Is it time to go shorter in bonds ?

[Kevin8696]

With the Fed's continuing program of raising short-term rates, the spread between the 2-yr and 10-yr Treasuries has narrowed to just 0.20% compared to a historic spread of about 2.0%. This flat yield curve has analysts saying that investors in intermediate term bond funds (such as Vanguard Total Bond Market Index Fund, VBTLX) are not being adequately compensated for the interest rate risk associated with the 6+ year duration of these funds.

We know that as interest rates go up, bond prices go down. The rule of thumb I have read is: Duration minus SEC yield approximates the impact of a 1% increase in rates. Using this method for VBTLX, portfolio duration of 6.1 years minus the current SEC yield of 3.13% indicates a price drop of approximately 3.0% for a 1% increase in rates. At current interest rate levels, this hit to principal would not be fun.

As a retiree with 50% of my portfolio in fixed income, I'm not enthused about taking capital losses on the bond side of the portfolio. I recognize that newer, higher yielding bonds that will be added to the portfolio will eventually offset the hit to total return coming from the capital losses. In the meantime I'm seeing losses, and I don't have a 30-yr time horizon. Would I be better off in Vanguard Prime Money Market Fund (VMMXX) at this point in time, until intermediate term rates settle out ?

Year-to-date results for VBTLX show total return of -1.00%. With a distribution yield of 2.77%, the fund has been taking capital losses over the last two quarters. During the same period, VMMXX return has been 1.19% and shows a 7-day yield of 2.08%. With rates still being very low on an historic basis, is it worth rolling the dice and riding it out the storm with an intermediate term bond fund, or just go with the safety of principal and the increasing returns of the money market fund ?

Would appreciate thoughts on this matter. Thanks !!

[UpperNwGuy]

What's your time horizon? That probably makes a difference in the right course to follow.

[Sandtrap]

With the Fed's continuing program of raising short-term rates, the spread between the 2-yr and 10-yr Treasuries has narrowed to just 0.20% compared to a historic spread of about 2.0%. This flat yield curve has analysts saying that investors in intermediate term bond funds (such as Vanguard Total Bond Market Index Fund, VBTLX) are not being adequately compensated for the interest rate risk associated with the 6+ year duration of these funds.

We know that as interest rates go up, bond prices go down. The rule of thumb I have read is: Duration minus SEC yield approximates the impact of a 1% increase in rates. Using this method for VBTLX, portfolio duration of 6.1 years minus the current SEC yield of 3.13% indicates a price drop of approximately 3.0% for a 1% increase in rates. At current interest rate levels, this hit to principal would not be fun.

As a retiree with 50% of my portfolio in fixed income, I'm not enthused about taking capital losses on the bond side of the portfolio. I recognize that newer, higher yielding bonds that will be added to the portfolio will eventually offset the hit to total return coming from the capital losses. In the meantime I'm seeing losses, and I don't have a 30-yr time horizon. Would I be better off in Vanguard Prime Money Market Fund (VMMXX) at this point in time, until intermediate term rates settle out ?

Year-to-date results for VBTLX show total return of -1.00%. With a distribution yield of 2.77%, the fund has been taking capital losses over the last two quarters. During the same period, VMMXX return has been 1.19% and shows a 7-day yield of 2.08%. With rates still being very low on an historic basis, is it worth rolling the dice and riding it out the storm with an intermediate term bond fund, or just go with the safety of principal and the increasing returns of the money market fund ?

Would appreciate thoughts on this matter. Thanks !!

As a retiree, I've had similar thoughts and come up with the following:

1. Nobody knows when "intermediate term rates" will "settle out". So. . .what to do?
2. What "storm are we in and if it is a storm, how long to ride it out? So. . what to do?

Options:

1. Stick to a low cost "bogle" portfolio and take risks on the equity side while not chasing returns on fixed.
2. Diversify the fixed portion with a balance of "bond funds (int,total bond, etc) ,. . . And. . . CD ladder, short/intermediate term treasuries, money market funds, high yield accounts. (what I did).
3. Stay as you are now and re-evaluate your IPS vs risk tolerance, response to market fluctuations.

#1-3 depends on how far you are into retirement (age 65, 75, 85, etc), how dependent you are on total portfolio return, total holdings, etc.

aloha
j

[aristotelian]

I did just this in my HSA. Pure timing move even though IPS called for intermediate bonds, but I just don't see the point of taking interest rate/duration risk when you can get virtually the same yield from ST. We'll see what happens!

[JBTX]

With the Fed's continuing program of raising short-term rates, the spread between the 2-yr and 10-yr Treasuries has narrowed to just 0.20% compared to a historic spread of about 2.0%. This flat yield curve has analysts saying that investors in intermediate term bond funds (such as Vanguard Total Bond Market Index Fund, VBTLX) are not being adequately compensated for the interest rate risk associated with the 6+ year duration of these funds.

We know that as interest rates go up, bond prices go down. The rule of thumb I have read is: Duration minus SEC yield approximates the impact of a 1% increase in rates. Using this method for VBTLX, portfolio duration of 6.1 years minus the current SEC yield of 3.13% indicates a price drop of approximately 3.0% for a 1% increase in rates. At current interest rate levels, this hit to principal would not be fun.

As a retiree with 50% of my portfolio in fixed income, I'm not enthused about taking capital losses on the bond side of the portfolio. I recognize that newer, higher yielding bonds that will be added to the portfolio will eventually offset the hit to total return coming from the capital losses. In the meantime I'm seeing losses, and I don't have a 30-yr time horizon. Would I be better off in Vanguard Prime Money Market Fund (VMMXX) at this point in time, until intermediate term rates settle out ?

Year-to-date results for VBTLX show total return of -1.00%. With a distribution yield of 2.77%, the fund has been taking capital losses over the last two quarters. During the same period, VMMXX return has been 1.19% and shows a 7-day yield of 2.08%. With rates still being very low on an historic basis, is it worth rolling the dice and riding it out the storm with an intermediate term bond fund, or just go with the safety of principal and the increasing returns of the money market fund ?

Would appreciate thoughts on this matter. Thanks !!

