Invesco bullet ETF shares

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painslayer
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Invesco bullet ETF shares

Post by painslayer »

Hello,

I have just started reading about the Invesco bullet ETF shares for my bond allocation percentage, at least a part of it.
I was wondering if anyone has any experience with this investment vehicle and can speak to it?
Thank you.
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arcticpineapplecorp.
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Re: Invesco bullet ETF shares

Post by arcticpineapplecorp. »

here's some past posts on the subject:
https://www.google.com/search?sitesearc ... let+shares
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Zosima
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Re: Invesco bullet ETF shares

Post by Zosima »

Invesco and iShares both offer target date bond funds. You can find more discussions via search such as the discussions below. I have used the corporate funds in the past, and am looking at them very closely now with bond yields at or exceeding MYGA rates to build out a fixed income ladder until I start collecting social security (which is still a ways off for me.)

viewtopic.php?t=327989

viewtopic.php?t=316073

viewtopic.php?t=265338
123
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Re: Invesco bullet ETF shares

Post by 123 »

I've been looking at them with interest but haven't pulled the trigger yet.

Since they are open-ended ETFs the "par" you'll end up at maturity is a moving target as the individual portfolios change, I haven't gotten comfortable with that yet.
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Re: Invesco bullet ETF shares

Post by vineviz »

123 wrote: Sun Apr 03, 2022 9:11 pm I've been looking at them with interest but haven't pulled the trigger yet.

Since they are open-ended ETFs the "par" you'll end up at maturity is a moving target as the individual portfolios change, I haven't gotten comfortable with that yet.
As far as I know, all the Bulletshares ETFs are priced such that the final NAV will be within a dollar of $100. Likewise, I think all the iShares iBond ETFs are priced so that the final NAV will be $25.

For any particular ETF you can project the final NAV if you know the time to maturity, coupon yield, YTM, and current price.
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Re: Invesco bullet ETF shares

Post by Zosima »

vineviz wrote: Sun Apr 03, 2022 9:58 pm
123 wrote: Sun Apr 03, 2022 9:11 pm I've been looking at them with interest but haven't pulled the trigger yet.

Since they are open-ended ETFs the "par" you'll end up at maturity is a moving target as the individual portfolios change, I haven't gotten comfortable with that yet.
As far as I know, all the Bulletshares ETFs are priced such that the final NAV will be within a dollar of $100. Likewise, I think all the iShares iBond ETFs are priced so that the final NAV will be $25.

For any particular ETF you can project the final NAV if you know the time to maturity, coupon yield, YTM, and current price.
iShares has a very helpful tool that allows an investor to model bond ladders, including a projected "Net Acquisition Yield" based on the above factors.

https://www.ishares.com/us/resources/tools/ibonds

iShares also has case studies for its iBonds target date maturity bond ETFs that show the historical performance of these funds. Munis have consistently been fairly close to the estimated Net Acquisition Yield. Corporates were until 2020 when the 2020 and 2021 vintages were off a considerable amount (39 bp for the Dec 2021 fund). I do not know what accounted for the difference (e.g. bond downgrades, the challenges of the Mar 2020 bond market freezeup, lower reinvestment of dividends due to decline in rates, other?)

https://www.ishares.com/us/literature/i ... -en-us.pdf

As I mentioned above, I have used iShares iBonds in the past and am looking at them now. I view them as useful tools in building a fixed income ladder, similar to Treasuries, CDs and MYGAs. In the last two years, MYGAs were the clear winner among these investment tools; currently, it is a closer call among Treasuries, iShares/Bulletshares and MYGAs depending on age, risk profile, liquidity needs and goals.
BackToSchoolDad
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Re: Invesco bullet ETF shares

Post by BackToSchoolDad »

Just wanted to add here that iShares iBonds now have a treasury option which is super compelling. One of the things that kept me away from these products was that they were all in corporate or municipal bonds, which didn't appeal to me.
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Re: Invesco bullet ETF shares

Post by grabiner »

BackToSchoolDad wrote: Mon Apr 04, 2022 7:11 am Just wanted to add here that iShares iBonds now have a treasury option which is super compelling. One of the things that kept me away from these products was that they were all in corporate or municipal bonds, which didn't appeal to me.
However, I don't see the point. With Treasury bonds, you don't need the diversification of a bond fund, so if you want a Treasury investment which liquidates in a particular year, you can just buy an individual Treasury bond maturing that year.
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Re: Invesco bullet ETF shares

Post by crefwatch »

I own some. It's important to understand that any ordinary bond currently selling above par will only be worth $100 when it matures.
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Re: Invesco bullet ETF shares

Post by BackToSchoolDad »

grabiner wrote: Mon Apr 04, 2022 10:26 pm However, I don't see the point. With Treasury bonds, you don't need the diversification of a bond fund, so if you want a Treasury investment which liquidates in a particular year, you can just buy an individual Treasury bond maturing that year.
Very true, I guess it just comes down to convenience. If I was in need of some laddering, I'd rather buy this than individual treasuries, but I'm lazy. It's worth the 7 basis points to me.
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Re: Invesco bullet ETF shares

Post by mega317 »

BackToSchoolDad wrote: Tue Apr 05, 2022 7:08 am
grabiner wrote: Mon Apr 04, 2022 10:26 pm However, I don't see the point. With Treasury bonds, you don't need the diversification of a bond fund, so if you want a Treasury investment which liquidates in a particular year, you can just buy an individual Treasury bond maturing that year.
Very true, I guess it just comes down to convenience. If I was in need of some laddering, I'd rather buy this than individual treasuries, but I'm lazy. It's worth the 7 basis points to me.
I am in the process of reading every thread I can find on these defined maturity bond funds, and bumping this instead of starting the thread I wanted to start. I also don't understand the purpose of a treasury fund and I don't follow your comment above. How is buying a target maturity fund better in any way than buying a treasury?
Just looking today at the iShares website for the next 2 funds:
For 2022 maturity 12/15/22, if you purchase at NAV the yield is 1.03%. But CUSIP 912828YW4 maturing the same day YTM is 1.41%.
For 2023 maturity, if purchased at NAV the yield is 2.1%. But CUSIP 912828V23 maturing 12/31/23 YTM is 2.41%.
The individual treasuries seem no more difficult, no riskier, and with significantly higher yield.
https://www.bogleheads.org/forum/viewtopic.php?t=6212
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Re: Invesco bullet ETF shares

