Total Bond

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
EnjoyIt
Posts: 1546
Joined: Sun Dec 29, 2013 8:06 pm

Total Bond

Post by EnjoyIt » Sun Dec 29, 2013 8:41 pm

Hi,
I am quite new to the boglehead community, and am thrilled I found it. Since, I have realized huge errors/mistakes in my portfolio and am looking to make drastic changes. Before I put up my full portfolio for review, I want to make sure I have a reasonable grasp of what the wiki has to offer. There is one thing that concerns me and it is bonds. I understand that past performance does not equal future returns, but I have a very hard time getting over the low interest rate and current bond prices. I am worried that buying any bonds today including Vanguard total bond is a loosing investment as prices can't really go up, and are almost certain to go down at some point in the future as interest rates rise.

Please get me through this mind block. Am I wrong on this assumption, and why should I buy bonds today?

-Beck

invhelpme
Posts: 48
Joined: Sun Apr 04, 2010 12:14 pm

Re: Total Bond

Post by invhelpme » Sun Dec 29, 2013 9:47 pm

Beck, your concerns are the same ones that a lot of us have on this forum. Remember that the bond portion of your portfolio is supposed to be for safety and not to make money. Even if interest rates continue to rise and TBM makes little or no money it is still better than losing 50% of your stock portfolio if the market crashes. If you are young and have a long time to invest I would go with TBM. If not, use Vangaurd Short Term Bond Index or Short Term Corporate. I wish we all had better answers but interest rates can really only go up from here at some point. I own a lot of TBM and don't want to exchange for Short Term now because of locking in losses.

User avatar
whaleknives
Posts: 1210
Joined: Sun Jun 24, 2012 7:19 pm

Re: Total Bond

Post by whaleknives » Sun Dec 29, 2013 10:49 pm

As often posted by nisiprius, one picture on bonds reducing portfolio volatility is worth a thousand words:
Image
The roller coaster is not bonds.
"I'm an indexer. I own the market. And I'm happy." (John Bogle, "BusinessWeek", 8/17/07) ☕ Maritime signal flag W - Whiskey: "I require medical assistance."

EnjoyIt
Posts: 1546
Joined: Sun Dec 29, 2013 8:06 pm

Re: Total Bond

Post by EnjoyIt » Mon Dec 30, 2013 2:52 am

I am 37 to answer the previous question.

Although I understand the graph, I do believe we are in uncharted waters of interest rates.
I saw a nice post on here regarding PenFed 5 year CDs at 3% which will guarantee an upward and to right slope probably much better than a total bond or short term bond could that be a better answer.

And another concern/question regarding allocation and taxes. With returns so low I now am having a hard time seeing why allocating bonds into a traditional IRA is the best tax decision today.

User avatar
LH
Posts: 5490
Joined: Wed Mar 14, 2007 2:54 am

Re: Total Bond

Post by LH » Mon Dec 30, 2013 4:17 am

Beckmaster wrote:Hi,
I am quite new to the boglehead community, and am thrilled I found it. Since, I have realized huge errors/mistakes in my portfolio and am looking to make drastic changes. Before I put up my full portfolio for review, I want to make sure I have a reasonable grasp of what the wiki has to offer. There is one thing that concerns me and it is bonds. I understand that past performance does not equal future returns, but I have a very hard time getting over the low interest rate and current bond prices. I am worried that buying any bonds today including Vanguard total bond is a loosing investment as prices can't really go up, and are almost certain to go down at some point in the future as interest rates rise.

Please get me through this mind block. Am I wrong on this assumption, and why should I buy bonds today?

-Beck

At any given point bond prices can go up, down, or stay the same.

At any given point stock prices can go up, down, or stay the same.

Stocks can plummet 50+ percent.

Bonds typically plummet less. (inflation can really cause loss of nominal value, TIPS in theory, can protect against theis)

If interest rates rise 2 percent, and your bond duration is five, that means you bonds will drop 2(5)=10 percent. It also means, going forward, your bonds will earn two percent more each year, than they did previously.
For instance. 100 dollars invested in bond fund duration 5 years. say fund pays out 2 percent a year. two cases:
1)Interest rates stay the same
100,102,104,106,108,110
2)interest rate jump to 4 percent a year. Bond fund value drops 2(5)=10 percent to 90. 100 dollars become 90 dollars.
90, 93.6,97.34,101.23,105,109.49

In 5 years of this state, breakeven occurs with bonds, then you earn more money with the 4 percent rate, versus the two percent rate.

