don’t watch for a while.

I’m new to bonds too, so this is a learning experience. I think it was Buffet who said: “Lessons are expensive, good ones are very expensive.”, keep this lesson to the former :D.

itstoomuch
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by itstoomuch » Tue Jan 23, 2018 3:30 am

@ visualguy, Seattle.
BUT we have high equity in them, ie Sunk a lot of cash and into the properties. We can make a small cashflow profit by being at or below the market. Rentals are nice but are just a conduit for idle assets, a diversifier, another stream of income, and a way to pass forward assets. One of the properties was from MIL's assets intended for ADD/austistic son, who we care for 30 years, deceased.

See signature line below. We can make do on two income streams and will give us FR=1.0
Last edited by itstoomuch on Tue Jan 23, 2018 3:36 am, edited 3 times in total.
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo

broslami
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by broslami » Tue Jan 23, 2018 3:32 am

The problem with bond funds are that their value will decrease as interest rates rise.

To mitigate this, you'll be better off buying individual bonds, which you can hold to maturity.

My 2 cents, altho I could be wrong.

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by birdog » Tue Jan 23, 2018 7:14 am

broslami wrote:
Tue Jan 23, 2018 3:32 am
The problem with bond funds are that their value will decrease as interest rates rise.

To mitigate this, you'll be better off buying individual bonds, which you can hold to maturity.

My 2 cents, altho I could be wrong.
The basic problem with owning individual bonds is that you lose the simple diversification you can get by owning one bond fund that owns many individual bonds. Owning individual bonds (especially to maturity) also makes it much harder to rebalance into equities during an equity downturn.

A question for the bond experts here: Are the bonds in a bond index fund held to maturity or are they always sold prior to maturing?

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ruralavalon
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by ruralavalon » Tue Jan 23, 2018 9:23 am

GibsonL6s wrote:
Mon Jan 22, 2018 8:25 pm
ruralavalon wrote:
Mon Jan 22, 2018 7:30 pm
metalworking wrote:
Mon Jan 22, 2018 6:44 pm
GibsonL6s wrote:
Mon Jan 22, 2018 6:38 pm
visualguy wrote:
Mon Jan 22, 2018 5:02 pm


You can't have it both ways. It's either not volatile, in which case it won't do much as a hedge for stock, or it's volatile. In reality, it's somewhat volatile, but nothing compared to stock. I don't see how it acts as a meaningful hedge, and I don't see a good reason to tolerate the volatility.

You're also likely to get a lower total return when compared to a CD ladder in a period of rising interest rates because the "double duration" rule will bite you. Regardless of whether this happens or not, no point in playing this game when there's no win, so I stay away from these funds as much as possible, and stick to other fixed income.
Volatility and correlation in my mind are two different concepts. Securities and be both volatile and correlated or non-correlated with stocks. Again CDs and Cash are not going to rise when stocks fall, bonds generally will so CDs are not a hedge against stocks. I am not suggesting that one may not prefer to hold CDs or cash as opposed to fixed income, just that they behave differently as opposed to bonds.
It sounds like you are saying bonds generally rise when stocks fall but in other post i read that they are not correlated at all. Which is it? thanks
Bonds and stocks do not have a negative correlation.

Bonds and stocks have a low correlation. Total Stock Market ETF and Total Bond Market ETF have a correlation of 4, where 100 equals a perfect correlation.
I am getting Negative .17

https://www.portfoliovisualizer.com/ass ... ingDays=60
It's probably a slightly different time frame or method of calculation.

I was using the correlation tool at advisoronline.
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by grabiner » Tue Jan 23, 2018 12:54 pm

birdog wrote:
Tue Jan 23, 2018 7:14 am
A question for the bond experts here: Are the bonds in a bond index fund held to maturity or are they always sold prior to maturing?
An index holds a bond as long as it fits in the index. Thus, an intermediate-term bond index will sell bonds about 5 years from maturity, when they become short-term. A total-market index usually holds bonds until one year from maturity; bonds in their last year behave more like cash, which is not what bond investors usually want. Indexes may also buy and sell bonds as new issues and redemptions cause the composition of the index to change.

