Bad time to invest in govt bonds?

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l1am
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Bad time to invest in govt bonds?

Post by l1am » Wed Oct 10, 2018 1:58 pm

So I made an investment (my first real bond investment in an attempt to minimize volatility in my taxable) into VWIUX recently. I opted for that over CDs since I realized I can absorb some level of risk.

Now, I've been reading opinions (on other forums), about why people should get out of govt bonds ASAP.

Is there really any truth to this sort of timing? Obviously I'm highly skeptical of any timing related predictions like this. What do you think?

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dwickenh
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Re: Bad time to invest in govt bonds?

Post by dwickenh » Wed Oct 10, 2018 2:06 pm

l1am wrote:
Wed Oct 10, 2018 1:58 pm
So I made an investment (my first real bond investment in an attempt to minimize volatility in my taxable) into VWIUX recently. I opted for that over CDs since I realized I can absorb some level of risk.

Now, I've been reading opinions (on other forums), about why people should get out of govt bonds ASAP.

Is there really any truth to this sort of timing? Obviously I'm highly skeptical of any timing related predictions like this. What do you think?
If you need to access/start spending these funds in less than 5.2 years(duration of the fund) you may get nicked by the rising rates. But if your horizon for this investment is over 5.2 years, the increased interest will make up for any capital loss of principal. I have most of my TIRA in Intermediate bonds and will not access them until 2026. Rates may not continue to climb, who knows. Your tax brkt would determine if you need to be in Fed Muny bonds.
The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” | — Warren Buffett

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Phineas J. Whoopee
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Re: Bad time to invest in govt bonds?

Post by Phineas J. Whoopee » Wed Oct 10, 2018 2:35 pm

What do you expect Vanguard's Intermediate-term Tax-exempt Fund, VWIUX, to do in the context of your portfolio? If it has little realistic chance of doing such a thing then sure, get out of it, but after that what will you plan to put the money into which will do what you expect?
PJW

l1am
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Re: Bad time to invest in govt bonds?

Post by l1am » Wed Oct 10, 2018 2:36 pm

dwickenh wrote:
Wed Oct 10, 2018 2:06 pm
If you need to access/start spending these funds in less than 5.2 years(duration of the fund) you may get nicked by the rising rates. But if your horizon for this investment is over 5.2 years, the increased interest will make up for any capital loss of principal. I have most of my TIRA in Intermediate bonds and will not access them until 2026. Rates may not continue to climb, who knows. Your tax brkt would determine if you need to be in Fed Muny bonds.
I don't quite understand this I guess. So in 5.2 years, as per your example, my principal may be lower but my principal + interest will necessarily be higher than my initial investment?

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Phineas J. Whoopee
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Re: Bad time to invest in govt bonds?

Post by Phineas J. Whoopee » Wed Oct 10, 2018 2:46 pm

l1am wrote:
Wed Oct 10, 2018 2:36 pm
dwickenh wrote:
Wed Oct 10, 2018 2:06 pm
If you need to access/start spending these funds in less than 5.2 years(duration of the fund) you may get nicked by the rising rates. But if your horizon for this investment is over 5.2 years, the increased interest will make up for any capital loss of principal. I have most of my TIRA in Intermediate bonds and will not access them until 2026. Rates may not continue to climb, who knows. Your tax brkt would determine if you need to be in Fed Muny bonds.
I don't quite understand this I guess. So in 5.2 years, as per your example, my principal may be lower but my principal + interest will necessarily be higher than my initial investment?
Hi. There's a simplified idea, which on its own is true, that messes people up when they try to extend it over long periods of time.

There's also an incorrect understanding that one has principal in a bond fund, or for that matter in any investment other than directly-held debt. There is no principal, in the sense somebody owes you a set amount of money on a certain day. There is capital, which is the sum total value of your holdings.

Yes, the oversimplified idea is your original investment and its returns will equal what they would have been after the average duration of the fund. The underlying idea is a one-time change in bond yields, then no changes afterward.

