Bonds and Investing

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
KandT
Posts: 101
Joined: Sun Mar 26, 2017 2:32 am

Bonds and Investing

Post by KandT » Wed Jun 05, 2019 9:37 pm

I throw myself at the mercy of the court here!

So far this has turned out well. I realize it could change any minute. I have my 401K's, extra cash (non emergency) and 529's all in the S&P. Kids are 7 and 12.

Quite frankly I just don't understand bond funds. I understand buying a bond from an organization that will pay you back at the prescribed terms. I don't understand how bond funds work. If interest rates go up doesn't the value of the bonds I am holding go down?? I assume there are funds that will hold more long term bonds and ones that will hold more short term bonds???

I have been putting off moving some of my kids 529's into bonds because of simply not understanding that market. I am afraid this is going to bite me in the rear end!

Any advice is appreciated. I would lean toward simple like a Vanguard bond fund but don't know where to start.

User avatar
vineviz
Posts: 4388
Joined: Tue May 15, 2018 1:55 pm

Re: Bonds and Investing

Post by vineviz » Wed Jun 05, 2019 9:58 pm

KandT wrote:
Wed Jun 05, 2019 9:37 pm
I throw myself at the mercy of the court here!

So far this has turned out well. I realize it could change any minute. I have my 401K's, extra cash (non emergency) and 529's all in the S&P. Kids are 7 and 12.

Quite frankly I just don't understand bond funds. I understand buying a bond from an organization that will pay you back at the prescribed terms. I don't understand how bond funds work. If interest rates go up doesn't the value of the bonds I am holding go down?? I assume there are funds that will hold more long term bonds and ones that will hold more short term bonds???

I have been putting off moving some of my kids 529's into bonds because of simply not understanding that market. I am afraid this is going to bite me in the rear end!

Any advice is appreciated. I would lean toward simple like a Vanguard bond fund but don't know where to start.
The best way to learn is to probably buy some bond funds.

A fund like Vanguard Total Bond Market Index Fund (VBTLX) may not be perfect for you but it certainly is "good enough".

A bond fund is just a portfolio of bonds that you own. Yes, as yields increase the price of the bonds goes down. And as yields decrease the price of the bonds goes up. The same thing happens with the dividend yield on your stock funds, by the way.

Bond funds can play two important roles in a portfolio. They can be used to diversify it, because to some degree bonds tend to increase in value when stocks are falling. And they can reduce the risk, because their steady cash flows dampen out the volatility that stocks have.

It wouldn't be at all surprised if the S&P lost 50% of its value sometime over the next 10 years. Not predicting it, necessarily, but statistically speaking it's likely. In that kind of market crash, Vanguard Total Bond Market Index Fund will almost certainly lose less than 5%.

If your oldest child is applying to college and their 529 plan balance is cut in half, would that be a big deal?

What if it only fell by 10% instead, because it was 30% stocks and 70% bonds? Would that be better?
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

User avatar
abuss368
Posts: 13983
Joined: Mon Aug 03, 2009 2:33 pm
Location: Where the water is warm, the drinks are cold, and I don't know the names of the players!

Re: Bonds and Investing

Post by abuss368 » Wed Jun 05, 2019 10:22 pm

With bonds, higher yield almost always means higher risk. Any good short or intermediate term bond fund that is investment grade, low cost, and diversified should provide safety and income to a portfolio.
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

User avatar
Stinky
Posts: 1219
Joined: Mon Jun 12, 2017 11:38 am
Location: Sweet Home Alabama

Re: Bonds and Investing

Post by Stinky » Thu Jun 06, 2019 9:23 am

vineviz wrote:
Wed Jun 05, 2019 9:58 pm

The best way to learn is to probably buy some bond funds.

A fund like Vanguard Total Bond Market Index Fund (VBTLX) may not be perfect for you but it certainly is "good enough".

A bond fund is just a portfolio of bonds that you own. Yes, as yields increase the price of the bonds goes down. And as yields decrease the price of the bonds goes up. The same thing happens with the dividend yield on your stock funds, by the way.

Bond funds can play two important roles in a portfolio. They can be used to diversify it, because to some degree bonds tend to increase in value when stocks are falling. And they can reduce the risk, because their steady cash flows dampen out the volatility that stocks have.

It wouldn't be at all surprised if the S&P lost 50% of its value sometime over the next 10 years. Not predicting it, necessarily, but statistically speaking it's likely. In that kind of market crash, Vanguard Total Bond Market Index Fund will almost certainly lose less than 5%.

If your oldest child is applying to college and their 529 plan balance is cut in half, would that be a big deal?

What if it only fell by 10% instead, because it was 30% stocks and 70% bonds? Would that be better?
This is excellent advice.

For the longest time, I was also 100% invested in the stock market. I thought that I understood bond funds, but didn't want to sacrifice the higher potential returns that stock funds provide over bonds.

But as I came closer to retirement, I moved into bond fund investments. They do provide lower, but less volatile, returns than stock funds. In OP's case, they would be appropriate for at least part of the college savings.