Indexes may also drop bonds if they no longer qualify for other reasons; for example, an investment-grade index will drop a bond which is downgraded to junk, and a junk-bond index will drop a bond which is upgraded to investment-grade.
Wiki David Grabiner

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by 92irish » Tue Jan 23, 2018 1:01 pm

BlackStrat wrote:
Mon Jan 22, 2018 9:18 am
"Half the time I wonder why I have so much in bonds, and the other half why so much in stocks"

-John Bogle
I've always liked this Bogle quote and is so true. Although, of late it seems like I wonder 90% of the time I have so much in bonds and only 10% why I have so much in stocks. But that will change if the stock market struggles. We will then start seeing Zvi Bodie threads again about the benefits of 100% bond portfolios!

Stay the course. Tune out the noise. Be aware of recency bias.

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by rgs92 » Tue Jan 23, 2018 1:16 pm

There could easily be some sort of incident that leads to a flight-to-quality (geopolitical of all sorts; remember Brexit?).

Flights to quality have been frequent over the last 20 years. I think the term started with the Asian Currency Crisis and the Long-Term-Capital crisis back in 1997-8. These seem to be long forgotten, but they were huge stories back then.

Also back in 1987, after the stock market crash (and interest rates were climbing back to 10% for medium term bonds), the fed lowered rates a lot and everybody moved into bonds. So I would always keep bonds (and some cash too in case both stocks and bonds drop at once like in the early 1980s).

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by SimplicityNow » Tue Jan 23, 2018 2:23 pm

My fixed income asset allocation (~40%) is split between several stable value funds and the rest is in total bond index.

They're all beating inflation at the moment and the bond dividends are being reinvested at lower prices as they fall in price. New purchases are also being made at a lower cost.

Their purpose, at least for me, is to soften the blow to my portfolio when equities correct. Then I will be selling them to buy more stocks. The stock portion of my portfolio is there for growth.

Yes it would be nice if stocks continues to rise in value, bond prices increased and yields did too but that's not the way it works.

Stick with the bond fund. In the long term I think you will be happy you did.

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by livesoft » Tue Jan 23, 2018 3:05 pm

rgs92 wrote:
Tue Jan 23, 2018 1:16 pm
There could easily be some sort of incident that leads to a flight-to-quality (geopolitical of all sorts; remember Brexit?).
Brexit was a fantastic buying opportunity where investors made 10% or so in about a week, so I am not sure that's the example you want to use. :)
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stocknoob4111
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by stocknoob4111 » Tue Jan 23, 2018 5:05 pm

https://www.barrons.com/articles/what-w ... 1516423392

Forecast is 2.75% on the 10Y by end of year, nothing to care too much about given it's currently 2.66%.

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by arcticpineapplecorp. » Tue Jan 23, 2018 5:46 pm

broslami wrote:
Tue Jan 23, 2018 3:32 am
The problem with bond funds are that their value will decrease as interest rates rise.

To mitigate this, you'll be better off buying individual bonds, which you can hold to maturity.

My 2 cents, altho I could be wrong.
not wrong entirely, but sort of an error in mental accounting. Say you buy a 10 year bond paying 2.6% and then at some point rates go up to 3%. Yes, you'll get you're 2.6% for 10 years and your return of principle at the end...but so what? New bonds are paying 3% and yours is not. If you want to sell your bond paying 2.6% to buy a new bond paying 3% what do you think happens? You guessed it. You have to sell your bond at a discount (loss) to someone who could just go out and buy a 3% bond now.

Even if you say, "Well I won't sell my 2.6% bond at a loss" you're still experiencing a loss. It's called opportunity cost. You're stuck with a bond paying 2.6% when new bonds are paying 3%. That is a loss in that you don't earn what you could be earning.

So regardless of whether you hold a bond fund or an individual bond you're still going to have to deal with interest rate sensitivity and its impact on your bond part of your portfolio.

Much better in my mind to be diversified with bonds. And if you're concerned about price volatility keep your duration lower to mitigate potential losses. But realize you give up some return doing that. But isn't that how investing goes? Take less risk, give up some potential for return.
"Invest we must." -- Jack Bogle | “The purpose of investing is not to simply optimise returns and make yourself rich. The purpose is not to die poor.” -- William Bernstein

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by tesuzuki2002 » Tue Jan 23, 2018 5:49 pm

Milo953 wrote:
Mon Jan 22, 2018 3:34 am
Novice here. I have small part of my retirement portfolio in the bond fund of SWAGX, an intermediate bond fund from Schwab. It’s been losing money ever since I bought it 6 months ago. I want to just give up and invest in a 2% cd at synchrony instead. I thought bonds were supposed to be the stablizing force in a portfolio ? My other bond investments are mixed in with a 2035 target date fund and vanguard’s wellsley mutual fund. Should I stay the course or bail now on the SWAGX ?
I am welcoming the decline in Bond funds.... It's the perfect time to top up your investment to the proper allocation!!!

