Is there any reason to buy a short term bond index versus long term one?

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schrute
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Is there any reason to buy a short term bond index versus long term one?

Post by schrute » Sat Mar 23, 2019 7:55 pm

I've seen short term, intermediate, and long term bond indexes. Long always has higher yield. Is there any reason why? If I can buy into the index, does it matter? It doesn't seem like a money market or CD where you're penalized if you leave early.

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by Wiggums » Sat Mar 23, 2019 7:59 pm

Certain factors can affect a bond's duration, including: Time to maturity. The longer the maturity, the higher the duration, and the greater the interest rate risk. A bond that matures faster – say, in one year – would repay its true cost faster than a bond that matures in 10 years.

Duration is a measure of a bond's sensitivity to interest rate changes. The higher the bond's duration, the greater its sensitivity to changes in interest rates (also known as volatility) and vice versa.

When one buys a 5 year CD, one locks in a certain return. Say 1.5% over 5 years. If rates on 5 year CD's go up to 2%, no one would buy a 1.5% 5 year CD at face value. The value of your CD has just fallen, but it does not show up on the statement you get from the bank. People feel good seeing their $10,000 CD is still worth $10,000 (even though it is not).

Bonds (and bond funds) are liquid. Therefore they get marked to market and you can see the fall in value, because (unlike CD's) there is a secondary market for same. People freak out because their $10,000 in a bond fund is now worth $9,600.

If you hold a bond fund for its duration, or a bond to maturity, you will get your principal back plus the interest you signed up for. If you hold the bond fund for its duration, you will be more or less indifferent to interest rate changes that occurred during the holding period.

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by bhsince87 » Sat Mar 23, 2019 9:01 pm

schrute wrote:
Sat Mar 23, 2019 7:55 pm
I've seen short term, intermediate, and long term bond indexes. Long always has higher yield. Is there any reason why? If I can buy into the index, does it matter? It doesn't seem like a money market or CD where you're penalized if you leave early.
If interest rates rise before you withdrawal, the longer term funds will drop in value more than the shorter term funds.

In that case, you will absolutely pay a penalty with the long term funds.

If interest rates stay the same until the time you withdrawal, or drop, then you will be better off with the long term bond funds.
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Re: Is there any reason to buy a short term bond index versus long term one?

Post by nisiprius » Sun Mar 24, 2019 8:47 am

Let me try to give a rough, oversimplified explanation.

The key to understanding bonds is that they are contracts to pay specific numbers of dollars on specific dates. For a quick hand-waving introduction it helps to imagine them as "zero coupon" bonds that just make one payment. (Most) real bonds are not like that so all the actual numbers I'm going to show are wildly unrealistic, they are just to illustrate generalities.

So, you have a contract that says "I will pay you $1,000 ten years from now." It is a negotiable security. You can wait ten years and get paid $1,000, or if you become impatient you can sell the contract it to someone else, before the time is up and let them hold it to maturity (or sell it again!)

What's the value of a $1,000 payment ten years from now? There are three elements. The first it, how much confidence do we have that the contract will be kept? The answer is that for investment-grade bonds we regard this as near-certain. We just accept what the bond rating agency says, for planning and pricing purposes we assume we will get paid. Stock is participation in an uncertain business and the value fluctuates with how the business does year to year. Bonds are bills that have to get paid, just like payroll or electricity; they have to get paid first, before stockholders get anything; and in order to get paid, you don't need to assume a good business year. All you have to assume is that the company is able to stay in business, even if just barely. So, for investment-grade bonds we're talking about, the business success isn't a factor. (For junk bonds it is, which is why junk bonds behave somewhat like stocks).

Second, inflation. This doesn't come in directly, but it comes in for planning purposes and it also comes in because prevailing interest rates are influenced by inflation.

Third, and this is the tricky part, the "time value of money." You wouldn't pay $1,000 for a bond that pays $1,000 ten years from now. Why would you do that, when you can use that $1,000 to make money over the next ten years, by putting it in a savings account that pays interest for example?

So, it's worth less than $1,000. But, how much less? You have to discount that $1,000 by the amount you could have earned in some other investment. If bank accounts are paying 2% per year, then, doing some math, you could put $820 in a bank account and it would grow to $1,000 in ten years. Since you could get the same $1,000-in-ten-years two different ways, it makes sense they would be "worth" the same amount, namely $820.