As stated above, investing in VBTLX would be an excellent place to start. Low cost, broadly diversified.
It's a GREAT day to be alive - Travis Tritt

dbr
Posts: 29442
Joined: Sun Mar 04, 2007 9:50 am

Re: Bonds and Investing

Post by dbr » Thu Jun 06, 2019 9:30 am

KandT wrote:
Wed Jun 05, 2019 9:37 pm
I throw myself at the mercy of the court here!

So far this has turned out well. I realize it could change any minute. I have my 401K's, extra cash (non emergency) and 529's all in the S&P. Kids are 7 and 12.

Quite frankly I just don't understand bond funds. I understand buying a bond from an organization that will pay you back at the prescribed terms. I don't understand how bond funds work. If interest rates go up doesn't the value of the bonds I am holding go down?? I assume there are funds that will hold more long term bonds and ones that will hold more short term bonds???

There are several good articles in the Wiki about bonds and a good book by Larry Swedroe, among others. For bond funds see in particular: https://www.bogleheads.org/wiki/Individ ... _bond_fund For understanding duration see: https://www.bogleheads.org/wiki/Bonds:_ ... s#Duration

Don't forget that as the time remaining till you want to use the money gets less the less risk you want to take. That means shifting to more and more shorter and shorter bonds. An alternative is to put money in CDs that come due when you need the money. In fact, generally speaking a purpose such as yours might be best served using CDs and not bonds at all for any fixed income allocation.


I have been putting off moving some of my kids 529's into bonds because of simply not understanding that market. I am afraid this is going to bite me in the rear end!

Any advice is appreciated. I would lean toward simple like a Vanguard bond fund but don't know where to start.

User avatar
ruralavalon
Posts: 15955
Joined: Sat Feb 02, 2008 10:29 am
Location: Illinois

Re: Bonds and Investing

Post by ruralavalon » Thu Jun 06, 2019 9:42 am

abuss368 wrote:
Wed Jun 05, 2019 10:22 pm
With bonds, higher yield almost always means higher risk. Any good short or intermediate term bond fund that is investment grade, low cost, and diversified should provide safety and income to a portfolio.
+ 1.

The most commonly used bond fund here is probably Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX) ER 0.04%.

The fund we use is Vanguard Intermediate-Term Bond Index Fund Admiral Shares (VBILX) ER 0.07℅.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

Topic Author
KandT
Posts: 101
Joined: Sun Mar 26, 2017 2:32 am

Re: Bonds and Investing

Post by KandT » Thu Jun 06, 2019 3:23 pm

ruralavalon wrote:
Thu Jun 06, 2019 9:42 am
abuss368 wrote:
Wed Jun 05, 2019 10:22 pm
With bonds, higher yield almost always means higher risk. Any good short or intermediate term bond fund that is investment grade, low cost, and diversified should provide safety and income to a portfolio.
+ 1.

The most commonly used bond fund here is probably Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX) ER 0.04%.

The fund we use is Vanguard Intermediate-Term Bond Index Fund Admiral Shares (VBILX) ER 0.07℅.
So by name I am assuming that the VBTLX buys short, intermediate and long term bonds. So if interest rates rise, they are locked into the long term but can peel off the shorter term bonds as they come due??

welsie
Posts: 88
Joined: Tue Feb 12, 2019 6:11 pm

Re: Bonds and Investing

Post by welsie » Thu Jun 06, 2019 4:16 pm

KandT wrote:
Wed Jun 05, 2019 9:37 pm
I throw myself at the mercy of the court here!

So far this has turned out well. I realize it could change any minute. I have my 401K's, extra cash (non emergency) and 529's all in the S&P. Kids are 7 and 12.

Quite frankly I just don't understand bond funds. I understand buying a bond from an organization that will pay you back at the prescribed terms. I don't understand how bond funds work. If interest rates go up doesn't the value of the bonds I am holding go down?? I assume there are funds that will hold more long term bonds and ones that will hold more short term bonds???

I have been putting off moving some of my kids 529's into bonds because of simply not understanding that market. I am afraid this is going to bite me in the rear end!

Any advice is appreciated. I would lean toward simple like a Vanguard bond fund but don't know where to start.
If interest rates rise, the price of the asset has to drop so the yield is the same as that in the market. So imagine you have a 3 year bond with a 3% interest rate which cost $100 (thus paying $3 per year). If tomorrow interest rates rose to 6% for a new issue of that 3 year bond (holding all else equal), your bond is now worth $50 (as the $3 per year is 6% of $50). When you own a bond this decrease in value also occurs, because if you sold your bond to a third party they would require the same discount, it just might not "feel" like your bond decreased in value because you still see the same face value on the note.

A bond fund is just a basket of bonds. However suppose you held a bond fund which holds bonds of a term of 3 years or less. Again, if the interest rate doubled, the value of your bonds would be cut in half. However over the next 3 years the 3% bonds would be replaced by 6% bonds, as this occurs the yield from the fund will gradually rise, as will the value of the fund. At the end of the 3 years, after the fund is now entirely composed of 6% bonds your value has returned to where it was on the face (again, holding all else equal).

You can see this with the rising distribution yield with Vanguard's short term bonds: https://investor.vanguard.com/mutual-fu ... ions/vbirx

Note that the yield is going up in early 2018 because the price is being cut, however over time the distribution per share is also rising.

