"Get out of bond funds"

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Manks
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"Get out of bond funds"

Post by Manks » Sat Nov 02, 2013 9:02 am

I am fairly new to the Boglehead investment way of doing things but have loved learning from the wiki and this forum. Before, I was 100% in equity index funds. Now, I have moved things around to 85/15 (I am 27 years old). I am still attempting to learn as much as I can about bonds since they are new to me. I have been hearing Warren Buffets advice on bonds and saw Suze Orman recommend getting out of bond funds on her show last night.

I am not really asking if this is good advice or not. Rather, I would appreciate some clear explanations as to what would make someone give this specific advice in the current state of the economy. For example, how exactly will the 'impending interest rises' affect bond funds influencing people to shy away from or leave this asset class.

It took a lot for me to make the move into my current AA, especially without fully grasping how bonds were and are influenced by interest changes. Thanks for the clarifications!

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Re: "Get out of bond funds"

Post by mhc » Sat Nov 02, 2013 9:36 am

The way I understand bonds is that they are used with equities to set your desired risk level. In general, I do not want bonds because historically they perform worse than stocks. On the other hand, when I play with firecalc.com with the investigate tab, I notice that bonds do not negatively impact my goals. Actually, they may help. Going forward, no one really knows what stocks and bonds will do. I am happy having some diversification.

Remember that Suze is in the entertainment business. She has to say something. I would ignore her as just noise.

Buffet is not in the same situation as you and I. He has a strategy, but that strategy is not the boglehead strategy. I would ignore him too.

I think it is just popular to talk about the looming interest rate increase and the impact on bonds. Keep in mind that bonds are way less volatile than stocks. When people are talking about how bad bonds are because they may drop in value and neglect to put that in context with stocks, ignore them. It is just investment porn.

Figure out the AA that you can live with through thick and thin, and stay with it. If you are falling short of your goals, then earn more, spend less, and/or change goals. Messing with AA is probably not the best way to make up any short comings in your plans. You cannot control returns.

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momar
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Re: "Get out of bond funds"

Post by momar » Sat Nov 02, 2013 9:41 am

Suze likes to pretend that her individual bonds haven't lost value if rates go up because she holds them to maturity, unlike a bond fund where you are forced to see what your bonds are worth. Yes, she will get the face value back at the end. But if I hold a bunch of bonds yielding 2% and rates go to 4%, you better believe my bonds are worth less regardless of if Isell them or not. Opportunity cost.
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Re: "Get out of bond funds"

Post by dbr » Sat Nov 02, 2013 9:44 am

The Forum is full of past discussion of this question both in general and with respect to interest rates, Suze Orman, etc., etc.

Browsing around through the various conversations would probably be educational.

There is also a lot of good information in the Wiki:

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

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Manks
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Re: "Get out of bond funds"

Post by Manks » Sat Nov 02, 2013 10:03 am

dbr wrote:The Forum is full of past discussion of this question both in general and with respect to interest rates, Suze Orman, etc., etc.

Browsing around through the various conversations would probably be educational.

There is also a lot of good information in the Wiki:

http://www.bogleheads.org/wiki/Category:Bonds
I do not watch the show for financial advice, but rather just for the entertainment aspect of it. I had read the previous threads about her advice on the topic and they were mostly just about her and not the actual topic.

In this thread, I was hoping to get some of the information from the Wiki on bonds more in conversational form since that helps me to understand and learn better rather than just reading the information. I do appreciate the responses, thus far.

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nedsaid
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Re: "Get out of bond funds"

Post by nedsaid » Sat Nov 02, 2013 10:11 am

Buffett and Orman both hold large portfolios of bonds. Buffett owns them indirectly through ownership in Berkshire Hathaway which is largely a big insurance company. Insurance companies hold large bond portfolios. Suze Orman holds lots of tax free bonds.

So don't listen to this bad advice. Buffett isn't practicing what he preaches. Orman holds bonds but not bond funds. Bonds are more complicated instruments than perceived and most investors are better off in an inexpensive, diversified bond fund.

Buffett is correct that bonds are not good value here. I am buying them not because I am enthusiastic about them but for diversification purposes. I don't want the volatility of a 100% stock portfolio. You are 27 years old and should be unconcerned about the direction of interest rates for your bonds as you have many years to reinvest. Stick to investment grade intermediate term bonds and reinvest your interest and you will do just fine.
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Re: "Get out of bond funds"

Post by telemark » Sat Nov 02, 2013 10:29 am

Bonds trade on the open market, so the value of a bond is whatever someone is willing to pay for it. If you want to sell an older bond that yields 2% and newer bonds are yielding 4%, you have a problem: nobody is going to buy yours at face value when they can get one of the newer, better ones. The best you can do is to sell it at a discount (Sale! 10% off! Everything must go!). So if interest rates go up, the resale value of existing bonds goes down. And vice versa, but rates going up are what these people are worrying about.

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Re: "Get out of bond funds"

Post by nisiprius » Sat Nov 02, 2013 10:36 am

People in Bogleheads say "tune out the noise."

"The noise" is the ebb and flow of memes, like hit tunes or clothing fashions or a joke that is going the rounds. The investing community is like a huge auditorium with the gain in the PA system turned up a bit too much--not only do you get reverberating echoes but they feed on themselves and get louder and louder. If 130/30 funds are a hot topic, then every columnist gets questions about them, every columnist has to write a column about it, it gets hotter, and you say "Gee, 'everyone' is talking about 130/30 funds."

(Maybe you haven't heard of 130/30 funds. I picked them because they were a hot topic around 2007-2008, Merrill Lynch was predicting they would reach $1 trillion by 2012 and "everybody" was saying they would become an important, mainstream fund category.)

Tuning out the noise is not easy to do. "The noise" is always compelling because it always contains a convincing kernel of truth in it. The truth is always some messy complex on-the-one-hand, on-the-other hand thing. In the echo chamber each echo becomes louder and more distorted. It also becomes twisted for self-serving purposes. For example, someone who, for whatever reason, has an interest in promoting stocks, will always diss bonds, but in order to keep the message fresh will seize on anything new that supports the message. The message is never "bonds suck." The message is always "sure, bonds used to be sorta OK, but because of totally new crushing fact X they suck now."

