Interest rates can only go up, why go intermediate in bonds?

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mathwhiz
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Interest rates can only go up, why go intermediate in bonds?

Post by mathwhiz » Sat Jul 18, 2009 11:36 pm

I see the total bond fund and intermediate treasuries recommended a lot on here. I know people don't like to market time but interest rates are currently zero and whether rates rise in 2010 or 2011 or 2015, eventually they will rise and intermediate term bonds will get hit.

So isn't it wise to go short in this environment where rates can only go up?

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Re: Interest rates can only go up, why go intermediate in bo

Post by zapper » Sat Jul 18, 2009 11:49 pm

mathwhiz wrote:I see the total bond fund and intermediate treasuries recommended a lot on here. I know people don't like to market time but interest rates are currently zero and whether rates rise in 2010 or 2011 or 2015, eventually they will rise and intermediate term bonds will get hit.

So isn't it wise to go short in this environment where rates can only go up?
Interest rates may indeed go up, I supect that they will. It looks to me though that the market is concerned about possible deflation (see Japan). If we do experience deflation, intermediate and long term bonds will do very well.

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Re: Interest rates can only go up, why go intermediate in bo

Post by yobria » Sun Jul 19, 2009 1:07 am

mathwhiz wrote:I see the total bond fund and intermediate treasuries recommended a lot on here. I know people don't like to market time but interest rates are currently zero and whether rates rise in 2010 or 2011 or 2015, eventually they will rise and intermediate term bonds will get hit.
The interest rate on the Vanguard Total Market Bond fund is 4%, not 0%. Japanese interest rates were low 15 years ago, and all they did was go lower. How can you be sure they will "eventually rise" during your time horizon?

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Post by traineeinvestor » Sun Jul 19, 2009 2:11 am

If interest rates rise, then you would expect bond prices to decline (with greater declines in longer dated and lower coupon bonds) in which case moving to shorter dated instruments (or even cash) may be a better strategy than holding bonds with medium or longer term maturities.

Of course, as others have pointed out, it is not a given that interest rates will rise any time soon - they may or they may not rise. If interest rates remain low or go lower then a 4% yield could end up looking like a very nice investment.

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mathwhiz
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Post by mathwhiz » Sun Jul 19, 2009 2:55 am

The interest rate on the Vanguard Total Market Bond fund is 4%, not 0%.
The benchmark fed funds rate is currently 0-0.25%. When, not if, but when, this increases it will negatively impact bond prices.

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Re: Interest rates can only go up, why go intermediate in bo

Post by Valuethinker » Sun Jul 19, 2009 3:34 am

mathwhiz wrote:I see the total bond fund and intermediate treasuries recommended a lot on here. I know people don't like to market time but interest rates are currently zero and whether rates rise in 2010 or 2011 or 2015, eventually they will rise and intermediate term bonds will get hit.

So isn't it wise to go short in this environment where rates can only go up?
Your premise is incorrect. Therefore your conclusion does not follow.

If you look at Japanese Government Bond Yields, you can see that US government bond yields can fall to 1.5%. And stay there.

As a bond investor, you care about yields, not interest rates.

I would be the first to admit this is unlikely. But it is certainly possible.

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Post by DennisRoche » Sun Jul 19, 2009 5:21 am

While you could be right that interest rates in 5 years will be higher than they are now, this is not certain. You'll be losing about 3.5%/yr in interest while you wait it out. If you guess right, but not as fast as you expected, you'll still come out behind by having lost the interest along the way. Also, keep in mind the volatility of intermediate bonds isn't that great, nothing like stocks. Bad timing is not as costly in intermediate bonds as it is in stocks.

Tough to own bonds while rates rise (as you note), but also tough to put all that FI in ST/MM at nearly 0% rates, while waiting for better rates. How would you feel in 4 yrs if rates stay flat? Might be better to buy TIPS maturing in 5-6 yrs. At least you get 1.5% plus inflation. Then you can reinvest in intermediate bonds in 2015 assuming your theory is right and rates are higher.