In fact yields change all the time, but even in a bad sequence, after about twice the average duration you'll reach the point of indifference, at which time your total value of the bond fund will be the same as if yields had stayed the same.

Does that help?

PJW

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dwickenh
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Re: Bad time to invest in govt bonds?

Post by dwickenh » Wed Oct 10, 2018 3:41 pm

Phineas J. Whoopee wrote:
Wed Oct 10, 2018 2:46 pm
l1am wrote:
Wed Oct 10, 2018 2:36 pm
dwickenh wrote:
Wed Oct 10, 2018 2:06 pm
If you need to access/start spending these funds in less than 5.2 years(duration of the fund) you may get nicked by the rising rates. But if your horizon for this investment is over 5.2 years, the increased interest will make up for any capital loss of principal. I have most of my TIRA in Intermediate bonds and will not access them until 2026. Rates may not continue to climb, who knows. Your tax brkt would determine if you need to be in Fed Muny bonds.
I don't quite understand this I guess. So in 5.2 years, as per your example, my principal may be lower but my principal + interest will necessarily be higher than my initial investment?
Hi. There's a simplified idea, which on its own is true, that messes people up when they try to extend it over long periods of time.

There's also an incorrect understanding that one has principal in a bond fund, or for that matter in any investment other than directly-held debt. There is no principal, in the sense somebody owes you a set amount of money on a certain day. There is capital, which is the sum total value of your holdings.

Yes, the oversimplified idea is your original investment and its returns will equal what they would have been after the average duration of the fund. The underlying idea is a one-time change in bond yields, then no changes afterward.

In fact yields change all the time, but even in a bad sequence, after about twice the average duration you'll reach the point of indifference, at which time your total value of the bond fund will be the same as if yields had stayed the same.

Does that help?

PJW
Well now we have 2 people confused instead of one! :confused
The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” | — Warren Buffett

l1am
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Re: Bad time to invest in govt bonds?

Post by l1am » Wed Oct 17, 2018 4:22 pm

What do you guys think about this?

https://seekingalpha.com/article/421049 ... nvironment
The Federal Reserve is in the midst of a rate hiking program that is expected to continue for the next year or two.

BND has been a steady loser over the past year due to these rate hikes and will likely continue to lose value for another year or two.

RCL
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Re: Bad time to invest in govt bonds?

Post by RCL » Wed Oct 17, 2018 5:08 pm

l1am wrote:
Wed Oct 17, 2018 4:22 pm
What do you guys think about this?

https://seekingalpha.com/article/421049 ... nvironment
The Federal Reserve is in the midst of a rate hiking program that is expected to continue for the next year or two.

BND has been a steady loser over the past year due to these rate hikes and will likely continue to lose value for another year or two.
I think that the "past year" in your quote is nowhere near what the duration of BND is, therefore, it is an irrelevant statement/observation
It Is Best To Consult Others Before Taking Unusual Actions

l1am
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Re: Bad time to invest in govt bonds?

Post by l1am » Wed Oct 17, 2018 6:14 pm

RCL wrote:
Wed Oct 17, 2018 5:08 pm
I think that the "past year" in your quote is nowhere near what the duration of BND is, therefore, it is an irrelevant statement/observation
I think I'm understanding this better now. Basically, interest rate hikes can negatively impact the bond value but the higher interest paid makes up for it over the duration of the bond (to maturity)?

RCL
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Re: Bad time to invest in govt bonds?

Post by RCL » Wed Oct 17, 2018 6:26 pm

Here is an on-going discussion going on right now about returns and duration.
viewtopic.php?f=1&t=261563#p4168549
It Is Best To Consult Others Before Taking Unusual Actions

OakPhilliesFan
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Re: Bad time to invest in govt bonds?