So in reality, the difference between individual bonds and funds is really more or less illusory, I think people just notice the change in price for a publicly traded asset more readily because they hold them in brokerage accounts where they can see their paper losses.

So for example, BSV (Vanguard Short Term Bonds) ranges from 1-5 years: https://investor.vanguard.com/etf/profile/portfolio/bsv

While BIV (Vanguard Intermediate Term Bonds) ranges from 5-10 years: https://investor.vanguard.com/etf/profile/portfolio/biv

Topic Author
KandT
Posts: 101
Joined: Sun Mar 26, 2017 2:32 am

Re: Bonds and Investing

Post by KandT » Thu Jun 06, 2019 9:49 pm

welsie wrote:
Thu Jun 06, 2019 4:16 pm
KandT wrote:
Wed Jun 05, 2019 9:37 pm
I throw myself at the mercy of the court here!

So far this has turned out well. I realize it could change any minute. I have my 401K's, extra cash (non emergency) and 529's all in the S&P. Kids are 7 and 12.

Quite frankly I just don't understand bond funds. I understand buying a bond from an organization that will pay you back at the prescribed terms. I don't understand how bond funds work. If interest rates go up doesn't the value of the bonds I am holding go down?? I assume there are funds that will hold more long term bonds and ones that will hold more short term bonds???

I have been putting off moving some of my kids 529's into bonds because of simply not understanding that market. I am afraid this is going to bite me in the rear end!

Any advice is appreciated. I would lean toward simple like a Vanguard bond fund but don't know where to start.
If interest rates rise, the price of the asset has to drop so the yield is the same as that in the market. So imagine you have a 3 year bond with a 3% interest rate which cost $100 (thus paying $3 per year). If tomorrow interest rates rose to 6% for a new issue of that 3 year bond (holding all else equal), your bond is now worth $50 (as the $3 per year is 6% of $50). When you own a bond this decrease in value also occurs, because if you sold your bond to a third party they would require the same discount, it just might not "feel" like your bond decreased in value because you still see the same face value on the note.

A bond fund is just a basket of bonds. However suppose you held a bond fund which holds bonds of a term of 3 years or less. Again, if the interest rate doubled, the value of your bonds would be cut in half. However over the next 3 years the 3% bonds would be replaced by 6% bonds, as this occurs the yield from the fund will gradually rise, as will the value of the fund. At the end of the 3 years, after the fund is now entirely composed of 6% bonds your value has returned to where it was on the face (again, holding all else equal).

You can see this with the rising distribution yield with Vanguard's short term bonds: https://investor.vanguard.com/mutual-fu ... ions/vbirx

Note that the yield is going up in early 2018 because the price is being cut, however over time the distribution per share is also rising.

So in reality, the difference between individual bonds and funds is really more or less illusory, I think people just notice the change in price for a publicly traded asset more readily because they hold them in brokerage accounts where they can see their paper losses.

So for example, BSV (Vanguard Short Term Bonds) ranges from 1-5 years: https://investor.vanguard.com/etf/profile/portfolio/bsv

While BIV (Vanguard Intermediate Term Bonds) ranges from 5-10 years: https://investor.vanguard.com/etf/profile/portfolio/biv
Thank you for this explanation. So do bond fund managers at Vanguard buy and hold the bond until it matures? Do some bond fund managers try and beat the market by trading on their best estimate on what will happen to interest rates?

Thanks all for your help!!!!

nix4me
Posts: 252
Joined: Sat Oct 13, 2018 9:32 am

Re: Bonds and Investing

Post by nix4me » Thu Jun 06, 2019 10:19 pm

All the books that recommend bonds were written when bonds were good...

User avatar
Dialectical Investor
Posts: 501
Joined: Mon Dec 03, 2018 11:41 pm

Re: Bonds and Investing

Post by Dialectical Investor » Thu Jun 06, 2019 10:20 pm

welsie wrote:
Thu Jun 06, 2019 4:16 pm

If interest rates rise, the price of the asset has to drop so the yield is the same as that in the market. So imagine you have a 3 year bond with a 3% interest rate which cost $100 (thus paying $3 per year). If tomorrow interest rates rose to 6% for a new issue of that 3 year bond (holding all else equal), your bond is now worth $50 (as the $3 per year is 6% of $50). When you own a bond this decrease in value also occurs, because if you sold your bond to a third party they would require the same discount, it just might not "feel" like your bond decreased in value because you still see the same face value on the note.

A bond fund is just a basket of bonds. However suppose you held a bond fund which holds bonds of a term of 3 years or less. Again, if the interest rate doubled, the value of your bonds would be cut in half. However over the next 3 years the 3% bonds would be replaced by 6% bonds, as this occurs the yield from the fund will gradually rise, as will the value of the fund. At the end of the 3 years, after the fund is now entirely composed of 6% bonds your value has returned to where it was on the face (again, holding all else equal).
This pricing behavior is not quite right. Price and yield are inversely related, but they are not proportional. You are focusing on the rate obtained from the coupon, but what matters is the bond's yield to maturity. That yield includes not only the coupon but also any discount or premium to par value, for instance, the $50 discount in your example. A 3-year bond trading at $50 with a 3% coupon has a yield to maturity of approximately 30%, not 6%. The price would fall to around $92, not $50, if the yield-to-maturity on comparable bonds was 6%.
Last edited by Dialectical Investor on Thu Jun 06, 2019 10:43 pm, edited 1 time in total.