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Post by gw » Sun Jul 19, 2009 7:00 am

How soon and by how much do interest rates need to go up in order to make short-term bonds a better deal than intermediate-term bonds?

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Post by nisiprius » Sun Jul 19, 2009 7:06 am

What do you know that the market doesn't know? Why don't you think this has already been priced in?
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Post by livesoft » Sun Jul 19, 2009 7:22 am

DennisRoche wrote:While you could be right that interest rates in 5 years will be higher than they are now, this is not certain. You'll be losing about 3.5%/yr in interest while you wait it out. ....
mathwhiz wrote "go short in this environment", not go to cash. Short-term bond funds are paying about 4% so no loss of interest by staying out of total bond and intermediate bond.

Indeed, there really is no reason not to avoid long-term bonds at the present time. The duration of intermediate term bond funds seems to have shortened up to 4.4 years or less. Many of the non-Vanguard intermediate term bond funds seem to have an unusual fraction of cash in them.

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Post by Maxwell Smart » Sun Jul 19, 2009 7:37 am

Short-term bond funds are paying about 4%
Which ones?

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Post by livesoft » Sun Jul 19, 2009 7:52 am

Maxwell Smart wrote:
Short-term bond funds are paying about 4%
Which ones?
The ones at Vanguard.

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Post by gw » Sun Jul 19, 2009 8:15 am

livesoft wrote:
Maxwell Smart wrote:
Short-term bond funds are paying about 4%
Which ones?
The ones at Vanguard.
C'mon, you know it's not fair to compare the total bond market index (3.87% yield) or the intermediate-term bond index (4.48%) to short-term investment grade (3.56%), which is the closest a short-term fund comes to meeting your claim [Edit: see below]. The short-term index is the fair comparison, and it returns only 2.01%.

Since index funds mix different types of bonds, maybe it's fairer to separately compare short-term and intermediate-term treasuries (1.05% and 2.42%) or short-term and intermediate-term corporates (3.56% and 5.27%).

[Edit: dm200 pointed out that GNMA pays 4.05%, and might be considered a short-term fund. GNMA is complicated, and I'll stand by my point about fair comparisons.]
Last edited by gw on Sun Jul 19, 2009 8:47 am, edited 1 time in total.

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Post by Munir » Sun Jul 19, 2009 8:31 am

If one doesn't get lost in the classification of bond funds, the facts are that Short Term Inv. Grade has a duration of 2 years and SEC yield of 3.68% compared to Total Bond Index with a duartion of 4.3 years and SEC yield of 3.96%. Even though it is a very short term period and not too significant for long term holders, the YTD perormance is 9.05% for the Short Term Inv. Gr. Fund and 2.35% for Total Bond Index. (All numbers from the Vanguard web site). The OP's question is a valid one.

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Post by dm200 » Sun Jul 19, 2009 8:37 am

livesoft wrote:
Maxwell Smart wrote:
Short-term bond funds are paying about 4%
Which ones?
The ones at Vanguard.
Vanguard GNMA is paying over 4% now.

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Re: Interest rates can only go up, why go intermediate in bo

Post by tibbitts » Sun Jul 19, 2009 8:49 am

mathwhiz wrote:I see the total bond fund and intermediate treasuries recommended a lot on here. I know people don't like to market time but interest rates are currently zero and whether rates rise in 2010 or 2011 or 2015, eventually they will rise and intermediate term bonds will get hit.

So isn't it wise to go short in this environment where rates can only go up?
In the meantime, many people have two choices:

1. use longer term bonds and spend the interest/dividends;

2. use shorter term funds and spend the principal, plus the interest and dividends.

In the end, I don't think it will make much difference, and certainly not any predictable difference. While it's true that if you could get the timing a little more precise than the five-year range you provided (which might be 10, or 20 years, too), you could profit (or avoid losses) from interest rate moves, you probably can't.