Here's the problem. Interest rates fluctuate. Let's say bank accounts pay 2% per year now, but very suddenly they start paying 3% per year. Now it only takes $744 in the bank to grow to $1,000, so the value of $1,000-in-ten-years has dropped from $820 to $744.

In real life, interest rates are market-based and need to be based on guesses on what is going to happen in the future over varying lengths of time. Well, there's more uncertainty over longer periods of time.

Therefore, the value of "$1,000-in-ten-years" is going to fluctuate more than the value of $1,000-in-a year, and less than the value of $1,000-in-thirty years.

Finally, notice that a payment of $1,000-in-ten-years is always worth exactly $1,000 on the day that it is made. So, if you are holding a single bond, as it approaches maturity, it's value must get closer and closer to $1,000 and the size of the fluctuations must decrease.

Measured in dollars, ignoring inflation, and assuming the bond will pay, the risk of a single bond is highest when you buy it; is higher for longer-term bonds; and goes away completely if you hold it to maturity. If it's a five-year bond, hold it for five years and there's no risk. If it's a thirty-year bond, you have to hold it for thirty years.

The next point is that people want to be paid for taking risk. There's no reason why they should make a risky investment if they can get the same return from a riskless investment. Since longer-term bonds are riskier before maturity, we would expect investors to demand a higher return. Unfortunately, there doesn't seem to be any economic theory on how much people want to be compensated for risk, but it's not zero. So usually longer-term bonds pay more, which is why it's such a big deal when, occasionally, they don't.

A bond fund is a collection of many bonds, maturing at different times, usually with the average maturity staying about the same. Since they do not mature at the same time, you don't have the nice clear "dollar-value risk goes away with maturity," but you have a statistical measure called the "duration." The risk is small for a bond fund that is held for about the same period of time as its duration.

Therefore, since longer-term bond funds are riskier, but usually have higher return, the rational thing to do is usually to choose a bond fund whose duration roughly matches your expected holding period.

At any given time you will find some people saying "No, shorten up to dodge a bullet from rising interest rates which are sure to be here soon." You will also find others saying "No, use longer-term bonds because the risk isn't what it looks like if you are holding them at the same time as stocks, because I have faith in the way I expect price movements of bonds and stocks to move in relationship to each other."

The last thing I want to show you is just how well the risk/reward relationship has actually held up, in practice, in the real world, using, as illustrations, the Vanguard short-term, intermediate-term, and long-term Treasury funds. I'm using these funds rather than index funds just because they are older, so we get a longer period of time to look at.

The longer-term fund has much more fluctuation and much more return than the short term fund. Only you can make the risk/reward decision, but as I say it at least makes sense to roughly match the duration with your expected holding period. In other words, I personally think it is overkill to use a short-term fund with a two- or three-year duration for retirement savings you plan to hold for more than ten years. (And I'm quite risk-averse myself).

https://quotes.morningstar.com/chart/fu ... %7D]Source

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by HEDGEFUNDIE » Sun Mar 24, 2019 8:54 am

nisiprius wrote:
Sun Mar 24, 2019 8:47 am
Therefore, since longer-term bond funds are riskier, but usually have higher return, the rational thing to do is usually to choose a bond fund whose duration roughly matches your expected holding period.
"No, use longer-term bonds because the risk isn't what it looks like if you are holding them at the same time as stocks, because I have faith in the way I expect price movements of bonds and stocks to move in relationship to each other."
These two statements are not at odds with each other. You can hold LTTs for their duration and their correlation to stocks. It’s actually the STT and ITT holders who are deviating from the “duration matching the holding period” principle.

But I am surprised to see you recommend duration = holding period. Are you jumping on board the LTT train, Nisi?

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by B4Xt3r » Sun Mar 24, 2019 9:11 am

nisiprius wrote:
Sun Mar 24, 2019 8:47 am
Let me try to give a rough, oversimplified explanation.
...
Dude, what a reply. :sharebeer

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by Rob1 » Sun Mar 24, 2019 9:22 am

I view it as part of diversifying a portfolio.

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by retiredjg » Sun Mar 24, 2019 9:31 am

schrute wrote:
Sat Mar 23, 2019 7:55 pm
I've seen short term, intermediate, and long term bond indexes. Long always has higher yield. Is there any reason why? If I can buy into the index, does it matter? It doesn't seem like a money market or CD where you're penalized if you leave early.
For general investing purposes, intermediate term bond funds are the most frequently recommended choice.