So, the truth is that it's really hard to predict anything, including interest rates, and even when "everyone" expect X to happen, a lot of the time Y will happen instead. And the truth is also that if everyone expects X to happen, then X is priced in, so if X does happen, it doesn't matter.

The consensus view--i.e. what I happen to think myself--is that very likely bonds will have a considerably lower return going forward for the next few decades than they did for the last few.

The noise is "Get out of bond funds" or "Bonds could lose 91%, just the way they (DIDN'T) do 1940-1980," or "Interest rates can only go ☝☝☝UP, and when they do your bonds will go ☟☟☟DOWN, and it will be whoa nellie, katy bar the door." The truth is
  • there are some fairly convincing reasons for thinking bonds won't be doing as well as they used to, but there are also reasons for thinking stocks won't, either, so it's not clear why your asset allocation should change;
  • bonds are always going to be more stable than stocks, so if you are going to get out of bonds you need to explain what has happened that makes you more risk-tolerant than you used to be;
  • to the extent that you can plan your withdrawals and stick to the plan, a portfolio of individual bonds may indeed be preferable to a bond fund, but it probably doesn't make that much difference as long as you are holding the bond fund for a period of time that's long compared to its duration. In either case, if you need to make an unplanned large withdrawal, if bonds are down, they're down.
  • People who make money when you buy bond funds and not when you buy a bank CD--which would include a) mutual fund companies, and b) many advisors--are not going to give you a fair comparison between bond funds and bank CDs. Typically they simply will not mention bank CDs as an alternative. It's unlikely that there's any big difference between bond funds and the best bank CDs and all sorts of hard-to-evaluate factors could tip the balance either way.
Last edited by nisiprius on Sat Nov 02, 2013 11:24 am, edited 3 times in total.
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Re: "Get out of bond funds"

Post by SpaceCowboy » Sat Nov 02, 2013 10:44 am

If your 15% bond allocation is in your 401(k), you probably have access to a stable value fund. This would provide similar diversification to a bond fund in reducing volatility of your portfolio. You would not be exposed to losses if interest rates rise, but you would receive a lower return if interest rates remained stable or fell. Right now there is very little room for interest rates to fall, whereas they have room to rise. Thus, the stable value fund may be a better risk/reward alternative than a bond fund at the current time.

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Re: "Get out of bond funds"

Post by staythecourse » Sat Nov 02, 2013 11:23 am

nisiprius wrote:just the way they (DIDN'T) do 1940-1980
Nisi,

Do you have an article or data talking about this. I do remember a post of Rick Ferri's on his website talking about that period and remember it showed zero return for bonds during that period (I believe long term treasuries). No loss and no gain.

Thanks in advance.

Good luck.
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Re: "Get out of bond funds"

Post by nisiprius » Sat Nov 02, 2013 11:30 am

staythecourse wrote:
nisiprius wrote:just the way they (DIDN'T) do 1940-1980
Nisi,

Do you have an article or data talking about this. I do remember a post of Rick Ferri's on his website talking about that period and remember it showed zero return for bonds during that period (I believe long term treasuries). No loss and no gain.

Thanks in advance.

Good luck.
Long discussion here:91% real loss in bonds--is this accurate? The actual number is very endpoint-sensitive, but it in the ballpark of 50% real loss for long-term and considerably less for intermediate-term.

And the loss is an inflation effect, not an interest-rate effect. In nominal terms, measured only in numbers of dollars, long-term corporate, long-term government, and intermediate-term government all made money 1940-1980, and some honest-to-gosh real-world bond funds made money. The rising rates from 1940 to 1980 were a stiff headwind. The SBBI yearbook shows total returns for intermediate-term government bonds averaging 3.4% annualized from the start of 1940 to the end of 1980. Unfortunately it is showing inflation averaging 4.5% annualized over the same period.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: "Get out of bond funds"

Post by FinancialDave » Sat Nov 02, 2013 2:03 pm

I personally think if you follow some simple advice like don't invest in things you don't understand and keep your investing simple, these two pieces of advice will go far in compounding your returns in your years ahead.

In general I don't see bonds as too complex to invest in and there are many articles here and on the web in general that explain in general how different bonds work, and the function they may serve. However, much of the advice, whether to invest in TIPS, or high yield bonds, or short duration treasuries, is just someone's guess on what the future may bring.

The "simple" aspect of this is the "undertone" that you might hear in many of these conversations and that is "I don't really expect bonds to do all that well in the near term."

The more broader concept (that I tend to subscribe to, especially relevant to younger investors like yourself) is that bonds in the long run are expected to, and always have returned less in relation to equities.

Now, I really don't expect you to change your Asset Allocation based on a few conversations on the internet, as you have to come up with this on your own - which you seem to have already done.

However, IMHO, at age 27, I would only ask yourself the reason why you think you need 15% bonds. Is this somehow a 15% bet that bonds will give you better returns over the next 30 years? Is it somehow a bet that 15% bonds will stabilize your portfolio enough to keep you fully invested? Have you done any research of your own to support your thesis that bonds will improve your long term results? Is it merely a bet that at some point in your career you may suffer an unexpected hardship where you may need to sell in a down market and the bonds could actually help you here? Any of these may be a valid reason to hold some bonds.

Maybe I am just biased since at 61 and retired my bond allocation has always been essentially zero, but there a no historical simulations that show over my investing career that adding bonds to a 100% equity index portfolio would have improved the results. Also, having an Engineering background leads me more to the technical math issues (absolute returns) rather than any "touchy feely" issues to own bonds - such as they might keep me from selling out at the bottom of the market.