Paul

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Post by gw » Sun Jul 19, 2009 8:51 am

Munir wrote:If one doesn't get lost in the classification of bond funds, the facts are that Short Term Inv. Grade has a duration of 2 years and SEC yield of 3.68% compared to Total Bond Index with a duartion of 4.3 years and SEC yield of 3.96%.
But it's grossly unfair to compare an all-corporate fund with a fund that includes treasuries, since the former has a default risk premium priced in. Intermediate-term investment grade yields 5.27%, which is a significant premium over the short-term fund.

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Post by Munir » Sun Jul 19, 2009 9:13 am

gw wrote:
Munir wrote:If one doesn't get lost in the classification of bond funds, the facts are that Short Term Inv. Grade has a duration of 2 years and SEC yield of 3.68% compared to Total Bond Index with a duartion of 4.3 years and SEC yield of 3.96%.
But it's grossly unfair to compare an all-corporate fund with a fund that includes treasuries, since the former has a default risk premium priced in. Intermediate-term investment grade yields 5.27%, which is a significant premium over the short-term fund.
When one makes a decision on which bond fund to choose, my understanding is that three factors are important to look at: yield, duration, and type of holdings. If one settles for the slightly increased risk of coporate holdings, and does not want an intermediate duration, then a short term investment grade fits the bill. There is no one type that fits all investors.

Personally, I'm hedging my bets and hold mostly Short Term Inv. Gr. but also significant holdings of TIPS and Total Bond Index in addition to a CD ladder. I also hold some Loomis Sayles Bond shares (a more risky mutli-sector fund) which recently are recovering nicely from their debacle last year, but don't intend to hold them too much longer. All of these are in my IRA.

I'm sure that those who believe that bond fund holdings should be considered only for stability and prefer treasuries and TIPS only, what I have done is folly. I still seek income in addition to stability.

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Post by gw » Sun Jul 19, 2009 9:50 am

Munir wrote:
gw wrote: But it's grossly unfair to compare an all-corporate fund with a fund that includes treasuries, since the former has a default risk premium priced in. Intermediate-term investment grade yields 5.27%, which is a significant premium over the short-term fund.
When one makes a decision on which bond fund to choose, my understanding is that three factors are important to look at: yield, duration, and type of holdings. If one settles for the slightly increased risk of coporate holdings, and does not want an intermediate duration, then a short term investment grade fits the bill. There is no one type that fits all investors.

Personally, I'm hedging my bets and hold mostly Short Term Inv. Gr. but also significant holdings of TIPS and Total Bond Index in addition to a CD ladder. I also hold some Loomis Sayles Bond shares (a more risky mutli-sector fund) which recently are recovering nicely from their debacle last year, but don't intend to hold them too much longer. All of these are in my IRA.

I'm sure that those who believe that bond fund holdings should be considered only for stability and prefer treasuries and TIPS only, what I have done is folly. I still seek income in addition to stability.
If instead of
Munir wrote:If one doesn't get lost in the classification of bond funds, the facts are that Short Term Inv. Grade has a duration of 2 years and SEC yield of 3.68% compared to Total Bond Index with a duartion of 4.3 years and SEC yield of 3.96%.
you had said
Munir wrote:If one doesn't get lost in the classification of bond funds, the facts are that Short Term Inv. Grade has a duration of 2 years and SEC yield of 3.68% compared to Intermediate Investment Grade with a duartion of 5.0 years and SEC yield of 5.27%.
I would have had no complaint.

But maybe I misunderstood, and your point was that 3.7% (short-term corporate) is about the same as 4.0% (total bond market), and you'd rather have default risk than term risk.

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Post by market timer » Sun Jul 19, 2009 10:31 am

mathwhiz wrote:The benchmark fed funds rate is currently 0-0.25%. When, not if, but when, this increases it will negatively impact bond prices.
Look at how long term bonds fared between June 30, 2004 and June 29, 2006, when Fed Funds went from 1% to 5.25%. Remember Greenspan's "conundrum," where long term rates did not respond to the short end of the curve? Could very well happen again.