Short term funds are the least risky and pay the least and are best used for short term purposes. Long term funds do pay more but they are the riskiest of the 3 and may not provide the safety you want during financial bad times.

Some funds, for example a total bond market index, will contain all 3 terms of bonds (good diversification) and "average out" to something in the intermediate term range. That's one reason total bond index is so popular here.

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by nisiprius » Sun Mar 24, 2019 9:40 am

HEDGEFUNDIE wrote:
Sun Mar 24, 2019 8:54 am
nisiprius wrote:
Sun Mar 24, 2019 8:47 am
Therefore, since longer-term bond funds are riskier, but usually have higher return, the rational thing to do is usually to choose a bond fund whose duration roughly matches your expected holding period.
"No, use longer-term bonds because the risk isn't what it looks like if you are holding them at the same time as stocks, because I have faith in the way I expect price movements of bonds and stocks to move in relationship to each other."
These two statements are not at odds with each other. You can hold LTTs for their duration and their correlation to stocks. It’s actually the STT and ITT holders who are deviating from the “duration matching the holding period” principle.

But I am surprised to see you recommend duration = holding period. Are you jumping on board the LTT train, Nisi?
No, I spoke too quickly and too carelessly. Unconsciously influenced by you, possibly. I was leaving out inflation risk. Having lived through the late 1970s and early 1980s, the idea of locking myself into a fixed number of dollars for more than ten years is a non-starter for me. Long-term TIPS for young investors seem reasonable to me.
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Re: Is there any reason to buy a short term bond index versus long term one?

Post by TaxingAccount » Sun Mar 24, 2019 12:23 pm

.....
Last edited by TaxingAccount on Tue Aug 13, 2019 3:05 pm, edited 1 time in total.

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by 50/50 » Sun Mar 24, 2019 4:14 pm

Wiggums wrote:
Sat Mar 23, 2019 7:59 pm
Certain factors can affect a bond's duration, including: Time to maturity. The longer the maturity, the higher the duration, and the greater the interest rate risk. A bond that matures faster – say, in one year – would repay its true cost faster than a bond that matures in 10 years.

Duration is a measure of a bond's sensitivity to interest rate changes. The higher the bond's duration, the greater its sensitivity to changes in interest rates (also known as volatility) and vice versa.

When one buys a 5 year CD, one locks in a certain return. Say 1.5% over 5 years. If rates on 5 year CD's go up to 2%, no one would buy a 1.5% 5 year CD at face value. The value of your CD has just fallen, but it does not show up on the statement you get from the bank. People feel good seeing their $10,000 CD is still worth $10,000 (even though it is not).

Bonds (and bond funds) are liquid. Therefore they get marked to market and you can see the fall in value, because (unlike CD's) there is a secondary market for same. People freak out because their $10,000 in a bond fund is now worth $9,600.

If you hold a bond fund for its duration, or a bond to maturity, you will get your principal back plus the interest you signed up for. If you hold the bond fund for its duration, you will be more or less indifferent to interest rate changes that occurred during the holding period.
TaxingAccount wrote:
Sun Mar 24, 2019 12:23 pm
Wiggums wrote:
Sat Mar 23, 2019 7:59 pm

People feel good seeing their $10,000 CD is still worth $10,000 (even though it is not).
How do you figure? If I have a 5 year CD I know when the CD matures I will have $10,000 I can take to the dollar store and purchase 10,000 tubes of toothpaste. If I have a bond fund instead of a CD, and sell the bond fund in 5 years, I may only have enough to buy 9,500 tubes of toothpaste or less.
Taxing Account; Agree. I have never failed to receive 100% back on a maturing CD.

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by Taylor Larimore » Sun Mar 24, 2019 5:13 pm

schrute wrote:
Sat Mar 23, 2019 7:55 pm
I've seen short term, intermediate, and long term bond indexes. Long always has higher yield. Is there any reason why? If I can buy into the index, does it matter? It doesn't seem like a money market or CD where you're penalized if you leave early.
schrute:

Other things being equal, in bonds the shorter the term--the lower the risk.

Best wishes.
Taylor
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Re: Is there any reason to buy a short term bond index versus long term one?