I am not saying there aren't reasons to own bonds, and I have pointed out only some of them. I am just asking you to decide for yourself if you need to own them at age 27. The consensus by many seems to be they are quite overvalued right now, so at your young age, I just think 15% might be a bit much - why not start out at 1% and see how this asset does compared to your others. In a few years it is very possible that you could buy the bonds on sale and with a much better return -- you will be able to see this by watching your 401k bond value decline (if it does.)

fd
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Re: "Get out of bond funds"

Post by Sunny Sarkar » Sat Nov 02, 2013 2:07 pm

Hi Manks,

You're not alone. When I started investing 12 years ago, I couldn't tell a nominal bond from James Bond. Luckily for me investing turned out to be not that hard.
Jack Bogle in 'Six Rules of Investing' wrote:It turns out that successful investing is about following common sense principles, and avoiding the myriad potholes that lie along the road of investing. You win by not losing. There may or may not be better winning strategies than putting, say, 80% of your investments into an equity index fund and 20% into a bond index fund when you begin investing at age 25, gradually reducing the equity ratio over the years so it is 30% when you're 70. But I can absolutely guarantee you that the number of worse strategies is infinite. Infinite!
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Re: "Get out of bond funds"

Post by stemikger » Sat Nov 02, 2013 3:42 pm

This is the first time many of us Bogleheads had to question bond investing.

I guess my solution to this dilemma is if you have the opportunity within your 401K invest in one of Vanguard's Target Retirement Funds or at the very least look at them and copy their allocation the best you can.

It may not be the best strategy in the world, but I think you can do a lot worse.
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Re: "Get out of bond funds"

Post by NightOwl » Sat Nov 02, 2013 4:17 pm

I think that Suze Orman knows that her audience is generally not very well educated about financial matters. She is probably right to assume that many of her viewers will panic sell if the NAV of their bond fund, which has almost always only gone up, goes down by any noticeable percentage over a short period of time.

I still think she is wrong to advise her viewers to get out of bond funds -- what, these uninformed viewers are going to purchase individual bonds? Actually, I assume that she thinks that they should pay an advisor to pick individual bonds for them -- her viewers will get fleeced on the markup, but that might actually be better than panic selling a bond fund when the NAV drops. I think that what she should do is to educate her listeners about duration, but she might well think that's a lost cause.

Anyone who is educated about duration, a category that really should include all Bogleheads, should have the knowledge necessary to stay the course, and should therefore not be afraid to invest in bond funds if their time threshold exceeds the duration of the fund. Yes, I know that duration only applies from the most recent increase in interest rate, and a long, steady rate increase will take a long time to outwait, but I see thirty-something investors here worried about investing retirement assets in a bond fund with a duration of 7 years, and I think that's kind of silly.

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Manks
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Re: "Get out of bond funds"

Post by Manks » Sat Nov 02, 2013 6:53 pm

FinancialDave wrote: However, IMHO, at age 27, I would only ask yourself the reason why you think you need 15% bonds. Is this somehow a 15% bet that bonds will give you better returns over the next 30 years? Is it somehow a bet that 15% bonds will stabilize your portfolio enough to keep you fully invested? Have you done any research of your own to support your thesis that bonds will improve your long term results? Is it merely a bet that at some point in your career you may suffer an unexpected hardship where you may need to sell in a down market and the bonds could actually help you here? Any of these may be a valid reason to hold some bonds.
fd
Excellent questions FD. I appreciate you laying them all out there. The reason for the addition was so that I would begin start slowly accumulating them to stabilize my portfolio. I am young enough that I have not had to face a major downturn in the market, and therefore, have not had to test my resolve, yet. I know that I just need to stay the course, and I expect that I will successfully be able to do so.

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Re: "Get out of bond funds"

Post by garlandwhizzer » Sat Nov 02, 2013 7:28 pm

I think a 100% equity position is appropriate for most who are early in the accumulating phase, say in their 20s or 30s. This, of course, is investing money that you feel confident that you're not going to need in the future to meet expenses. All bonds offer such a person is psychological comfort when stocks tank, but that comes at a high price if you're looking at the difference in bond versus stock returns over 40 or 50 years. That's a long enough time period that stock gains would be expected to dwarf bond gains, especially starting from a very low interest rate environment like now. Vanguard estimates that nominal high quality bond returns over the next decade to be somewhere around 2%, which is likely to be at or below the 10 year inflation rate. That is to say about a zero real return for a decade. Why lock up dead money for a decade when you're early in the accumulating phase and you're got several decades to recuperate from any stock bear markets? I personally don't see the rationale for any bond holdings in this early accumulation phase unless you're very risk averse and you fear that you will panic and sell stocks during a crash. However if you're 100% s stocks it might be wise to keep a modest emergency cash fund on hand to cover unforeseen future expenses should they occur so you never get forced to sell stocks into market weakness.

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Re: "Get out of bond funds"

Post by livesoft » Sat Nov 02, 2013 8:26 pm

Early this past summer interest rates rose and bond funds dropped in both price and value. So one doesn't have to look back far in time to see what bond funds do when faced with adversity. And one only has to go back to those discussions in late June and early July to see lots of seriously worried folks.
http://www.bogleheads.org/forum/viewtop ... 0&t=118074
http://www.bogleheads.org/forum/viewtop ... 0&t=119232

And what has happened since then? Oh my goodness! Bond funds retested their early July lows in early September, but they have gone up a few percent since then. What does that mean? It means that bond funds fluctuate in value.
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Re: "Get out of bond funds"

Post by john94549 » Sat Nov 02, 2013 9:18 pm

As my past posts will illustrate, I am not a huge fan of bond funds. That said, having a modicum of fixed income in bond funds can be worthy. First and foremost, many 401K plans just don't offer viable alternatives to bond funds. So, if you want to hedge your investments by plopping a tad in fixed income, it's bond funds or a MMF, as many stable value funds have been eliminated (as my wife's was). If you plan to live longer than 5 or 6 years, an intermediate term bond fund with an SEC yield of 2.2% and a duration of 5+ years might seem preferable to the MMF, and at least on par with a 5-yr CD, unavailable in any event through a 401K.

Second, if you plan on re-balancing in the event of a market swoon, bond funds are ever so much easier to utilize for that purpose than a rung or rungs of a CD ladder, whether tax-advantaged or not. If you need to move $4500 from fixed-income to equities to re-balance back to 60/40, will you be able to accomplish a partial withdrawal of a CD without penalty to do so? Doubtful. Ally, for example, allows no partials at all.

Thirdly, liquidity and laddering. Should you absolutely, positively, need some money from your fixed-income stash, bond funds are generally liquid. No worries (as Nisiprius has pointed out) about "discretionary" redemptions. And, as to laddering, I must admit a CD ladder, while it might offer a tad better yield, and less interest-rate risk, does require a bit of management.

