Total Bond Market Fund - interest rates rising!

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onourway
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Re: Total Bond Market Fund - interest rates rising!

Post by onourway » Sat Oct 20, 2018 10:50 am

Thanks HomerJ for bringing this up. Over the last couple of years I've provided evidence in numerous 'bond doomsday' threads of previous times in history where Total Bond Market funds provided positive returns even in periods of rapidly rising interest rates. This is yet another real-world example that proves that things don't work out as badly as people often expect.

I personally have some money on the line that illustrates what's happened as well. In January 2017, so nearly the same date you chose, I purchased $99,000 of Total Bond Market Admiral. That was 9,299.812 shares at $10.64 each (I guess that's $98,950 after accounting for the charge my 401k levies to purchase funds outside of American Funds). I have not added or changed this holding in any way other than reinvesting dividends. Today, it is worth $99,812.70. Despite the Fed raising their rate 1.5% during that time, I'm still above water and the sky hasn't fallen! :sharebeer

z3r0c00l
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Re: Total Bond Market Fund - interest rates rising!

Post by z3r0c00l » Sat Oct 20, 2018 10:53 am

restingonmylaurels wrote:
Sat Oct 20, 2018 9:42 am

After listening to the discussion on the board here for some time, I went with an allocation to TBM in the spring of 2016, two and half years ago.

My average buy-in price was 10.86.

The current TBM price is 10.26.

That is a NAV loss of 5.5% in 2.5 years, for a supposedly safe investment.
How do you invest in stocks then? 5.5% is a medium-bad week in stocks. (Or a very bad hour of trading.)

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Earl Lemongrab
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Re: Total Bond Market Fund - interest rates rising!

Post by Earl Lemongrab » Sat Oct 20, 2018 11:51 am

sport wrote:
Sat Oct 20, 2018 10:03 am
You don't need to move around to chase CD interest rates. You can buy brokered CDs in your IRA. It is quick and easy, and the rates are competitive with the best direct CDs. Brokered CDs also have the advantage that they do not auto-reinvest at some low rate if you aren't paying close enough attention to them.
Brokered CDs are essentially bonds. You might as well buy Treasuries.
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

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Earl Lemongrab
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Re: Total Bond Market Fund - interest rates rising!

Post by Earl Lemongrab » Sat Oct 20, 2018 11:55 am

I guess that's the problem with the so-called bull market in bonds. Some people seem to have gotten the idea that bond funds would always go up and never down. Oddly, people were happy to invest in them all this time, but now that they've actually become better investments (higher yield, lower share price), they all the sudden shy away.
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

restingonmylaurels
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Re: Total Bond Market Fund - interest rates rising!

Post by restingonmylaurels » Sat Oct 20, 2018 12:07 pm

vineviz wrote:
Sat Oct 20, 2018 10:17 am
restingonmylaurels wrote:
Sat Oct 20, 2018 9:42 am
That is a NAV loss of 5.5% in 2.5 years, for a supposedly safe investment.

To make matters worse, that loss is a long-term capital loss but the higher income from rising yields that will supposedly make up for this loss is taxed at ordinary rates.
Evaluating any investment SOLELY on NAV is unfair and misleading: Vanguard Total Bond Market has been paying higher distributions the entire time you've owned it and (depending on you exact purchase date) is likely to have had a HIGHER total return than a short-term bond fund.

For example, starting at January 4th, 2016 (since I don't know precisely when you bought TBM) the total CAGR of total bond market has been 1.2% versus only 0.8% for Vanguard Short-Term Bond fund.

Owning bonds during a bull market for stocks is never going to feel great, but we know that investing based on EMOTIONAL reactions is often counterproductive. Holding an intermediate or long-term bond fund is usually going to end up giving you more wealth and lower volatility over a six year holding period or more.
Unfair? Although the particular dates I am using are personal to my investment, NAV is a perfectly valid metric to use.

Bond investors would likely hope that NAV is constant over time and their return comes entirely from the income distributions.