Post by pezblanco » Sun Mar 24, 2019 8:36 pm

Wiggums wrote:
Sat Mar 23, 2019 7:59 pm

If you hold a bond fund for its duration, or a bond to maturity, you will get your principal back plus the interest you signed up for. If you hold the bond fund for its duration, you will be more or less indifferent to interest rate changes that occurred during the holding period.
This is false ... If interest rates go up right at the end of your holding period, you will lose money.

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by HEDGEFUNDIE » Sun Mar 24, 2019 8:43 pm

pezblanco wrote:
Sun Mar 24, 2019 8:36 pm
Wiggums wrote:
Sat Mar 23, 2019 7:59 pm

If you hold a bond fund for its duration, or a bond to maturity, you will get your principal back plus the interest you signed up for. If you hold the bond fund for its duration, you will be more or less indifferent to interest rate changes that occurred during the holding period.
This is false ... If interest rates go up right at the end of your holding period, you will lose money.
Of course if you hit a bad sequence of returns you will suffer. That is true of any investment.

The question is what is the expected value of the bond fund at the time of purchase. Duration=holding period will always yield the highest expected value, because the markets have priced in rate risk all along the yield curve.

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by Dialectical Investor » Sun Mar 24, 2019 9:01 pm

HEDGEFUNDIE wrote:
Sun Mar 24, 2019 8:43 pm

The question is what is the expected value of the bond fund at the time of purchase. Duration=holding period will always yield the highest expected value, because the markets have priced in rate risk all along the yield curve.
It seems difficult to recommend an investment on this basis. I don't see a lot of advice telling people to hold zero-coupon treasuries. Liability-matching bond portfolios are disparaged with claims against the idea of knowing what future liabilities will be. Then there's rebalancing issues, if one chooses to go that way.

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by Dialectical Investor » Sun Mar 24, 2019 9:07 pm

nisiprius wrote:
Sun Mar 24, 2019 9:40 am

Long-term TIPS for young investors seem reasonable to me.
They do, don't they? Yet, would you go so far as to recommend it, this slice of the bond world that consists of but a few shillings compared to the uncontroversial intermediate agg?

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by vineviz » Sun Mar 24, 2019 9:31 pm

nisiprius wrote:
Sun Mar 24, 2019 9:40 am
Long-term TIPS for young investors seem reasonable to me.
Young investors who are unemployable and don't own any stocks, maybe.
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Re: Is there any reason to buy a short term bond index versus long term one?

Post by pezblanco » Sun Mar 24, 2019 9:33 pm

HEDGEFUNDIE wrote:
Sun Mar 24, 2019 8:43 pm
pezblanco wrote:
Sun Mar 24, 2019 8:36 pm
Wiggums wrote:
Sat Mar 23, 2019 7:59 pm

If you hold a bond fund for its duration, or a bond to maturity, you will get your principal back plus the interest you signed up for. If you hold the bond fund for its duration, you will be more or less indifferent to interest rate changes that occurred during the holding period.
This is false ... If interest rates go up right at the end of your holding period, you will lose money.
Of course if you hit a bad sequence of returns you will suffer. That is true of any investment.

I don't believe this is true either.

The question is what is the expected value of the bond fund at the time of purchase.

This is certainly an important question but it is also certainly not the overriding question when choosing fixed income investments.


Duration=holding period will always yield the highest expected value, because the markets have priced in rate risk all along the yield curve.

This is not correct. Duration risk will usually go monotonically with expected value. The longest duration bonds will have the highest expected value over any holding period


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Re: Is there any reason to buy a short term bond index versus long term one?

Post by HoosierJim » Sun Mar 24, 2019 9:52 pm

Great post by nisiprius (as usual)

But it reminds me of my recent investigations into bonds and decided to look at german bonds for fun and was shocked that the 10 year is NEGATIVE.
nisiprius wrote:
Sun Mar 24, 2019 8:47 am
... You wouldn't pay $1,000 for a bond that pays $1,000 ten years from now. Why would you do that, when you can use that $1,000 to make money over the next ten years, by putting it in a savings account that pays interest for example?
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Re: Is there any reason to buy a short term bond index versus long term one?