Post by Electron »

mega317 wrote: Mon May 23, 2022 10:53 pmHow is buying a target maturity fund better in any way than buying a treasury? Just looking today at the iShares website for the next 2 funds: For 2022 maturity 12/15/22, if you purchase at NAV the yield is 1.03%. But CUSIP 912828YW4 maturing the same day YTM is 1.41%. The individual treasuries seem no more difficult, no riskier, and with significantly higher yield.
I just checked the holdings in the iShares 2022 Treasury fund and there are securities maturing every month from May through mid December. That would explain the lower yield.

Buying Treasuries is easy both at auction and in the secondary market. The target maturity fund might have a slight advantage if you needed to sell before maturity and rates had gone up.
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Re: Invesco bullet ETF shares

Post by vineviz »

mega317 wrote: Mon May 23, 2022 10:53 pm The individual treasuries seem no more difficult, no riskier, and with significantly higher yield.
If you're comfortable buying individual Treasuries , and your brokerage firm doesn't charge a commission when you buy them, then I'd agree that the target maturity ETFs probably don't offer any real advantage for you (especially the near term ones).

The only plus for the ETF might be auto reinvestment of the income back into the ETF, but if you choose a low coupon Treasury that's also probably not a big deal.

That said, many ETF investors have never bought an individual bond so the target maturity can be a good alternative for those folks. And the other types (corporate, high yield, municipal, emerging markets) offer a clear diversification advantage.
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Invesco Bulletshares ETF

Post by NavyIC3 »

Like to know your thoughts on these. Saw an article in Kiplingers about them.

[Merged into existing thread on topic by Moderator Misenplace]
sycamore
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Re: Invesco Bulletshares ETF

Post by sycamore »

I don't use them myself but I know they've been discussed previously.

Here are some Boglehead threads on the subject: https://www.google.com/search?sitesearc ... shares+etf
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Re: Invesco Bulletshares ETF

Post by Silk McCue »

This sort of question is best served by first searching the Bogleheads site as this a regular topic time. Here is one from April with responses and links to other threads.

viewtopic.php?t=374405

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Re: Invesco Bulletshares ETF

Post by petulant »

After participating in several threads about these types of products (they're similar in concept to the iShares target maturity iBond product), I do not like them for individual investors. Generally an individual investor would be interested in these products because they package bond portfolio diversification into a target maturity end date that is more similar to CDs or individual bonds. So you can get a little credit risk premium with a defined maturity, something you wouldn't get with a total bond ETF or other mutual fund/ETF product.

But unlike CDs or individual bonds, you don't know exactly what you'll get at the end of the maturity date since the maturity amount moves around depending on whether the underlying portfolio of bonds is primarily at par or at a discount. The same uncertainty applies to coupon payments. I think most individual investors buying CDs or individual bonds with a specific maturity need some amount of certainty about these figures 1) because they're designing a ladder strategy and/or 2) the psychological value of individual bonds and CDs is to protect nominal principal value at maturity.

That said, the products are probably fairly priced and there's nothing inherently wrong with them if they fit the investor's needs.
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Re: Invesco bullet ETF shares

Post by Misenplace »

Hi NavyIC3, I merged your question into the previous thread on the topic so that all the information can be in one place.

Thanks to the users who pointed out the previous thread.

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Re: Invesco Bulletshares ETF

Post by vineviz »

petulant wrote: Fri Sep 02, 2022 11:29 am But unlike CDs or individual bonds, you don't know exactly what you'll get at the end of the maturity date since the maturity amount moves around depending on whether the underlying portfolio of bonds is primarily at par or at a discount. The same uncertainty applies to coupon payments.
Although it is true that there is some uncertainty about the final NAV and income payments, the amount of uncertainty is orders of magnitude smaller than the uncertainty associated with traditional bond funds.

Individual Treasuries and/or bank CDs are sometimes good substitutes for target maturity ETFs, but not for all use cases.
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Re: Invesco bullet ETF shares

Post by fundaddy22 »

I find these target maturity bond funds interesting and would consider using them in certain instances.

But, I'd really like to know what happens to the remaining shareholders' investment when a shareholder sells their investment during a period when interest rates have spiked? I understand that the selling shareholder will likely incur a loss. But, my question is, does that sale have any effect on the market value or returns of the remaining shareholders assuming they hold until maturity?

For example, if I were to create a ladder of individual bonds (which is not something I plan to do), my principal would not change if interest rates change (as long as I hold until maturity). So, I'd like to know if using these bond funds to create a ladder will work the same way.

I've been trying to find something in the Blackrock iShares and Invesco's Bullet Shares website and prospectuses with no luck.

Any thoughts would be appreciated.

Thanks,
Steve
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Re: Invesco bullet ETF shares

Post by petulant »

fundaddy22 wrote: Thu Sep 22, 2022 4:53 pm I find these target maturity bond funds interesting and would consider using them in certain instances.

But, I'd really like to know what happens to the remaining shareholders' investment when a shareholder sells their investment during a period when interest rates have spiked? I understand that the selling shareholder will likely incur a loss. But, my question is, does that sale have any effect on the market value or returns of the remaining shareholders assuming they hold until maturity?

For example, if I were to create a ladder of individual bonds (which is not something I plan to do), my principal would not change if interest rates change (as long as I hold until maturity). So, I'd like to know if using these bond funds to create a ladder will work the same way.

I've been trying to find something in the Blackrock iShares and Invesco's Bullet Shares website and prospectuses with no luck.

Any thoughts would be appreciated.