User avatar
fortfun
Posts: 2028
Joined: Tue Apr 19, 2016 7:31 pm

Re: Bonds and Investing

Post by fortfun » Thu Jun 06, 2019 10:22 pm

Why not just use one of Vanguard's age based 529s that automatically adjusts. You can pick conservative, moderate, or aggressive. Sounds like aggressive would suit you best.

Beehave
Posts: 513
Joined: Mon Jun 19, 2017 12:46 pm

Re: Bonds and Investing

Post by Beehave » Thu Jun 06, 2019 10:53 pm

OP asks:
"Thank you for this explanation. So do bond fund managers at Vanguard buy and hold the bond until it matures? Do some bond fund managers try and beat the market by trading on their best estimate on what will happen to interest

There's a huge difference between you buying a bond and holding it to maturity, and you buying into a mutual fund and the manager of the fund holding it to maturity. That's because you may (and probably will, today) be buying into a fund and paying more than the par value of the bonds held.
So even if the bonds are held to maturity,you may not be getting the full amount of what you paid (so to speak) back. This is not to say that bonds are a bad investment today. No one knows for sure. So it may be best to diversify "bond" type holdings into some cash (such as money market or CD), some bonds (such as VG Total Bond Fund) and some TIPS (such a VG Short TIPS fund).

For two different perspectives on bonds (although both agree on the benefits of holding some cash), you might check out two of Consuelo Mack's Wealthtrack shows (Kessler under the current circumstances a bond proponent and Grant under current circumstances a skeptic):

https://wealthtrack.com/treasury-bond-m ... e-shelter/

and

https://wealthtrack.com/credit-market-m ... es-matter/

Hope this is helpful to you.

User avatar
Socrates
Posts: 339
Joined: Sun May 13, 2018 10:27 pm
Location: Margaritaville

Re: Bonds and Investing

Post by Socrates » Thu Jun 06, 2019 11:09 pm

The fund we use is Vanguard Intermediate-Term Bond Index Fund Admiral Shares (VBILX) ER 0.07℅.
Yeah I'm in on bonds and that fund especially......moving from 95% stock age 53 to 70% stock 30% bonds


PIMIX and VBILX

I'll sprinkle in some Wellesley
“Don't waste your time looking back. You're not going that way.” ― Ragnar Lothbrok.

User avatar
Dialectical Investor
Posts: 501
Joined: Mon Dec 03, 2018 11:41 pm

Re: Bonds and Investing

Post by Dialectical Investor » Thu Jun 06, 2019 11:12 pm

Beehave wrote:
Thu Jun 06, 2019 10:53 pm

There's a huge difference between you buying a bond and holding it to maturity, and you buying into a mutual fund and the manager of the fund holding it to maturity. That's because you may (and probably will, today) be buying into a fund and paying more than the par value of the bonds held.
So even if the bonds are held to maturity,you may not be getting the full amount of what you paid (so to speak) back.
It is not a problem to pay more than par because the premium is accounted for in the yield to maturity. If you were to purchase an equivalent bond at par, the yield to maturity would be the same, and the coupons would be lower. All that is different is the timing of some of the cash flows.

There really is no difference between buying individual bond(s) or a bond fund, except that individual issues decline in duration without intervention and in a more steady fashion compared to regularly moving money between bond funds of different durations or between a bond fund and a zero-duration cash-equivalent. This can have some impact on the outcome depending on the timing of yield changes and the degree to which one seeks precision in controlling duration. It's likely easier to use individual bonds if you have precise cash flow needs. Otherwise, for the most part, there only is a difference if you create a difference, say, by comparing a bond fund of one duration with a portfolio of individual bonds with a different duration.

longinvest
Posts: 3626
Joined: Sat Aug 11, 2012 8:44 am

Re: Bonds and Investing

Post by longinvest » Fri Jun 07, 2019 7:24 am

KandT wrote:
Wed Jun 05, 2019 9:37 pm
I throw myself at the mercy of the court here!

So far this has turned out well. I realize it could change any minute. I have my 401K's, extra cash (non emergency) and 529's all in the S&P. Kids are 7 and 12.

Quite frankly I just don't understand bond funds. I understand buying a bond from an organization that will pay you back at the prescribed terms. I don't understand how bond funds work. If interest rates go up doesn't the value of the bonds I am holding go down?? I assume there are funds that will hold more long term bonds and ones that will hold more short term bonds???

I have been putting off moving some of my kids 529's into bonds because of simply not understanding that market. I am afraid this is going to bite me in the rear end!

Any advice is appreciated. I would lean toward simple like a Vanguard bond fund but don't know where to start.
Kand, I think that a picture might be worth a thousand words. Here's a 20-year growth chart of Taylor's Three-Fund Portfolio with 36% Total US Stock Market, 24% Total International Stock Market, and 40% Total Bond Market (in blue). That's a 60/40 stocks/bonds portfolio. I also included the growth of stocks (red) and bonds (yellow) so that you can see that (1) bonds are significantly less volatile than stocks, and (2) mixing bonds with stocks dampens the volatility of stocks.

