Short term bonds in rising interest rates?

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allroads
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Short term bonds in rising interest rates?

Post by allroads » Wed Jan 14, 2015 1:40 pm

I was reading an article that quoted William Bernstein on the topic of bonds. His position is to invest in short term high grade bond funds exclusively. One point in the article talked about the risk of rising interest rates as it relates to bonds and that the shorter duration of the bond fund, the less risk exposure to interest rates. I'm a newbie here so I hope that last statement is correct, and I welcome any needed correction by others.

Though the fed has hinted to rising interest rates for awhile, it does sound like its only a matter of time until they follow through, even if its not in 2015. Do people here use a short term fund (or even a CD ladder) to decrease their interest risk? I hope this doesn't sound like market timing (i don't mean it to), but since the fed is unnaturally manipulating interest rates, does that even offer more interest rate risk for the near future? A thought is to maybe use a short term fund or cd ladder until interest rates are less manipulated and then reallocate to an intermediate fund ?!?
"All Roads Lead to Rome." "Compound interest is the eighth wonder of the world" - Einstein

billyt
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Re: Short term bonds in rising interest rates?

Post by billyt » Wed Jan 14, 2015 2:14 pm

At the present time rates are falling, not rising. The Fed may raise short term rates, but the market has much more control over longer rates. No one can tell you if investing in short term bonds today will turn out to have been the winning strategy 10 years from now.

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Re: Short term bonds in rising interest rates?

Post by dkturner » Wed Jan 14, 2015 2:14 pm

allroads wrote:I was reading an article that quoted William Bernstein on the topic of bonds. His position is to invest in short term high grade bond funds exclusively. One point in the article talked about the risk of rising interest rates as it relates to bonds and that the shorter duration of the bond fund, the less risk exposure to interest rates. I'm a newbie here so I hope that last statement is correct, and I welcome any needed correction by others.

Though the fed has hinted to rising interest rates for awhile, it does sound like its only a matter of time until they follow through, even if its not in 2015. Do people here use a short term fund (or even a CD ladder) to decrease their interest risk? I hope this doesn't sound like market timing (i don't mean it to), but since the fed is unnaturally manipulating interest rates, does that even offer more interest rate risk for the near future? A thought is to maybe use a short term fund or cd ladder until interest rates are less manipulated and then reallocate to an intermediate fund ?!?
Even if the Fed begins the process of raising interest rates in 2015 what will be the impact on short-term bonds versus intermediate-term bonds? What happened with short versus intermediate bonds the last time (2003-2006) the Fed raised interest rates substantially? You should probably compare the total return of short and intermediate bond funds in the 2003-2006 period to get a feel for what to expect when/if the Fed decides to meaningfully increase interest rates.

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Re: Short term bonds in rising interest rates?

Post by asif408 » Wed Jan 14, 2015 2:18 pm

allroads,

Read this article: http://www.obliviousinvestor.com/what-h ... tes-go-up/. It's not as straightforward and some make it out to be.

Some people have shortened their bond duration during the past few years and have missed out on some pretty good returns. IMO if you are young and have a long investment horizon ahead there really isn't much reason to shorten your bond duration if you are investing in intermediate term bonds (long bonds would be another story). If you are near retirement and/or need the money sooner then it may make sense to shorten duration.

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allroads
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Re: Short term bonds in rising interest rates?

Post by allroads » Wed Jan 14, 2015 2:23 pm

dkturner wrote: Even if the Fed begins the process of raising interest rates in 2015 what will be the impact on short-term bonds versus intermediate-term bonds? What happened with short versus intermediate bonds the last time (2003-2006) the Fed raised interest rates substantially? You should probably compare the total return of short and intermediate bond funds in the 2003-2006 period to get a feel for what to expect when/if the Fed decides to meaningfully increase interest rates.
I will take a look. Thanks!
Am I correct that Bernstein's position is to only utilize short term bonds in a portfolio?
"All Roads Lead to Rome." "Compound interest is the eighth wonder of the world" - Einstein

sport
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Re: Short term bonds in rising interest rates?

Post by sport » Wed Jan 14, 2015 2:26 pm

The problem with short duration bonds/funds is the yield is very small while you are waiting for rates to climb. If rates climb soon, it would be worthwhile to wait to extend duration. If rates do not climb soon, you are paying a price for the "insurance" against rising rates that did not happen. So, it really does come down to market timing.
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2retire
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Re: Short term bonds in rising interest rates?

Post by 2retire » Wed Jan 14, 2015 2:32 pm

allroads wrote:I will take a look. Thanks!
Am I correct that Bernstein's position is to only utilize short term bonds in a portfolio?
That is all I have ever read him endorse.