Thanks,
Steve
Interest rate movements causing changes to the market value of bonds can result in the amount received at maturity being different from purchase price, although the overall return should be fair--more or less of the return will be passed through distributions. For example, if the bonds in the index were issued at 6% rates but when packaged into the ETF were yielding 3%, they would have been trading above par at a premium. The ETF's yield would have then been high until maturity, and the amount returned to ETF owners at maturity would be less than they initially paid. And vice versa--if the bonds in the package were issued at 2% but packaged at 3%, then they were packaged at a discount, so the ETF would appear to have low distributions and would mature above the amount paid. Further, these effects can shift over time for the same ETF. A target maturity bond ETF issued in the early 2010s would have had many bonds trading above par, so the effect of larger distributions and declining principal value would have been in effect. However, as new bonds were issued at historic low rates, the figure reversed. So while these products are fairly priced and have fair returns, their maturity figures are not fixed as in the case of a CD or individual bond.
Last edited by petulant on Thu Sep 22, 2022 7:37 pm, edited 1 time in total.
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Re: Invesco bullet ETF shares

Post by vineviz »

fundaddy22 wrote: Thu Sep 22, 2022 4:53 pm But, I'd really like to know what happens to the remaining shareholders' investment when a shareholder sells their investment during a period when interest rates have spiked? I understand that the selling shareholder will likely incur a loss. But, my question is, does that sale have any effect on the market value or returns of the remaining shareholders assuming they hold until maturity?
By definition, if yield on the bonds goes up then the price of the bonds must go down.

So the market value of the bonds will change due to market conditions, but the par value (or maturity value) of the bonds won't change because other ETF shareholders buy or sell the ETF.
fundaddy22 wrote: Thu Sep 22, 2022 4:53 pm For example, if I were to create a ladder of individual bonds (which is not something I plan to do), my principal would not change if interest rates change (as long as I hold until maturity). So, I'd like to know if using these bond funds to create a ladder will work the same way.
Normally "principal" is more akin to "market value" than to "par value" or "maturity value", so I'd say that your principal WOULD change if yields change. But if you continue to hold the bonds (or the target maturity ETF) until redemption, you'll get exactly the cash flows you signed up for.
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Re: Invesco bullet ETF shares

Post by petulant »

vineviz wrote: Thu Sep 22, 2022 5:31 pm
fundaddy22 wrote: Thu Sep 22, 2022 4:53 pm But, I'd really like to know what happens to the remaining shareholders' investment when a shareholder sells their investment during a period when interest rates have spiked? I understand that the selling shareholder will likely incur a loss. But, my question is, does that sale have any effect on the market value or returns of the remaining shareholders assuming they hold until maturity?
By definition, if yield on the bonds goes up then the price of the bonds must go down.

So the market value of the bonds will change due to market conditions, but the par value (or maturity value) of the bonds won't change because other ETF shareholders buy or sell the ETF.
fundaddy22 wrote: Thu Sep 22, 2022 4:53 pm For example, if I were to create a ladder of individual bonds (which is not something I plan to do), my principal would not change if interest rates change (as long as I hold until maturity). So, I'd like to know if using these bond funds to create a ladder will work the same way.
Normally "principal" is more akin to "market value" than to "par value" or "maturity value", so I'd say that your principal WOULD change if yields change. But if you continue to hold the bonds (or the target maturity ETF) until redemption, you'll get exactly the cash flows you signed up for.
But you won't get exactly the cash flows you signed up for--the composition of cash flows between distributions and maturity will fluctuate based on the underlying bond index.
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Re: Invesco bullet ETF shares

Post by Zosima »

petulant wrote: Thu Sep 22, 2022 7:38 pm
vineviz wrote: Thu Sep 22, 2022 5:31 pm
Normally "principal" is more akin to "market value" than to "par value" or "maturity value", so I'd say that your principal WOULD change if yields change. But if you continue to hold the bonds (or the target maturity ETF) until redemption, you'll get exactly the cash flows you signed up for.
But you won't get exactly the cash flows you signed up for--the composition of cash flows between distributions and maturity will fluctuate based on the underlying bond index.
An investor in defined maturity ETFs through Invesco or iShares (or future offerings) at a particular point in time can determine the bonds in the ETF, the interest payments from those bonds and the par value of those bonds at maturity. The market value of the underlying bonds will change based on interest rates but the cash flows are largely known. Subject to the caveat below, a second investor who invests at a different point in time will receive the same cash flows but the mix between the interest payments and premium/discount to par will differ so a second investor will earn more or less than the first investor but the cash flows from the ETF will be identical. The only difference is that the two investors will have paid different prices for those cash flows. In this respect ETFs are like individual bonds, which is why I find them to be useful.

Where ETFs are different than individual bonds is that there will be bonds entering and exiting the fund through new issuances and downgrades that remove them from the index/ETF. These changes should result in a slight decrease in actual return from the stated Adjusted Yield to Maturity published by iShares. Historically, this difference has been between 0 and -40 bp for corporate defined maturity ETFs and +20 and -20 bp for munis. I find defined maturity Treasuries and high yield bonds harder to justify for differing reasons but the difference in Treasuries should be virtually 0 and could be quite significant for high yield bonds.

https://www.ishares.com/us/literature/i ... -en-us.pdf
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Re: Invesco bullet ETF shares

Post by petulant »

Zosima wrote: Fri Sep 23, 2022 6:22 am
petulant wrote: Thu Sep 22, 2022 7:38 pm
vineviz wrote: Thu Sep 22, 2022 5:31 pm
Normally "principal" is more akin to "market value" than to "par value" or "maturity value", so I'd say that your principal WOULD change if yields change. But if you continue to hold the bonds (or the target maturity ETF) until redemption, you'll get exactly the cash flows you signed up for.
But you won't get exactly the cash flows you signed up for--the composition of cash flows between distributions and maturity will fluctuate based on the underlying bond index.
An investor in defined maturity ETFs through Invesco or iShares (or future offerings) at a particular point in time can determine the bonds in the ETF, the interest payments from those bonds and the par value of those bonds at maturity. The market value of the underlying bonds will change based on interest rates but the cash flows are largely known. Subject to the caveat below, a second investor who invests at a different point in time will receive the same cash flows but the mix between the interest payments and premium/discount to par will differ so a second investor will earn more or less than the first investor but the cash flows from the ETF will be identical. The only difference is that the two investors will have paid different prices for those cash flows. In this respect ETFs are like individual bonds, which is why I find them to be useful.

