Vanguard bond ETF to ?temporarily rebalance into

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Ryzan
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Vanguard bond ETF to ?temporarily rebalance into

Post by Ryzan »

I need to rebalance some of my total stock market fund within my Roth 401k into bonds to restore my desired asset allocation. My main bond holding is BND (Vanguard Total Bond Market Index Fund ETF), which is inside the non-Roth portion of my 401k, and then the rest is in VWIUX (Vanguard Intermediate-Term Tax-Exempt Fund) within my taxable account.

After all the discussion about bonds, interest rates, expectations, etc., my general conclusion is that the duration of BND is fine since my plan is buy-and-hold over decades. The issue is in this case, I don't necessarily expect to hold this additional bond amount long-term, and ideally would rebalance back into total stock market as soon as that's viable (either through a correction in equities or gradually by building up the VWIUX in my taxable account).

With that in mind, does BND still make sense for this scenario, or would a shorter-duration fund like BSV (Vanguard Short-Term Bond ETF), VTIP (Vanguard Short-Term Inflation-Protected Securities ETF), or VGSH (Vanguard Short-Term Treasury ETF) be more optimal for this purpose?
wetgear
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Re: Vanguard bond ETF to ?temporarily rebalance into

Post by wetgear »

BND is going to be great for your purpose, you don't know what the market is going to do so don't speculate just cross that bridge if/when it arrives until then BND is a perfectly good option. Is your trad 401k already full of BND?
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Ryzan
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Re: Vanguard bond ETF to ?temporarily rebalance into

Post by Ryzan »

wetgear wrote: Tue Jan 12, 2021 5:57 pm BND is going to be great for your purpose, you don't know what the market is going to do so don't speculate just cross that bridge if/when it arrives until then BND is a perfectly good option. Is your trad 401k already full of BND?
Thanks. And yes, traditional 401k = 100% BND.
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grabiner
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Re: Vanguard bond ETF to ?temporarily rebalance into

Post by grabiner »

Since you are rebalancing, you may not hold the whole bond allocation for its duration, but you will hold most of your bond allocation.

Also, you don't need to hold a specific fund for its duration; you get the same effect of interest-rate changes if you switch to another fund of similar durations. Thus, if rates rise, and you sell Total Bond Market Index and buy Intermediate-Term Tax-Exempt, you still earn the higher interest rates for as long as you hold the bond funds.
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Ryzan
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Re: Vanguard bond ETF to ?temporarily rebalance into

Post by Ryzan »

grabiner wrote: Tue Jan 12, 2021 9:30 pm Since you are rebalancing, you may not hold the whole bond allocation for its duration, but you will hold most of your bond allocation.

Also, you don't need to hold a specific fund for its duration; you get the same effect of interest-rate changes if you switch to another fund of similar durations. Thus, if rates rise, and you sell Total Bond Market Index and buy Intermediate-Term Tax-Exempt, you still earn the higher interest rates for as long as you hold the bond funds.
I can sense there's a pearl of wisdom in the second paragraph, but reading it over several times last night and this morning, I can't seem to wrap my head around it. Would you (or anyone else) be so kind as to explain it again, as if I'm 5 years old? Thanks!
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Re: Vanguard bond ETF to ?temporarily rebalance into

Post by grabiner »

Ryzan wrote: Wed Jan 13, 2021 9:19 am
grabiner wrote: Tue Jan 12, 2021 9:30 pm Since you are rebalancing, you may not hold the whole bond allocation for its duration, but you will hold most of your bond allocation.

Also, you don't need to hold a specific fund for its duration; you get the same effect of interest-rate changes if you switch to another fund of similar durations. Thus, if rates rise, and you sell Total Bond Market Index and buy Intermediate-Term Tax-Exempt, you still earn the higher interest rates for as long as you hold the bond funds.
I can sense there's a pearl of wisdom in the second paragraph, but reading it over several times last night and this morning, I can't seem to wrap my head around it. Would you (or anyone else) be so kind as to explain it again, as if I'm 5 years old? Thanks!
Bond Fund A has a 3% yield and a 6-year duration. Bond Fund B has a 2% yield and a 6-year duration.

You invest $10K in Bond Fund A, which would be worth $11,941 in six years. Yields don't change, and one year later, you sell Bond Fund A to buy Bond Fund B, for $10,300. After another five years, you have $11,372, the result of earning 3% for one year and 5% for two years.

Now, see what happens if rates change. You invest $10K in Bond Fund A, and rates immediately rise by 1%, dropping your fund value to $9437 (the value which would be worth $11,941 after six years invested at 4%). One year later, you sell Bond Fund A for $9814, and invest in Bond Fund B, which is now yielding 3%. After another five years, you have $11,377, essentially the same as if rates hadn't changed. You were invested in bond funds with a six-year duration for six years, so the change in rates in the first year was cancelled out even though you switched funds.
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Ryzan
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Re: Vanguard bond ETF to ?temporarily rebalance into

Post by Ryzan »

grabiner wrote: Wed Jan 13, 2021 9:04 pm
Ryzan wrote: Wed Jan 13, 2021 9:19 am
grabiner wrote: Tue Jan 12, 2021 9:30 pm Since you are rebalancing, you may not hold the whole bond allocation for its duration, but you will hold most of your bond allocation.

Also, you don't need to hold a specific fund for its duration; you get the same effect of interest-rate changes if you switch to another fund of similar durations. Thus, if rates rise, and you sell Total Bond Market Index and buy Intermediate-Term Tax-Exempt, you still earn the higher interest rates for as long as you hold the bond funds.
I can sense there's a pearl of wisdom in the second paragraph, but reading it over several times last night and this morning, I can't seem to wrap my head around it. Would you (or anyone else) be so kind as to explain it again, as if I'm 5 years old? Thanks!
Bond Fund A has a 3% yield and a 6-year duration. Bond Fund B has a 2% yield and a 6-year duration.

