Stocks vs Bonds???

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mm711mm
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Stocks vs Bonds???

Post by mm711mm » Fri Aug 12, 2011 1:45 pm

Because of the current stock market (August 2011), I exited my blended stock/bonds mutual fund for 80% bonds + 20% Prime Fund. The has yielded 0, while the bond funds have gone up and down every day with the end result of a 0.5% gain. Why all the volitility? Why only a small gain? Do bond funds yield reverse results of stock funds? Are bonds a safe place for your retirement savings?

Thanks for your help!

Tom_T
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Post by Tom_T » Fri Aug 12, 2011 2:53 pm

Short answer: bonds have been volatile recently because of the market gyrations, with people rushing into/out of bonds.

Long answer: check out the Wiki and review the basics of the different asset classes, particularly bonds:

http://www.bogleheads.org/wiki/Category:Asset_Classes

hsv_climber
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Post by hsv_climber » Fri Aug 12, 2011 2:54 pm

If I were you then I'd consider spending some money to buy (and read) this book:

http://www.bogleheads.org/wiki/Boglehea ... t_Planning

That would probably be the safest and the most profitable investment that you can make at this time.

djw
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Post by djw » Fri Aug 12, 2011 4:17 pm

Unless you're over 60 years old, I wouldn't suggest 20% stocks, 80% bonds at this time.

Just as stocks have their weaknesses, so do bonds.

Just yesterday, VBLTX, Vanguard's Long Bond Fund lost 4.24% in a single day.

To provide useful advice, we'd need to know more about your situation: age, income, $ set aside in emergency fund, which bond funds you're invested in, IRAs, 401(k)s, etc. Also, do you feel your job is secure, any medical issues, and any large expenditures anticipated (ie. buying a house or paying tuition) in the next 10 years? (e.g. how soon might you need a large chunk of money?)
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nisiprius
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Re: Stocks vs Bonds???

Post by nisiprius » Sun Aug 14, 2011 6:52 am

mm711mm wrote:Because of the current stock market (August 2011), I exited my blended stock/bonds mutual fund for 80% bonds + 20% Prime Fund. The has yielded 0, while the bond funds have gone up and down every day with the end result of a 0.5% gain. Why all the volitility? Why only a small gain? Do bond funds yield reverse results of stock funds? Are bonds a safe place for your retirement savings?
[Added] Removing bogus mental calculation per livesoft's post below.

Yes, that runup looks "speculative" to me and I think it would be prudent to assume there will be a similar decline at some point.

Image

It's often debated whether we can expect to get the "historical rate of return" for an asset class going forward, but let's not get into that.

The historical rate of return for the S&P 500 has been roughly 10% per year; for intermediate-term bonds, 5.5% per year.

That's per year.

If you figure about 200 trading days per year, that means the average return for stocks is 0.05% per day, yet the stock market often fluctuates 1% or more on any single day. The average return for bonds is 0.026% per day. The whole point of your investments, their long-term earnings, are not going to be visible day-by-day--they're going to be completely masked by the short-term volatility of the markets.

It sounds to me as if you're unfamiliar with the behavior of bond funds. A general-purpose intermediate-term bond fund like VBMFX is not going to behave like a money market account or a bank account. Here's how money would have grown in VBMFX versus a money market account.
Image
Notice these things:
a) The money market fund, like a bank account, moves one way only: up. It moves up at different speeds from time to time, sometimes slowly (flat sections), sometimes quickly (steep) sections, never down. The bond fund does not. It generally rises pretty steady but there are definitely some downward fluctuations. Notice particularly the area around 1994, a 4% dip, and, more recently, about a 2% dip earlier this year.

b) Think about what a 4% downward dip means as in 1994 it means that several years' growth can be wiped out in a few months. However, it is quite different from the shock of a 50% drop in the stock market.

You ask "Are bonds a safe place for your retirement savings?"

1) Safety is all relative. Vanguard calls VBMFX "risk level 2" and says "In general, such funds may be appropriate for investors with medium-term investment horizons (four to ten years)." They of course qualify it with a "may" but they are implying it's pretty safe if you won't need the money for at least ten years, because that's usually long enough for the growth from reinvested interest to overcome any downward fluctuations that might occur.