Take the case where interest rates stay low for 10 years, and stock plummet and lose 50 percent of value in 2014, and basically stay flat for 10 years, until 2024, or heck make it 2034. Look for instance, at japanese experience with low interest rates for 20 years, and a stock market that has not recovered in 20 years.......

Bonds are always good to mitigate stock risk, to diversify. Just because rates low now, does not mean they have to go up in next tens of years. In fact, in real terms, if inflation spikes up, and financial repression continues, they can even go more negative real than they have been.......

I would not be surprised if interest rates stayed low for 20 years and inflation stays low too, I would not be surprised if inflation jumps to 10 percent within 5 years and rates jump up to 7 percent.... etc.

You cannot know. Or if you do know, by all means lever up, and place your bet. (hint don't bet, you do not know)

Interest rate jumps, are a double edged sword, sure, they drop value of marked to market bonds, but then you make MORE money going forward.

Inflation now, that is a bigger risk imo, once its inflated away its gone, you do not make anything up per se via higher interest rates de facto, although interest rates do expectantly go up with inflation going up nominally at least. This is why I hold TIPS as 50 percent of my bonds.

I do not believe I can time what will happen. I believe it will be like 2007 everything looks good, to 2008, everything looks bad. or roaring 20s, 1929, to 1934. or stagflation in70s with gas lines. or in 1979 "death of equites" business week cover, 1981 best selling books listing stocks as one of last things to buy, right before the stock boom......

Humans cannot predict.

Bonds are as good now, as they ever have been. Just as stocks in 2007, or 1929, were as good as they ever had been. You do not know what is around the corner.

Diversify.

YDNAL
Posts: 13774
Joined: Tue Apr 10, 2007 4:04 pm
Location: Biscayne Bay

Re: Total Bond

Post by YDNAL » Mon Dec 30, 2013 5:12 am

Beckmaster wrote:I am 37 to answer the previous question.

Although I understand the graph, I do believe we are in uncharted waters of interest rates.
I saw a nice post on here regarding PenFed 5 year CDs at 3% which will guarantee an upward and to right slope probably much better than a total bond or short term bond could that be a better answer.

And another concern/question regarding allocation and taxes. With returns so low I now am having a hard time seeing why allocating bonds into a traditional IRA is the best tax decision today.
Two things. You shouldn't see investment options in isolation and should avoid recency bias when making decisions.

1. Bonds are in the overall portfolio to mitigate Equity risk. When Equity drops 50%, 60%, whatever, how would you use - and what is the net cost/benefit of - a PenFed CD to rebalance the portfolio and purchase more Equity? You see, it is not as straightforward and simple as a chart with 3% PenFed here, 3% Bonds with potential drop over there.
read about DURATION.

2. You say to have a hard time on investment *location* decisions based on Bond returns "so low now." What happens in the same scenario as #1? You give-up tax loss harvesting opportunities that may be worth significantly more depending on the severity of the drop and your marginal tax rate. You see, it is not as straightforward as you may think (be led to think).
THIS may be of interest.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

dbr
Posts: 27207
Joined: Sun Mar 04, 2007 9:50 am

Re: Total Bond

Post by dbr » Mon Dec 30, 2013 9:31 am

Beckmaster wrote:Hi,
t I have a very hard time getting over the low interest rate and current bond prices.

-Beck
Sometimes an important lesson is that life can be the pits instead of the cherries.

User avatar
midareff
Posts: 5712
Joined: Mon Nov 29, 2010 10:43 am
Location: Biscayne Bay, South Florida

Re: Total Bond

Post by midareff » Mon Dec 30, 2013 9:42 am

Beckmaster wrote:I am 37 to answer the previous question.

Although I understand the graph, I do believe we are in uncharted waters of interest rates.
I saw a nice post on here regarding PenFed 5 year CDs at 3% which will guarantee an upward and to right slope probably much better than a total bond or short term bond could that be a better answer.