You invest $10K in Bond Fund A, which would be worth $11,941 in six years. Yields don't change, and one year later, you sell Bond Fund A to buy Bond Fund B, for $10,300. After another five years, you have $11,372, the result of earning 3% for one year and 5% for two years.

Now, see what happens if rates change. You invest $10K in Bond Fund A, and rates immediately rise by 1%, dropping your fund value to $9437 (the value which would be worth $11,941 after six years invested at 4%). One year later, you sell Bond Fund A for $9814, and invest in Bond Fund B, which is now yielding 3%. After another five years, you have $11,377, essentially the same as if rates hadn't changed. You were invested in bond funds with a six-year duration for six years, so the change in rates in the first year was cancelled out even though you switched funds.
So in the second example with the 1% rate rise, wouldn't it be better to stick with bond fund A, since it would be worth $11,941 after 6 years instead of $11,377 by jumping into bond fund B after 1 year?

I also fail to understand what's gained by selling one bond fund and buying into another bond fund with a similar duration as a result of a rate change. It sounds kind of like using partner funds for tax loss harvesting, but I can't understand what this maneuver with bonds accomplishes.
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Ryzan
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Re: Vanguard bond ETF to ?temporarily rebalance into

Post by Ryzan »

grabiner wrote: Tue Jan 12, 2021 9:30 pm Bond Fund A has a 3% yield and a 6-year duration. Bond Fund B has a 2% yield and a 6-year duration.

You invest $10K in Bond Fund A, which would be worth $11,941 in six years. Yields don't change, and one year later, you sell Bond Fund A to buy Bond Fund B, for $10,300. After another five years, you have $11,372, the result of earning 3% for one year and 5% for two years.

Now, see what happens if rates change. You invest $10K in Bond Fund A, and rates immediately rise by 1%, dropping your fund value to $9437 (the value which would be worth $11,941 after six years invested at 4%). One year later, you sell Bond Fund A for $9814, and invest in Bond Fund B, which is now yielding 3%. After another five years, you have $11,377, essentially the same as if rates hadn't changed. You were invested in bond funds with a six-year duration for six years, so the change in rates in the first year was cancelled out even though you switched funds.
So in the second example with the 1% rate rise, wouldn't it be better to stick with bond fund A, since it would be worth $11,941 after 6 years instead of $11,377 by jumping into bond fund B after 1 year?

I also fail to understand what's gained by selling one bond fund and buying into another bond fund with a similar duration as a result of a rate change. It feels kind of like using partner funds for tax loss harvesting, but I can't understand what this maneuver with bonds accomplishes.
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grabiner
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Re: Vanguard bond ETF to ?temporarily rebalance into

Post by grabiner »

Ryzan wrote: Wed Jan 13, 2021 9:13 pm
grabiner wrote: Wed Jan 13, 2021 9:04 pm
Ryzan wrote: Wed Jan 13, 2021 9:19 am
grabiner wrote: Tue Jan 12, 2021 9:30 pm Since you are rebalancing, you may not hold the whole bond allocation for its duration, but you will hold most of your bond allocation.

Also, you don't need to hold a specific fund for its duration; you get the same effect of interest-rate changes if you switch to another fund of similar durations. Thus, if rates rise, and you sell Total Bond Market Index and buy Intermediate-Term Tax-Exempt, you still earn the higher interest rates for as long as you hold the bond funds.
I can sense there's a pearl of wisdom in the second paragraph, but reading it over several times last night and this morning, I can't seem to wrap my head around it. Would you (or anyone else) be so kind as to explain it again, as if I'm 5 years old? Thanks!
Bond Fund A has a 3% yield and a 6-year duration. Bond Fund B has a 2% yield and a 6-year duration.

You invest $10K in Bond Fund A, which would be worth $11,941 in six years. Yields don't change, and one year later, you sell Bond Fund A to buy Bond Fund B, for $10,300. After another five years, you have $11,372, the result of earning 3% for one year and 5% for two years.

Now, see what happens if rates change. You invest $10K in Bond Fund A, and rates immediately rise by 1%, dropping your fund value to $9437 (the value which would be worth $11,941 after six years invested at 4%). One year later, you sell Bond Fund A for $9814, and invest in Bond Fund B, which is now yielding 3%. After another five years, you have $11,377, essentially the same as if rates hadn't changed. You were invested in bond funds with a six-year duration for six years, so the change in rates in the first year was cancelled out even though you switched funds.
So in the second example with the 1% rate rise, wouldn't it be better to stick with bond fund A, since it would be worth $11,941 after 6 years instead of $11,377 by jumping into bond fund B after 1 year?

I also fail to understand what's gained by selling one bond fund and buying into another bond fund with a similar duration as a result of a rate change. It sounds kind of like using partner funds for tax loss harvesting, but I can't understand what this maneuver with bonds accomplishes.
In either example, you would have $11,941 after six years if you didn't switch, so you would only switch if you had a reason, and the rate change would not be the reason.

In your situation, you are planning to sell a taxable bond fund in your 401(k) and buy a lower-yielding muni bond fund in your taxable account, so that you can get a compensating gain by holding stocks in your 401(k) instead. My point is that you don't lose anything by doing this, even if rates rise before you switch.

(Another reason you might make this type of move is to reduce risk; you might switch from a corporate bond fund to an equal-duration Treasury bond fund.)
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