1. If interest rates go up 2%, which would put them higher than they have been in a long time, and from my perspective unlikely but not impossible, then that is 6% 12% price decrease. Add in your 5% 3% interest and you are down 1% 9% over a year. If this has you up at night then you really need to contemplate your tolerance for risk.

2. If anything a flattening yield curve signals an economic slowdown, which typically is bad for stocks and good for long term bonds. If you bail on bonds now for short term instruments you may be abandoning them when they are the most valuable as bonds tend to be negatively correlated with stocks during economic slowdowns.

Edited for corrections.

[Kevin8696]

I did just this in my HSA. Pure timing move even though IPS called for intermediate bonds, but I just don't see the point of taking interest rate/duration risk when you can get virtually the same yield from ST. We'll see what happens!

Thanks for the feedback. Btw, a couple of replies mentioned "IPS". What's an IPS ? And where do I get one ?

Kevin

[Admiral]

With the Fed's continuing program of raising short-term rates, the spread between the 2-yr and 10-yr Treasuries has narrowed to just 0.20% compared to a historic spread of about 2.0%. This flat yield curve has analysts saying that investors in intermediate term bond funds (such as Vanguard Total Bond Market Index Fund, VBTLX) are not being adequately compensated for the interest rate risk associated with the 6+ year duration of these funds.

We know that as interest rates go up, bond prices go down. The rule of thumb I have read is: Duration minus SEC yield approximates the impact of a 1% increase in rates. Using this method for VBTLX, portfolio duration of 6.1 years minus the current SEC yield of 3.13% indicates a price drop of approximately 3.0% for a 1% increase in rates. At current interest rate levels, this hit to principal would not be fun.

As a retiree with 50% of my portfolio in fixed income, I'm not enthused about taking capital losses on the bond side of the portfolio. I recognize that newer, higher yielding bonds that will be added to the portfolio will eventually offset the hit to total return coming from the capital losses. In the meantime I'm seeing losses, and I don't have a 30-yr time horizon. Would I be better off in Vanguard Prime Money Market Fund (VMMXX) at this point in time, until intermediate term rates settle out ?

Year-to-date results for VBTLX show total return of -1.00%. With a distribution yield of 2.77%, the fund has been taking capital losses over the last two quarters. During the same period, VMMXX return has been 1.19% and shows a 7-day yield of 2.08%. With rates still being very low on an historic basis, is it worth rolling the dice and riding it out the storm with an intermediate term bond fund, or just go with the safety of principal and the increasing returns of the money market fund ?

Would appreciate thoughts on this matter. Thanks !!

What is your age and what is your investing horizon? "Retired" can mean 55 or 85.

Are you currently selling your Total Bond holdings to pay your bills and realizing a loss? Or are you using interest payments and simply nervous watching NAV go lower.

Rates have been rising, that's true, but the problem is we have no way of knowing if they will continue to do so. A loss in NAV over a few quarters would not worry me... though I am not retired. Certainly if you want to diversify your bond holdings into something that you feel is a better match to your investing horizon, there is nothing wrong with that. But just acknowledge that you are placing at bet on how rates will move. You may be wrong.

[Admiral]

An IPS (Investment Policy Statement) outlines your asset allocation and your comfort with taking risk.

[Angst]

An IPS (Investment Policy Statement) outlines your asset allocation and your comfort with taking risk.

In the Wiki you can search for IPS and will find this link:
https://www.bogleheads.org/wiki/Investm ... _statement

[goblue100]

So, I remember reading a post back in 2011 from someone who was retired. Everyone was sure interest rates were going up and long term bonds should be avoided, but this one poster said he had a 30 year retirement so he was in a long bond fund. I thought to myself, you poor man, you are going to regret that decision. If I plug the 30 year treasury fund(VSUSTX) into portfolio visualizer vs BND, it appears he wasn't crazy after all:
https://www.portfoliovisualizer.com/bac ... ion2_2=100

I guess my point is even though rates have risen over the last 7 years, it hasn't been a disaster to be in long duration bonds.

Edit: Before anyone accuses me of cherry picking dates (I used 2011 because that is when I remember reading that post, but it was a pretty good year for the long bond) here is a comparison of long term treasury, intermediate term treasury, and short term treasury from 2015:
https://www.portfoliovisualizer.com/bac ... ion3_3=100

Not as impressive, but long bond still comes out ahead.

[Kevin8696]

1. If interest rates go up 2%, which would put them higher than they have been in a long time, and from my perspective unlikely but not impossible, then that is 6% price decrease. Add in your 5% interest and you are down 1% over a year. If this has you up at night then you really need to contemplate your tolerance for risk.

JBTX.... Are you saying that all the bonds in the fund's portfolio will start paying a 5% coupon rate of interest in a year ?

[Admiral]

1. If interest rates go up 2%, which would put them higher than they have been in a long time, and from my perspective unlikely but not impossible, then that is 6% price decrease. Add in your 5% interest and you are down 1% over a year. If this has you up at night then you really need to contemplate your tolerance for risk.

JBTX.... Are you saying that all the bonds in the fund's portfolio will start paying a 5% coupon rate of interest in a year ?

JBTX is saying in aggregate the fund pays 3% now (3.13% is SEC yield), and would pay 5% if rates increase 2 additional percent.

[Admiral]

So, I remember reading a post back in 2011 from someone who was retired. Everyone was sure interest rates were going up and long term bonds should be avoided, but this one poster said he had a 30 year retirement so he was in a long bond fund. I thought to myself, you poor man, you are going to regret that decision. If I plug the 30 year treasury fund(VSUSTX) into portfolio visualizer vs BND, it appears he wasn't crazy after all:
https://www.portfoliovisualizer.com/bac ... ion2_2=100

I guess my point is even though rates have risen over the last 7 years, it hasn't been a disaster to be in long duration bonds.

Edit: Before anyone accuses me of cherry picking dates (I used 2011 because that is when I remember reading that post, but it was a pretty good year for the long bond) here is a comparison of long term treasury, intermediate term treasury, and short term treasury from 2015:
https://www.portfoliovisualizer.com/bac ... ion3_3=100

Not as impressive, but long bond still comes out ahead.

