Basic Questions about Bonds from New Investor

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PineForest
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Joined: Thu Jan 23, 2020 5:12 pm

Basic Questions about Bonds from New Investor

Post by PineForest »

I've been reading some posts about bonds and I'm confused about a few things.

a) What is the difference between yield and returns, if any?

b) I keep reading about how low the returns are for bonds (1 to 2%), but then I look at the websites for funds like the following and see that in the past year they have returns of 10% or more.

VBILX--
https://investor.vanguard.com/mutual-fu ... ance/vbilx

FCBFX--
https://fundresearch.fidelity.com/mutua ... /316146596

I am confused. I am reading about how bonds don't give much return, but these two accounts above look like they (at least for the past year) are offering great returns. Wouldn't these two funds be great options for something that offers solid return on investment with less risk than equities?

c) I live in Minnesota. I saw this bond fund offered by fidelity
FIMIX
https://fundresearch.fidelity.com/mutua ... /316412303

It looks like it's had good returns over the years. I am wondering if people could share their opinion about how good a fund this would be to hold some of my bond allocation. I'm a married teacher in the 24% bracket and don't have huge tolerance for risk.

Thanks much.
Pikel
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Re: Basic Questions about Bonds from New Investor

Post by Pikel »

Just to take a step back, it is important to learn how the price of a single bond is determined.

In 2019 the federal reserve reduced the risk free interest rate that is used to calculate the present value of future coupon payments. That's to say, the present value of future coupons has gone up, which in turn made the value of bonds go up.

If you understand that basic calculation for a single bond, you can apply the understanding to a fund of bonds. And it will also be intuitive why there is greater interest rate risk for long term bonds.

The price of a bond fund is not speculative the way stocks are.

I also think, for the most part, if you are chasing bond yield, your overall asset allocation is too conservative.
Last edited by Pikel on Sat Feb 15, 2020 9:33 am, edited 1 time in total.
bradinsky
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Re: Basic Questions about Bonds from New Investor

Post by bradinsky »

OP,
You might try Larry Swedroes book "The Only Guide to a Winning Bond Investment Strategy". Good advice from a pro.
dbr
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Re: Basic Questions about Bonds from New Investor

Post by dbr »

The difference between yield and return for any investment is fundamental to investing. In short yield is the rate* at which a dividend or interest is paid out and return is the rate* of total change in value of a position including dividend and interest payouts and change in the market value of the holdings. Market values of bonds change constantly as the current yield that people think they can get changes. In the example you quoted bond prices went up because interest rates the market could deliver went down. For the same number of dollars delivered in interest on a bond the price has to go up if the rate of interest is to go down. I would add that since interest rates on average over a long time do not have an upward or downward trend the average result is that the yield will be the return for bonds. Those good returns on bonds last year could turn into bad returns this year, or some year.

*Rate here means a ratio of payment in dollars to price in dollars expressed as a percent. It is also a time rate in the sense that one obtains the payment for a certain period of time such as day, month, year, etc. Thus one has expression such as percent/annum which has the units dollars per dollars (converted to percent) per year.
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BolderBoy
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Re: Basic Questions about Bonds from New Investor

Post by BolderBoy »

PineForest wrote: Sat Feb 15, 2020 8:40 amb) I keep reading about how low the returns are for bonds (1 to 2%), but then I look at the websites for funds like the following and see that in the past year they have returns of 10% or more.
I'm not an expert on bonds - they are mysterious creatures - but this is how the BHs have helped me to simplify what it means.

The websites you are visiting are throwing around the term "return" in a loose way that confuses you (and me.)

The "return" that you are interested in - the only truly meaningful "return" - is "total return". For bonds the total return captures the effect of the % interest it pays & the effect of the change in NAV of the bond.

So in your example I quoted above, the 1-2% may be the interest rate (%) the bond pays (the yield). The 10% number cited probably takes into account both the interest rate & the increase in NAV of the bond over a period of time.