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Re: "Get out of bond funds"

Post by in_reality » Sun Nov 03, 2013 3:45 am

nisiprius wrote:Long discussion here:91% real loss in bonds--is this accurate? The actual number is very endpoint-sensitive, but it in the ballpark of 50% real loss for long-term and considerably less for intermediate-term.

And the loss is an inflation effect, not an interest-rate effect. In nominal terms, measured only in numbers of dollars, long-term corporate, long-term government, and intermediate-term government all made money 1940-1980, and some honest-to-gosh real-world bond funds made money. The rising rates from 1940 to 1980 were a stiff headwind. The SBBI yearbook shows total returns for intermediate-term government bonds averaging 3.4% annualized from the start of 1940 to the end of 1980. Unfortunately it is showing inflation averaging 4.5% annualized over the same period.
How do I reconcile that information with Standard & Poor's data:

Between 1926 and December 31, 2010, the annualized return for a portfolio comprised exclusively of stocks in Standard & Poor's Composite Index of 500 Stocks was 9.93% -- well above the average inflation rate of 2.99% for the same period. The average annual return for long-term government bonds, on the other hand, was only 5.53%

http://fc.standardandpoors.com/cms/Arti ... 18503.JPEG

This chart tracks inflation versus the annual returns of the S&P 500 and long-term government bonds.**

Large-Cap stocks are represented by the total annual returns of the S&P 500. Long-Term Government bonds are represented by a composite of the total annual returns of long-term Treasuries (10+ year maturities) and the Barclays U.S. Aggregate index. Inflation is represented by the annual change in the Consumer Price Index.

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Re: "Get out of bond funds"

Post by gmtret » Sun Nov 03, 2013 5:27 am

All very interesting, I'm sure... But Nisi nailed it, per the norm. To the OP I say that, while I have no idea the value of your portfolio, if you have established a position of 15%, good on ya. Values will fluctuate, yet compound over time. Hopefully this will strengthen your resolve to ignore the noise and stay the course. Again, it is only duration that actually matters with bond funds, and who knows, you just might run on quite the buying opportunity. And regardless of your leanings concerning rebalancing, by all means establish an asset allocation you can stick with through thick and thin. ( We need a coffee smiley.) :)

Good luck,
Chris
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Re: "Get out of bond funds"

Post by linuxizer » Sun Nov 03, 2013 8:10 am

Lots good said so far. Orman has been fearmongering about bond funds for as long as she's been on the air, AFAIK.

Important to differentiate between claims that bonds are to be avoided vs. claims that bonds are fine but bond funds are to be avoided. See the Wiki for the latter: http://www.bogleheads.org/wiki/Individu ... _Bond_Fund

For the former, as has been said the purpose of bonds in a portfolio is not to earn more than stocks, it's to dampen volatility.

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Re: "Get out of bond funds"

Post by nisiprius » Sun Nov 03, 2013 12:36 pm

in_reality wrote:
nisiprius wrote:Long discussion here:91% real loss in bonds--is this accurate? The actual number is very endpoint-sensitive, but it in the ballpark of 50% real loss for long-term and considerably less for intermediate-term.

And the loss is an inflation effect, not an interest-rate effect. In nominal terms, measured only in numbers of dollars, long-term corporate, long-term government, and intermediate-term government all made money 1940-1980, and some honest-to-gosh real-world bond funds made money. The rising rates from 1940 to 1980 were a stiff headwind. The SBBI yearbook shows total returns for intermediate-term government bonds averaging 3.4% annualized from the start of 1940 to the end of 1980. Unfortunately it is showing inflation averaging 4.5% annualized over the same period.
How do I reconcile that information with Standard & Poor's data:

Between 1926 and December 31, 2010, the annualized return for a portfolio comprised exclusively of stocks in Standard & Poor's Composite Index of 500 Stocks was 9.93% -- well above the average inflation rate of 2.99% for the same period. The average annual return for long-term government bonds, on the other hand, was only 5.53%

http://fc.standardandpoors.com/cms/Arti ... 18503.JPEG

This chart tracks inflation versus the annual returns of the S&P 500 and long-term government bonds.**

Large-Cap stocks are represented by the total annual returns of the S&P 500. Long-Term Government bonds are represented by a composite of the total annual returns of long-term Treasuries (10+ year maturities) and the Barclays U.S. Aggregate index. Inflation is represented by the annual change in the Consumer Price Index.
Image
Where's the problem? That looks completely consistent with what I said. It's hard to tell exactly because the chart doesn't show inflation during the deflationary period, but you can see that the nominal return of long-term bonds was strictly positive during the period of rising rates. The curve just keeps going up. There was a headwind, it goes up much more slowly from 1940-1980 then 1980-present. But it doesn't go downward.

Now, for real rates, we have to mentally subtract off inflation. But the nominal dollar value of bonds roughly doubled, and inflation did not go up by a factor of twenty or anything close to it.

1940-1980, long-term government bonds increased in dollar value, and declined about 50% in real value--NOT THE 91% claimed by "The Economist."

For intermediate-term government bonds, which are a better comparison to the usual retirement-savings "core" bond funds, the decline in value was very noticeably less, although I don't recall the exact number.
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Re: "Get out of bond funds"

Post by berntson » Sun Nov 03, 2013 1:03 pm

FinancialDave wrote: Maybe I am just biased since at 61 and retired my bond allocation has always been essentially zero, but there a no historical simulations that show over my investing career that adding bonds to a 100% equity index portfolio would have improved the results. Also, having an Engineering background leads me more to the technical math issues (absolute returns) rather than any "touchy feely" issues to own bonds - such as they might keep me from selling out at the bottom of the market.
Thanks for this post FinancialDave. I've been frustrated for awhile now by the "touchy feely" role that bonds are supposed to play in an investor's portfolio. I don't know what people do when they introspect to find the level of bonds makes them "comfortable" with holding a portfolio. This may work for others--I just can't do it.