In contrast, Vanguard calls its less-risky stock funds "risk level 4" and says they "are subject to wide fluctuations in share price... may be appropriate for investors who have a long-term investment horizon (ten years or longer)."

2) VBMFX invests in strongly-rated "investment grade bonds." A bond is (typically) a loan of $1,000 to a corporation or to the Treasury, which pays you back regular interest payments for the term of the bond, then pays back the $1,000. Unlike a stock, which is a sort of share or partnership in a business, a bond is a specific promise to pay agreed-on amounts. "Investment-grade bonds" are from reliable issuers who, the ratings agency judges, are well able to afford the loan and will almost certainly pay it back. That means that virtually every bond in VBMFX is going to pay back the loan within a known period of time--average about 7 years for VBMFX. In that sense, it is pretty safe against long-term dollar loss. Unlike stocks, there is good reason to believe that the dollar value of VBMFX will recover from downturns and that losses will be temporary. 1994 is not a worst-case scenario but it was a very severe event in the bond market, and you can see what happened.

3) Like a cash investment, VBMFX is an investment in "nominal" bonds. All the statements about loss and recovery refer to numbers of dollars. Inflation is potentially serious to bond holders; in that sense, bonds are not so safe. This is why many Bogleheads favor an allocation to TIPS, as represented by the Vanguard Inflation-Protected Securities Fund, VIPSX.

4) So, you should expect your bond funds to fluctuate; they're not like bank accounts. You should not be terribly surprised to see, let's say, a 5% loss over a period of a year. You're hoping to get more than you get in a cash investment, but you can put in $10,000 at the beginning of the year and see only $9,500 at the end of it.

You are balancing risk against return. Over the 25-period shown, we are talking about the difference between growing $10,000 to $28,000 in a money market fund--other safe cash investments wouldn't be very different--or $50,000 in the bond fund.

5) Here's one more way to look at risk. This is a price chart for VBMFX. Suppose you simply spend the dividend payments from the fund instead of reinvesting them. The dividend payments represent the source of long-term growth for the fund; the price fluctuations represent the short-term effects of the market. If there were no market fluctuations, every bond in the fund would always be exactly worth its $1,000 face value and the market value of the fund should be perfectly stable. Asking whether a bond fund is "safe for retirement savings" is basically asking whether the price and NAV of the fund are holding up stably over time.

A money market or bank account, if you withdrew the interest as it accrued, would just sit there and hold precisely the same number of dollars all the time. This is what VBMFX did. NOTE: This is a price chart, without reinvested returns.

Image

The short-term fluctuations up and down, within perhaps a 10% band, illustrates the short-term risk of the bond fund. The fact that the long-term behavior is more or less flat indicates the relative safety to a long-term holder. The flatness and relative safety of the bond fund become clearer if we plot it together with a similar price chart for a stock fund:

Image
Last edited by nisiprius on Sun Aug 14, 2011 10:23 am, edited 2 times in total.
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Taylor Larimore
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Re: Stocks vs Bonds???

Post by Taylor Larimore » Sun Aug 14, 2011 7:28 am

mm711mm wrote:Because of the current stock market (August 2011), I exited my blended stock/bonds mutual fund for 80% bonds + 20% Prime Fund. The has yielded 0, while the bond funds have gone up and down every day with the end result of a 0.5% gain. Why all the volitility? Why only a small gain? Do bond funds yield reverse results of stock funds? Are bonds a safe place for your retirement savings?

Thanks for your help!
Hi mm:

Welcome to the Bogleheads Forum!

You will not get a better answer to your question anywhere than your reply from nisiprius.
Last edited by Taylor Larimore on Sun Aug 14, 2011 9:36 am, edited 1 time in total.
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Boglenaut
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Re: Stocks vs Bonds???