Where ETFs are different than individual bonds is that there will be bonds entering and exiting the fund through new issuances and downgrades that remove them from the index/ETF. These changes should result in a slight decrease in actual return from the stated Adjusted Yield to Maturity published by iShares. Historically, this difference has been between 0 and -40 bp for corporate defined maturity ETFs and +20 and -20 bp for munis. I find defined maturity Treasuries and high yield bonds harder to justify for differing reasons but the difference in Treasuries should be virtually 0 and could be quite significant for high yield bonds.

https://www.ishares.com/us/literature/i ... -en-us.pdf
Okay, I'm going to put together a numerical example to illustrate what I'm talking about since something isn't clicking. For simplicity, I will be using time value of money formulas in Excel rather than precise bond formulas.

The example is going focus on a target maturity ETF issued in 2017 and maturing in 2027. At inception, it contained a single 30-year bond originally issued in 1997. When the bond was issued by MegaCorp A, the bond had an 7.5% coupon, but by 2017 the market rate had dropped to 3% (FRED data here; check April 1997 and April 2017), so the bond was trading at a premium around $38.39. That's =PV(0.03,10,-7.5,-100)-100. Thus, if the initial ETF share is $25, the investor would expect to receive distributions of 5.42% or $1.35 each year (100/138.39 * .075 = .0542; .0542 * 25 = 1.3549). However, the investor will only expect about $18.06 at maturity (100/138.39 * 25), which results in a fair yield to maturity of 3%. Let's say the investor bought the ETF at inception. Here is the first point where an uneducated investor can be led astray--the marketing for these products may not make it obvious that the investor is going to get $18.06 at maturity instead of $25.

Let's say that one year after inception and purchase by the investor, a new 9-year bond was issued by MegaCorp B, this time with a coupon rate of 3.5% (from FRED). Half of the ETF's assets quickly become invested in this bond. (We will assume the new asset was added in conjunction with new money entering the fund or some other reason for no tax consequences on any sales of the old bond.) Before shifting assets, the MegaCorp A bond had moved to a premium of only $30.43 from =PV(.035,9,-7.5,-100)-100 since interest rates went up to 3.5%. So the ETF would be now be trading around 130.43/138.39 * 25 = $23.56, same distributions of $1.35, and new yield to maturity of 3.5%. After the new bond is added to the ETF, distributions become about $1.09 (that's .035*23.56*.5+1.3549/2). And the amount to be realized at maturity becomes $20.81 (that's 18.065*.5+23.56*.5). The new yield to maturity from market value of $23.56 is still 3.5%, the same it was before the new bond was added. Yes, a new investor buying in now can see the new cash flows. But the old investor's expected cash flows have materially shifted with respect to the composition between distributions and the amount to be received at maturity: the maturity amount is much higher, but the distributions will be materially lower (almost 20% lower). I want to be clear, nobody is being robbed--the yield to maturity (3.5%) is still fair. But it's the composition of the cash flows that I'm saying is volatile and which makes these products undesirable for many use cases like bond ladders or as CD substitutes with psychological confidence in the maturity principal.

These numbers would continue to jump around after 2017 and 2018. Corporations would continue to issue bonds with shorter maturities, which would be constantly recycled into the index--imagine the significant issuance in later 2020 and early 2021 at historic low interest rates, and then the current climb up. (And similar shifts would be happening from yield curve fluctuations and average credit spread fluctuations in the underlying index!) The investor is never certain what the composition will be between distributions and maturity amount, although to be fair the range of variability would narrow dramatically as the ETF ages from inception to being 2-3 years from maturity. In other words, this effect is biggest for ETFs with 5-10 years until maturity.
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Re: Invesco bullet ETF shares

Post by vineviz »

petulant wrote: Fri Sep 23, 2022 7:39 am These numbers would continue to jump around after 2017 and 2018. Corporations would continue to issue bonds with shorter maturities, which would be constantly recycled into the index--imagine the significant issuance in later 2020 and early 2021 at historic low interest rates, and then the current climb up.
This effect is certainly real, and I should have mentioned it.

It's also the case, though, that the strong majority (>80%) of corporate debt is issued with a maturity of 10 years or greater. This is why BlackRock and Invesco typically don't create new target maturity ETFs with redemption dates much more 10 years out (and even less in some categories, like municipal bonds and high yield bonds).

In implementation, the variation in monthly distributions will be swamped by the predictability in the redemption value. For someone either building a ladder or targeting a single expense, the overall cash flows can be described as "predictable" IMHO.
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Re: Invesco bullet ETF shares

Post by petulant »

vineviz wrote: Fri Sep 23, 2022 8:10 am
petulant wrote: Fri Sep 23, 2022 7:39 am These numbers would continue to jump around after 2017 and 2018. Corporations would continue to issue bonds with shorter maturities, which would be constantly recycled into the index--imagine the significant issuance in later 2020 and early 2021 at historic low interest rates, and then the current climb up.
This effect is certainly real, and I should have mentioned it.

It's also the case, though, that the strong majority (>80%) of corporate debt is issued with a maturity of 10 years or greater. This is why BlackRock and Invesco typically don't create new target maturity ETFs with redemption dates much more 10 years out (and even less in some categories, like municipal bonds and high yield bonds).