Source: Portfolio Visualizer
Period: June 1999 to May 2019 (20 years)

Image

The biggest loss of bonds, over the last 20 years, was -4% from April to October 2008. The biggest loss of stocks was -54% from November 2007 to February 2009. The balanced portfolio's losses were dampened to -35% from November 2007 to February 2009.

It's best to accept that markets will return whatever they'll return. But, knowing that bonds are significantly less volatile than stocks, it's a good idea to add some to one's portfolio to dampen volatility. A total-market bond index fund is a good choice to do so.

Good luck!
Bogleheads investment philosophy | single-ETF balanced portfolio | VBAL

longinvest
Posts: 3626
Joined: Sat Aug 11, 2012 8:44 am

Re: Bonds and Investing

Post by longinvest » Fri Jun 07, 2019 7:46 am

It might help to think about this. To recover from a -54% loss, a portfolio must grow 117%. To recover from a -35% loss, it must "only" grow 54%.

A balanced portfolio dampens the volatility of stocks and also dampens the impact of the usually lower long-term returns of bonds.
Bogleheads investment philosophy | single-ETF balanced portfolio | VBAL

bgf
Posts: 958
Joined: Fri Nov 10, 2017 9:35 am

Re: Bonds and Investing

Post by bgf » Fri Jun 07, 2019 8:03 am

longinvest wrote:
Fri Jun 07, 2019 7:46 am
It might help to think about this. To recover from a -54% loss, a portfolio must grow 117%. To recover from a -35% loss, it must "only" grow 54%.

A balanced portfolio dampens the volatility of stocks and also dampens the impact of the usually lower long-term returns of bonds.
i think that is the wrong way to conceptualize returns. returns are based on price paid for the shares, and history means nothing [if you disagree, then i have a $10,000 technical stock charting course to sell you, its a steal considering you should be able to print money with it!!!]. when someone pays $2.00 for the shares or $200,000, they are doing the same thing. the bid/ask process is the same. there is no "gravity" or "force" working stronger against a 100% gain in contrast to a 10% gain.

someone who sells after sustaining a 30% loss because they feel defeated knowing that they would now need make a gain of ~40% is... mistaken.
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"

longinvest
Posts: 3626
Joined: Sat Aug 11, 2012 8:44 am

Re: Bonds and Investing

Post by longinvest » Fri Jun 07, 2019 8:28 am

bgf wrote:
Fri Jun 07, 2019 8:03 am
longinvest wrote:
Fri Jun 07, 2019 7:46 am
It might help to think about this. To recover from a -54% loss, a portfolio must grow 117%. To recover from a -35% loss, it must "only" grow 54%.

A balanced portfolio dampens the volatility of stocks and also dampens the impact of the usually lower long-term returns of bonds.
i think that is the wrong way to conceptualize returns. returns are based on price paid for the shares, and history means nothing [if you disagree, then i have a $10,000 technical stock charting course to sell you, its a steal considering you should be able to print money with it!!!]. when someone pays $2.00 for the shares or $200,000, they are doing the same thing. the bid/ask process is the same. there is no "gravity" or "force" working stronger against a 100% gain in contrast to a 10% gain.

someone who sells after sustaining a 30% loss because they feel defeated knowing that they would now need make a gain of ~40% is... mistaken.
My post was about the emotional impact of a loss. If I had accumulated a $300,000 portfolio in November 2007 after years of working hard and living below my means, and 15 months later, in February 2009, my portfolio's value had dropped to $138,000, I would probably had anchored my hopes on that previous $300,000 balance. Getting back to it would require my portfolio to grow $162,000, that's 117%. Yes, I am perfectly aware that anchoring is a behavioral bias, but it's difficult for many humans not to do it.

Thinking about our biases ahead of time, before the next crisis happens, is important. In good times, greed could lead us to maximize our exposure to stocks (why not use leverage and get some alleged "optimal" 140% stock exposure based on the Kelly criterion?). But, being aware of the potential emotional impact of seeing one's portfolio well below a previously anchored value might incite us to prudence.

There are many other reasons to include bonds in a portfolio (portfolio efficiency, uncertainty about future unexpected liquidity needs, etc.), but I wanted to put the emphasis on the behavioral aspect. As you said, someone who sells after the loss, because the person had not anticipated the emotional impact of a market crash, will make the loss permanent.

For some investors who have never lived through a severe bear market, the difference between a -54% and a -35% loss might not seem as emotionally big as it really is. Considering the required growth to get back even (117% versus 54%) can help with the process of selecting an asset allocation.

A good rule of thumb is to assume that stocks could lose 50% of their value at any point in time and not recover for a long time, but that bonds might severely underperform stocks, and allocate the portfolio trying to balance these risks.
Bogleheads investment philosophy | single-ETF balanced portfolio | VBAL

Novice2020
Posts: 11
Joined: Sat May 25, 2019 10:32 am

Re: Bonds and Investing

Post by Novice2020 » Fri Jun 07, 2019 8:42 am

vineviz wrote:
Wed Jun 05, 2019 9:58 pm
KandT wrote:
Wed Jun 05, 2019 9:37 pm
I throw myself at the mercy of the court here!