VUSTX lost 13.3% in 2013! Doh!

[Kevin8696]

So, I remember reading a post back in 2011 from someone who was retired. Everyone was sure interest rates were going up and long term bonds should be avoided, but this one poster said he had a 30 year retirement so he was in a long bond fund. I thought to myself, you poor man, you are going to regret that decision. If I plug the 30 year treasury fund(VSUSTX) into portfolio visualizer vs BND, it appears he wasn't crazy after all:
https://www.portfoliovisualizer.com/bac ... ion2_2=100

I guess my point is even though rates have risen over the last 7 years, it hasn't been a disaster to be in long duration bonds.

Portfolio Visualizer is a great tool !! Thanks for sharing it on the forum.

As for the long bonds, folks were a bit worried about rising rates in 2011, and were even more worried in 2013. The bond market sold off big time in 2013, even though the Fed did nothing to raise rates. VUSTX was down 13.03% that year !! The market rebounded in 2014 when people realized that the 2013 panic was unwarranted. VUSTX was up 25.27% in 2014. What a wild ride that would have been !!!

Year to date, VUSTX is feeling the impact of the rate increases, with total return of -3.11%. With a 2.82% distribution yield, that fund has been taking 3 steps forward and 6 steps back this year.

I like roller coasters... but not this kind.

[goblue100]

Just to be clear, I was not really advocating going longer term. I was just trying to point out that duration was not a disaster for someone "staying the course".

[Kevin8696]

1. If interest rates go up 2%, which would put them higher than they have been in a long time, and from my perspective unlikely but not impossible, then that is 6% price decrease. Add in your 5% interest and you are down 1% over a year. If this has you up at night then you really need to contemplate your tolerance for risk.

JBTX.... Are you saying that all the bonds in the fund's portfolio will start paying a 5% coupon rate of interest in a year ?

JBTX is saying in aggregate the fund pays 3% now (3.13% is SEC yield), and would pay 5% if rates increase 2 additional percent.

Admiral.... The SEC yield is of little value. It is a hypothetical figure that assumes bond prices won't change. The fund is not "paying" 3.13% now, the latest annualized distribution yield was 2.77%, and that's what fund owners are actually being paid. The question is how many years will it take for the bond fund to break-even to a money market fund when interest rates go up, and bond prices go down ?

[munemaker]

With the Fed's continuing program of raising short-term rates, the spread between the 2-yr and 10-yr Treasuries has narrowed to just 0.20% compared to a historic spread of about 2.0%. This flat yield curve has analysts saying that investors in intermediate term bond funds (such as Vanguard Total Bond Market Index Fund, VBTLX) are not being adequately compensated for the interest rate risk associated with the 6+ year duration of these funds.

We know that as interest rates go up, bond prices go down. The rule of thumb I have read is: Duration minus SEC yield approximates the impact of a 1% increase in rates. Using this method for VBTLX, portfolio duration of 6.1 years minus the current SEC yield of 3.13% indicates a price drop of approximately 3.0% for a 1% increase in rates. At current interest rate levels, this hit to principal would not be fun.

As a retiree with 50% of my portfolio in fixed income, I'm not enthused about taking capital losses on the bond side of the portfolio. I recognize that newer, higher yielding bonds that will be added to the portfolio will eventually offset the hit to total return coming from the capital losses. In the meantime I'm seeing losses, and I don't have a 30-yr time horizon. Would I be better off in Vanguard Prime Money Market Fund (VMMXX) at this point in time, until intermediate term rates settle out ?

Year-to-date results for VBTLX show total return of -1.00%. With a distribution yield of 2.77%, the fund has been taking capital losses over the last two quarters. During the same period, VMMXX return has been 1.19% and shows a 7-day yield of 2.08%. With rates still being very low on an historic basis, is it worth rolling the dice and riding it out the storm with an intermediate term bond fund, or just go with the safety of principal and the increasing returns of the money market fund ?

Would appreciate thoughts on this matter. Thanks !!

1. If interest rates go up 2%, which would put them higher than they have been in a long time, and from my perspective unlikely but not impossible, then that is 6% price decrease. Add in your 5% interest and you are down 1% over a year. If this has you up at night then you really need to contemplate your tolerance for risk.

2. If anything a flattening yield curve signals an economic slowdown, which typically is bad for stocks and good for long term bonds. If you bail on bonds now for short term instruments you may be abandoning them when they are the most valuable as bonds tend to be negatively correlated with stocks during economic slowdowns.

If VBTLX has a duration of 6 years and the applicable interest rate would go up 2%, then the price of VBTLX would be expected to go down by 12%. Is that correct? And you would only receive the higher interest rate on the proportion of bonds that were bought since the rates increased; the fund is still dragging a bunch of old bonds at lower interest rates. Do I understand that correctly?

[Kevin8696]

With the Fed's continuing program of raising short-term rates, the spread between the 2-yr and 10-yr Treasuries has narrowed to just 0.20% compared to a historic spread of about 2.0%. This flat yield curve has analysts saying that investors in intermediate term bond funds (such as Vanguard Total Bond Market Index Fund, VBTLX) are not being adequately compensated for the interest rate risk associated with the 6+ year duration of these funds.

We know that as interest rates go up, bond prices go down. The rule of thumb I have read is: Duration minus SEC yield approximates the impact of a 1% increase in rates. Using this method for VBTLX, portfolio duration of 6.1 years minus the current SEC yield of 3.13% indicates a price drop of approximately 3.0% for a 1% increase in rates. At current interest rate levels, this hit to principal would not be fun.

As a retiree with 50% of my portfolio in fixed income, I'm not enthused about taking capital losses on the bond side of the portfolio. I recognize that newer, higher yielding bonds that will be added to the portfolio will eventually offset the hit to total return coming from the capital losses. In the meantime I'm seeing losses, and I don't have a 30-yr time horizon. Would I be better off in Vanguard Prime Money Market Fund (VMMXX) at this point in time, until intermediate term rates settle out ?