Post by OakPhilliesFan » Wed Oct 17, 2018 11:08 pm

l1am wrote:
Wed Oct 17, 2018 6:14 pm
I think I'm understanding this better now. Basically, interest rate hikes can negatively impact the bond value but the higher interest paid makes up for it over the duration of the bond (to maturity)?
It's a bond fund, so there are many bonds, not just one. At the moment that rates go up, the NAV (share price) of the fund will go down, since the fund now holds bonds paying less than the going rate, which makes them less valuable. However, as the bonds that the fund holds mature and new bonds are purchased, the fund will return more interest than before the rate hike (since some of the bonds were purchased after), and the fund's holdings will gradually catch up to the new rate. The amount of time it takes to catch up is approximately equal to the average duration of bonds in the fund. So if you plan to hold the fund longer than the average duration, it won't matter.

This assumes a single rate hike. It gets more complicated when considering sequences of rate changes over time. PJW claims above that even in the worst case, it will even out after twice the average duration has passed.

S_Track
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Re: Bad time to invest in govt bonds?

Post by S_Track » Thu Oct 18, 2018 4:56 am

OakPhilliesFan wrote:
Wed Oct 17, 2018 11:08 pm
l1am wrote:
Wed Oct 17, 2018 6:14 pm
I think I'm understanding this better now. Basically, interest rate hikes can negatively impact the bond value but the higher interest paid makes up for it over the duration of the bond (to maturity)?
It's a bond fund, so there are many bonds, not just one. At the moment that rates go up, the NAV (share price) of the fund will go down, since the fund now holds bonds paying less than the going rate, which makes them less valuable. However, as the bonds that the fund holds mature and new bonds are purchased, the fund will return more interest than before the rate hike (since some of the bonds were purchased after), and the fund's holdings will gradually catch up to the new rate. The amount of time it takes to catch up is approximately equal to the average duration of bonds in the fund. So if you plan to hold the fund longer than the average duration, it won't matter.
Great explanantion, I can understand the fund changing duration as it purchases new bonds to cover those that have matured. But what if the funds gets a flood of new investors, the fund would need to purchanse new bonds as well at the current rate. Assuming rising interest would't that also change the average duration of the fund? thanks

OakPhilliesFan
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Re: Bad time to invest in govt bonds?

Post by OakPhilliesFan » Thu Oct 18, 2018 1:05 pm

S_Track wrote:
Thu Oct 18, 2018 4:56 am
Great explanantion, I can understand the fund changing duration as it purchases new bonds to cover those that have matured. But what if the funds gets a flood of new investors, the fund would need to purchanse new bonds as well at the current rate. Assuming rising interest would't that also change the average duration of the fund? thanks
No, the duration does not change -- each bond fund has an objective, which includes what duration bonds to purchase, and in what proportions. In the case of Vanguard Total Bond Market, the average duration is currently 6.2 years, but it holds a wide range of durations (1-30 years). An intermediate bond fund would have a similar average duration, but a much smaller range of durations among its bonds. Whatever new bonds are purchased, they will fit in with the fund's objective, but they will be at whatever interest rate the market offers at the time of purchase. That will affect the interest returned by the fund, as well as its NAV.

You are correct that inflows would cause the fund to purchase new bonds and outflows would cause it to redeem bonds. I am not sure what impact that generally has on bond funds during dramatic market events. If the stock market crashes and there is a flight to bonds, and current interest rates are lower than most bonds already in the fund, I can see that noticeably lowering the NAV. It might be useful to view the price history of different bond funds during particular past events to see how they were impacted.

J295
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Re: Bad time to invest in govt bonds?

Post by J295 » Thu Oct 18, 2018 1:09 pm

Definitely listen to the anonymous people posting their future projections on the Internet, as well as the so-called experts, because for sure they know what happen with bonds and interest rates in the future. Let me know their predictions for equities as well, along with who will win the Super Bowl this year. :happy

On a more serious note, your question is completely legitimate… My answer is to do the hard work of developing an investment policy statement and then follow it, and not engage in market timing with any asset classes.

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Re: Bad time to invest in govt bonds?

Post by patrick » Thu Oct 18, 2018 1:58 pm

l1am wrote:
Wed Oct 17, 2018 4:22 pm
What do you guys think about this?

https://seekingalpha.com/article/421049 ... nvironment
The Federal Reserve is in the midst of a rate hiking program that is expected to continue for the next year or two.