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Post by gotherelate » Sun Jul 19, 2009 10:48 am

mathwhiz wrote:The benchmark fed funds rate is currently 0-0.25%. When, not if, but when, this increases it will negatively impact bond prices.
So we finally have a sure thing in investing? I'll tell you what. I will guarantee that, starting at 0.25%, the Fed can not only leave interest rates alone but can CUT interest rates in half every time they meet for eternity.

-Grandpa
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Post by Munir » Sun Jul 19, 2009 10:53 am

Hi gw,

You said:

"But maybe I misunderstood, and your point was that 3.7% (short-term corporate) is about the same as 4.0% (total bond market), and you'd rather have default risk than term risk."

Yes. That is what I was trying to say. Thank you for your patience and perseverance.

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Re: Interest rates can only go up, why go intermediate in bo

Post by grabiner » Sun Jul 19, 2009 11:09 am

mathwhiz wrote:I see the total bond fund and intermediate treasuries recommended a lot on here. I know people don't like to market time but interest rates are currently zero and whether rates rise in 2010 or 2011 or 2015, eventually they will rise and intermediate term bonds will get hit.

So isn't it wise to go short in this environment where rates can only go up?
Since all bond investors have the same information, the current prices of bonds reflect the expectation of increased rates. Short-Term Treasury (2-year duration) is yielding 1.05%, and Intermediate-Term Treasury (5-year duration) is yielding 2.42%; therefore, you get paid an extra 1.37% in interest over five years for accepting the risk that the prices of your intermediate-term bonds will decline if interest rates rise as the short-term bonds mature.

Is that a good deal? It depends on your situation. If you need the money in two years, you shouldn't invest it in five-year bonds because you won't have a chance to recover if interest rates go up. If you are holding bonds for diversification, rising interest rates hurt stock prices as well, so you might still prefer short-term bonds in a mostly-stock portfolio.
Wiki David Grabiner

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Post by yobria » Sun Jul 19, 2009 11:13 am

livesoft wrote:mathwhiz wrote "go short in this environment", not go to cash. Short-term bond funds are paying about 4% so no loss of interest by staying out of total bond and intermediate bond.
As mentioned, this is incorrect, unless you're considering riskier bond funds, an invalid comparison.

Nick

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Post by DennisRoche » Thu Aug 20, 2009 9:54 am

Since the original post on July 19 declaring that interest rates could only rise and that bond prices would fall, VBIIX is up about 2% with dividends. Good lesson on how tough it is to predict this stuff.

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higher rates

Post by hollowcave2 » Thu Aug 20, 2009 11:41 am

Because higher interest rates helps bond funds over the long run. As interest rates rise, the NAV will fall in the short run, but over the long run, the higher rates will generate more interest and if you reinvest, you have a chance to buy more shares at lower prices, compounding the increased interest.

So for long term investors, gradually rising rates are very good for bond funds.

JMHO

BTW, most of your risk is in stock funds, not bonds, so be wary of your asset allocation.

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Post by minesweep » Thu Aug 20, 2009 1:42 pm

Hollowcave2 wrote:Because higher interest rates helps bond funds over the long run. As interest rates rise, the NAV will fall in the short run, but over the long run, the higher rates will generate more interest and if you reinvest, you have a chance to buy more shares at lower prices, compounding the increased interest.

So for long term investors, gradually rising rates are very good for bond funds.
Vanguard wrote an article on that very topic back in 2004.

The good news about rising rates

Mike

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Post by neverknow » Thu Aug 20, 2009 1:54 pm

..
Last edited by neverknow on Sun Jan 16, 2011 7:06 am, edited 1 time in total.

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good link

Post by hollowcave2 » Thu Aug 20, 2009 1:58 pm

Thanks for resurrecting that link from Vanguard, Mike. I was looking for that again. Good to have handy in these threads about bond funds.