When I do think about what would make me feel better after a market crash, I start thinking about a nice glass of Scotch, not a 20% bond allocation. :beer

I'm also glad to see that there are more experienced investors who also think that a portfolio strongly tilted towards equities is suitable for young investors. While I've spent lots of time thinking about this, I sometimes worry that my small bond position is the result of naiveté rather than careful analysis. I'm glad to see that it's possible to hold mostly equities and stay the course.

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Re: "Get out of bond funds"

Post by kenner » Sun Nov 03, 2013 1:28 pm

Did Suze say "get out of all bonds" or "get out of all bond funds" regardless of quality, duration, or investor needs and psychology.

Suze's advice on bonds is notoriously bad.

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Re: "Get out of bond funds"

Post by nimo956 » Sun Nov 03, 2013 1:32 pm

It's hard to know how to invest without defining your goals first. Given two portfolios of equal return, an investor should choose the one with the lowest risk (ie the least amount of volatility). If you define your goals and realize that you can meet them by investing in 100% cash, why should you accept any volatility at all? Most of us can't do that, so we have to accept some risk of principal loss. I don't think that many people who advocate for 100% equities have stopped to think about how much they need to meet their goals. They are investing for maximum return. In other words, they want to invest their way to a higher standard of living than their current salary/savings rate will allow (possibly at the expense of not being able to maintain their current standard of living). It's an investing strategy driven by greed rather than careful planning. You should start with 100% in bonds and ask what % of equities do I need to add to meet my goals, not the other way around.
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Re: "Get out of bond funds"

Post by Call_Me_Op » Sun Nov 03, 2013 1:43 pm

kenner wrote:Did Suze say "get out of all bonds" or "get out of all bond funds" regardless of quality, duration, or investor needs and psychology.
I record her shows in case I want to watch later. She said to get out of bond funds. She was, by the way, talking about how to protect your money in light of the debt-ceiling issue in Washington. She felt that interest rates would be going up because people will spurn US Government debt, and that bond funds would be a bad place to be under this scenario.
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Re: "Get out of bond funds"

Post by kenner » Sun Nov 03, 2013 2:04 pm

Thanks, Call Me Op,

I have long admired your contributions to this forum. I cannot say the same about Suze.

IMHO, no nationally televised salesperson should tell every viewer that they should ditch bond funds without knowing the specifics of their investment situation.

I remember three years ago when Suze advised everyone to sell bonds. Bonds have done okay since her incorrect advice.

Ken

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Re: "Get out of bond funds"

Post by Kalo » Sun Nov 03, 2013 3:03 pm

Those advocating 100% stock AA or very high stock ratios have yet to mention the possibility of deflation in this thread. It's always that bear markets will inevitably be followed by bull markets and then you're off to the races again.

Check out the four pillars of investing by Bernstein for a historical perspective on asset class returns. It remains for me the most enlightening book I've read on investing.

Kalo
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Re: "Get out of bond funds"

Post by YDNAL » Sun Nov 03, 2013 3:35 pm

Manks wrote:I am fairly new to the Boglehead investment way of doing things but have loved learning from the wiki and this forum. Before, I was 100% in equity index funds. Now, I have moved things around to 85/15 (I am 27 years old). I am still attempting to learn as much as I can about bonds since they are new to me. I have been hearing Warren Buffets advice on bonds and saw Suze Orman recommend getting out of bond funds on her show last night.

I am not really asking if this is good advice or not. Rather, I would appreciate some clear explanations as to what would make someone give this specific advice in the current state of the economy. For example, how exactly will the 'impending interest rises' affect bond funds influencing people to shy away from or leave this asset class.

It took a lot for me to make the move into my current AA, especially without fully grasping how bonds were and are influenced by interest changes. Thanks for the clarifications!
You asked the Forum why would Suze Orman make such recommendation.... I don't know (don't care).

I do know, however, the "impending interest rate rise" has been *impending* for 3-4 years. In fact, rates have increased already since 2012 with corresponding Bond price decrease.

Code: Select all

Vanguard Total Bond Market Index Fund Investor Shares (VBMFX)
52-week:
High of $11.22 on 11/13/2012 
Low of  $10.47 on 09/05/2013 <<< -6.7% decrease
That said, if you hold through duration, at the end you should get exactly what you signed-up to get in 2012, for instance.
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Re: "Get out of bond funds"

Post by fishnskiguy » Sun Nov 03, 2013 4:38 pm

I have been saving and investing since the early 1960's, mostly in various fixed income stuff.

I have never had the mindset that I was going to "make money" in FI. I simply assumed that I could stuff money into CD's faster than I would lose out due to inflation and thereby wind up ahead. Believe me, when there are no taxed advantaged accounts, and a single, mid grade naval officer is in the 50% marginal tax bracket, that's about all one could hope for.

That we were able to see real gains in FI investing from the early 1980's to the present was icing on the cake.

We did not have a significant equity position until after I retired and got a job with an excellent 401K plan. Even then we stayed around 15% equity until we "made our number " on FI alone. Since then we have let our equity allocation creep up to 25%.

Folks who save and invest (even in only FI) always seem to end up happier and in a better place than those who live large and in the now. At least that has been my observation.

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Re: "Get out of bond funds"

Post by Kevin M » Sun Nov 03, 2013 6:42 pm

Manks wrote: I am not really asking if this is good advice or not. Rather, I would appreciate some clear explanations as to what would make someone give this specific advice in the current state of the economy. For example, how exactly will the 'impending interest rises' affect bond funds influencing people to shy away from or leave this asset class.

It took a lot for me to make the move into my current AA, especially without fully grasping how bonds were and are influenced by interest changes.
First, a very simplified summary of the basics. Bond prices and interest rates move in opposite directions, since they are really just two ways of measuring the same thing. The longer the maturity and duration of the bond or bond fund, the larger the change in price for a given percentage point change in interest rate(s) (the interest rate(s) that is/are applicable to the particular bond or bond fund). The uncertainty in the value of your bond fund going up or down because of general change in interest rates is known as interest-rate risk or term risk. An intermediate-term bond fund, such as Total Bond, has more term risk than a short-term bond fund. Cash has no term risk, and therefore generally earns less interest than bonds.

Someone who is recommending to stay out of bonds or bond funds now is likely thinking that interest rates will be increasing, possibly by a lot, in the not too distant future. Why might they be thinking that?