BND has been a steady loser over the past year due to these rate hikes and will likely continue to lose value for another year or two.
If the rate hikes are already "expected" they should already be factored in to current bond prices.

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patrick013
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Re: Bad time to invest in govt bonds?

Post by patrick013 » Thu Oct 18, 2018 9:44 pm

Highest expectation is the FFR at 3.5% which would put the Prime
rate guideline at 6.5%. So govt and corp bonds could get rates
at some spread to the FFR.

Interest rates are still low and investors are expecting their rise.
Interest rates can be a concern to investors because as rates rise,
the NAV of existing bonds declines. Individual bondholders and bond
fund shareholders can lessen the effect of rising interest rates by
reducing the maturities of the bonds. That would be especially
effective if the portfolio contained a large AA of long-term bonds.
Another strategy in this case would be bond or CD laddering. As
each bond in the ladder matures, reinvesting the proceeds at higher
yields as the market rates rise should put the portfolio at a higher
yield at a sooner date and with no gain or loss.

Plus the new bonds purchased are at the new market rate not at an old
rate subject to the duration time period for their original YTM.
age in bonds, buy-and-hold, 10 year business cycle

l1am
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Re: Bad time to invest in govt bonds?

Post by l1am » Fri Oct 19, 2018 2:09 pm

patrick013 wrote:
Thu Oct 18, 2018 9:44 pm
Highest expectation is the FFR at 3.5% which would put the Prime
rate guideline at 6.5%. So govt and corp bonds could get rates
at some spread to the FFR.

Interest rates are still low and investors are expecting their rise.
Interest rates can be a concern to investors because as rates rise,
the NAV of existing bonds declines. Individual bondholders and bond
fund shareholders can lessen the effect of rising interest rates by
reducing the maturities of the bonds. That would be especially
effective if the portfolio contained a large AA of long-term bonds.
Another strategy in this case would be bond or CD laddering. As
each bond in the ladder matures, reinvesting the proceeds at higher
yields as the market rates rise should put the portfolio at a higher
yield at a sooner date and with no gain or loss.

Plus the new bonds purchased are at the new market rate not at an old
rate subject to the duration time period for their original YTM.
Sounds like a strong prediction that interest rates will indeed rise?

That was the point of this thread. It seems like people are highly confident that interest rates will continue to rise (or at least the probability sits in that favor), so I was wondering how my investment strategy change in lieu of that.

Obviously I went ahead and stuck to my original plan and ignored market timing (a VG philosophy). My goal was to reduce volatility in my taxable, and I acheived that by buying the bond fund. In another thread I was deliberating between CDs and the muni bond fund, but the consensus didn't really push either way; it seemed to come down to my own risk aversion and when I needed the money.

z3r0c00l
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Re: Bad time to invest in govt bonds?

Post by z3r0c00l » Fri Oct 19, 2018 2:20 pm

l1am wrote:
Fri Oct 19, 2018 2:09 pm

Sounds like a strong prediction that interest rates will indeed rise?

That was the point of this thread. It seems like people are highly confident that interest rates will continue to rise (or at least the probability sits in that favor), so I was wondering how my investment strategy change in lieu of that.
The issue is, they can't actually predict this. Preemption and trillions of dollars of smart money, along with stochastic economic and political events, prevent anyone from predicting the future of interest rates across the bond market. It seems reasonable to expect interest rates to keep going up, but that could change instantly, with or without obvious reasons. The best we can do is understand how a bond fund behaves in a range of markets, and decide if that behavior works for us. There is really no harm in using CDs instead. The harm is in going back and forth based on some kind of prediction about rates. You are likely to chase performance and miss out.

l1am
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Re: Bad time to invest in govt bonds?