Year-to-date results for VBTLX show total return of -1.00%. With a distribution yield of 2.77%, the fund has been taking capital losses over the last two quarters. During the same period, VMMXX return has been 1.19% and shows a 7-day yield of 2.08%. With rates still being very low on an historic basis, is it worth rolling the dice and riding it out the storm with an intermediate term bond fund, or just go with the safety of principal and the increasing returns of the money market fund ?

Would appreciate thoughts on this matter. Thanks !!

1. If interest rates go up 2%, which would put them higher than they have been in a long time, and from my perspective unlikely but not impossible, then that is 6% price decrease. Add in your 5% interest and you are down 1% over a year. If this has you up at night then you really need to contemplate your tolerance for risk.

2. If anything a flattening yield curve signals an economic slowdown, which typically is bad for stocks and good for long term bonds. If you bail on bonds now for short term instruments you may be abandoning them when they are the most valuable as bonds tend to be negatively correlated with stocks during economic slowdowns.

If VBTLX has a duration of 6 years and the applicable interest rate would go up 2%, then the price of VBTLX would be expected to go down by 12%. Is that correct? And you would only receive the higher interest rate on the proportion of bonds that were bought since the rates increased; the fund is still dragging a bunch of old bonds at lower interest rates. Do I understand that correctly?

Munemaker,

Yes your understanding is correct. I have seen two rules of thumb on duration, rate increases, and bond prices.

(1) With a 1% increase in rates, bond prices drop 1% for each year of duration. So, yes. With a 2% increase in rates, the 6-yr duration bond fund value goes down 12%.

(2) The rule of thumb I have see on Morningstar lately is: Duration minus SEC yield approximates the impact of a 1% increase in rates. Using this method for VBTLX, portfolio duration of 6.1 years minus the current SEC yield of 3.13% indicates a price drop of approximately 6.0% for a 2% increase in rates.

And Yes, the fund is still dragging around lots and lots of the old lower rate bonds, so getting back to even is the question. Because meanwhile, the money market rates are up too, with no hit to principal for these $1 denominated shares.

[JBTX]

1. If interest rates go up 2%, which would put them higher than they have been in a long time, and from my perspective unlikely but not impossible, then that is 6% 12% price decrease. Add in your 5% 3% interest and you are down 1% 9% over a year. If this has you up at night then you really need to contemplate your tolerance for risk.

JBTX.... Are you saying that all the bonds in the fund's portfolio will start paying a 5% coupon rate of interest in a year ?

JBTX is saying in aggregate the fund pays 3% now (3.13% is SEC yield), and would pay 5% if rates increase 2 additional percent.

^^This

Edit: That is indeed what I said, but I wasn't right. See edited post above

[nedsaid]

This is a hard question to answer, a big reason is that we don't know the future. I was advised almost 10 years ago to shorten the maturity of my bonds. I kept everything Intermediate Term and Investment Grade and I am glad that I did because I would have foregone a lot of interest. Yield curve was still relatively steep in those days, short bonds paid very little interest unlike today. Plus, I was still a ways from retirement and I was still reinvesting the dividends. Now that the yield curve has flattened out and there is not much difference between 2 year and 10 year interest rates, that has complicated things. With a relatively flat yield curve right now, it makes more sense to shorten maturities now than when yield curves were relatively steep. My best guess is that both inflation and interest rates will keep ticking up for a while but then again my crystal ball is cloudy. If my best guess is right then this would add even more weight to the argument that investors should shorten maturities.

[nedsaid]

I hesitate to give advice here as I will be accused of market timing. My best educated guess is that yes, this would be a good time to shorten maturities in your bonds. But it is just a guess and I don't know for certain. I am not running a market timing newsletter here but just offering my thoughts. So far, I have not changed a thing regarding bonds in my own portfolio.

[MnD]

July 2016 would have been an excellent time to deploy the go shorter strategy.

[Phineas J. Whoopee]

What the Fed sets is an overnight interest rate, called the Federal Funds Rate, which only applies to the most creditworthy banks lending among themselves.

The Fed does not set bond yields.

OP - I'll respond to some of your further points after this post.

PJW

[Kevin8696]

What the Fed sets is an overnight interest rate, called the Federal Funds Rate, which only applies to the most creditworthy banks lending among themselves.

The Fed does not set bond yields.

OP - I'll respond to some of your further points after this post.

PJW

PJW.... I don't think anyone in this thread has claimed that the Fed sets bond yields.

[Phineas J. Whoopee]

...
JBTX.... Are you saying that all the bonds in the fund's portfolio will start paying a 5% coupon rate of interest in a year ?

I'm not JBTX, but no, because that's not what a bond yield is. Coupons apply to the original face value. Yields take current market prices into account. It's a frequent point of misunderstanding here.

Yield, in very rough conceptual terms that ignore important aspects, can be thought of as if it were the coupon divided by current market price. That's why if the price goes down the yield goes up. The coupon doesn't change, but the yield does.

PJW

[Phineas J. Whoopee]

What the Fed sets is an overnight interest rate, called the Federal Funds Rate, which only applies to the most creditworthy banks lending among themselves.

The Fed does not set bond yields.

OP - I'll respond to some of your further points after this post.

PJW

PJW.... I don't think anyone in this thread has claimed that the Fed sets bond yields.

Fortunately for me, then, I didn't address my post to anybody in particular.

PJW

[Phineas J. Whoopee]

...
Admiral.... The SEC yield is of little value. It is a hypothetical figure that assumes bond prices won't change. The fund is not "paying" 3.13% now, the latest annualized distribution yield was 2.77%, and that's what fund owners are actually being paid. The question is how many years will it take for the bond fund to break-even to a money market fund when interest rates go up, and bond prices go down ?

The SEC yield is the best measure for comparing one bond fund with another, taking their risk characteristics into account. It's an aggregate measure of what a person buying the fund's whole portfolio of bonds today would end up with if held to maturity. It is not meant to predict how your own portfolio will fare if you buy and sell.

Bond yields, if not otherwise specified by the writer, by convention mean Yield to Maturity, YTM.

The distribution yield is what the fund owners were actually being paid. It's backward looking. SEC yield is forward looking.