Rates are historically very low now. In the US, the Fed is trying to keep rates low to stimulate the economy. They are doing this for short-term rates by keeping the federal funds target rate close to 0%, and for longer-term rates by buying $85B dollars worth of bonds of various maturities each month.

Many people are concerned that intermediate to long term interest rates will increase when the Fed slows down (tapers) and eventually stops its rate of monthly bond buying, and that short-term rates will rise when it eventually raises the federal funds target rate. Also, interest rates are generally higher when the economy is doing well and lower when it is not doing so well.

Note that at least one highly respected Boglehead author, William Bernstein, is in this camp, and AFAIK has been keeping his fixed income in treasury bills (very short-term bonds, so very little term risk).

As to your situation, with a meager 15% in bonds, you have very little to worry about relative to the risk of the 85% you have in stocks. The risk of your stock holdings dwarfs the risk of your bond holdings. Also, there's not that much difference in risk vs. expected return between a 100% stock portfolio and an 85/15 stock/bond portfolio, so I wouldn't worry much about having put a little bit in bonds recently.

Kevin
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Re: "Get out of bond funds"

Post by BigOil » Sun Nov 03, 2013 6:47 pm

stemikger wrote:This is the first time many of us Bogleheads had to question bond investing.

I guess my solution to this dilemma is if you have the opportunity within your 401K invest in one of Vanguard's Target Retirement Funds or at the very least look at them and copy their allocation the best you can.

It may not be the best strategy in the world, but I think you can do a lot worse.
I have Vanguard Target Retirement funds in my 401K. I'd use only these funds if practical! I do have some money in one for assets not used to balance our overall portfolio (i.e. looking at financial assets outside this 401K in total).

What an amazing, EXCELLENT, outstanding, choice for most 401k investors. The science in these Vanguard Target Retirement funds is the best objective, widely applicable, financial theory put in a practical product--- at astoundingly low low cost.

Yes, you can quibble at the edges. But the ignorance of most savers is huge. Even in a 401k plan with *average* balances north of $450K; based on my occasional conversations with pretty bright colleagues many are not fully savvy! If most folks used these funds (or similar), MUCH more money would be in America's pockets and not NYC/Wall Street. You can do a WHOLE lot worse.

The only major concern is for the risk averse. Back to the oft discussed behavior issues. At only 10% bonds for the youngun's, some are gonna' bail at the wrong time. Of course, one can help that concern by picking an earlier virtual retirement date (adding some complexity to the decision).

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Re: "Get out of bond funds"

Post by john94549 » Sun Nov 03, 2013 7:24 pm

Fishnskiguy, in Colorado? Reminds me of the standing joke our senior enlisted had when asked where they might retire. "I'm going to start walking across the country with an anchor on my shoulder. When the first person says 'what's that', that's where I'll retire."

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Re: "Get out of bond funds"

Post by nisiprius » Sun Nov 03, 2013 8:58 pm

john94549 wrote:Fishnskiguy, in Colorado? Reminds me of the standing joke our senior enlisted had when asked where they might retire. "I'm going to start walking across the country with an anchor on my shoulder. When the first person says 'what's that', that's where I'll retire."
Everyone's aware that that is straight out of the Odyssey?
Samuel Butler, translating Homer wrote:"You shall go to bed as soon as you please," replied Penelope, "now that the gods have sent you home to your own good house and to your country. But as heaven has put it in your mind to speak of it, tell me about the task that lies before you...."

"My dear," answered Ulysses, "...I will not conceal it from you, though you will not like it... Teiresias bade me travel far and wide, carrying an oar, till I came to a country where the people have never heard of the sea, and do not even mix salt with their food. They know nothing about ships, nor oars that are as the wings of a ship.... He said that a wayfarer should meet me and ask me whether it was a winnowing shovel that I had on my shoulder. On this, I was to fix my oar in the ground and sacrifice a ram, a bull, and a boar to Neptune; after which I was to go home and offer hecatombs to all the gods in heaven, one after the other. As for myself, he said that death should come to me from the sea, and that my life should ebb away very gently when I was full of years and peace of mind, and my people should bless me.
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Re: "Get out of bond funds"

Post by john94549 » Sun Nov 03, 2013 9:10 pm

Nisi, I promise you, none of my senior enlisted was as eloquent. They just stuck to anchors on shoulders. But the genesis was, I might admit, interesting. A tale handed down from seafarer to seafarer?

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Re: "Get out of bond funds"

Post by Angst » Sun Nov 03, 2013 9:12 pm

nisiprius wrote:
john94549 wrote:Fishnskiguy, in Colorado? Reminds me of the standing joke our senior enlisted had when asked where they might retire. "I'm going to start walking across the country with an anchor on my shoulder. When the first person says 'what's that', that's where I'll retire."
Everyone's aware that that is straight out of the Odyssey?
Samuel Butler, translating Homer wrote:"You shall go to bed as soon as you please," replied Penelope, "now that the gods have sent you home to your own good house and to your country. But as heaven has put it in your mind to speak of it, tell me about the task that lies before you...."

"My dear," answered Ulysses, "...I will not conceal it from you, though you will not like it... Teiresias bade me travel far and wide, carrying an oar, till I came to a country where the people have never heard of the sea, and do not even mix salt with their food. They know nothing about ships, nor oars that are as the wings of a ship.... He said that a wayfarer should meet me and ask me whether it was a winnowing shovel that I had on my shoulder. On this, I was to fix my oar in the ground and sacrifice a ram, a bull, and a boar to Neptune; after which I was to go home and offer hecatombs to all the gods in heaven, one after the other. As for myself, he said that death should come to me from the sea, and that my life should ebb away very gently when I was full of years and peace of mind, and my people should bless me.
There are no jokes like the old jokes.
Wonderful! You've transported me back to 9th grade Latin, in the best of ways.
Thank you Nisi.