In implementation, the variation in monthly distributions will be swamped by the predictability in the redemption value. For someone either building a ladder or targeting a single expense, the overall cash flows can be described as "predictable" IMHO.
I don't think that's right. In 2019 S&P reported that a strong majority of corporate debt was issued with maturity of 13 years or less, with a huge peak in the "7 to 13 years" range, which I infer is going to clump at 10 years. So the bundle of bonds at inception for a target maturity ETF is going to be a mix of old bonds and very recent 10-year bonds, and then it will have a huge shift immediately for more new issues at the 10 year mark, and then it's still going to shift for 3, 5, and 7-year issues as it approaches maturity. https://www.spglobal.com/en/research-in ... ay-in-2019

For example, the iShares corporate bond ETF for 2032 had an inception date on June 28, 2022. So right off the bat, it will still be collecting new 10-year bonds issued in the second half of 2022 (and even those issued in late May or June not yet included in the index). I think it is very realistic to imagine that the bundle of bonds at inception of a target date ETF can move by 35%, and even still by as much as 20% once the ETF is completely past picking up new 10-year issues.
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Re: Invesco bullet ETF shares

Post by vineviz »

petulant wrote: Fri Sep 23, 2022 8:52 am For example, the iShares corporate bond ETF for 2032 had an inception date on June 28, 2022. So right off the bat, it will still be collecting new 10-year bonds issued in the second half of 2022 (and even those issued in late May or June not yet included in the index). I think it is very realistic to imagine that the bundle of bonds at inception of a target date ETF can move by 35%, and even still by as much as 20% once the ETF is completely past picking up new 10-year issues.
You may be right.

Historically, corporations have issued relatively few 7-year bonds but I think I significantly underestimated the amount of new 5-year bonds being issued. And there was certainly a surge in new issuance of shorter term bonds in 2020-2022.

For instance, only about 70% of iShares iBonds Dec 2023 Term Corporate ETF (by market value) was issued in 2019 or earlier. Another 19% was issued in 2020 and 11% in 2021.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Zosima
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Re: Invesco bullet ETF shares

Post by Zosima »

petulant wrote: Fri Sep 23, 2022 7:39 am
Okay, I'm going to put together a numerical example to illustrate what I'm talking about since something isn't clicking. For simplicity, I will be using time value of money formulas in Excel rather than precise bond formulas.

The example is going focus on a target maturity ETF issued in 2017 and maturing in 2027. At inception, it contained a single 30-year bond originally issued in 1997. When the bond was issued by MegaCorp A, the bond had an 7.5% coupon, but by 2017 the market rate had dropped to 3% (FRED data here; check April 1997 and April 2017), so the bond was trading at a premium around $38.39. That's =PV(0.03,10,-7.5,-100)-100. Thus, if the initial ETF share is $25, the investor would expect to receive distributions of 5.42% or $1.35 each year (100/138.39 * .075 = .0542; .0542 * 25 = 1.3549). However, the investor will only expect about $18.06 at maturity (100/138.39 * 25), which results in a fair yield to maturity of 3%. Let's say the investor bought the ETF at inception. Here is the first point where an uneducated investor can be led astray--the marketing for these products may not make it obvious that the investor is going to get $18.06 at maturity instead of $25.

Let's say that one year after inception and purchase by the investor, a new 9-year bond was issued by MegaCorp B, this time with a coupon rate of 3.5% (from FRED). Half of the ETF's assets quickly become invested in this bond. (We will assume the new asset was added in conjunction with new money entering the fund or some other reason for no tax consequences on any sales of the old bond.) Before shifting assets, the MegaCorp A bond had moved to a premium of only $30.43 from =PV(.035,9,-7.5,-100)-100 since interest rates went up to 3.5%. So the ETF would be now be trading around 130.43/138.39 * 25 = $23.56, same distributions of $1.35, and new yield to maturity of 3.5%. After the new bond is added to the ETF, distributions become about $1.09 (that's .035*23.56*.5+1.3549/2). And the amount to be realized at maturity becomes $20.81 (that's 18.065*.5+23.56*.5). The new yield to maturity from market value of $23.56 is still 3.5%, the same it was before the new bond was added. Yes, a new investor buying in now can see the new cash flows. But the old investor's expected cash flows have materially shifted with respect to the composition between distributions and the amount to be received at maturity: the maturity amount is much higher, but the distributions will be materially lower (almost 20% lower). I want to be clear, nobody is being robbed--the yield to maturity (3.5%) is still fair. But it's the composition of the cash flows that I'm saying is volatile and which makes these products undesirable for many use cases like bond ladders or as CD substitutes with psychological confidence in the maturity principal.

These numbers would continue to jump around after 2017 and 2018. Corporations would continue to issue bonds with shorter maturities, which would be constantly recycled into the index--imagine the significant issuance in later 2020 and early 2021 at historic low interest rates, and then the current climb up. (And similar shifts would be happening from yield curve fluctuations and average credit spread fluctuations in the underlying index!) The investor is never certain what the composition will be between distributions and maturity amount, although to be fair the range of variability would narrow dramatically as the ETF ages from inception to being 2-3 years from maturity. In other words, this effect is biggest for ETFs with 5-10 years until maturity.
Thank you for sharing this example; it was very useful. I think I understand your point: The monthly dividends from defined maturity ETFs are inherently unpredictable. The implication is that investors who are looking for predictable cash flow should invest in individual bonds, CDs, MYGAs and similar investments with known cash flows.
petulant wrote: Fri Sep 23, 2022 7:39 am
The new yield to maturity from market value of $23.56 is still 3.5%, the same it was before the new bond was added. Yes, a new investor buying in now can see the new cash flows. But the old investor's expected cash flows have materially shifted with respect to the composition between distributions and the amount to be received at maturity: the maturity amount is much higher, but the distributions will be materially lower (almost 20% lower). I want to be clear, nobody is being robbed--the yield to maturity (3.5%) is still fair. But it's the composition of the cash flows that I'm saying is volatile and which makes these products undesirable for many use cases like bond ladders or as CD substitutes with psychological confidence in the maturity principal.
I believe the highlighted statements also indicate that for investors who are looking to build out a fixed income ladder and intend on reinvesting dividends (similar to an investment in a zero coupon bond or TIPS' inflation adjustment), defined maturity ETFs could have a role (along with Treasuries, CDs, MYGAs, individual bonds, etc.). When I invest in an investment grade defined maturity ETF and reinvest the dividends, I will have a good approximation (not 100% exact but close enough for my purposes) of the amount I will receive at the end.
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Re: Invesco bullet ETF shares