PJW

[greg24]

Many have been attempting to time the bond market since 2008/2009 meltdown.

At some point, they may end up being correct.

[Kevin8696]

...
JBTX.... Are you saying that all the bonds in the fund's portfolio will start paying a 5% coupon rate of interest in a year ?

I'm not JBTX, but no, because that's not what a bond yield is. Coupons apply to the original face value. Yields take current market prices into account. It's a frequent point of misunderstanding here.

Yield, in very rough conceptual terms that ignore important aspects, the coupon divided by current market price. That's why if the price goes down the yield goes up. The coupon doesn't change, but the yield does.

PJW

PJW,

Assume I bought a 3.0% coupon, AAA-rated, 10 year bond for $1,000. Semi-annual interest payments, 8.7 year duration.

The next day rates spike upward, my bond drops in value to $918, and now has a new yield to maturity of 4.0%.

Did my yield just go up to 4.0% ? Or is my return still 3% on a $1,000 investment ?

Kevin

[bltn]

With the Fed's continuing program of raising short-term rates, the spread between the 2-yr and 10-yr Treasuries has narrowed to just 0.20% compared to a historic spread of about 2.0%. This flat yield curve has analysts saying that investors in intermediate term bond funds (such as Vanguard Total Bond Market Index Fund, VBTLX) are not being adequately compensated for the interest rate risk associated with the 6+ year duration of these funds.

We know that as interest rates go up, bond prices go down. The rule of thumb I have read is: Duration minus SEC yield approximates the impact of a 1% increase in rates. Using this method for VBTLX, portfolio duration of 6.1 years minus the current SEC yield of 3.13% indicates a price drop of approximately 3.0% for a 1% increase in rates. At current interest rate levels, this hit to principal would not be fun.

As a retiree with 50% of my portfolio in fixed income, I'm not enthused about taking capital losses on the bond side of the portfolio. I recognize that newer, higher yielding bonds that will be added to the portfolio will eventually offset the hit to total return coming from the capital losses. In the meantime I'm seeing losses, and I don't have a 30-yr time horizon. Would I be better off in Vanguard Prime Money Market Fund (VMMXX) at this point in time, until intermediate term rates settle out ?

Year-to-date results for VBTLX show total return of -1.00%. With a distribution yield of 2.77%, the fund has been taking capital losses over the last two quarters. During the same period, VMMXX return has been 1.19% and shows a 7-day yield of 2.08%. With rates still being very low on an historic basis, is it worth rolling the dice and riding it out the storm with an intermediate term bond fund, or just go with the safety of principal and the increasing returns of the money market fund ?

Would appreciate thoughts on this matter. Thanks !!

1. If interest rates go up 2%, which would put them higher than they have been in a long time, and from my perspective unlikely but not impossible, then that is 6% price decrease. Add in your 5% interest and you are down 1% over a year. If this has you up at night then you really need to contemplate your tolerance for risk.

2. If anything a flattening yield curve signals an economic slowdown, which typically is bad for stocks and good for long term bonds. If you bail on bonds now for short term instruments you may be abandoning them when they are the most valuable as bonds tend to be negatively correlated with stocks during economic slowdowns.

If VBTLX has a duration of 6 years and the applicable interest rate would go up 2%, then the price of VBTLX would be expected to go down by 12%. Is that correct? And you would only receive the higher interest rate on the proportion of bonds that were bought since the rates increased; the fund is still dragging a bunch of old bonds at lower interest rates. Do I understand that correctly?

You do.
I have only recently been participating in bond funds. Until a couple of years ago, I was with a couple of brokerages from which I bought individual bonds of intermediate durations in a ladder of maturities. After transferring my funds over to Vanguard and Fidelity, my individual bonds are being called or maturing,and I am investing in the Vanguard Ultra Short Term Bond Fund and the Doubleline Low Duration Bond Fund with 50% of the proceeds. The other 50% I m keeping in money market funds for now. I wait for some indication that the interest rate rise to more traditional levels will slow, and the long term rates will rise to catch up with the short term increases , before going longer. The interest rate risk doesn t justify the low returns of intermediate bonds,imo.

[bltn]

This is a hard question to answer, a big reason is that we don't know the future. I was advised almost 10 years ago to shorten the maturity of my bonds. I kept everything Intermediate Term and Investment Grade and I am glad that I did because I would have foregone a lot of interest. Yield curve was still relatively steep in those days, short bonds paid very little interest unlike today. Plus, I was still a ways from retirement and I was still reinvesting the dividends. Now that the yield curve has flattened out and there is not much difference between 2 year and 10 year interest rates, that has complicated things. With a relatively flat yield curve right now, it makes more sense to shorten maturities now than when yield curves were relatively steep. My best guess is that both inflation and interest rates will keep ticking up for a while but then again my crystal ball is cloudy. If my best guess is right then this would add even more weight to the argument that investors should shorten maturities.

I agree with this. When do you begin to transfer from intermediate bond funds to short term bond funds?

[skime]

With the Fed's continuing program of raising short-term rates, the spread between the 2-yr and 10-yr Treasuries has narrowed to just 0.20% compared to a historic spread of about 2.0%. This flat yield curve has analysts saying that investors in intermediate term bond funds (such as Vanguard Total Bond Market Index Fund, VBTLX) are not being adequately compensated for the interest rate risk associated with the 6+ year duration of these funds.

We know that as interest rates go up, bond prices go down. The rule of thumb I have read is: Duration minus SEC yield approximates the impact of a 1% increase in rates. Using this method for VBTLX, portfolio duration of 6.1 years minus the current SEC yield of 3.13% indicates a price drop of approximately 3.0% for a 1% increase in rates. At current interest rate levels, this hit to principal would not be fun.

As a retiree with 50% of my portfolio in fixed income, I'm not enthused about taking capital losses on the bond side of the portfolio. I recognize that newer, higher yielding bonds that will be added to the portfolio will eventually offset the hit to total return coming from the capital losses. In the meantime I'm seeing losses, and I don't have a 30-yr time horizon. Would I be better off in Vanguard Prime Money Market Fund (VMMXX) at this point in time, until intermediate term rates settle out ?

