Why hold total bond market fund when 7 year CDs yield more?

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tc101
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Why hold total bond market fund when 7 year CDs yield more?

Post by tc101 » Tue Jan 23, 2018 10:16 am

You can get a 7 year CD at Vanguard yielding 2.75%. The total bond market fund has a longer average maturity of 8.4 years, yields 2.65%, and is slightly less safe. Why buy the total bond market fund?

If you are are investing a large amount of money and the $250K FDIC insurance limit per bank is a problem I can understand that, but buying them from different banks easily insures you up to a million.

If you think you will need the money in less than 7 years I understand that, but for a long term investor with under a million in bonds, why would you buy the total bond market fund?
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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by jebmke » Tue Jan 23, 2018 10:26 am

For many it is probably just convenience.
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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by renner » Tue Jan 23, 2018 10:31 am

history != future

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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by livesoft » Tue Jan 23, 2018 10:31 am

I bought more total bond index fund yesterday. I bought it because it was down 1% YTD and I was rebalancing from equities (up 6% YTD) into bonds following my asset allocation plan. While many people talk about yield, I only care about Total Return. The yield on CD is its total return, but the yield on a bond fund is not usually its Total Return. Sometimes a bond fund goes down and sometimes it goes up.

2017 was a tough year for bond funds, yet they still outperformed CDs purchased in the past few years. I expect bond funds to outperform 7-year CDs purchased today.

And bond funds are up 0.25% to 0.3% today, so I already made some money.
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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by dbr » Tue Jan 23, 2018 10:32 am

Convenience and it is probably a wash on return. When CD yields are competitive with the alternative in bond they can be a good choice. Don't forget CDs have reinvestment risk if you can't redeem the CD early without too large a penalty to replace it with a higher yielding CD if interest rates go up. Some accounts, such as 401Ks most often would not have an option to hold CDs.

Too many people get twisted up on wanting to avoid duration risk in bonds by buying a fixed "cash" instrument. For the long term investor that is not a very important concern.

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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by LukeHeinz57 » Tue Jan 23, 2018 10:34 am

The Bond Market Fund will be buying issues with progressively higher yields in a rising environment increasing the amount it pays out over the course of the next seven years...If interest rates go the other way the fund's shares will appreciate in value hold older higher coupon bonds. The CD's are locked in at the 2.75% which is very minimally higher than the bond fund you referenced.
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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by Agggm » Tue Jan 23, 2018 10:37 am

tc101 wrote:
Tue Jan 23, 2018 10:16 am
You can get a 7 year CD at Vanguard yielding 2.75%. The total bond market fund has a longer average maturity of 8.4 years, yields 2.65%, and is slightly less safe. Why buy the total bond market fund?

If you are are investing a large amount of money and the $250K FDIC insurance limit per bank is a problem I can understand that, but buying them from different banks easily insures you up to a million.

If you think you will need the money in less than 7 years I understand that, but for a long term investor with under a million in bonds, why would you buy the total bond market fund?
CDs and Bond funds are different assets with different risks and rewards.

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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by midareff » Tue Jan 23, 2018 10:49 am

If for some reason you need to draw money the CD will have an early withdrawal penalty while the bond fund does not.

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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by friar1610 » Tue Jan 23, 2018 11:46 am

It doesn't have to be bond funds OR CDs. Why not bond funds AND CDs? Both fit in the FI category yet each has slightly different set of pros and cons.(And I-Bonds could also be added to the mix.)
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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by BolderBoy » Tue Jan 23, 2018 11:50 am

tc101 wrote:
Tue Jan 23, 2018 10:16 am
You can get a 7 year CD at Vanguard yielding 2.75%. The total bond market fund has a longer average maturity of 8.4 years, yields 2.65%, and is slightly less safe. Why buy the total bond market fund?
For ease of rebalancing?
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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by dbr » Tue Jan 23, 2018 11:53 am

friar1610 wrote:
Tue Jan 23, 2018 11:46 am
It doesn't have to be bond funds OR CDs. Why not bond funds AND CDs? Both fit in the FI category yet each has slightly different set of pros and cons.(And I-Bonds could also be added to the mix.)
The reason why not is because there has to be a right answer and if your answer is different from mine, then you are wrong.

Bonds are a natural area in which alternatives that don't make much difference provoke unending discussion.

Of course in reality many people would indeed hold both bonds (funds) and CDs.

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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by garlandwhizzer » Tue Jan 23, 2018 12:00 pm

Why hold total bond market fund when 7 year CDs yield more?
Instant liquidity for unanticipated expenses or rebalancing which is not available with a 7 yr. CD without penalty.

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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by willthrill81 » Tue Jan 23, 2018 12:18 pm

LukeHeinz57 wrote:
Tue Jan 23, 2018 10:34 am
The Bond Market Fund will be buying issues with progressively higher yields in a rising environment increasing the amount it pays out over the course of the next seven years...If interest rates go the other way the fund's shares will appreciate in value hold older higher coupon bonds. The CD's are locked in at the 2.75% which is very minimally higher than the bond fund you referenced.
The boost in yield from higher interest rates will be largely offset by a reduction in the bonds' principal value due to increased rates. Consequently, the current TBM yield of about 2.52% is, based on history, unlikely to result in a total return greater than 2.75% over the next seven years.
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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by itstoomuch » Tue Jan 23, 2018 12:26 pm

+1 :shock: @thrillbill81
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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by Tyler Aspect » Tue Jan 23, 2018 12:51 pm