Post by petulant »

Zosima wrote: Fri Sep 23, 2022 12:04 pm
petulant wrote: Fri Sep 23, 2022 7:39 am
The new yield to maturity from market value of $23.56 is still 3.5%, the same it was before the new bond was added. Yes, a new investor buying in now can see the new cash flows. But the old investor's expected cash flows have materially shifted with respect to the composition between distributions and the amount to be received at maturity: the maturity amount is much higher, but the distributions will be materially lower (almost 20% lower). I want to be clear, nobody is being robbed--the yield to maturity (3.5%) is still fair. But it's the composition of the cash flows that I'm saying is volatile and which makes these products undesirable for many use cases like bond ladders or as CD substitutes with psychological confidence in the maturity principal.
I believe the highlighted statements also indicate that for investors who are looking to build out a fixed income ladder and intend on reinvesting dividends (similar to an investment in a zero coupon bond or TIPS' inflation adjustment), defined maturity ETFs could have a role (along with Treasuries, CDs, MYGAs, individual bonds, etc.). When I invest in an investment grade defined maturity ETF and reinvest the dividends, I will have a good approximation (not 100% exact but close enough for my purposes) of the amount I will receive at the end.
I think you're right that it's manageable to just reinvest extra distributions if interest rates rise and the sum of distributions and maturities in a ladder year become too large. But what happens if interest rates drop, new issues are included in the ETF, and distributions are lower than expected, as in my example above? What would you recommend the investor do when their cash-on-hand from all distributions and maturities in a ladder year are lower than expected, or how would you design the ladder to mitigate this risk?
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Re: Invesco bullet ETF shares

Post by Zosima »

petulant wrote: Fri Sep 23, 2022 1:12 pm
Zosima wrote: Fri Sep 23, 2022 12:04 pm
petulant wrote: Fri Sep 23, 2022 7:39 am
The new yield to maturity from market value of $23.56 is still 3.5%, the same it was before the new bond was added. Yes, a new investor buying in now can see the new cash flows. But the old investor's expected cash flows have materially shifted with respect to the composition between distributions and the amount to be received at maturity: the maturity amount is much higher, but the distributions will be materially lower (almost 20% lower). I want to be clear, nobody is being robbed--the yield to maturity (3.5%) is still fair. But it's the composition of the cash flows that I'm saying is volatile and which makes these products undesirable for many use cases like bond ladders or as CD substitutes with psychological confidence in the maturity principal.
I believe the highlighted statements also indicate that for investors who are looking to build out a fixed income ladder and intend on reinvesting dividends (similar to an investment in a zero coupon bond or TIPS' inflation adjustment), defined maturity ETFs could have a role (along with Treasuries, CDs, MYGAs, individual bonds, etc.). When I invest in an investment grade defined maturity ETF and reinvest the dividends, I will have a good approximation (not 100% exact but close enough for my purposes) of the amount I will receive at the end.
I think you're right that it's manageable to just reinvest extra distributions if interest rates rise and the sum of distributions and maturities in a ladder year become too large. But what happens if interest rates drop, new issues are included in the ETF, and distributions are lower than expected, as in my example above? What would you recommend the investor do when their cash-on-hand from all distributions and maturities in a ladder year are lower than expected, or how would you design the ladder to mitigate this risk?
Personally, I simply accept it as an inherent feature of a defined maturity ETF. The recent corporate defined maturity ETFs are probably a good example because as you pointed out there were a lot of new, lower yielding issuances in 2020 and 2021 which had a negative effect on returns due to lower reinvestment. According to iShares, this had a negative variance of 29 bp for the 2020 maturity and 39 bp for the 2021 maturity. These are outliers as 9 of the other 10 cohorts were within 10bp of expected yield to maturity (the March 2020 cohort was the other exception which may or may not have been pandemic related).

https://www.ishares.com/us/literature/i ... -en-us.pdf

To get more granular, if an investor invests $50,000 in a 10-year defined maturity ETF with an adjusted yield to maturity of 5.4% (approximate yield on IBDX) and is able to achieve that result after reinvesting all dividends, the final payout would be $84,609. If the actual yield to maturity were only 5.0% due to downgrades, lower reinvestment, prepayments or other reasons, the final payout would be $81,444. This variance is far lower than if I kept it in an intermediate bond fund. I am OK with that level of variance, in part because I also have TIPS and rollover MYGAs as part of my overall ladder. Other investors may want more precision in the final payout, in which case they should not invest in defined maturity corporate ETFs.
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Re: Invesco bullet ETF shares

Post by Hebell »

^^^ same here. An integral part of my nominal bond portion of my portfolio.
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Re: Invesco bullet ETF shares

Post by petulant »