Year-to-date results for VBTLX show total return of -1.00%. With a distribution yield of 2.77%, the fund has been taking capital losses over the last two quarters. During the same period, VMMXX return has been 1.19% and shows a 7-day yield of 2.08%. With rates still being very low on an historic basis, is it worth rolling the dice and riding it out the storm with an intermediate term bond fund, or just go with the safety of principal and the increasing returns of the money market fund ?

Would appreciate thoughts on this matter. Thanks !!

I'm not a fan of bond funds - especially in rising interest rate environments. There's a real risk of permanent capital loss. I hold individual bonds and hold to maturity. I only buy AAA. CDs aren't a bad idea now either.

[Phineas J. Whoopee]

...
PJW,

Assume I bought a 3.0% coupon, AAA-rated, 10 year bond for $1,000. Semi-annual interest payments, 8.7 year duration.

The next day rates spike upward, my bond drops in value to $918, and now has a new yield to maturity of 4.0%.

Did my yield just go up to 4.0% ? Or is my return still 3% on a $1,000 investment ?

Kevin

Any yield is always a ratio. YTM is a ratio to the current market price. Yes, your YTM went up.

YTM, in relation to the current market price, takes into account three things:

1) The coupon payments, often called interest;
2) Reinvestment of the coupon payments at the bond's original yield through its original maturity date, often called interest on interest; and
3) The inevitable approach of the bond's market price to its face value as its maturity approaches zero. Who would accept $918 for a $1,000 face-value bond that matures tomorrow?

In your example you still will receive $15 twice a year for ten years, plus $1000 at the end, but that's not a yield. That's a coupon and a face value.

Whose interest rates do you refer to?

PJW

[Phineas J. Whoopee]

...
You do.
...

That's a common misunderstanding, and a conflation of yield with coupon, and coupon with interest rates. Please see my posts in this thread for a further explanation.

PJW

[asif408]

If I was in your shoes I would probably move a portion of my fixed income (whatever I needed in the next 5 years, say) into a money market, CDs, or T-bills/notes, and leave the remainder in VBTLX. As you say, the yield curve is pretty flat, and the difference between 1 month bills and 30 year bonds is only 1%, whereas it was around 4% 7 years ago. You could even set up a rolling T-bill ladder if you like to quickly reinvest at higher rates assuming rates rise.

So I don't see you missing out on much for shorter term money by moving some amount to T-bills, notes, or a MM fund paying 2%+. If you have a longer time horizon with the money, and want to keep in fixed income, I don't see anything wrong with VBTLX, either.

[Youngblood]

...
JBTX.... Are you saying that all the bonds in the fund's portfolio will start paying a 5% coupon rate of interest in a year ?

I'm not JBTX, but no, because that's not what a bond yield is. Coupons apply to the original face value. Yields take current market prices into account. It's a frequent point of misunderstanding here.

Yield, in very rough conceptual terms that ignore important aspects, the coupon divided by current market price. That's why if the price goes down the yield goes up. The coupon doesn't change, but the yield does.

PJW

PJW,

Assume I bought a 3.0% coupon, AAA-rated, 10 year bond for $1,000. Semi-annual interest payments, 8.7 year duration.

The next day rates spike upward, my bond drops in value to $918, and now has a new yield to maturity of 4.0%.

Did my yield just go up to 4.0% ? Or is my return still 3% on a $1,000 investment ?

Kevin

Your yield is still the same 3% on your original investment. Unfortunately, it is now longer worth $1,000. So you are now getting 4% on the money you have left and anyone buying would now get 4% on new purchases.

[Phineas J. Whoopee]

...
I'm not a fan of bond funds - especially in rising interest rate environments. There's a real risk of permanent capital loss. I hold individual bonds and hold to maturity. I only buy AAA. CDs aren't a bad idea now either.

A mutual fund is nothing more nor less than a vehicle by which to own its underlying holdings. If you held the same bonds in the same proportions the fund does, and rolled them over as they approach maturity, your portfolio value, throughout, would be the same.

PJW

[nisiprius]

Just forget about "is it time." Stay the course.

Interest rates can only go up, why go intermediate in bonds?
Post by mathwhiz » Sun Jul 19, 2009 12:36 am

I see the total bond fund and intermediate treasuries recommended a lot on here. I know people don't like to market time but interest rates are currently zero and whether rates rise in 2010 or 2011 or 2015, eventually they will rise and intermediate term bonds will get hit.

So isn't it wise to go short in this environment where rates can only go up?

Point #1: the poster was correct about interest rates rising.



Point #2: Despite this, on the date of the posting, an investor who invested $10,000 the Vanguard Short-Term Treasury Fund on 7/19/2009 (orange) instead of the Vanguard Intermediate-Term Treasury Fund (blue),

http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D



would today, have earned a total of only $1,024.75, compared to the $2,918.46 he would have earned in intermediate-term bonds. That is to say, the short-term bond investor would have foregone almost two-thirds of the gains enjoyed by the intermediate-term investor.

Furthermore, at this point, I personally guess that interest rates probably will go up and--a stronger prediction they will go up far enough, fast enough, for long enough that I am quite likely to see a one-year loss in my intermediate-term bond fund. Nevertheless, I am staying the course because even if it were to fall by 10-15%, which is two or three times as much as it has ever dropped before, I would still be ahead of the short-term bond investor.

In order to do anything else, I would have to believe that

• In 2009, nobody could predict what was going to happen to intermediate-term bonds, and yet
• in 2018, anybody can predict what is going to happen to intermediate-term bonds.

[nedsaid]

This is a hard question to answer, a big reason is that we don't know the future. I was advised almost 10 years ago to shorten the maturity of my bonds. I kept everything Intermediate Term and Investment Grade and I am glad that I did because I would have foregone a lot of interest. Yield curve was still relatively steep in those days, short bonds paid very little interest unlike today. Plus, I was still a ways from retirement and I was still reinvesting the dividends. Now that the yield curve has flattened out and there is not much difference between 2 year and 10 year interest rates, that has complicated things. With a relatively flat yield curve right now, it makes more sense to shorten maturities now than when yield curves were relatively steep. My best guess is that both inflation and interest rates will keep ticking up for a while but then again my crystal ball is cloudy. If my best guess is right then this would add even more weight to the argument that investors should shorten maturities.