However, the problem with Bernstein's recommendation is that using the word short term doesn't really tell you what he means. I think that many people on here view short terms as 2 years or less, but in his Four Pillars Book, he calls anything under 5 years short term. That is an old book, we don't know if he still considers five years short term or if he has modified it to shorter term.

So, it is left up to you to decide what he really means when he says short term.

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Re: Short term bonds in rising interest rates?

Post by Postmon » Wed Jan 14, 2015 2:33 pm

I kept going back and forth between short and intermediate. Couldn't decide so I just split it. 50% in an intermediate fund and 50% in a short fund. Average duration is around 4.2 years or so.

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Re: Short term bonds in rising interest rates?

Post by saltycaper » Wed Jan 14, 2015 2:33 pm

If you are going to engage in this sort of timing, you not only have to accurately predict when "rates" will go "up," you have to predict the shape of the yield curve. If rates were to rise uniformly across the yield curve, you will take less of a hit if you hold shorter duration bonds. But the yield curve does not behave so predictably. You are better off IMO maintaining some exposure on the intermediate part of the curve regardless of short term interest rate predictions. You'll probably be better off in the long run.
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Re: Short term bonds in rising interest rates?

Post by dkturner » Wed Jan 14, 2015 2:36 pm

allroads wrote:
dkturner wrote: Even if the Fed begins the process of raising interest rates in 2015 what will be the impact on short-term bonds versus intermediate-term bonds? What happened with short versus intermediate bonds the last time (2003-2006) the Fed raised interest rates substantially? You should probably compare the total return of short and intermediate bond funds in the 2003-2006 period to get a feel for what to expect when/if the Fed decides to meaningfully increase interest rates.
I will take a look. Thanks!
Am I correct that Bernstein's position is to only utilize short term bonds in a portfolio?
Yes, Bill has been on the wrong side of history for the last 6 years. Unless he experienced an "awakening" on New Year's Eve he is in now in his 7th year of fighting the Fed.

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Re: Short term bonds in rising interest rates?

Post by msi » Wed Jan 14, 2015 3:37 pm

Bernstein's position in the most recent book, Rational Expections, is that short-term is the "least bad" place to be, not that he thinks you'll get higher returns in short-term bonds.

In the "If You Can" pamphlet, which is meant for a different audience, he recommended Total Bond Market for the sake of simplicity.

Time will tell. Interest rates are notoriously hard to predict. The market itself, Bill Gross, and plenty of other people have gotten it wrong.

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allroads
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Re: Short term bonds in rising interest rates?

Post by allroads » Wed Jan 14, 2015 4:40 pm

2retire wrote:
allroads wrote:I will take a look. Thanks!
Am I correct that Bernstein's position is to only utilize short term bonds in a portfolio?
That is all I have ever read him endorse.

However, the problem with Bernstein's recommendation is that using the word short term doesn't really tell you what he means. I think that many people on here view short terms as 2 years or less, but in his Four Pillars Book, he calls anything under 5 years short term. That is an old book, we don't know if he still considers five years short term or if he has modified it to shorter term.

So, it is left up to you to decide what he really means when he says short term.
Interesting. Thanks.
"All Roads Lead to Rome." "Compound interest is the eighth wonder of the world" - Einstein

Twins Fan
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Re: Short term bonds in rising interest rates?

Post by Twins Fan » Wed Jan 14, 2015 4:58 pm

I should get the book out to quote it accurately, but I'm feeling lazy :happy ... I'm reminded of a line in Bogleheads Guide to Investing about how if predicting the stock market is difficult, predicting interest rate movement is about impossible.

Unless it's money you need in a short time, don't worry about switching to short term bonds/funds.

There are some, even some experts out there, that say if bonds are for safety in a portfolio keep them as short in duration and as safe in credit risk as possible. Makes sense and I don't really see anything wrong with that. But, I think many Bogleheads feel that is too safe. Many of us, myself included, would say a good intermediate type total bond or intermediate term index bond fund will treat you just fine over the long haul.

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Re: Short term bonds in rising interest rates?

Post by VPP » Thu Jan 15, 2015 9:04 am

allroads wrote:I was reading an article that quoted William Bernstein on the topic of bonds. His position is to invest in short term high grade bond funds exclusively. One point in the article talked about the risk of rising interest rates as it relates to bonds and that the shorter duration of the bond fund, the less risk exposure to interest rates. I'm a newbie here so I hope that last statement is correct, and I welcome any needed correction by others.