Post by fennewaldaj » Sun Mar 24, 2019 9:57 pm

vineviz wrote:
Sun Mar 24, 2019 9:31 pm
nisiprius wrote:
Sun Mar 24, 2019 9:40 am
Long-term TIPS for young investors seem reasonable to me.
Young investors who are unemployable and don't own any stocks, maybe.
Would a portfolio that contains both long TIPS and long nominal treasuries make sense? The long treasuries will do there thing if the status quo persist. If high inflation takes hold the TIPs will do their thing. Stocks didn't do all that well in the inflationary 70s so I am not all that confident in them being good during inflation. Or is it just that since they are young stocks will eventually catch up with inflation and they don't really need to worry about poor medium term performance?

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by travelspot » Sun Mar 24, 2019 10:29 pm

nisiprius wrote:
Sun Mar 24, 2019 8:47 am
Let me try to give a rough, oversimplified explanation.

The key to understanding bonds is that they are contracts to pay specific numbers of dollars on specific dates. For a quick hand-waving introduction it helps to imagine them as "zero coupon" bonds that just make one payment. (Most) real bonds are not like that so all the actual numbers I'm going to show are wildly unrealistic, they are just to illustrate generalities.

So, you have a contract that says "I will pay you $1,000 ten years from now." It is a negotiable security. You can wait ten years and get paid $1,000, or if you become impatient you can sell the contract it to someone else, before the time is up and let them hold it to maturity (or sell it again!)

What's the value of a $1,000 payment ten years from now? There are three elements. The first it, how much confidence do we have that the contract will be kept? The answer is that for investment-grade bonds we regard this as near-certain. We just accept what the bond rating agency says, for planning and pricing purposes we assume we will get paid. Stock is participation in an uncertain business and the value fluctuates with how the business does year to year. Bonds are bills that have to get paid, just like payroll or electricity; they have to get paid first, before stockholders get anything; and in order to get paid, you don't need to assume a good business year. All you have to assume is that the company is able to stay in business, even if just barely. So, for investment-grade bonds we're talking about, the business success isn't a factor. (For junk bonds it is, which is why junk bonds behave somewhat like stocks).

Second, inflation. This doesn't come in directly, but it comes in for planning purposes and it also comes in because prevailing interest rates are influenced by inflation.

Third, and this is the tricky part, the "time value of money." You wouldn't pay $1,000 for a bond that pays $1,000 ten years from now. Why would you do that, when you can use that $1,000 to make money over the next ten years, by putting it in a savings account that pays interest for example?

So, it's worth less than $1,000. But, how much less? You have to discount that $1,000 by the amount you could have earned in some other investment. If bank accounts are paying 2% per year, then, doing some math, you could put $820 in a bank account and it would grow to $1,000 in ten years. Since you could get the same $1,000-in-ten-years two different ways, it makes sense they would be "worth" the same amount, namely $820.

Here's the problem. Interest rates fluctuate. Let's say bank accounts pay 2% per year now, but very suddenly they start paying 3% per year. Now it only takes $744 in the bank to grow to $1,000, so the value of $1,000-in-ten-years has dropped from $820 to $744.

In real life, interest rates are market-based and need to be based on guesses on what is going to happen in the future over varying lengths of time. Well, there's more uncertainty over longer periods of time.

Therefore, the value of "$1,000-in-ten-years" is going to fluctuate more than the value of $1,000-in-a year, and less than the value of $1,000-in-thirty years.

Finally, notice that a payment of $1,000-in-ten-years is always worth exactly $1,000 on the day that it is made. So, if you are holding a single bond, as it approaches maturity, it's value must get closer and closer to $1,000 and the size of the fluctuations must decrease.

Measured in dollars, ignoring inflation, and assuming the bond will pay, the risk of a single bond is highest when you buy it; is higher for longer-term bonds; and goes away completely if you hold it to maturity. If it's a five-year bond, hold it for five years and there's no risk. If it's a thirty-year bond, you have to hold it for thirty years.

The next point is that people want to be paid for taking risk. There's no reason why they should make a risky investment if they can get the same return from a riskless investment. Since longer-term bonds are riskier before maturity, we would expect investors to demand a higher return. Unfortunately, there doesn't seem to be any economic theory on how much people want to be compensated for risk, but it's not zero. So usually longer-term bonds pay more, which is why it's such a big deal when, occasionally, they don't.

A bond fund is a collection of many bonds, maturing at different times, usually with the average maturity staying about the same. Since they do not mature at the same time, you don't have the nice clear "dollar-value risk goes away with maturity," but you have a statistical measure called the "duration." The risk is small for a bond fund that is held for about the same period of time as its duration.