I agree with this. When do you begin to transfer from intermediate bond funds to short term bond funds?

So far, I have kept everything Intermediate Term and not shifted anything towards Short Term. I may not do anything based upon what I posted above. Truth is, I just don't know. I have an informed opinion and can make educated guesses but I could be wrong.

I have been beating the drums for Large Value stocks for I don't know, four years now. The market just will not listen. We are still in a Large Growth stock market and the Growth bias seems to be holding in the International Stock markets as well. So I had good reasoning behind my opinions but the market as a whole did not agree with me.

Pretty much I am saying there is excellent reasoning behind shortening bond maturities at this time. But then again, I had excellent reasoning about Large Cap Value. I don't want to run a market timing service on the Bogleheads forum.

Note: please read Nisiprius' post above. I stayed in Intermediate Bonds rather than shorten maturities and his post above vindicates my decision. How will things fare from this point forward? Don't know. But as long as I reinvest the dividends and have a few years before retirement, it shouldn't matter much.

[livesoft]

I like to do short-term market timing of my bond fund assets. I don't know if it is time to go shorter in bonds. I know that earlier this year it was time to go shorter in bonds.

Just because the FOMC will raise the FFR in September does not mean that VBTLX and the Total US Bond Index funds will drop in NAV. That's because everybody already knows that the FOMC will raise the FFR in September. Nobody in their right mind would buy VBTLX / BND / AGG / SPAB etc without already factoring in the expected rate increase.

Here is a chart of the recent performance of VBTLX through yesterday:


Yes, VBLTX is up 1.98% since May 17, 2018. And that included a FOMC FFR hike in June. It was certainly time to go longer in bonds on May 17, 2018 and some bogleheads.org posters did so as noted in their posts around that time.

My point is that one cannot predict what VBTLX will do, but that one can see what VBTLX did. So here's my advice:

1. If AGG or BND or SPAB drop by at least 0.4% on any day in the near future, then buy VBTLX that day. It would indicate it is time to go to intermediate-term bonds. See also . viewtopic.php?p=3928505#p3928505

2. If AGG or BND or SPAB pop by at least 0.4% on any day in the near futre, then sell VBTLX that day. It would indicate it is time to go to shorter-term bonds. See also viewtopic.php?p=3944045#p3944045 and viewtopic.php?p=3948556#p3948556

Generally, in order to do either 1 or 2, one should own some intermediate-term bonds and also some shorter-term bonds.

Also note, there are no predictions being made that AGG or BND or SPAB will go up or down by 0.4% or not in a single day or hour. Maybe they won't change hardly at all. In that case then the prudent thing to do would be to do nothing.

[livesoft]

Portfolio Visualizer is a great tool !! Thanks for sharing it on the forum.

Portfolio Visualizer would completely miss the 2% rise in May 2018 that I showed in the chart for VBTLX. Portfolio Visualizer is a tool with limitations.

[Kevin8696]

Portfolio Visualizer is a great tool !! Thanks for sharing it on the forum.

Portfolio Visualizer would completely miss the 2% rise in May 2018 that I showed in the chart for VBTLX. Portfolio Visualizer is a tool with limitations.

You are indeed correct that Portfolio Visualizer is not a good tool for day-trading mutual funds.

[InvestingGeek]

This basically comes down to whether you want to get into the game of 'timing the market'.

When you buy a bond fund, you're basically signing up for the prevailing SEC yield for the 'duration' of the bond fund. I think of it like buying an individual bond with a coupon equal to the SEC yield and maturity equal to the duration. So when you put in your $1000 a few years ago at 1% yield, that's the return you signed up to get for those $1000 at the end of 6 years (assuming that's the duration of the fund). So if interest rates go up in the meantime, the price and yield will adjust to give you that return at the end of 6 years. Then those proceeds will be nominally rolled over into new bonds that will return the prevailing coupon for the next 6 years.

You say rates are going to keep going up, but what if they go down next year. Then bond fund prices would rise and so would your principal (with yield going down to compensate of course). The money market fund holders would have a choice of lower interest on their existing fund or jumping to a higher priced bond fund with a higher yield (carryover from the higher interest rates from this year) thus ending up with a lower return, while the folks who stayed the course would end up with a higher return (from the purchases the fund made this year as a result of maturing older bonds and lower prices).

CDs seem safer but really you're giving up potentially higher yields that the flexibility of bond funds gives you in return for seemingly safe principal.

The conclusion is the same as the stock question. Get an AA you're comfortable with and act accordingly without regards to the market.

[JBTX]

With the Fed's continuing program of raising short-term rates, the spread between the 2-yr and 10-yr Treasuries has narrowed to just 0.20% compared to a historic spread of about 2.0%. This flat yield curve has analysts saying that investors in intermediate term bond funds (such as Vanguard Total Bond Market Index Fund, VBTLX) are not being adequately compensated for the interest rate risk associated with the 6+ year duration of these funds.

We know that as interest rates go up, bond prices go down. The rule of thumb I have read is: Duration minus SEC yield approximates the impact of a 1% increase in rates. Using this method for VBTLX, portfolio duration of 6.1 years minus the current SEC yield of 3.13% indicates a price drop of approximately 3.0% for a 1% increase in rates. At current interest rate levels, this hit to principal would not be fun.

As a retiree with 50% of my portfolio in fixed income, I'm not enthused about taking capital losses on the bond side of the portfolio. I recognize that newer, higher yielding bonds that will be added to the portfolio will eventually offset the hit to total return coming from the capital losses. In the meantime I'm seeing losses, and I don't have a 30-yr time horizon. Would I be better off in Vanguard Prime Money Market Fund (VMMXX) at this point in time, until intermediate term rates settle out ?