Though the fed has hinted to rising interest rates for awhile, it does sound like its only a matter of time until they follow through, even if its not in 2015. Do people here use a short term fund (or even a CD ladder) to decrease their interest risk? I hope this doesn't sound like market timing (i don't mean it to), but since the fed is unnaturally manipulating interest rates, does that even offer more interest rate risk for the near future? A thought is to maybe use a short term fund or cd ladder until interest rates are less manipulated and then reallocate to an intermediate fund ?!?
allroads, if your asset allocation is correct based on your financial needs, core philosophy and risk tolerance, rates do not matter along with stock valuations or anything else. The prospect of rising rates would only bother a market timer or someone that is uncomfortable with their AA. There is a very complex brew of economic ingredients determining future rates, not to mention how the market reacts and over how long of a period it happens, this is much to complicated for anyone to digest. Unless there is more to the story than you are describing?

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Re: Short term bonds in rising interest rates?

Post by pascalwager » Thu Jan 15, 2015 12:13 pm

allroads wrote:
I will take a look. Thanks!
Am I correct that Bernstein's position is to only utilize short term bonds in a portfolio?
That is all I have ever read him endorse.

However, the problem with Bernstein's recommendation is that using the word short term doesn't really tell you what he means. I think that many people on here view short terms as 2 years or less, but in his Four Pillars Book, he calls anything under 5 years short term. That is an old book, we don't know if he still considers five years short term or if he has modified it to shorter term.

So, it is left up to you to decide what he really means when he says short term.
In Rational Expectations he specifies using 2.5 year maturities with the exception that you can use state-specific intermediate muni funds.
Overall AA: 51/37/12 | Portfolio 1: total world stock market, short-term TIPS | Portfolio 2: global large value, global small cap, ultra short-term global bonds | Cash: Treasury money market

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Re: Short term bonds in rising interest rates?

Post by YDNAL » Thu Jan 15, 2015 1:16 pm

allroads wrote:I was reading an article that quoted William Bernstein on the topic of bonds. His position is to invest in short term high grade bond funds exclusively. One point in the article talked about the risk of rising interest rates as it relates to bonds and that the shorter duration of the bond fund, the less risk exposure to interest rates. I'm a newbie here so I hope that last statement is correct, and I welcome any needed correction by others.
Yes, the shorter the Duration of a bond fund, the lesser exposure to interest rate risk. But, also, the lesser exposure to projected growth. Regarding Duration, this is a good place to start.
allroads wrote:Though the fed has hinted to rising interest rates for awhile, it does sound like its only a matter of time until they follow through, even if its not in 2015.
This sentiment has been expressed in the Forum hundreds (thousands?) of times over the past 5+ years (since 2010 if I recall). A quick Google search provides some quick examples of posts regarding this topic -- there are certainly many, many others.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

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allroads
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Re: Short term bonds in rising interest rates?

Post by allroads » Thu Jan 15, 2015 9:53 pm

pascalwager wrote:
allroads wrote:
I will take a look. Thanks!
Am I correct that Bernstein's position is to only utilize short term bonds in a portfolio?
That is all I have ever read him endorse.

However, the problem with Bernstein's recommendation is that using the word short term doesn't really tell you what he means. I think that many people on here view short terms as 2 years or less, but in his Four Pillars Book, he calls anything under 5 years short term. That is an old book, we don't know if he still considers five years short term or if he has modified it to shorter term.

So, it is left up to you to decide what he really means when he says short term.
In Rational Expectations he specifies using 2.5 year maturities with the exception that you can use state-specific intermediate muni funds.
Thanks
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Re: Short term bonds in rising interest rates?

Post by Ged » Thu Jan 15, 2015 10:20 pm

When picking duration I think you want to consider when you are going to need the money. If it's 5 years or so short term makes sense because there won't be time for increased rates to make up for the price decrease with an intermediate bond. If it's 10 years then intermediate makes sense because the higher rates will more than compensate. In between it depends on the details of the situation.

Longer term is ok only if you holding till maturity to meet a specific known obligation.

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Re: Short term bonds in rising interest rates?

Post by hoops777 » Thu Jan 15, 2015 10:27 pm

What if you do not need the money until you start your RMD's in 8 years and your bond funds will be the main source of the RMD's?Foolish to have it in short term in this case?
K.I.S.S........so easy to say so difficult to do.

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Re: Short term bonds in rising interest rates?

Post by sport » Fri Jan 16, 2015 1:10 am

hoops777 wrote:What if you do not need the money until you start your RMD's in 8 years and your bond funds will be the main source of the RMD's?Foolish to have it in short term in this case?
You could hold intermediate bonds/funds for 5 years or so. Once RMDs start, you will not be using all of the money within a few years. So, at that time, you might want to have some short term funds to augment your intermediate term funds. The shorter funds will provide safety and the intermediate funds will provide better yield. If you follow this type of plan, you would want to convert some of the intermediate funds to shorter funds each year as you spend the shorter funds.
Jeff

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Re: Short term bonds in rising interest rates?