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Re: "Get out of bond funds"

Post by linenfort » Mon Nov 04, 2013 2:46 pm

The funny thing is, I've always thought of my bond allocation as an anchor,
but in a good way.
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Re: "Get out of bond funds"

Post by Toons » Mon Nov 04, 2013 3:14 pm

On a side note(not that it has any particular significance) :happy

"Pimco Total Return loses title as world's largest mutual fund"

http://www.reuters.com/article/2013/11/ ... NP20131104
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

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Re: "Get out of bond funds"

Post by Bustoff » Mon Nov 04, 2013 7:06 pm

When your 40% tax-advantaged, it seems like there is no way to get out of bond funds and into something like CD's without moving it out of Vanguard. :annoyed
Moreover, FDIC limits necessitate opening multiple accounts.

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Re: "Get out of bond funds"

Post by TheTimeLord » Mon Nov 04, 2013 7:23 pm

Seems like not many fans of bond ladders versus bond funds which does surprise me. My favorite feature of a bond ladder is while the interest rate the bond pays remains constant the time to maturity decreases which is a natural hedge as shorter term bonds virtually always pay lower than similar quality longer term bonds. Now buying a TIPS fund I understand.
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Re: "Get out of bond funds"

Post by Kevin M » Tue Nov 05, 2013 5:57 pm

Bustoff wrote:When your 40% tax-advantaged, it seems like there is no way to get out of bond funds and into something like CD's without moving it out of Vanguard. :annoyed
True, which is what I've done--a number of partial IRA transfers. Reducing interest-rate risk while still earning a competitive yield has been more important to me than simplicity.

Of course this is true for direct CDs only, since you can buy brokered CDs through Vanguard, but that doesn't help with the term risk. However, since you currently can earn much higher yields on brokered CDs than on treasuries of comparable maturities, you can increase yield without increasing credit risk. So for someone who wants to stick with Vanguard, but is OK with more complexity, you could replace the treasuries in your TBM fund with brokered CDs, and use investment-grade or corporate funds to replace the corporates, thus boosting yield without increasing risk.
Bustoff wrote:Moreover, FDIC limits necessitate opening multiple accounts.
True again, and again, the tradeoff is between simplicity and optimizing expected return/risk. This is more of a constraint for IRAs, since for taxable accounts there are many ways to increase FDIC/NCUA insurance coverage at a single financial institution by using different ownership categories.

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Re: "Get out of bond funds"

Post by Kevin M » Tue Nov 05, 2013 6:19 pm

StarbuxInvestor wrote:Seems like not many fans of bond ladders versus bond funds which does surprise me. My favorite feature of a bond ladder is while the interest rate the bond pays remains constant the time to maturity decreases which is a natural hedge as shorter term bonds virtually always pay lower than similar quality longer term bonds.
Only if you don't maintain the ladder by rolling over the maturing bonds. I think it's been fairly well substantiated here that a rolling bond ladder and a bond fund have very similar risk/return characteristics, except that unless you are using treasuries, you are taking on additional default risk with a ladder due to the smaller number of bonds (unless you have a huge bond portfolio). If you're living off of your portfolio, and spending the money from the maturing bonds instead of reinvesting it, then you have a point, but still need to consider the default risk unless using treasuries. Otherwise, you also have the issue of reinvesting the coupon payments.
StarbuxInvestor wrote:Now buying a TIPS fund I understand.
Why? Since TIPS have essentially no credit risk, as with all treasuries, there is no need to diversify with lots of bonds to hedge against defaults. This saves you the expense of owning a fund, and if you buy at auction, there is no bid/ask spread or other transaction cost. If you're into bond ladders, it seems to me that TIPS and other treasuries would be exactly what you would want to use. Of course a CD ladder currently would provide higher yield than a nominal treasury ladder (unless perhaps you go beyond 5-year maturities for direct CDs and maybe 10 years for brokered CDs).

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Re: "Get out of bond funds"

Post by Scott S » Tue Nov 05, 2013 7:12 pm

My investing horizon will be something like 55-60 years if I take care of myself. In light of that, I'm not too worried about what bonds do in the next five or ten years. I'll just keep investing in my target AA, and rebalance if and when I need to. :moneybag
My Plan: (Age-10)% in bonds until I reach age 60, 50/50 thereafter. Equity split: 50/50 US/Int'l, Bond split: 50/50 TBM/TIPS.

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Re: "Get out of bond funds"

Post by CWRadio » Tue Nov 05, 2013 10:36 pm

Kevin,
Does it makes sense when you are in retirement to get out of multiple bond funds (NAV down 2.8%) now and buy CDs or stay with the bond funds? Thanks Paul

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Re: "Get out of bond funds"

Post by Call_Me_Op » Wed Nov 06, 2013 6:59 am

adlerps wrote:Kevin,
Does it makes sense when you are in retirement to get out of multiple bond funds (NAV down 2.8%) now and buy CDs or stay with the bond funds? Thanks Paul
Clearly, I am not Kevin. But I can tell you that there is no agreement on this. If you are talking bank CD's, this option is safer but will tend to give you lower return.
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Re: "Get out of bond funds"

Post by FinancialDave » Wed Nov 06, 2013 11:27 am

Call_Me_Op wrote:
adlerps wrote:Kevin,
Does it makes sense when you are in retirement to get out of multiple bond funds (NAV down 2.8%) now and buy CDs or stay with the bond funds? Thanks Paul
Clearly, I am not Kevin. But I can tell you that there is no agreement on this. If you are talking bank CD's, this option is safer but will tend to give you lower return.
But I can tell you that there is no agreement on this
This part is true - which does not imply one option is better than the other. If you believe that bonds can do better, just compare your bonds total return over the last year with say a simple savings account earning 1%. Ask yourself if you think they will be any better over the next 12 months.

To be in the bond camp right now you have to have a compelling reason to do so, but to also sell out of part of your asset allocation because that asset is down, you need to have a compelling reason to do that as well.

When you are in retirement, the one thing that matters the most is your income, unless of course you are not using this account for income. So if you sell out of the bond funds you have to understand how this is going to affect your retirement income and how you are going to make up the slack.

fd
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Re: "Get out of bond funds"

Post by Akiva » Wed Nov 06, 2013 1:23 pm

Manks wrote:I am fairly new to the Boglehead investment way of doing things but have loved learning from the wiki and this forum. Before, I was 100% in equity index funds. Now, I have moved things around to 85/15 (I am 27 years old). I am still attempting to learn as much as I can about bonds since they are new to me. I have been hearing Warren Buffets advice on bonds and saw Suze Orman recommend getting out of bond funds on her show last night.