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by bondsr4me » Tue Jan 23, 2018 6:13 pm

tesuzuki2002 wrote:
Tue Jan 23, 2018 5:49 pm
Milo953 wrote:
Mon Jan 22, 2018 3:34 am
Novice here. I have small part of my retirement portfolio in the bond fund of SWAGX, an intermediate bond fund from Schwab. It’s been losing money ever since I bought it 6 months ago. I want to just give up and invest in a 2% cd at synchrony instead. I thought bonds were supposed to be the stablizing force in a portfolio ? My other bond investments are mixed in with a 2035 target date fund and vanguard’s wellsley mutual fund. Should I stay the course or bail now on the SWAGX ?
I am welcoming the decline in Bond funds.... It's the perfect time to top up your investment to the proper allocation!!!
+1.
As the bond fund pays quarterly/monthly distributions, these distributions can be reinvested in the bond fund. In this way you will get a piece of the new, higher interest rate bonds the fund manager will buy.

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by Agggm » Tue Jan 23, 2018 7:01 pm

Milo953 wrote:
Mon Jan 22, 2018 3:34 am
Novice here. I have small part of my retirement portfolio in the bond fund of SWAGX, an intermediate bond fund from Schwab. It’s been losing money ever since I bought it 6 months ago. I want to just give up and invest in a 2% cd at synchrony instead. I thought bonds were supposed to be the stablizing force in a portfolio ? My other bond investments are mixed in with a 2035 target date fund and vanguard’s wellsley mutual fund. Should I stay the course or bail now on the SWAGX ?
Stay your course.

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by visualguy » Tue Jan 23, 2018 7:56 pm

itstoomuch wrote:
Tue Jan 23, 2018 3:30 am
@ visualguy, Seattle.
BUT we have high equity in them, ie Sunk a lot of cash and into the properties. We can make a small cashflow profit by being at or below the market. Rentals are nice but are just a conduit for idle assets, a diversifier, another stream of income, and a way to pass forward assets. One of the properties was from MIL's assets intended for ADD/austistic son, who we care for 30 years, deceased.

See signature line below. We can make do on two income streams and will give us FR=1.0
Thanks. Seattle is pretty expensive to get into now... Anyway, I'm a big believer in owning rental real estate as part of a retirement portfolio.

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by jalbert » Tue Jan 23, 2018 8:17 pm

One of the hardest things to do emotionally is to just look at overall portfolio return, risk, and volatility, and not look at the returns of individual investments in the portfolio.

Bonds are included to smooth out the peaks and valleys that can be quite steep if you are 100% stocks. In return for risking less drawdown when stocks do poorly, you give up some upside when stocks do well. Over the long haul, you eliminate more risk than return and most people find that attractive. It is acceptable to hold cash or a short-term bond fund, but it will not offer as much protection if a bear market for stocks is accompanied by falling interest rates, as is common (but not guaranteed).
Risk is not a guarantor of return.

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by stocknoob4111 » Tue Jan 23, 2018 8:36 pm

visualguy wrote:
Tue Jan 23, 2018 7:56 pm
Thanks. Seattle is pretty expensive to get into now... Anyway, I'm a big believer in owning rental real estate as part of a retirement portfolio.
Unfortunately for some of us Real Estate is not an option. I live in Los Angeles area and real estate prices are breathtaking. It takes 2 six figure incomes to even think about owning comfortable. On a single income forget it, way too much stress for me.

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by jalbert » Wed Jan 24, 2018 1:14 pm

broslami wrote:
Tue Jan 23, 2018 3:32 am
The problem with bond funds are that their value will decrease as interest rates rise.

To mitigate this, you'll be better off buying individual bonds, which you can hold to maturity.

My 2 cents, altho I could be wrong.
A bond fund manager can choose to hold bonds to maturity.
Risk is not a guarantor of return.