But in this rising inflation expectations/rising rates environment, bond fund NAVs are mostly heading southward. So the income distributions are offsetting that but as mentioned before, those two components are not treated the same tax-wise and are not really equivalent offsets.

Using the total return point that you are making, let me compare two bond funds I evaluated before funding them, TBM and USB (Ultra Short-term Bond).

YTD, TBM is -2.42% and USB is +1.44% (Prime MMR is even better at 1.49%). So while TBM has a higher YTD income component, on a total return basis it nearly 4 percent lower than my alternate ultra short bond fund and money market funds. After tax it would be even a larger differential.

Nothing really emotional about it, just simple math. TBM has been a stinker since I followed BH received wisdom and invested in it.

Will it remain so? Don't know but at some point inflation expectations and Fed funds rates will level off and from that point (or more precisely when the market expects those) TBM's longer duration (higher risk) portfolio should start to be a better investment. It just has not since I have been in it.

restingonmylaurels
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Re: Total Bond Market Fund - interest rates rising!

Post by restingonmylaurels » Sat Oct 20, 2018 12:12 pm

aspirit wrote:
Sat Oct 20, 2018 10:30 am
restingonmylaurels wrote:
Sat Oct 20, 2018 9:42 am
HomerJ wrote:
Fri Oct 19, 2018 10:11 am
So I've seen plenty of people here and in the media warn about bond funds "crashing" when interest rates rise.

Just because I was curious, I checked Total Bond Market Index Fund since 12/14/2016 to today.

Why did I pick 12/14/2016? Because the Fed raised interest rates 0.25% on that day. In fact, including that day, the Fed has raised interest rates 0.25% SEVEN times in less than 2 years since that day. Up a total 1.75%.

Over that same period Total Bond Market lost sorry, gained 1.5% (including reinvested dividends of course). Not much of a gain, to be sure. But a gain. In a rising interest rate environment. Bonds are self-correcting.

When interest rates go up, bond fund values go down, but they start increasing their dividends.
When interest rates go down, dividends decrease, but the bond fund values go up.

Inflation is a real bond killer, not slowly rising interest rates.
Let me provide a personal and different perspective to this discussion.

After listening to the discussion on the board here for some time, I went with an allocation to TBM in the spring of 2016, two and half years ago.

My average buy-in price was 10.86.

The current TBM price is 10.26.

That is a NAV loss of 5.5% in 2.5 years, for a supposedly safe investment.

To make matters worse, that loss is a long-term capital loss but the higher income from rising yields that will supposedly make up for this loss is taxed at ordinary rates.

This has been my worst investment decision in some time. Fortunately, I only allocated a small part of my FI to TBM and made smarter choices like USB with larger allocations.

I will be TLHing this fund shortly. My only question is, when the wash sale period is over, should I move the funds back in or give up on TBM in favor of short term funds or direct T-bill or CD purchases.
U.S Bank-corp? A bank? Good luck!
USB is VG's Ultra-Short Bond fund, which if one needs to be in bond funds during this time of rising rates and inflation expectations, I cannot say enough good things about.

restingonmylaurels
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Re: Total Bond Market Fund - interest rates rising!

Post by restingonmylaurels » Sat Oct 20, 2018 12:32 pm

onourway wrote:
Sat Oct 20, 2018 10:50 am
Thanks HomerJ for bringing this up. Over the last couple of years I've provided evidence in numerous 'bond doomsday' threads of previous times in history where Total Bond Market funds provided positive returns even in periods of rapidly rising interest rates. This is yet another real-world example that proves that things don't work out as badly as people often expect.

I personally have some money on the line that illustrates what's happened as well. In January 2017, so nearly the same date you chose, I purchased $99,000 of Total Bond Market Admiral. That was 9,299.812 shares at $10.64 each (I guess that's $98,950 after accounting for the charge my 401k levies to purchase funds outside of American Funds). I have not added or changed this holding in any way other than reinvesting dividends. Today, it is worth $99,812.70. Despite the Fed raising their rate 1.5% during that time, I'm still above water and the sky hasn't fallen! :sharebeer
Three thoughts arise in reading this post.