So far this has turned out well. I realize it could change any minute. I have my 401K's, extra cash (non emergency) and 529's all in the S&P. Kids are 7 and 12.

Quite frankly I just don't understand bond funds. I understand buying a bond from an organization that will pay you back at the prescribed terms. I don't understand how bond funds work. If interest rates go up doesn't the value of the bonds I am holding go down?? I assume there are funds that will hold more long term bonds and ones that will hold more short term bonds???

I have been putting off moving some of my kids 529's into bonds because of simply not understanding that market. I am afraid this is going to bite me in the rear end!

Any advice is appreciated. I would lean toward simple like a Vanguard bond fund but don't know where to start.
The best way to learn is to probably buy some bond funds.

A fund like Vanguard Total Bond Market Index Fund (VBTLX) may not be perfect for you but it certainly is "good enough".

A bond fund is just a portfolio of bonds that you own. Yes, as yields increase the price of the bonds goes down. And as yields decrease the price of the bonds goes up. The same thing happens with the dividend yield on your stock funds, by the way.

Bond funds can play two important roles in a portfolio. They can be used to diversify it, because to some degree bonds tend to increase in value when stocks are falling. And they can reduce the risk, because their steady cash flows dampen out the volatility that stocks have.

It wouldn't be at all surprised if the S&P lost 50% of its value sometime over the next 10 years. Not predicting it, necessarily, but statistically speaking it's likely. In that kind of market crash, Vanguard Total Bond Market Index Fund will almost certainly lose less than 5%.

If your oldest child is applying to college and their 529 plan balance is cut in half, would that be a big deal?

What if it only fell by 10% instead, because it was 30% stocks and 70% bonds? Would that be better?
Silly question, so apologies in advance, but with a total bund fund like VBTLX (or the Fidelity counterpart FXNAX) in an IRA, can you sell the bond fund at any time to raise cash? Or does buying it commit you to the life of the bond?

User avatar
vineviz
Posts: 4388
Joined: Tue May 15, 2018 1:55 pm

Re: Bonds and Investing

Post by vineviz » Fri Jun 07, 2019 8:44 am

Novice2020 wrote:
Fri Jun 07, 2019 8:42 am
Silly question, so apologies in advance, but with a total bund fund like VBTLX (or the Fidelity counterpart FXNAX) in an IRA, can you sell the bond fund at any time to raise cash? Or does buying it commit you to the life of the bond?
Yes, you can totally sell a bond fund at any time.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

22twain
Posts: 1928
Joined: Thu May 10, 2012 5:42 pm

Re: Bonds and Investing

Post by 22twain » Fri Jun 07, 2019 8:50 am

Novice2020 wrote:
Fri Jun 07, 2019 8:42 am
can you sell the bond fund at any time to raise cash? Or does buying it commit you to the life of the bond?
A bond fund contains many many bonds. Probably every day, or at least every month, some of them mature. (I don't know whether bonds typically mature on certain days of the month.) Actually, my understanding is that bond funds typically don't hold bonds to maturity, but instead sell them as they approach maturity, so there is always cash available for redeeming shares of the fund.
My investing princiPLEs do not include absolutely preserving princiPAL.

3funder
Posts: 1007
Joined: Sun Oct 15, 2017 9:35 pm

Re: Bonds and Investing

Post by 3funder » Fri Jun 07, 2019 8:57 am

KandT wrote:
Thu Jun 06, 2019 3:23 pm
ruralavalon wrote:
Thu Jun 06, 2019 9:42 am
abuss368 wrote:
Wed Jun 05, 2019 10:22 pm
With bonds, higher yield almost always means higher risk. Any good short or intermediate term bond fund that is investment grade, low cost, and diversified should provide safety and income to a portfolio.
+ 1.

The most commonly used bond fund here is probably Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX) ER 0.04%.

The fund we use is Vanguard Intermediate-Term Bond Index Fund Admiral Shares (VBILX) ER 0.07℅.
So by name I am assuming that the VBTLX buys short, intermediate and long term bonds. So if interest rates rise, they are locked into the long term but can peel off the shorter term bonds as they come due??
The average duration of the two funds is somewhat similar, so it's really a function of the following:

Do you want to invest in a relatively even split among corporates, treasuries, and agency-rated mortgage-backed securities (VBTLX)?

OR

Do you want to invest in an even split between corporates and treasuries (VBILX)?

For what it's worth, the latter is a little bit riskier but should have a little higher return over time. I utilize the former in my 403(b).

Broken Man 1999
Posts: 2703
Joined: Wed Apr 08, 2015 11:31 am

Re: Bonds and Investing

Post by Broken Man 1999 » Fri Jun 07, 2019 9:50 am

fortfun wrote:
Thu Jun 06, 2019 10:22 pm
Why not just use one of Vanguard's age based 529s that automatically adjusts. You can pick conservative, moderate, or aggressive. Sounds like aggressive would suit you best.
Good choice, easy to use. We use them for our grand-kids 529 plans.

We use Vanguard Aggressive Age-Based Option funds. They range from 70% equities/30% bonds for our ten year old to 90% equities/10% bonds for our five year old. Bond holding increases as child gets older, very much like target retirement date funds, just with a shorter period of time.