Post by Boglenaut » Sun Aug 14, 2011 9:29 am

nisiprius wrote:
The short-term fluctuations up and down, within perhaps a 10% band, illustrates the short-term risk of the bond fund. The fact that the long-term behavior is more or less flat indicates the relative safety to a long-term holder. The flatness and relative safety of the bond fund become clearer if we plot it together with a similar price chart for a stock fund:

Image
I agree with your analysis, but make sure to point out this chart is not showing total return. Most bond funds look like steady horizontal lines until you add in distributions.

hsv_climber
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Re: Stocks vs Bonds???

Post by hsv_climber » Sun Aug 14, 2011 9:34 am

Boglenaut wrote: I agree with your analysis, but make sure to point out this chart is not showing total return. Most bond funds look like steady horizontal lines until you add in distributions.
Morningstar (the picture in nisiprius post) shows growth charts, which show total return.

livesoft
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Post by livesoft » Sun Aug 14, 2011 9:41 am

I'm looking at that first chart. Isn't going from 11.05 to 10.95 a 1% drop? Whatever you do, don't plot the action of VIPSX in the last month. :twisted:

The volatility in the past week is unprecedented. Check out this chart in the NYTimes: http://www.nytimes.com/interactive/2011 ... -rare.html

One thing that happened is that S&P downgraded the credit rating of US government bonds.

Here's a 5-day chart showing Vanguard Total Bond Market Index fund (blue line, ETF share class) percent changes for the previous week:
Image
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Post by nisiprius » Sun Aug 14, 2011 10:20 am

livesoft wrote:I'm looking at that first chart. Isn't going from 11.05 to 10.95 a 1% drop?
:oops: Duh. I yam stoopid. I yam not as numerate as I thunk. Thanks for checking.
Whatever you do, don't plot the action of VIPSX in the last month.
Reverse psychology works every time. I literally haven't looked in months.

Price chart...
Image

Oh, I see you already did it.
Last edited by nisiprius on Sun Aug 14, 2011 10:30 am, edited 2 times in total.
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Post by livesoft » Sun Aug 14, 2011 10:54 am

I think there will probably be a little "reversion to the mean" and those relatively big gains in those bond funds will revert downwards. For instance, it has already been mentioned by djw that long bonds gave up some of their gains.

Selling equities this week and buying bonds may turn out to be a case of selling low and buying high. Or maybe not.
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Re: Stocks vs Bonds???

Post by MekongTrader » Mon Aug 15, 2011 4:11 am

nisiprius wrote:
mm711mm wrote:Because of the current stock market (August 2011), I exited my blended stock/bonds mutual fund for 80% bonds + 20% Prime Fund. The has yielded 0, while the bond funds have gone up and down every day with the end result of a 0.5% gain. Why all the volitility? Why only a small gain? Do bond funds yield reverse results of stock funds? Are bonds a safe place for your retirement savings?
[Added] Removing bogus mental calculation per livesoft's post below.

Yes, that runup looks "speculative" to me and I think it would be prudent to assume there will be a similar decline at some point.

Image

It's often debated whether we can expect to get the "historical rate of return" for an asset class going forward, but let's not get into that.

The historical rate of return for the S&P 500 has been roughly 10% per year; for intermediate-term bonds, 5.5% per year.

That's per year.

If you figure about 200 trading days per year, that means the average return for stocks is 0.05% per day, yet the stock market often fluctuates 1% or more on any single day. The average return for bonds is 0.026% per day. The whole point of your investments, their long-term earnings, are not going to be visible day-by-day--they're going to be completely masked by the short-term volatility of the markets.

It sounds to me as if you're unfamiliar with the behavior of bond funds. A general-purpose intermediate-term bond fund like VBMFX is not going to behave like a money market account or a bank account. Here's how money would have grown in VBMFX versus a money market account.
Image
Notice these things:
a) The money market fund, like a bank account, moves one way only: up. It moves up at different speeds from time to time, sometimes slowly (flat sections), sometimes quickly (steep) sections, never down. The bond fund does not. It generally rises pretty steady but there are definitely some downward fluctuations. Notice particularly the area around 1994, a 4% dip, and, more recently, about a 2% dip earlier this year.

b) Think about what a 4% downward dip means as in 1994 it means that several years' growth can be wiped out in a few months. However, it is quite different from the shock of a 50% drop in the stock market.