Year-to-date results for VBTLX show total return of -1.00%. With a distribution yield of 2.77%, the fund has been taking capital losses over the last two quarters. During the same period, VMMXX return has been 1.19% and shows a 7-day yield of 2.08%. With rates still being very low on an historic basis, is it worth rolling the dice and riding it out the storm with an intermediate term bond fund, or just go with the safety of principal and the increasing returns of the money market fund ?

Would appreciate thoughts on this matter. Thanks !!

1. If interest rates go up 2%, which would put them higher than they have been in a long time, and from my perspective unlikely but not impossible, then that is 6% price decrease. Add in your 5% interest and you are down 1% over a year. If this has you up at night then you really need to contemplate your tolerance for risk.

2. If anything a flattening yield curve signals an economic slowdown, which typically is bad for stocks and good for long term bonds. If you bail on bonds now for short term instruments you may be abandoning them when they are the most valuable as bonds tend to be negatively correlated with stocks during economic slowdowns.

If VBTLX has a duration of 6 years and the applicable interest rate would go up 2%, then the price of VBTLX would be expected to go down by 12%. Is that correct? And you would only receive the higher interest rate on the proportion of bonds that were bought since the rates increased; the fund is still dragging a bunch of old bonds at lower interest rates. Do I understand that correctly?

yes, you are correct. I should have gone back and checked the original post - I just took the 3% drop at face value, and I was just flat out wrong on the second part.

[JBTX]

1. If interest rates go up 2%, which would put them higher than they have been in a long time, and from my perspective unlikely but not impossible, then that is 6% price decrease. Add in your 5% interest and you are down 1% over a year. If this has you up at night then you really need to contemplate your tolerance for risk.

JBTX.... Are you saying that all the bonds in the fund's portfolio will start paying a 5% coupon rate of interest in a year ?

That's what I said, but I got myself confused and wasn't correct.

Edited:

1. If interest rates go up 2%, which would put them higher than they have been in a long time, and from my perspective unlikely but not impossible, then that is 6% 12% price decrease. Add in your 5% 3% interest and you are down 1% 9% over a year. If this has you up at night then you really need to contemplate your tolerance for risk.

Sorry for the mix up. I better understand your concern.

Having said all that, while it is purely speculation, I don't expect long term rates to go up another 2%. I tend to think the macroeconomic factors that have been holding rates down worldwide will probably continue to be at play. The fact that the yield curve is flat signals that the fixed income investors are expecting lower future growth and maybe an economic downturn.

I will say one thing I have been horrible at is forecasting interest rates over the decades, so take it for what it is worth.

[Kevin8696]

1. If interest rates go up 2%, which would put them higher than they have been in a long time, and from my perspective unlikely but not impossible, then that is 6% price decrease. Add in your 5% interest and you are down 1% over a year. If this has you up at night then you really need to contemplate your tolerance for risk.

JBTX.... Are you saying that all the bonds in the fund's portfolio will start paying a 5% coupon rate of interest in a year ?

That's what I said, but I got myself confused and wasn't correct.

Edited:

1. If interest rates go up 2%, which would put them higher than they have been in a long time, and from my perspective unlikely but not impossible, then that is 6% 12% price decrease. Add in your 5% 3% interest and you are down 1% 9% over a year. If this has you up at night then you really need to contemplate your tolerance for risk.

Sorry for the mix up. I better understand your concern.

Having said all that, while it is purely speculation, I don't expect long term rates to go up another 2%. I tend to think the macroeconomic factors that have been holding rates down worldwide will probably continue to be at play. The fact that the yield curve is flat signals that the fixed income investors are expecting lower future growth and maybe an economic downturn.

I will say one thing I have been horrible at is forecasting interest rates over the decades, so take it for what it is worth.

Thanks for posting the revision. Looks to me like the yield curve is flat because the Fed has pushed up the short end with increases to the Fed Funds Rate, while the intermediate term bond market has not followed suit. In fact, the 10-yr rate has been down a bit recently. I think the 10-yr bond could go up 1% over the next year or so, and I'd just as soon not be along for that ride. Not losing sleep over it, but would prefer not to ride a bond roller coaster (again) like we did in 2013-2014.

[venkman]

With the Fed's continuing program of raising short-term rates, the spread between the 2-yr and 10-yr Treasuries has narrowed to just 0.20% compared to a historic spread of about 2.0%. This flat yield curve has analysts saying that investors in intermediate term bond funds (such as Vanguard Total Bond Market Index Fund, VBTLX) are not being adequately compensated for the interest rate risk associated with the 6+ year duration of these funds.

If investors in intermediate bond funds aren't being adequately compensated for the duration risk, doesn't that make you wonder WHY so many investors are staying with intermediate bonds, and not moving to short-term?

[jclear]

Instead of moving some of your bonds to cash, consider moving some of your equities to REITs.
If you want to make a bond move though, consider short TIPS instead of cash.
What is your equity/bond split? 50/50. Then probably the bond move, but make sure as well that REITs aren’t totally absent from your equities.

[glock19]

With the Fed's continuing program of raising short-term rates, the spread between the 2-yr and 10-yr Treasuries has narrowed to just 0.20% compared to a historic spread of about 2.0%. This flat yield curve has analysts saying that investors in intermediate term bond funds (such as Vanguard Total Bond Market Index Fund, VBTLX) are not being adequately compensated for the interest rate risk associated with the 6+ year duration of these funds.

If investors in intermediate bond funds aren't being adequately compensated for the duration risk, doesn't that make you wonder WHY so many investors are staying with intermediate bonds, and not moving to short-term?

I would not criticize anyone for staying with intermediate term bonds, but could it be that the vast majority of bond fund holders don't have a clue as to how rising rates and duration affect the NAV/total return of the fund? Many may not even understand the yield curve (flattening, inversion, etc).

Personally, I can't see not being currently compensated for longer term risk.

I use individual treasuries in a ladder. With maturing bonds each year, if I see the curve approaching a more "normal" pattern, I'll have funds to increase duration.

[stan1]

July 2016 would have been an excellent time to deploy the go shorter strategy.

Right, I was a little later that that but not too much so.

So that brings the question: what is the signal to go back to intermediate term?

Just to note I do make a half hearted attempt to market time fixed income yields myself.