Broken Man 1999
“If I cannot drink Bourbon and smoke cigars in Heaven than I shall not go. " -Mark Twain

JoeFriday
Posts: 4
Joined: Sat May 18, 2019 11:33 am

Re: Bonds and Investing

Post by JoeFriday » Fri Jun 07, 2019 10:31 am

Before you invest in bonds you should know/learn the basics. The best investment advice I ever received when I was young and starting out was this, "don't buy investments you don't understand".

Some basic bond fund terms to learn: 1) Credit risk 2) Interest rate risk 3) Duration. Just do an internet search of these terms, they'll likely lead to others. Be patient, learning bonds takes some time.

For corporate bond funds, credit quality is front and center at this time. Read this article from Bloomberg: https://www.bloomberg.com/graphics/2018 ... t-ratings/

US Treasury securities (Bills, Notes and Bonds), held to maturity, are considered to be among the safest investments available.

Beehave
Posts: 513
Joined: Mon Jun 19, 2017 12:46 pm

Re: Bonds and Investing

Post by Beehave » Fri Jun 07, 2019 11:04 am

Dialectical Investor wrote:
Thu Jun 06, 2019 11:12 pm
Beehave wrote:
Thu Jun 06, 2019 10:53 pm

There's a huge difference between you buying a bond and holding it to maturity, and you buying into a mutual fund and the manager of the fund holding it to maturity. That's because you may (and probably will, today) be buying into a fund and paying more than the par value of the bonds held.
So even if the bonds are held to maturity,you may not be getting the full amount of what you paid (so to speak) back.
It is not a problem to pay more than par because the premium is accounted for in the yield to maturity. If you were to purchase an equivalent bond at par, the yield to maturity would be the same, and the coupons would be lower. All that is different is the timing of some of the cash flows.

There really is no difference between buying individual bond(s) or a bond fund, except that individual issues decline in duration without intervention and in a more steady fashion compared to regularly moving money between bond funds of different durations or between a bond fund and a zero-duration cash-equivalent. This can have some impact on the outcome depending on the timing of yield changes and the degree to which one seeks precision in controlling duration. It's likely easier to use individual bonds if you have precise cash flow needs. Otherwise, for the most part, there only is a difference if you create a difference, say, by comparing a bond fund of one duration with a portfolio of individual bonds with a different duration.
Thank you for your correction! It took me a couple of readings of your post and thinking through some examples for me to understand, and it is very helpful. Bonds are more complex in their behavior, bounds, and role in asset allocation than they initially seem, and I am apparantly still learning. I appreciate your taking the time to write and suspect that your post will be helpful to others as well.

welsie
Posts: 88
Joined: Tue Feb 12, 2019 6:11 pm

Re: Bonds and Investing

Post by welsie » Fri Jun 07, 2019 11:06 am

Dialectical Investor wrote:
Thu Jun 06, 2019 10:20 pm
welsie wrote:
Thu Jun 06, 2019 4:16 pm

If interest rates rise, the price of the asset has to drop so the yield is the same as that in the market. So imagine you have a 3 year bond with a 3% interest rate which cost $100 (thus paying $3 per year). If tomorrow interest rates rose to 6% for a new issue of that 3 year bond (holding all else equal), your bond is now worth $50 (as the $3 per year is 6% of $50). When you own a bond this decrease in value also occurs, because if you sold your bond to a third party they would require the same discount, it just might not "feel" like your bond decreased in value because you still see the same face value on the note.

A bond fund is just a basket of bonds. However suppose you held a bond fund which holds bonds of a term of 3 years or less. Again, if the interest rate doubled, the value of your bonds would be cut in half. However over the next 3 years the 3% bonds would be replaced by 6% bonds, as this occurs the yield from the fund will gradually rise, as will the value of the fund. At the end of the 3 years, after the fund is now entirely composed of 6% bonds your value has returned to where it was on the face (again, holding all else equal).
This pricing behavior is not quite right. Price and yield are inversely related, but they are not proportional. You are focusing on the rate obtained from the coupon, but what matters is the bond's yield to maturity. That yield includes not only the coupon but also any discount or premium to par value, for instance, the $50 discount in your example. A 3-year bond trading at $50 with a 3% coupon has a yield to maturity of approximately 30%, not 6%. The price would fall to around $92, not $50, if the yield-to-maturity on comparable bonds was 6%.
I agree.

The proportional example was an illustration of why the value of bond drops to adjust the yield. I was not trying to calculate the actual value of the premium associated with the discount. If you do that it complicates the example unnecessarily for someone who doesn't even understand why the value of a bond is changing with interest rates at all in the first place. Similarly my example with a fund being a basket is an illustration, in reality bonds don't have to be held until maturity within a fund.

User avatar
Phineas J. Whoopee
Posts: 8390
Joined: Sun Dec 18, 2011 6:18 pm

Re: Bonds and Investing

Post by Phineas J. Whoopee » Fri Jun 07, 2019 1:03 pm

longinvest wrote:
Fri Jun 07, 2019 7:46 am
It might help to think about this. To recover from a -54% loss, a portfolio must grow 117%. To recover from a -35% loss, it must "only" grow 54%.