I am not really asking if this is good advice or not. Rather, I would appreciate some clear explanations as to what would make someone give this specific advice in the current state of the economy. For example, how exactly will the 'impending interest rises' affect bond funds influencing people to shy away from or leave this asset class.

It took a lot for me to make the move into my current AA, especially without fully grasping how bonds were and are influenced by interest changes. Thanks for the clarifications!
So the argument is that because bond yields are so low, if you use portfolio theory to decide your weights, the lower returns of bonds will cause the weight to be less than it would have been historically and thus you should be more stock-heavy right now.

It's true that current bond yields do a decent job of predicting bond returns over a longish horizon, but it isn't correct to look at the valuation-implied expected returns for bonds and compare them with long-run average returns for stocks because it's *also* true that long-run stock returns are similarly predictable with valuation ratios. And if you look at what those ratios say about expected stock returns, you'll see that those returns are similarly low. So while the lower expected returns for bonds imply a decreased allocation, the lower expected returns for stocks make bonds *more* attractive. And the two very nearly offset one another (which should probably be expected if you believe that markets actually work).

More generally, bonds are dramatically less risky than stocks and, in general, less risky investments tend to have better risk-adjusted returns over the long-run. So the rule of thumb is that you should only have as much of a stock allocation as you need to meet your goals because increasing it further will not increase your returns enough to offset the additional risk.

So, based on this, I wouldn't tinker with your investment strategy or go in and change your allocation. If you've done the research and picked an allocation that matches your risk tolerance and meets your long-term goals, you should stick with it. At most, you should adjust your overall return expectations down for now and just save more in general rather than adjusting how you allocate your savings.

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Re: "Get out of bond funds"

Post by Kevin M » Wed Nov 06, 2013 3:12 pm

adlerps wrote:Kevin,
Does it makes sense when you are in retirement to get out of multiple bond funds (NAV down 2.8%) now and buy CDs or stay with the bond funds? Thanks Paul
Hi Paul,

Only you can decide if it makes sense for you. I think most Bogleheads are just sticking with their bond funds. For the last couple of years, some of us have been seeing a better risk/return tradeoff in direct CDs. Here are a few things to think about.

It's probably not useful to consider recent past performance in this decision. It's more important to look at expected return and risk going forward. Also, the NAV of your bond funds may be down over the last year, but they're up over the last five years.

I think a good starting point is to compare CDs to treasuries of comparable maturities, since both federally-insured CDs and treasuries have essentially no credit risk. A brokered CD has similar term (interest-rate) risk, while a direct CD with good early withdrawal terms has much less term risk--limited to the early withdrawal penalty (EWP).

Just looking at Vanguard's overview table, a 5-year brokered CD is earning 2.2% and a 5-year treasury is earning 1.41%. A 10-year CD is earning 3.35% and a 10-year treasury is earning 2.64%. So it seems that the retail investor is being offered a better deal with CDs; institutional investors can't take advantage of the FDIC insurance, so treasuries are safer for them. But also consider that treasuries are more liquid; if you want to sell your brokered CD, you pay a steep price due to large bid/ask spreads.

With direct CDs, you can earn about 2% on a 5-year, and you're probably not going to get much more than that be extending maturity. So up to maturities of 5 years you earn almost as much as a brokered CD, but limit your downside risk to about 1% assuming an EWP of 180 days of interest. But you also have to consider the possibility that an early withdrawal will not be allowed, or the early withdrawal terms might be changed.

To beat the yields on CDs with maturities up to 5 years for direct and 10 years for brokered, you have to take some credit risk in addition to the term risk of a treasury. But even for Total Bond Market, a favorite of many Bogleheads, the SEC yield is only 2.15%. So you're taking more risk, both term risk (compared to direct CDs) and credit risk, for about the same expected return. I don't see the point in that unless you have no choice (e.g., in a 401k/403b), or you value simplicity over optimizing risk/return (which is a perfectly valid reason), or unless your fixed income allocation is small enough that it doesn't make much difference. Also, as many will point out, the current yield of the US aggregate bond market is a very good predictor of return over the following 10 years, so chances are good that your total return will be about 2% over the next 10 years if you just stick with TBM. Finally, there's always the concern that the early withdrawal terms of a direct CD will be changed, or that an early withdrawal will not be allowed.

If you want to take more credit risk to increase expected returns, you can use intermediate-term investment-grade or tax-exempt bond funds. SEC yield on int-term inv-grade is 2.89%, and on the newer int-term corporate bond index fund it's 3.36% (all numbers are for Admiral shares). Of course you can increase yields even more by taking more term risk with long-term bond funds, but not many here will support that.

Also consider that it doesn't have to be an all or none decision. I currently have about 2/3 of my fixed income in direct CDs and 1/3 in mostly intermediate-term investment-grade and tax-exempt bond funds. Since TBM is about 2/3 government bonds, I think this gives me comparable if not lower risk than TBM in terms of risk, and somewhat higher expected return. I moved to this position gradually over the last three years or so as rates dropped and bond fund NAVs rose, with my last bond fund sales in May of this year.

If in taxable accounts, you should be looking at after-tax returns. This gives intermediate-term tax-exempt funds quite an edge in terms of expected return, but of course you're taking the extra term and credit risk. Int-term tax-exempt SEC yield is 2.35%. Assuming an effective marginal tax rate of 25%, a 2% CD is only earning 1.5% after tax. Again, you can always mix and match to get the balance of yield and risk that works for you.

Hope this helps.

Kevin
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Re: "Get out of bond funds"

Post by Greenman72 » Wed Nov 06, 2013 3:24 pm

nedsaid wrote:Buffett and Orman both hold large portfolios of bonds. Buffett owns them indirectly through ownership in Berkshire Hathaway which is largely a big insurance company. Insurance companies hold large bond portfolios....
So don't listen to this bad advice. Buffett isn't practicing what he preaches.
Disagree. Buffett definitely practices what he preaches. He preaches, "Buy stocks when they're a good value and hold them forever."

He buys bonds through his insurance company because he has to in order to conform to regulations.

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