TxInjun
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by TxInjun » Wed Jan 24, 2018 1:49 pm

arcticpineapplecorp. wrote:
Tue Jan 23, 2018 5:46 pm

not wrong entirely, but sort of an error in mental accounting. Say you buy a 10 year bond paying 2.6% and then at some point rates go up to 3%. Yes, you'll get you're 2.6% for 10 years and your return of principle at the end...but so what? New bonds are paying 3% and yours is not. If you want to sell your bond paying 2.6% to buy a new bond paying 3% what do you think happens? You guessed it. You have to sell your bond at a discount (loss) to someone who could just go out and buy a 3% bond now.

Even if you say, "Well I won't sell my 2.6% bond at a loss" you're still experiencing a loss. It's called opportunity cost. You're stuck with a bond paying 2.6% when new bonds are paying 3%. That is a loss in that you don't earn what you could be earning.

So regardless of whether you hold a bond fund or an individual bond you're still going to have to deal with interest rate sensitivity and its impact on your bond part of your portfolio.

Much better in my mind to be diversified with bonds. And if you're concerned about price volatility keep your duration lower to mitigate potential losses. But realize you give up some return doing that. But isn't that how investing goes? Take less risk, give up some potential for return.
I want to understand the practical difference between holding to maturity, or switching out closer-to-maturing bonds for longer-to-maturing bonds (as would happen in a bond ETF/fund trying to maintain a constant weighted maturity)

If the closer-to-maturing bonds were sold, the market forces should equalize the price of the bond to match the new (3%) yield. OK so far. - you took a "capital loss" but you buy a higher yield. So relative to holding-to-maturity, it should be a wash, right? Wouldn't the price of the bond you sold and the bond you bought adjust to the point at which holding to maturity has no more benefit? Otherwise everyone would simply hold...

Cheers

TxInjun

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by saltycaper » Wed Jan 24, 2018 2:04 pm

TxInjun wrote:
Wed Jan 24, 2018 1:49 pm

I want to understand the practical difference between holding to maturity, or switching out closer-to-maturing bonds for longer-to-maturing bonds (as would happen in a bond ETF/fund trying to maintain a constant weighted maturity)

If the closer-to-maturing bonds were sold, the market forces should equalize the price of the bond to match the new (3%) yield. OK so far. - you took a "capital loss" but you buy a higher yield. So relative to holding-to-maturity, it should be a wash, right? Wouldn't the price of the bond you sold and the bond you bought adjust to the point at which holding to maturity has no more benefit? Otherwise everyone would simply hold...

Cheers

TxInjun
(underline added)

No. It won't match the new 3% yield of longer dated bonds. (At least, not normally.) When you sell the close-to-maturing bond, it won't have a 3% yield anymore. It will have a yield close to the yield of bonds with a comparable remaining maturity. For example, if you bought a 10-year bond and sold it 1 year out from maturity, it will be yielding close to other comparable 1-year bonds. You would be selling what is now a 1-year bond with a lower yield and buying a 10-year bond with a higher yield.
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TxInjun
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by TxInjun » Thu Jan 25, 2018 9:20 pm

saltycaper wrote:
Wed Jan 24, 2018 2:04 pm
TxInjun wrote:
Wed Jan 24, 2018 1:49 pm

I want to understand the practical difference between holding to maturity, or switching out closer-to-maturing bonds for longer-to-maturing bonds (as would happen in a bond ETF/fund trying to maintain a constant weighted maturity)

If the closer-to-maturing bonds were sold, the market forces should equalize the price of the bond to match the new (3%) yield. OK so far. - you took a "capital loss" but you buy a higher yield. So relative to holding-to-maturity, it should be a wash, right? Wouldn't the price of the bond you sold and the bond you bought adjust to the point at which holding to maturity has no more benefit? Otherwise everyone would simply hold...

Cheers

TxInjun
(underline added)

No. It won't match the new 3% yield of longer dated bonds. (At least, not normally.) When you sell the close-to-maturing bond, it won't have a 3% yield anymore. It will have a yield close to the yield of bonds with a comparable remaining maturity. For example, if you bought a 10-year bond and sold it 1 year out from maturity, it will be yielding close to other comparable 1-year bonds. You would be selling what is now a 1-year bond with a lower yield and buying a 10-year bond with a higher yield.
Thanks for your clear reply - that makes sense. My real question is to compare holding-to-maturity strategy, vs. holding a constant-maturity bond fund.