Therefore, since longer-term bond funds are riskier, but usually have higher return, the rational thing to do is usually to choose a bond fund whose duration roughly matches your expected holding period.

At any given time you will find some people saying "No, shorten up to dodge a bullet from rising interest rates which are sure to be here soon." You will also find others saying "No, use longer-term bonds because the risk isn't what it looks like if you are holding them at the same time as stocks, because I have faith in the way I expect price movements of bonds and stocks to move in relationship to each other."

The last thing I want to show you is just how well the risk/reward relationship has actually held up, in practice, in the real world, using, as illustrations, the Vanguard short-term, intermediate-term, and long-term Treasury funds. I'm using these funds rather than index funds just because they are older, so we get a longer period of time to look at.

The longer-term fund has much more fluctuation and much more return than the short term fund. Only you can make the risk/reward decision, but as I say it at least makes sense to roughly match the duration with your expected holding period. In other words, I personally think it is overkill to use a short-term fund with a two- or three-year duration for retirement savings you plan to hold for more than ten years. (And I'm quite risk-averse myself).

https://quotes.morningstar.com/chart/fu ... %7D]Source

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Nisiprius thank you for this dissertation on short- vs long-term bonds/funds. Very timely and helpful.
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Re: Is there any reason to buy a short term bond index versus long term one?

Post by middistancerunner » Sun Mar 24, 2019 11:04 pm

nisiprius wrote:
Sun Mar 24, 2019 8:47 am

Therefore, since longer-term bond funds are riskier, but usually have higher return, the rational thing to do is usually to choose a bond fund whose duration roughly matches your expected holding period.
It’s probably a stupid question, but practically speaking, how do you implement this? Suppose I have a cash need in 5 years, like a house down payment. I pick an intermediate-term bond fund that as of the moment I picked it, had a duration that matched my holding period of 5 years. As time wears on, do I need to “rebalance” into a shorter-term fund, perhaps every year into a fund with a one year shorter duration? Or, I can I stick to the initial bond fund choice for the full 5 years and all the math is expected to work out in that case?

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Re: Is there any reason to buy a short term bond index versus long term one?

Post by Dialectical Investor » Sun Mar 24, 2019 11:08 pm

middistancerunner wrote:
Sun Mar 24, 2019 11:04 pm
nisiprius wrote:
Sun Mar 24, 2019 8:47 am

Therefore, since longer-term bond funds are riskier, but usually have higher return, the rational thing to do is usually to choose a bond fund whose duration roughly matches your expected holding period.
It’s probably a stupid question, but practically speaking, how do you implement this? Suppose I have a cash need in 5 years, like a house down payment. I pick an intermediate-term bond fund that as of the moment I picked it, had a duration that matched my holding period of 5 years. As time wears on, do I need to “rebalance” into a shorter-term fund, perhaps every year into a fund with a one year shorter duration? Or, I can I stick to the initial bond fund choice for the full 5 years and all the math is expected to work out in that case?
It's not very practical. Gotta keep it matched, and because it's not a smooth transition (you're exchanging only every so often), no guarantee it will work precisely. A zero-coupon bond is best for a scenario like this, if that's really what one wants to do. There also are bond funds that mature/liquidate in a particular year, but no experience with them.

HoosierJim
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Re: Is there any reason to buy a short term bond index versus long term one?

Post by HoosierJim » Mon Mar 25, 2019 7:00 am

middistancerunner wrote:
Sun Mar 24, 2019 11:04 pm
.... Suppose I have a cash need in 5 years, like a house down payment. I pick an intermediate-term bond fund that as of the moment I picked it, had a duration that matched my holding period of 5 years. As time wears on, do I need to “rebalance” into a shorter-term fund, perhaps every year into a fund with a one year shorter duration? Or, I can I stick to the initial bond fund choice for the full 5 years and all the math is expected to work out in that case?
You could also buy a ladder of cd's 50/50 - and keep renewing the 18 month and finalize with a 6 month to get you to the 5 years.
Qty 1 - 5 year CD
Qty 1 - 18 month cd

However - you will note that due to the current yield curve - there isn't a huge difference.
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vineviz
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Re: Is there any reason to buy a short term bond index versus long term one?