When you compare a CD versus US Treasury Note there are some differences. FDIC insurance will protect a CD's principle and accrued interests, but FDIC does not protect any future interest payments. If your CD's bank goes under during a recession, then any new CD you could re-purchase at that time with FDIC payment might have a lower yield.
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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by LukeHeinz57 » Tue Jan 23, 2018 1:38 pm

willthrill81 wrote:
Tue Jan 23, 2018 12:18 pm
LukeHeinz57 wrote:
Tue Jan 23, 2018 10:34 am
The Bond Market Fund will be buying issues with progressively higher yields in a rising environment increasing the amount it pays out over the course of the next seven years...If interest rates go the other way the fund's shares will appreciate in value hold older higher coupon bonds. The CD's are locked in at the 2.75% which is very minimally higher than the bond fund you referenced.
The boost in yield from higher interest rates will be largely offset by a reduction in the bonds' principal value due to increased rates. Consequently, the current TBM yield of about 2.52% is, based on history, unlikely to result in a total return greater than 2.75% over the next seven years.
That's the great thing about posting here, you can always learn more! So if the duration is 7yrs, and interest rates increase above the market's expectations in the first couple of years, all those increased coupon payments the following five years will not make up for the loss in N.A.V. from the first couple of years?
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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by willthrill81 » Tue Jan 23, 2018 1:57 pm

LukeHeinz57 wrote:
Tue Jan 23, 2018 1:38 pm
willthrill81 wrote:
Tue Jan 23, 2018 12:18 pm
LukeHeinz57 wrote:
Tue Jan 23, 2018 10:34 am
The Bond Market Fund will be buying issues with progressively higher yields in a rising environment increasing the amount it pays out over the course of the next seven years...If interest rates go the other way the fund's shares will appreciate in value hold older higher coupon bonds. The CD's are locked in at the 2.75% which is very minimally higher than the bond fund you referenced.
The boost in yield from higher interest rates will be largely offset by a reduction in the bonds' principal value due to increased rates. Consequently, the current TBM yield of about 2.52% is, based on history, unlikely to result in a total return greater than 2.75% over the next seven years.
That's the great thing about posting here, you can always learn more! So if the duration is 7yrs, and interest rates increase above the market's expectations in the first couple of years, all those increased coupon payments the following five years will not make up for the loss in N.A.V. from the first couple of years?
Yes, we're all here to learn and share our knowledge.

It's unlikely, though possible, that the higher yields could compensate for the drop in principal. Keep in mind that the best measure of an intermediate term bond fund's return over the next decade is its current yield.

Also, people act as though interest rates are guaranteed to rise over the next few years, but that is far from guaranteed. Look at how long interest rates have been in the basement in Japan, for instance.
Last edited by willthrill81 on Tue Jan 23, 2018 1:59 pm, edited 1 time in total.
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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by dbr » Tue Jan 23, 2018 1:59 pm

LukeHeinz57 wrote:
Tue Jan 23, 2018 1:38 pm
willthrill81 wrote:
Tue Jan 23, 2018 12:18 pm
LukeHeinz57 wrote:
Tue Jan 23, 2018 10:34 am
The Bond Market Fund will be buying issues with progressively higher yields in a rising environment increasing the amount it pays out over the course of the next seven years...If interest rates go the other way the fund's shares will appreciate in value hold older higher coupon bonds. The CD's are locked in at the 2.75% which is very minimally higher than the bond fund you referenced.
The boost in yield from higher interest rates will be largely offset by a reduction in the bonds' principal value due to increased rates. Consequently, the current TBM yield of about 2.52% is, based on history, unlikely to result in a total return greater than 2.75% over the next seven years.
That's the great thing about posting here, you can always learn more! So if the duration is 7yrs, and interest rates increase above the market's expectations in the first couple of years, all those increased coupon payments the following five years will not make up for the loss in N.A.V. from the first couple of years?
See: https://www.bogleheads.org/wiki/Bonds:_ ... s#Duration In the case of interest rates constantly varying computation of the outcome is complex. But yes two years is not long enough to reach indifference between the interest rate having increased or not. But then, who is invested for a two year outcome? Someone who is would not be in seven year CDs either, probably.

Note the problem here consists of two parts. One is understanding duration, which is just math. The other is predicting interest rates, which is impossible.

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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by hoops777 » Tue Jan 23, 2018 2:00 pm

I buy CDs when they are a good deal simply because I want to know exactly what I have.My largest investment is a 10 year CD I bought about 4 years ago at 3.4 pct.I also have bond funds.I like the mix of both with the certainty of the CD return.
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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by dm200 » Tue Jan 23, 2018 6:08 pm

It is very possible that the TBM fund will yield more at the end of 7 years (reinvesting dividends) than the CD. My "guess" is that a higher return than the 2.75% is much more likely - but no guarantee.

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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by mega317 » Tue Jan 23, 2018 8:34 pm

willthrill81 wrote:
Tue Jan 23, 2018 12:18 pm
Consequently, the current TBM yield of about 2.52% is, based on history, unlikely to result in a total return greater than 2.75% over the next seven years.
Does this mean you prefer CDs, then?

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Re: Why hold total bond market fund when 7 year CDs yield more?

Post by willthrill81 » Tue Jan 23, 2018 8:42 pm

mega317 wrote:
Tue Jan 23, 2018 8:34 pm
willthrill81 wrote:
Tue Jan 23, 2018 12:18 pm
Consequently, the current TBM yield of about 2.52% is, based on history, unlikely to result in a total return greater than 2.75% over the next seven years.
Does this mean you prefer CDs, then?
At the moment, if I was buying fixed income on the open market, yes, I would prefer CDs. Larry Swedroe really likes them as well.

But I have access to a stable value fund that is currently paying 3.25% with full liquidity, so I would go for that if I wanted fixed income. Right now, it's stocks almost all the way.
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