And another concern/question regarding allocation and taxes. With returns so low I now am having a hard time seeing why allocating bonds into a traditional IRA is the best tax decision today.
If we look at today under a microscope your answer is correct, and it may be correct looking forward, or not. The 3.0% is just that, 3.0%. well, almost, it is taxable as interest. ... and you are locked in for 5 years. This is not rebalance money, unless you loose almost all interest. For a portion of fixed income it certainly merits strong consideration for someone with a time horizon wherein 5 years fits comfortably.

jimkinny
Posts: 1271
Joined: Sun Mar 14, 2010 1:51 pm

Re: Total Bond

Post by jimkinny » Mon Dec 30, 2013 10:11 am

Don't worry about interests rates going up, down or staying the same.

Compare yields and risk. Is the increase yield of an insured CD is worth the potential early withdrawal penalty?

Something like Vanguard's Total Bond Market fund has about 30% corporate bonds, the rest is in federally back bonds. An insured CD is that, 100% government backed.

The TBM fund has a duration in the 5 year range. If you can buy an insured 5 year CD for a yield greater than the TBM and that yield is worth the extra trouble of an early withdrawal penalty and opening another account, then I would buy the CD. An extra benefit is that if you want your money back at the end of 5 years, you will get it, even if interest rates go up. The only potential downside is that if interest rates drop, you will not benefit like owners of bonds funds (but future interest rates are not really a factor in making the bond fund vs CD decision)

Read the Wiki about bond risks. It may help you decide how you want to take risks using fixed income.

jim

User avatar
abuss368
Posts: 12738
Joined: Mon Aug 03, 2009 2:33 pm
Location: Where the water is warm, the drinks are cold, and I don't know the names of the players!

Re: Total Bond

Post by abuss368 » Mon Dec 30, 2013 10:20 am

whaleknives wrote:As often posted by nisiprius, one picture on bonds reducing portfolio volatility is worth a thousand words:
Image
The roller coaster is not bonds.
And that picture was over many different interest rate environments.
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

User avatar
abuss368
Posts: 12738
Joined: Mon Aug 03, 2009 2:33 pm
Location: Where the water is warm, the drinks are cold, and I don't know the names of the players!

Re: Total Bond

Post by abuss368 » Mon Dec 30, 2013 10:24 am

Bonds are for safety and income. Any good low cost and diversified fund form vanguard should accomplish this.

Bond returns are a function of term and credit. A fund with a higher duration will be more sensitive to changes in interest rates.

I would consider the simple, low cost, and diversified Total Bond Market Index Fund. While the fund will probably finish the year with a 2% or so loss, that is nothing compared to a 50% loss in equities.

Back in 2008, the bond funds provided an excellent pool of funds to use to rebalance back into equities along with new contributions.

Develop a portfolio plan and stay the course.
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

billyt
Posts: 687
Joined: Wed Aug 06, 2008 9:57 am

Re: Total Bond

Post by billyt » Mon Dec 30, 2013 10:26 am

In the long run, virtually 100% of a bond funds total return comes from the interest.

User avatar
abuss368
Posts: 12738
Joined: Mon Aug 03, 2009 2:33 pm
Location: Where the water is warm, the drinks are cold, and I don't know the names of the players!

Re: Total Bond

Post by abuss368 » Mon Dec 30, 2013 10:28 am

billyt wrote:In the long run, virtually 100% of a bond funds total return comes from the interest.
Exactly. All of Jack Bogle's books have shown this. Investors would be wise to follow this advice.
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

EnjoyIt
Posts: 1546
Joined: Sun Dec 29, 2013 8:06 pm

Re: Total Bond

Post by EnjoyIt » Thu Jan 02, 2014 11:39 pm

Thank you all for the response. I am fully convinced on TBM allocation. apply and forget until I reallocate mentality.

Since I recently had some life changes I need to recreate my yearly/monthly budget. Once that is done I will have a pretty good plan set forward. Don't get me wrong I am still paying myself first, but currently don't have a clear cut picture of offense vs defense which I normally have. This is the first year in a very long time, and I don't particularly like it.

Can't wait for all the responses once I post my strategy.

-Beck

Post Reply