OK - so sell the closer-to-maturity for a loss, and buy another slightly longer-term bond - as you say, with a higher yield (for duration risk). Now, the new bond has the higher duration risk, but it is paying more too. So, assuming no more rate changes, would you be worse off in a bond fund, or is it a wash - when compared to holding-to-maturity strategy?

(Let's assume intermediate-term bonds, 5-6 years for now).

Cheers

TxInjun

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ogd
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by ogd » Fri Jan 26, 2018 12:39 am

TxInjun wrote:
Thu Jan 25, 2018 9:20 pm
Thanks for your clear reply - that makes sense. My real question is to compare holding-to-maturity strategy, vs. holding a constant-maturity bond fund.

OK - so sell the closer-to-maturity for a loss, and buy another slightly longer-term bond - as you say, with a higher yield (for duration risk). Now, the new bond has the higher duration risk, but it is paying more too. So, assuming no more rate changes, would you be worse off in a bond fund, or is it a wash - when compared to holding-to-maturity strategy?

(Let's assume intermediate-term bonds, 5-6 years for now).
If nothing particularly bad happens to bond yields [*] in the meantime, you would expect the fund to make significantly more money, simply because it has more risk. The source of risk is very mundane and has nothing to do with holding to maturity: the fund will keep a constant duration, so particularly in the later years it will have higher duration than the bond approaching maturity. This interest rate risk is likely to get rewarded when the risk doesn't strike, so you're likely to make more money.

You are right to note that in an efficient market, selling a bond instead of holding it to maturity does not make a difference. Here's a simple thought experiment: suppose that in a bad bond market (yields keep rising, values keep dropping), you keep selling your 5 year Treasury and buying a new bond of the same exact maturity (i.e. shorter and shorter). Assuming no transaction losses, 5 years later you'll actually be in the same place as if you had kept the original through maturity. This is despite taking capital losses every single time you sold! Selling a depreciated bond does not per se change anything, it's what you buy after that that makes a difference. You took losses, but you immediately gained the right to participate in higher bond coupons, which is the direct equivalent of those losses by bond mathematics.

The legitimate risk difference is, as I said, the constant duration. But whether to keep the duration constant or not is ultimately a matter of choice, and you can do either with either instrument. For a long lived bond portfolio, you probably want constant duration anyway rather than seesawing between 5 years and zero at arbitrary times; whether you achieve this with a fund or a bond portfolio is immaterial, the fund being of course much easier. If for some reason all the money needs to be available 5 years from now, you can still do it with funds by gradually shortening duration, but it's no longer as easy and single bonds might be best - though in less than perfectly safe sectors I'd recommend a defined maturity fund instead for diversification.

Bottom line is, do not mistake holding bonds to maturity with interest rate safety. The value decline is exactly equivalent to the lower yield of the holder-to-maturity.

[*] As it happens, it's actually hard to define "nothing particularly bad" for bonds. It turns out the neutral scenario is NOT "bond yields don't change at all" - this scenario can have a constant-maturity fund yield considerably more than expected (see here for a discussion), but rather a scenario where the yield curve changes in a way that leaves bond of different maturities equivalent. For example, in 2 years the yield of the 3 year bond has to become the same as the present yield of the 5 year plus the yield difference over those years, and so on. It's only above that that the changes start to hurt a fund, at least initially. If you run those numbers at times when the market is worried about rates, they can get pretty high, meaning that a steep yield curve provides a cushion before interest rate risk starts to hurt. The market does price in interest rate risk at all times and it's a stretch to think we can outsmart it.

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by saltycaper » Fri Jan 26, 2018 7:51 am

TxInjun wrote:
Thu Jan 25, 2018 9:20 pm

Thanks for your clear reply - that makes sense. My real question is to compare holding-to-maturity strategy, vs. holding a constant-maturity bond fund.

OK - so sell the closer-to-maturity for a loss, and buy another slightly longer-term bond - as you say, with a higher yield (for duration risk). Now, the new bond has the higher duration risk, but it is paying more too. So, assuming no more rate changes, would you be worse off in a bond fund, or is it a wash - when compared to holding-to-maturity strategy?

(Let's assume intermediate-term bonds, 5-6 years for now).