Zosima wrote: Fri Sep 23, 2022 1:39 pm
petulant wrote: Fri Sep 23, 2022 1:12 pm
Zosima wrote: Fri Sep 23, 2022 12:04 pm
petulant wrote: Fri Sep 23, 2022 7:39 am
The new yield to maturity from market value of $23.56 is still 3.5%, the same it was before the new bond was added. Yes, a new investor buying in now can see the new cash flows. But the old investor's expected cash flows have materially shifted with respect to the composition between distributions and the amount to be received at maturity: the maturity amount is much higher, but the distributions will be materially lower (almost 20% lower). I want to be clear, nobody is being robbed--the yield to maturity (3.5%) is still fair. But it's the composition of the cash flows that I'm saying is volatile and which makes these products undesirable for many use cases like bond ladders or as CD substitutes with psychological confidence in the maturity principal.
I believe the highlighted statements also indicate that for investors who are looking to build out a fixed income ladder and intend on reinvesting dividends (similar to an investment in a zero coupon bond or TIPS' inflation adjustment), defined maturity ETFs could have a role (along with Treasuries, CDs, MYGAs, individual bonds, etc.). When I invest in an investment grade defined maturity ETF and reinvest the dividends, I will have a good approximation (not 100% exact but close enough for my purposes) of the amount I will receive at the end.
I think you're right that it's manageable to just reinvest extra distributions if interest rates rise and the sum of distributions and maturities in a ladder year become too large. But what happens if interest rates drop, new issues are included in the ETF, and distributions are lower than expected, as in my example above? What would you recommend the investor do when their cash-on-hand from all distributions and maturities in a ladder year are lower than expected, or how would you design the ladder to mitigate this risk?
Personally, I simply accept it as an inherent feature of a defined maturity ETF. The recent corporate defined maturity ETFs are probably a good example because as you pointed out there were a lot of new, lower yielding issuances in 2020 and 2021 which had a negative effect on returns due to lower reinvestment. According to iShares, this had a negative variance of 29 bp for the 2020 maturity and 39 bp for the 2021 maturity. These are outliers as 9 of the other 10 cohorts were within 10bp of expected yield to maturity (the March 2020 cohort was the other exception which may or may not have been pandemic related).

https://www.ishares.com/us/literature/i ... -en-us.pdf

To get more granular, if an investor invests $50,000 in a 10-year defined maturity ETF with an adjusted yield to maturity of 5.4% (approximate yield on IBDX) and is able to achieve that result after reinvesting all dividends, the final payout would be $84,609. If the actual yield to maturity were only 5.0% due to downgrades, lower reinvestment, prepayments or other reasons, the final payout would be $81,444. This variance is far lower than if I kept it in an intermediate bond fund. I am OK with that level of variance, in part because I also have TIPS and rollover MYGAs as part of my overall ladder. Other investors may want more precision in the final payout, in which case they should not invest in defined maturity corporate ETFs.
I think we're talking past each other a bit here. I agree with you that the total returns will be fair for the asset class, so if investors are using target maturity ETFs as a general way to achieve a total return with a specific maturity, they're fairly priced and constructed. As a way to generally control duration, they may be reasonable (but I'm unsure). Yet often investors are interested in target maturity bonds specifically to construct ladders where for each year, bonds maturing that year plus distributions from all future maturity years are used to fund a specific portion of living expenses. If the composition of cashflows between distributions and maturity is volatile, this will not work. So, they shouldn't use these products, or they need some type of additional buffer.
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Re: Invesco bullet ETF shares

Post by Zosima »

petulant wrote: Fri Sep 23, 2022 1:51 pm
I think we're talking past each other a bit here. I agree with you that the total returns will be fair for the asset class, so if investors are using target maturity ETFs as a general way to achieve a total return with a specific maturity, they're fairly priced and constructed.


Yet often investors are interested in target maturity bonds specifically to construct ladders where for each year, bonds maturing that year plus distributions from all future maturity years are used to fund a specific portion of living expenses. If the composition of cashflows between distributions and maturity is volatile, this will not work. So, they shouldn't use these products, or they need some type of additional buffer.
I think we are aligned. Defined maturity bond ETFs are a specific tool for specific purposes. They work well in the first set of examples but do not work well for the second set of examples.
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Re: Invesco bullet ETF shares

Post by vineviz »

petulant wrote: Fri Sep 23, 2022 1:51 pm Yet often investors are interested in target maturity bonds specifically to construct ladders where for each year, bonds maturing that year plus distributions from all future maturity years are used to fund a specific portion of living expenses. If the composition of cashflows between distributions and maturity is volatile, this will not work. So, they shouldn't use these products, or they need some type of additional buffer.
I disagree.

The amount of volatility you're talking about is negligible in this use case: maybe +/- 5% in any given year. If someone is expecting, say, $25k in income then I think it's unreasonable for them to avoid the ladder because the income might be $23,700 or $26,250.

Besides, what's the alternative? Building a ladder out of individual corporate or municipal bonds is incredibly complicated and expensive at small scale.
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Re: Invesco bullet ETF shares

Post by petulant »

vineviz wrote: Fri Sep 23, 2022 2:43 pm
petulant wrote: Fri Sep 23, 2022 1:51 pm Yet often investors are interested in target maturity bonds specifically to construct ladders where for each year, bonds maturing that year plus distributions from all future maturity years are used to fund a specific portion of living expenses. If the composition of cashflows between distributions and maturity is volatile, this will not work. So, they shouldn't use these products, or they need some type of additional buffer.
I disagree.

The amount of volatility you're talking about is negligible in this use case: maybe +/- 5% in any given year. If someone is expecting, say, $25k in income then I think it's unreasonable for them to avoid the ladder because the income might be $23,700 or $26,250.

Besides, what's the alternative? Building a ladder out of individual corporate or municipal bonds is incredibly complicated and expensive at small scale.
I don't think 5% is negligible unless there's some kind of other buffer to cheerfully draw down. The obvious alternatives are treasury bonds, CDs, and MYGAs. MYGAs have the added benefit of deferring taxes.
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Re: Invesco bullet ETF shares

Post by vineviz »

petulant wrote: Fri Sep 23, 2022 2:50 pm
vineviz wrote: Fri Sep 23, 2022 2:43 pm
petulant wrote: Fri Sep 23, 2022 1:51 pm Yet often investors are interested in target maturity bonds specifically to construct ladders where for each year, bonds maturing that year plus distributions from all future maturity years are used to fund a specific portion of living expenses. If the composition of cashflows between distributions and maturity is volatile, this will not work. So, they shouldn't use these products, or they need some type of additional buffer.
I disagree.

The amount of volatility you're talking about is negligible in this use case: maybe +/- 5% in any given year. If someone is expecting, say, $25k in income then I think it's unreasonable for them to avoid the ladder because the income might be $23,700 or $26,250.