Post by l1am » Fri Oct 19, 2018 2:42 pm

z3r0c00l wrote:
Fri Oct 19, 2018 2:20 pm
The issue is, they can't actually predict this. Preemption and trillions of dollars of smart money, along with stochastic economic and political events, prevent anyone from predicting the future of interest rates across the bond market. It seems reasonable to expect interest rates to keep going up, but that could change instantly, with or without obvious reasons. The best we can do is understand how a bond fund behaves in a range of markets, and decide if that behavior works for us. There is really no harm in using CDs instead. The harm is in going back and forth based on some kind of prediction about rates. You are likely to chase performance and miss out.
The bolded statement implies a higher probability of interest rates continuing to rise though. Like instead of investing in the bond fund now like I did, I could've chosen a CD or "waited it out" in interest savings until rates shifted neutrally or down.

I'm assuming I must be wrong here. Because if an edge did exist in any market (i.e. the bond doesn't currently 'price in' predicted rates) people can exploit the edge.

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Re: Bad time to invest in govt bonds?

Post by z3r0c00l » Fri Oct 19, 2018 3:30 pm

l1am wrote:
Fri Oct 19, 2018 2:42 pm
z3r0c00l wrote:
Fri Oct 19, 2018 2:20 pm
The issue is, they can't actually predict this. Preemption and trillions of dollars of smart money, along with stochastic economic and political events, prevent anyone from predicting the future of interest rates across the bond market. It seems reasonable to expect interest rates to keep going up, but that could change instantly, with or without obvious reasons. The best we can do is understand how a bond fund behaves in a range of markets, and decide if that behavior works for us. There is really no harm in using CDs instead. The harm is in going back and forth based on some kind of prediction about rates. You are likely to chase performance and miss out.
The bolded statement implies a higher probability of interest rates continuing to rise though. Like instead of investing in the bond fund now like I did, I could've chosen a CD or "waited it out" in interest savings until rates shifted neutrally or down.

I'm assuming I must be wrong here. Because if an edge did exist in any market (i.e. the bond doesn't currently 'price in' predicted rates) people can exploit the edge.
I don't want to get into hysterics and hyperbole here : ) But there are literally trillions of dollars in bonds around the globe. Are you really planning to outsmart pension funds, insurance companies, investment banks? There is no interest rate forecast to be made here. If there was, preemption would render that forecast wrong in short order.

Imagine a Ouija board with millions of hands, each with a different strength pushing in various directions, and by the way everyone playing is getting randomly jostled by people behind them, and the board is also constantly tipping from one side to the next because it is perched precariously on a tiny pole. Or check out an animation here: https://www.youtube.com/watch?v=SdAuHSKtpmk

(Skip ahead to 1978 - 1986 if you dont have that much time.)

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patrick013
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Re: Bad time to invest in govt bonds?

Post by patrick013 » Fri Oct 19, 2018 3:53 pm

l1am wrote:
Fri Oct 19, 2018 2:09 pm
patrick013 wrote:
Thu Oct 18, 2018 9:44 pm
Highest expectation is the FFR at 3.5% which would put the Prime
rate guideline at 6.5%. So govt and corp bonds could get rates
at some spread to the FFR.

Interest rates are still low and investors are expecting their rise.
Interest rates can be a concern to investors because as rates rise,
the NAV of existing bonds declines. Individual bondholders and bond
fund shareholders can lessen the effect of rising interest rates by
reducing the maturities of the bonds. That would be especially
effective if the portfolio contained a large AA of long-term bonds.
Another strategy in this case would be bond or CD laddering. As
each bond in the ladder matures, reinvesting the proceeds at higher
yields as the market rates rise should put the portfolio at a higher
yield at a sooner date and with no gain or loss.

Plus the new bonds purchased are at the new market rate not at an old
rate subject to the duration time period for their original YTM.
Sounds like a strong prediction that interest rates will indeed rise?
You'll have to ask the FOMC about that. They would be the ones to refer
to about that. It never ceases to amaze that when info puts interest rates
into a rising trend the newspapers are full of ads selling long term bond
funds or funds with large long term allocations. Absolutely amazing.

So people feel like being their own advisors about that.
age in bonds, buy-and-hold, 10 year business cycle

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