You ask "Are bonds a safe place for your retirement savings?"

1) Safety is all relative. Vanguard calls VBMFX "risk level 2" and says "In general, such funds may be appropriate for investors with medium-term investment horizons (four to ten years)." They of course qualify it with a "may" but they are implying it's pretty safe if you won't need the money for at least ten years, because that's usually long enough for the growth from reinvested interest to overcome any downward fluctuations that might occur.

In contrast, Vanguard calls its less-risky stock funds "risk level 4" and says they "are subject to wide fluctuations in share price... may be appropriate for investors who have a long-term investment horizon (ten years or longer)."

2) VBMFX invests in strongly-rated "investment grade bonds." A bond is (typically) a loan of $1,000 to a corporation or to the Treasury, which pays you back regular interest payments for the term of the bond, then pays back the $1,000. Unlike a stock, which is a sort of share or partnership in a business, a bond is a specific promise to pay agreed-on amounts. "Investment-grade bonds" are from reliable issuers who, the ratings agency judges, are well able to afford the loan and will almost certainly pay it back. That means that virtually every bond in VBMFX is going to pay back the loan within a known period of time--average about 7 years for VBMFX. In that sense, it is pretty safe against long-term dollar loss. Unlike stocks, there is good reason to believe that the dollar value of VBMFX will recover from downturns and that losses will be temporary. 1994 is not a worst-case scenario but it was a very severe event in the bond market, and you can see what happened.

3) Like a cash investment, VBMFX is an investment in "nominal" bonds. All the statements about loss and recovery refer to numbers of dollars. Inflation is potentially serious to bond holders; in that sense, bonds are not so safe. This is why many Bogleheads favor an allocation to TIPS, as represented by the Vanguard Inflation-Protected Securities Fund, VIPSX.

4) So, you should expect your bond funds to fluctuate; they're not like bank accounts. You should not be terribly surprised to see, let's say, a 5% loss over a period of a year. You're hoping to get more than you get in a cash investment, but you can put in $10,000 at the beginning of the year and see only $9,500 at the end of it.

You are balancing risk against return. Over the 25-period shown, we are talking about the difference between growing $10,000 to $28,000 in a money market fund--other safe cash investments wouldn't be very different--or $50,000 in the bond fund.

5) Here's one more way to look at risk. This is a price chart for VBMFX. Suppose you simply spend the dividend payments from the fund instead of reinvesting them. The dividend payments represent the source of long-term growth for the fund; the price fluctuations represent the short-term effects of the market. If there were no market fluctuations, every bond in the fund would always be exactly worth its $1,000 face value and the market value of the fund should be perfectly stable. Asking whether a bond fund is "safe for retirement savings" is basically asking whether the price and NAV of the fund are holding up stably over time.

A money market or bank account, if you withdrew the interest as it accrued, would just sit there and hold precisely the same number of dollars all the time. This is what VBMFX did. NOTE: This is a price chart, without reinvested returns.

Image

The short-term fluctuations up and down, within perhaps a 10% band, illustrates the short-term risk of the bond fund. The fact that the long-term behavior is more or less flat indicates the relative safety to a long-term holder. The flatness and relative safety of the bond fund become clearer if we plot it together with a similar price chart for a stock fund:

Image
Thanks Nisiprius. Your contributions in bond threads are absolutely price-less. If it wasn't for you I'd have sold all bonds a long time ago because of the bond bubble mania out there.

MT

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Post by Retired in California » Mon Aug 15, 2011 11:10 am

I want to thank nisiprius also -- one of the most easy-to-follow, informative, thoughtful replies I've enjoyed reading ever!

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Post by Joke » Tue Aug 16, 2011 8:28 am

Thanks from me also - I too had moved MM funds into the Bond market (8/12) due to 0% growth in the MM account. Now I'm hoping I did the right thing. I'll be 65 this year and won't need the funds for 7-10 years.

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