Besides, what's the alternative? Building a ladder out of individual corporate or municipal bonds is incredibly complicated and expensive at small scale.
I don't think 5% is negligible unless there's some kind of other buffer to cheerfully draw down. The obvious alternatives are treasury bonds, CDs, and MYGAs. MYGAs have the added benefit of deferring taxes.
The ladder itself can serve as a buffer. Indeed it is very liquid, in contrast to some of the alternatives you suggest, as well as potentially offering higher yields and longer terms.
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Re: Invesco bullet ETF shares

Post by fundaddy22 »

Yuk!

Petulant, thanks for that example. I have a background in math/actuarial science and I understand your calculations. I had a feeling there would be some underlying mechanIcs like that and that were obviously not laid out in the prospectus/marketing materials.

As your example shows, if you buy a bullet ETF when market rates are at 3%, you get 3% over the time horizon. If you buy in at 6%, you get 6%, and so on. It's just the timing of the cash flows that are different. That's fair enough.

So, now I turn my attention to comparing these bullet ETFs to traditional bond funds (I've owned Vanguard bond funds for years). How would you describe the mechanics in this case?

For example, let's say I invest in the Vanguard Intermediate Term Bond Fund. So: (a) If you buy in at 3% 5 years ago (i.e., when market rates were 3%) you get a 3% return (I think?), and (b) if you buy in today, assuming market rates are 6% today, you get a 6% return (I think?). But, if market rates go up to 10% in 5 years and you sell, what would your yield be in case (a) and in case (b)?

I hope I'm not over thinking this. I'm just trying to figure out if I want create a ladder with bullet ETFs with part of my bold portfolio.

Thanks
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Re: Invesco bullet ETF shares

Post by grabiner »

fundaddy22 wrote: Sun Sep 25, 2022 1:39 pm So, now I turn my attention to comparing these bullet ETFs to traditional bond funds (I've owned Vanguard bond funds for years). How would you describe the mechanics in this case?

For example, let's say I invest in the Vanguard Intermediate Term Bond Fund. So: (a) If you buy in at 3% 5 years ago (i.e., when market rates were 3%) you get a 3% return (I think?), and (b) if you buy in today, assuming market rates are 6% today, you get a 6% return (I think?). But, if market rates go up to 10% in 5 years and you sell, what would your yield be in case (a) and in case (b)?
The only way to be certain of the return on a bond is to hold it to maturity. Intermediate-term bond funds don't do this; they buy bonds, and then sell the bonds several years before maturity.

All calculations below are approximate; there are second-order effects which cause numbers not to add up quite as expected, but that is not the main point and I would like to keep the discussion understandable to non-mathematicians.

The one year return on a bond fund will be very close to the current yield, minus the product of interest-rate increases and the duration. For example, Vanguard Intermediate-Term Bond Index currently yields 4.03%, and has a duration of 6.4 years. If interest rates don't change, the fund will earn 4.03% (actually slightly more because each individual bond gets one year closer to maturity, and thus the yield on that bond will decline if the constant-maturity yield is stable). If the yields on the bonds in the fund rise by 1%, the fund will lose 6.4% of its value, but the future returns will now be 1% higher. If yields rise by 1% tomorrow, the one-year return would be 5.03%-6.40%=-1.37%. If yields are flat but rise by 1% one year from today, the one-year return would be -2.37%. If yields rise steadily over the year, the one-year return would be -1.87%.

The math works out similarly over a longer time period, and eventually the increased yield will make up for the immediate loss. The duration is the point of indifference to a change today. That is, if yields change today, then stay level for the next 6.4 years, the 6.4-year annualized return will be 4.03%. But you can still get a lower return if you hold the fund for 6.4 years, because rates might rise several years in the future. If the rise in yields is steady over twice the duration, then the average time since the rising yield is equal to the duration, and you are again indifferent.

So, given your example, suppose you buy a bond fund with a 6% yield and a 5-year duration, and yields rise to 10%. If that rise is at a steady rate, your average yield on the bonds is 8%. The rise of 0.8% per year costs you 4%, so your annualized return will be 4%. (For such a large change, the secondary effects become significant. The duration of a non-callable bond decreases when its yield increases, so you will come out slightly ahead. But if you buy a fund with mostly callable bonds, such as a muni fund, the duration will increase and you will lose more than expected after a large rise in rates.)
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Re: Invesco bullet ETF shares

Post by petulant »

fundaddy22 wrote: Sun Sep 25, 2022 1:39 pm Yuk!

Petulant, thanks for that example. I have a background in math/actuarial science and I understand your calculations. I had a feeling there would be some underlying mechanIcs like that and that were obviously not laid out in the prospectus/marketing materials.

As your example shows, if you buy a bullet ETF when market rates are at 3%, you get 3% over the time horizon. If you buy in at 6%, you get 6%, and so on. It's just the timing of the cash flows that are different. That's fair enough.

So, now I turn my attention to comparing these bullet ETFs to traditional bond funds (I've owned Vanguard bond funds for years). How would you describe the mechanics in this case?

For example, let's say I invest in the Vanguard Intermediate Term Bond Fund. So: (a) If you buy in at 3% 5 years ago (i.e., when market rates were 3%) you get a 3% return (I think?), and (b) if you buy in today, assuming market rates are 6% today, you get a 6% return (I think?). But, if market rates go up to 10% in 5 years and you sell, what would your yield be in case (a) and in case (b)?

I hope I'm not over thinking this. I'm just trying to figure out if I want create a ladder with bullet ETFs with part of my bold portfolio.

Thanks
I agree with grabiner's post. Also there are also lots of threads on BH and also the wiki to review bond fund math. The takeaway is going to be pretty similar as the takeaway on the target maturity ETF--some people are going to be be more comfortable with the volatility of bond funds and are interested in duration exposure because it hedges future needs, some are going to be okay with bond fund volatility because it's all fair returns and efficient markets and rebalanced with stocks, while others are nervous about bond fund volatility. My suggestion would be that the kind of people nervous about bond funds are often the kind of people who build ladders etc. and are the same people who needed my explanation on the target maturity ETFs.
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