By example, look at this for Vanguard's VWIUX fund:

https://i.postimg.cc/k4rJ4Sh2/Bond-Yields.jpg

You see at the top the yield is shown as 1.31% (interest rate paid). Look further down under Performance, you'll see the 1-yr return percentage is 6%+ because it is the total return.
"Never underestimate one's capacity to overestimate one's abilities" - The Dunning-Kruger Effect
alex_686
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Re: Basic Questions about Bonds from New Investor

Post by alex_686 »

There is a inverse relationship between price and yield. When yield goes down prices go up.

For example, let us say that a 10 year bond was issued at 5%. The next day the yield drops to 4%. A new set of bonds are issued.

Now, the law of one price says the 2 bonds have to have the same. However, a 5% coupon is more valuable than a 4% coupon. So the price of the old bond would now be worth $110 instead of the ild price of $100. A 10% gain.

For the past 10 years rates have fallen, giving bonds a fair tailwind. As long as yields continue to fall bonds will outperform. Rates are basically at zero now. Can they go negative?

And of course if rates increase bond holders will be crushed.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Phineas J. Whoopee
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Re: Basic Questions about Bonds from New Investor

Post by Phineas J. Whoopee »

alex_686 wrote: Sat Feb 15, 2020 7:24 pm There is a inverse relationship between price and yield. When yield goes down prices go up.

For example, let us say that a 10 year bond was issued at 5%. The next day the yield drops to 4%. A new set of bonds are issued.

Now, the law of one price says the 2 bonds have to have the same. However, a 5% coupon is more valuable than a 4% coupon. So the price of the old bond would now be worth $110 instead of the ild price of $100. A 10% gain.

For the past 10 years rates have fallen, giving bonds a fair tailwind. As long as yields continue to fall bonds will outperform. Rates are basically at zero now. Can they go negative?

And of course if rates increase bond holders will be crushed.
Bond returns come from yields, specifically Yield to Maturity, YTM. It includes coupons plus reinvestment of them, and the fact market prices for bonds must of necessity approach their face values as they approach maturity. Who would pay much more, or accept much less, than $1,000 for a thirty-year $1,000 face value bond that matures tomorrow?

For long-term investors increased yields are good, not bad.

PJW
Topic Author
PineForest
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Re: Basic Questions about Bonds from New Investor

Post by PineForest »

BolderBoy wrote: Sat Feb 15, 2020 6:05 pm
PineForest wrote: Sat Feb 15, 2020 8:40 amb) I keep reading about how low the returns are for bonds (1 to 2%), but then I look at the websites for funds like the following and see that in the past year they have returns of 10% or more.
I'm not an expert on bonds - they are mysterious creatures - but this is how the BHs have helped me to simplify what it means.

The websites you are visiting are throwing around the term "return" in a loose way that confuses you (and me.)

The "return" that you are interested in - the only truly meaningful "return" - is "total return". For bonds the total return captures the effect of the % interest it pays & the effect of the change in NAV of the bond.

So in your example I quoted above, the 1-2% may be the interest rate (%) the bond pays (the yield). The 10% number cited probably takes into account both the interest rate & the increase in NAV of the bond over a period of time.

By example, look at this for Vanguard's VWIUX fund:

https://i.postimg.cc/k4rJ4Sh2/Bond-Yields.jpg

You see at the top the yield is shown as 1.31% (interest rate paid). Look further down under Performance, you'll see the 1-yr return percentage is 6%+ because it is the total return.
This is helpful--thanks.
aristotelian
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Re: Basic Questions about Bonds from New Investor

Post by aristotelian »

Yield is part of a bonds total return. The other part is changes in the bonds market value. The value of bonds goes up as interest rates fall (existing bonds with a higher rate become more valuable relative to the principal).

Interests have on the whole been falling since 2008, so a lot of the positive returns you are seeing are due to that trend. Nobody know if it will continue. If rates ever normalize to historical levels, you would see negative total returns.
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