Cheers

TxInjun
Without "rate changes" (the yield curve hasn't shifted while the bond was outstanding), the close-to-maturity bond would actually be sold for a gain, normally. (By normally, I mean if the yield curve has a positive slope--longer maturities yielding more than shorter maturities.) As time goes by, the yield decreases and the price increases, before heading back to par.

With "rate changes" (say, the entire curve shifts upward), the close-to-maturity bond may or may not be sold at a loss. It depends on how much yields changed on the short end of the yield curve compared to the yield at the time of purchase. For instance, assume an initial yield of 3%, and assume yields on 1-year bonds jumped from 1% to 2%. When your bond has 1 year to maturity, you still will have a gain, because 2% is less than 3%, even though "rates" went up.

I think I see what you're getting at, but I can envision so many scenarios, I'm not sure there is a definite answer. Consider two scenarios, one where your duration initially is shorter than the bond fund and one where your duration initially is longer than the bond fund.

If the duration of your individual bond is significantly less than the duration of the bond fund, and if yields go up uniformly across the yield curve, you will have a smaller loss than the bond fund, and you can turn around and purchase a bond with a higher yield. Having a shorter duration right before yields increase and then lengthening your duration afterward, and then having the yields stay the same, that's threading a needle that pretty much won't happen in real life unless you get very lucky. You've essentially timed the occurrence of interest rate risk.

Conversely, if you have a bond with a duration much longer than the bond fund, and yields go up, you are stuck with this bond for some time, while the fund can turn around and purchase higher yielding bonds more quickly. So I imagine the fund would outperform in time. But, I suppose there could be some scenario where you could have a longer-dated bond (longer than the fund's longest-dated bond) with a high enough yield that even after yields go up and you initially have a loss greater than the fund, you would still be better off than the bond fund in the long run because the yield on your bond was much higher to begin with.

Other scenarios could be worked out where, by holding an individual bond, you are worse off than the bond fund in the long run, regardless of whether your initial duration was shorter or longer than the fund.

This is all very dependent on the shape of the yield curve, the duration of your bond compared to the bond fund at the time of the rate increase, and the time period under consideration.

It's true that if you are taking less of a risk at the time that risk shows up, you are better off in the short run. The problem is you don't know when the risk will show up.
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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by TxInjun » Fri Jan 26, 2018 12:05 pm

Thank you for your considered replies, ogd and saltycaper. Primarily for convenience, my fixed-income portfolio is in intermediate-term ETFs, instead of individual bonds. I guess I was looking for confirmation that my strategy was no worse than any other, but it's clear this is a complex topic.

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by rgs92 » Fri Jan 26, 2018 2:08 pm

livesoft wrote:
Tue Jan 23, 2018 3:05 pm
rgs92 wrote:
Tue Jan 23, 2018 1:16 pm
There could easily be some sort of incident that leads to a flight-to-quality (geopolitical of all sorts; remember Brexit?).
Brexit was a fantastic buying opportunity where investors made 10% or so in about a week, so I am not sure that's the example you want to use. :)
Point taken. Thx agn Livesoft.

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Re: Ready to give up on bond fund, Lost 2.25% past 6 months

Post by saltycaper » Fri Jan 26, 2018 2:45 pm

TxInjun wrote:
Fri Jan 26, 2018 12:05 pm
Thank you for your considered replies, ogd and saltycaper. Primarily for convenience, my fixed-income portfolio is in intermediate-term ETFs, instead of individual bonds. I guess I was looking for confirmation that my strategy was no worse than any other, but it's clear this is a complex topic.
The situations in which individual bonds could outperform an intermediate-term bond fund probably involve cases where the duration of the individual bonds is different from the bond fund, or the maturities are different from the bond fund, or the cost is less, or someone is pretending they can see the future, or some other factor that makes the situations unfair comparisons.

I would prefer individual bonds if I knew I needed/wanted a specific amount of money to be available at some set date(s). I would rather just have the bond(s) mature than to have to periodically change the duration of my fund(s). I do see less risk in individual bonds in that case because it's possible a bond fund could drop in value just before I sold some of it to reduce my duration. Some people might not see the magnitude of this risk as great enough to warrant consideration. Or they might question the "need/want."*

I do hold individual TIPS because I want specific maturities, and there are no funds that invest only in those maturities. I might save a little on the expense ratio too. For just about every other type of bond though, there is a fund one could use.

*ogd has questioned this in the past. Welcome back(?), ogd. :happy
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