A balanced portfolio dampens the volatility of stocks and also dampens the impact of the usually lower long-term returns of bonds.
OP: Please read our wiki article about how percentage gains and losses work.

PJW

User avatar
Phineas J. Whoopee
Posts: 8390
Joined: Sun Dec 18, 2011 6:18 pm

Re: Bonds and Investing

Post by Phineas J. Whoopee » Fri Jun 07, 2019 1:20 pm

KandT wrote:
Thu Jun 06, 2019 9:49 pm
...
Thank you for this explanation. So do bond fund managers at Vanguard buy and hold the bond until it matures?
That is not typical of bond funds, although there are a few that use such a strategy. Holding to maturity frequently will reduce bond fund returns, as opposed to selling them to money market funds as the date approaches and using the proceeds to buy longer-term securities. I didn't say long term, just longer term than is typical for money market mutual funds.
KandT wrote:
Thu Jun 06, 2019 9:49 pm
Do some bond fund managers try and beat the market by trading on their best estimate on what will happen to interest rates?
Yes, naturally some bond fund managers bet their clients' money on timing bond yield changes.

I'd like to say a few more words about Yield to Maturity, YTM, referred to upthread.

YTM, often mischaracterized as interest rates, has to do with what will happen over time if the bond is held to maturity and all the periodic payments, the coupons, are reinvested at the yield of the bond in question. It is often conflated with coupon, the amount of money the bond issuer will pay out periodically. For uncomplicated bonds, like Treasuries, it's a constant. It's the same number of dollars each time.

YTM takes into account present market values. It says what the yield would be if the bond is bought now, at its market value, and held to maturity with coupon reinvestments. It's an important distinction, because it takes into account the fact that as a bond approaches maturity its market value must of necessity approach its face value. Who would pay much more, or accept much less, than $1,000 for a thirty-year $1,000 face value bond that matures tomorrow?

Yield is the important number, not coupon, or even interest rate, both often mistaken for the financial term yield.

Does that help?

PJW

yobyot
Posts: 19
Joined: Wed Oct 09, 2013 5:19 pm

Re: Bonds and Investing

Post by yobyot » Fri Jun 07, 2019 7:39 pm

KandT wrote:
Wed Jun 05, 2019 9:37 pm
I throw myself at the mercy of the court here!

So far this has turned out well. I realize it could change any minute. I have my 401K's, extra cash (non emergency) and 529's all in the S&P. Kids are 7 and 12.

Quite frankly I just don't understand bond funds. I understand buying a bond from an organization that will pay you back at the prescribed terms. I don't understand how bond funds work. If interest rates go up doesn't the value of the bonds I am holding go down?? I assume there are funds that will hold more long term bonds and ones that will hold more short term bonds???

I have been putting off moving some of my kids 529's into bonds because of simply not understanding that market. I am afraid this is going to bite me in the rear end!

Any advice is appreciated. I would lean toward simple like a Vanguard bond fund but don't know where to start.
OK, I'm just gonna say it: I despise bonds -- esp. bond funds.

That's why I buy only T-bills at auction (no brokers to take basis points in the murky, opaque bond market. And as to bond funds, they have a terrible flaw: there's no floor under the price of the fund. It's unlikely, esp. if you buy BND or AGG but if the Fed blows up the economy and inflation spirals out of control, you'll lose principal endlessly in a bond fund. At least if you own the bond, you can hold on and get your principal back (subject to credit risk). Some people will tell you you can minimize that risk with a short-duration fund. But the word is "minimize." If something really scary happens, all bets are off for bond funds.

User avatar
aspirit
Posts: 454
Joined: Wed Jan 03, 2018 12:52 am
Location: SMA.SFL

Re: Bonds and Investing

Post by aspirit » Fri Jun 07, 2019 8:01 pm

This certainly has insights viewtopic.php?p=1115319
Time & tides wait for no one. A man has to know his limitations. | "Give me control of a nation's money and I care not who makes it's laws" | — Mayer Amschel Bauer Rothschild ~

User avatar
grabiner
Advisory Board
Posts: 24573
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Bonds and Investing

Post by grabiner » Fri Jun 07, 2019 9:12 pm

yobyot wrote:
Fri Jun 07, 2019 7:39 pm
OK, I'm just gonna say it: I despise bonds -- esp. bond funds.

That's why I buy only T-bills at auction (no brokers to take basis points in the murky, opaque bond market. And as to bond funds, they have a terrible flaw: there's no floor under the price of the fund. It's unlikely, esp. if you buy BND or AGG but if the Fed blows up the economy and inflation spirals out of control, you'll lose principal endlessly in a bond fund. At least if you own the bond, you can hold on and get your principal back (subject to credit risk).
Inflation is just as much a risk with individual bonds. If you buy a $1000 Treasury bond, you are guaranteed to get $1000 back at maturity (plus the coupon payments), but you have no guarantee of what you will be able to buy with that $1000.

The way to avoid this particular risk is to buy TIPS or I-Bonds. If you buy a $1000 TIPS, you are guaranteed to get $1000 of today's purchasing power at maturity (plus the much smaller coupon payments, since you get a larger principal). TIPS funds likewise avoid inflation risk, although the fund value may vary as rates change.
Wiki David Grabiner

Post Reply