Post by vineviz » Mon Mar 25, 2019 7:23 am

middistancerunner wrote:
Sun Mar 24, 2019 11:04 pm
nisiprius wrote:
Sun Mar 24, 2019 8:47 am

Therefore, since longer-term bond funds are riskier, but usually have higher return, the rational thing to do is usually to choose a bond fund whose duration roughly matches your expected holding period.
It’s probably a stupid question, but practically speaking, how do you implement this? Suppose I have a cash need in 5 years, like a house down payment. I pick an intermediate-term bond fund that as of the moment I picked it, had a duration that matched my holding period of 5 years. As time wears on, do I need to “rebalance” into a shorter-term fund, perhaps every year into a fund with a one year shorter duration? Or, I can I stick to the initial bond fund choice for the full 5 years and all the math is expected to work out in that case?
The ideal solution would be, IMO, to take advantage of one of the target maturity bond bonds specifically targeted for the year you need the cash. E.g. iShares® iBonds® Dec 2024 Term Corporate ETF (IBDP). https://www.ishares.com/us/products/272 ... porate-etf

At most brokerages buying individual Treasury bonds/bills that mature in 2024 (or whenever) is pretty easy too. This just trades lower yield for increased safety. CDs aren't a terrible option either.

At the end of the day, though, there's not need to get it perfect: follow the spirit of the guidance as close as is feasible for your circumstance. For most people (especially beyond the five year horizon) that just means picking a bond fund with approximately the right duration at the start and then adding new money to progressively shorter duration funds as their portfolio grows. Or starting with a mix of long and short funds and then withdrawing from the longer funds as you spend down the portfolio.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

rkhusky
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Re: Is there any reason to buy a short term bond index versus long term one?

Post by rkhusky » Mon Mar 25, 2019 7:32 am

TaxingAccount wrote:
Sun Mar 24, 2019 12:23 pm
Wiggums wrote:
Sat Mar 23, 2019 7:59 pm

People feel good seeing their $10,000 CD is still worth $10,000 (even though it is not).
How do you figure? If I have a 5 year CD I know when the CD matures I will have $10,000 I can take to the dollar store and purchase 10,000 tubes of toothpaste. If I have a bond fund instead of a CD, and sell the bond fund in 5 years, I may only have enough to buy 9,500 tubes of toothpaste or less.
But your $1 tubes of toothpaste may have gone from 12 oz to 11.5 oz in the intervening 5 years.

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vineviz
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Re: Is there any reason to buy a short term bond index versus long term one?

Post by vineviz » Mon Mar 25, 2019 7:40 am

fennewaldaj wrote:
Sun Mar 24, 2019 9:57 pm
vineviz wrote:
Sun Mar 24, 2019 9:31 pm
nisiprius wrote:
Sun Mar 24, 2019 9:40 am
Long-term TIPS for young investors seem reasonable to me.
Young investors who are unemployable and don't own any stocks, maybe.
Would a portfolio that contains both long TIPS and long nominal treasuries make sense? The long treasuries will do there thing if the status quo persist. If high inflation takes hold the TIPs will do their thing. Stocks didn't do all that well in the inflationary 70s so I am not all that confident in them being good during inflation. Or is it just that since they are young stocks will eventually catch up with inflation and they don't really need to worry about poor medium term performance?
My position is mostly based on the last rationale: inflation is a risk for people who need to spend money from their portfolio during a period of time in which they can't compensate somehow.

AFAIK, there has never been a 20 year period in which the real return of a diversified stock portfolio was negative (i.e. more than outpaced inflation). This is what you'd expect, since over a sufficiently long period of time companies in aggregate should be able to adjust to the inflationary environment they are experiencing. So over medium to long investment horizons, my view is that equities don't have much inflation risk.

The US wage data I have doesn't date back quite as far as the stock data, but likewise over 15 to 20 year periods aggregate wage growth has pretty much always matched consumer inflation. Furthermore, younger workers generally experience faster wage growth than the average worker. As a result, we can think of the human capital of young workers as being fairly well matched to inflation.

So my view is that TIPS really start to add value for a portfolio in the 5-10 years before expected retirement (maybe a little earlier for risk-averse investors who don't hold quite as much in equities).

By age 55 or so many Bogleheads are probably starting to figure out with increased certainty when they expect to retireme, are lowering their equity exposure in anticipation of that, and realistically are starting to see sharper declines in the value of their human capital.

THIS is the spot, IMHO, where long-term TIPS (e.g. PIMCO 15+ Year U.S. TIPS Index ETF, LTPZ) start to make sense for the average investor.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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