Post by YDNAL » Fri Jan 16, 2015 10:02 am

hoops777 wrote:What if you do not need the money until you start your RMD's in 8 years and your bond funds will be the main source of the RMD's? Foolish to have it in short term in this case?
Yes, foolish.
  • 1. If you buy Vanguard IT Bond Index (VBILX) today, you can expect to get compensated an amount approximating its SEC yield (2.38%) over the fund's average duration (6.4 years).
    2. With an 8-year investment horizon, why would you settle for ST Bond Index (VBIRX)'s SEC yield of 1.07% over the fund's average duration (2.7 years)?
Generally, it makes sense to switch, after 6 years, from IT to ST to meet money needs in 8 years.
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hoops777
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Re: Short term bonds in rising interest rates?

Post by hoops777 » Fri Jan 16, 2015 11:04 pm

Thanks.....just wanted to confirm what appeared to be obvious :happy
K.I.S.S........so easy to say so difficult to do.

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Re: Short term bonds in rising interest rates?

Post by allroads » Sat Jan 17, 2015 9:53 pm

Ged wrote:When picking duration I think you want to consider when you are going to need the money. If it's 5 years or so short term makes sense because there won't be time for increased rates to make up for the price decrease with an intermediate bond. If it's 10 years then intermediate makes sense because the higher rates will more than compensate. In between it depends on the details of the situation.

Longer term is ok only if you holding till maturity to meet a specific known obligation.
I'm investing for retirement (30+ years away). Does that mean I should be investing in long term bond funds?
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Re: Short term bonds in rising interest rates?

Post by Day9 » Sat Jan 17, 2015 10:19 pm

allroads wrote:
Ged wrote:When picking duration I think you want to consider when you are going to need the money. If it's 5 years or so short term makes sense because there won't be time for increased rates to make up for the price decrease with an intermediate bond. If it's 10 years then intermediate makes sense because the higher rates will more than compensate. In between it depends on the details of the situation.

Longer term is ok only if you holding till maturity to meet a specific known obligation.
I'm investing for retirement (30+ years away). Does that mean I should be investing in long term bond funds?
These three factors would push you to increase the duration of your Fixed Income:

1. Long time horizon

2. Very high equity allocations

3. Any exposure to commodities
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Re: Short term bonds in rising interest rates?

Post by john94549 » Sat Jan 17, 2015 10:52 pm

allroads, I suspect most folks 30 years or so from retirement just use your garden-variety bond fund for fixed-income. That said, what I did roughly ten years from retirement was to construct an IRA CD ladder. Currently have fifteen years (+/-) in IRA CDs to cover the first leg of retirement. We're 67, and plan to start withdrawals next year. When those CDs run out, then we plan to start tapping tax-deferred equity and bond funds, and/or other assets.

I'd look at a CD ladder when you get on the cusp (ten years or so from retirement). It does help me sleep at night. A five-year ladder of 5-yr IRA CDs. That said, there's still a place for bond funds in your portfolio. I just carved out a "sum certain" some years back and built the CD ladder.

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Re: Short term bonds in rising interest rates?

Post by steve roy » Sun Jan 18, 2015 12:29 am

allroads wrote:
dkturner wrote: Even if the Fed begins the process of raising interest rates in 2015 what will be the impact on short-term bonds versus intermediate-term bonds? What happened with short versus intermediate bonds the last time (2003-2006) the Fed raised interest rates substantially? You should probably compare the total return of short and intermediate bond funds in the 2003-2006 period to get a feel for what to expect when/if the Fed decides to meaningfully increase interest rates.
I will take a look. Thanks!
Am I correct that Bernstein's position is to only utilize short term bonds in a portfolio?
Yup. But I've heard Dr. Bernstein say that he's been wrong about where interest rates would be going these past few years.

dkturner
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Re: Short term bonds in rising interest rates?

Post by dkturner » Sun Jan 18, 2015 7:52 am

steve roy wrote:
allroads wrote:
dkturner wrote: Even if the Fed begins the process of raising interest rates in 2015 what will be the impact on short-term bonds versus intermediate-term bonds? What happened with short versus intermediate bonds the last time (2003-2006) the Fed raised interest rates substantially? You should probably compare the total return of short and intermediate bond funds in the 2003-2006 period to get a feel for what to expect when/if the Fed decides to meaningfully increase interest rates.
I will take a look. Thanks!
Am I correct that Bernstein's position is to only utilize short term bonds in a portfolio?
Yup. But I've heard Dr. Bernstein say that he's been wrong about where interest rates would be going these past few years.
In fairness to Dr. Bernstein I believe his definition of "short-term" is longer than the way that term is used by many other Gurus.

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