Steve

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Re: Interest rates can only go up, why go intermediate in bo

Post by JLou » Mon Aug 24, 2009 2:48 pm

neverknow wrote:
Valuethinker wrote: If you look at Japanese Government Bond Yields, you can see that US government bond yields can fall to 1.5%. And stay there.
...
I would be the first to admit this is unlikely. But it is certainly possible.
This is the only compelling argument, that I can find. Perhaps not the most likely, but - agreed, certainly possible.

Deflation is actually good for folks living off their nest eggs (and have no debt).
neverknow
Yes, unfortunately I am one of those that lives off SS/pension and can only invest div/int of returns. Time frame much shorter too. So deflation good and inflation bad and no change best.

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Taylor Larimore
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A bond allocation

Post by Taylor Larimore » Mon Aug 24, 2009 3:18 pm

Hi Mathwhiz:
So isn't it wise to go short in this environment where rates can only go up?


There are many excellent posts in this thread that answer your question very well.

So what to do? This is my solution (there are others):

It is often said that "diversification" is the only free-lunch in investing. For this primary reason, in 1996 we purchased Vanguard's Total Bond Market Index Fund primarily because it holds a collection of high-quality short-term, intermediate-term, long-term bonds, GNMAs, etc..

In 2000 we added 50% Vanguard's Inflation-Protected Securities bond fund for income and inflation protection.

These two bond funds have provided us with safety, income, and a worry-free retirement!

I hope this information is helpful.
"Simplicity is the master key to financial success." -- Jack Bogle

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Post by JLou » Sat Aug 29, 2009 3:31 pm

Taylor

Thank you for the insight. TIPS 50% is a big number. How much is in the taxable side? Any recommendations regarding TIPS AA for me where I can only shield 13% in an IRA?

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Post by trico » Sat Aug 29, 2009 3:53 pm

No one can predict what interest rates will do just like no one can predict their time of death. That is why most financial advisors say to invest in a wide diversivication of bond funds.

For example short term corporate bonds, long term treasury bonds, hi yeild bonds, and intermediate term bonds.

You should also have a wide variety of maturites split between government bonds, corporate bonds and municipal bonds.

Just like in equity funds a wide diversification and cost controls are what matters in the long haul.

Today's investors try to much to predict whats going to happen in the short term.

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Need more information

Post by Taylor Larimore » Sat Aug 29, 2009 4:48 pm

JLou wrote:Taylor

Thank you for the insight. TIPS 50% is a big number. How much is in the taxable side? Any recommendations regarding TIPS AA for me where I can only shield 13% in an IRA?
Hi JLou:

Your first and most important portfolio decision is is your allocation between stocks and bonds.

Assuming you want more than 13% in bonds, you will need to put the balance in a taxable account. The type of bonds (taxable or tax-exempt) depends on your tax bracket.

So, to answer your question, we need to know the desired bond percentage of your total (family) portfolio, and your income tax bracket. Also, what state do you live in?

If you need help to determine your percentage of bonds, use this link:

How to Create Your Investment Plan
"Simplicity is the master key to financial success." -- Jack Bogle

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Post by DennisRoche » Tue Oct 06, 2009 10:09 am

Total Bond Fund now up 3.7% since OP insisted it was time to get out of anything but short-term bonds. Pretty good return for less than 3 months. Who on Earth thinks they can predict these things?

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Post by bmb » Tue Oct 06, 2009 10:33 am

I think it is a fairly well-established fact (for now, anyway) that IT is usually the "sweet spot" between return and risk, so long-term investors who don't think they can predict the future should lean that way. (TIPS, where maturity is far less important, are an exception, and I am frankly guessing munis right now as well.)

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Post by greg24 » Tue Oct 06, 2009 10:37 am

The longer I invest, the more I realize how little I know.

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Post by RobG » Tue Oct 06, 2009 11:05 am

For what is is worth, people have been saying that interest rates have nowhere to go but up for several years now and the opposite has happened. The trend has been downward for 35 years. If it continues or stays flat you will make more money in intermediate bonds.

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