First, this would be worse if the bond fund was held in taxable, which is unavoidable when assets reach a certain point.

Second, it is not only the rise in the Fed funds rates but the change in inflation expectations that have impacted TBM's NAV of late.

Third, is the point of investing to tread water? Just calling it two years for simplicity's sake, you have an annual return of around 0.4% on your TBM investment since January 2017. A bit above cash in the mattress but surely nothing to write home about.

restingonmylaurels
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Re: Total Bond Market Fund - interest rates rising!

Post by restingonmylaurels » Sat Oct 20, 2018 12:36 pm

z3r0c00l wrote:
Sat Oct 20, 2018 10:53 am
restingonmylaurels wrote:
Sat Oct 20, 2018 9:42 am

After listening to the discussion on the board here for some time, I went with an allocation to TBM in the spring of 2016, two and half years ago.

My average buy-in price was 10.86.

The current TBM price is 10.26.

That is a NAV loss of 5.5% in 2.5 years, for a supposedly safe investment.
How do you invest in stocks then? 5.5% is a medium-bad week in stocks. (Or a very bad hour of trading.)
When investing in stocks, you expect the volatility. And there really are not significant alternatives.

When investing in bonds you do not expect such volatility. And there really are significant alternatives (direct T-bill ownership, CDs, etc.)

I would imagine that is why the fixed income topic gets sufficient airtime here and why rational people are coming to different conclusions on the right approach to take to fixed income investing.

rkhusky
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Re: Total Bond Market Fund - interest rates rising!

Post by rkhusky » Sat Oct 20, 2018 1:01 pm

restingonmylaurels wrote:
Sat Oct 20, 2018 12:36 pm
z3r0c00l wrote:
Sat Oct 20, 2018 10:53 am
restingonmylaurels wrote:
Sat Oct 20, 2018 9:42 am

After listening to the discussion on the board here for some time, I went with an allocation to TBM in the spring of 2016, two and half years ago.

My average buy-in price was 10.86.

The current TBM price is 10.26.

That is a NAV loss of 5.5% in 2.5 years, for a supposedly safe investment.
How do you invest in stocks then? 5.5% is a medium-bad week in stocks. (Or a very bad hour of trading.)
When investing in stocks, you expect the volatility. And there really are not significant alternatives.

When investing in bonds you do not expect such volatility. And there really are significant alternatives (direct T-bill ownership, CDs, etc.)

I would imagine that is why the fixed income topic gets sufficient airtime here and why rational people are coming to different conclusions on the right approach to take to fixed income investing.
If you can't stand any volatility, then you should invest in CD's or very short bond funds. But you can expect to have lower returns over the long term in exchange. There is a strong correlation between risk and return. For some, lower return is worth the lower volatility.

The average duration of Total Bond fund is 6.2 years. You should wait at least that long before passing judgement.

Looking at only NAV is a poor indicator of the quality of a bond fund, whose primary source of income is dividends. By that measure, my money market account hasn't returned anything for the past 20 years.

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willthrill81
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Re: Total Bond Market Fund - interest rates rising!

Post by willthrill81 » Sat Oct 20, 2018 1:19 pm

restingonmylaurels wrote:
Sat Oct 20, 2018 12:36 pm
z3r0c00l wrote:
Sat Oct 20, 2018 10:53 am
restingonmylaurels wrote:
Sat Oct 20, 2018 9:42 am

After listening to the discussion on the board here for some time, I went with an allocation to TBM in the spring of 2016, two and half years ago.

My average buy-in price was 10.86.

The current TBM price is 10.26.

That is a NAV loss of 5.5% in 2.5 years, for a supposedly safe investment.
How do you invest in stocks then? 5.5% is a medium-bad week in stocks. (Or a very bad hour of trading.)
When investing in stocks, you expect the volatility. And there really are not significant alternatives.

When investing in bonds you do not expect such volatility.
Bonds don't have the volatility in the short-term of stocks, but they are far from perfectly stable, and there is no guarantee that they will even keep pace with inflation. From 1977 to 1981, intermediate-term Treasuries had a 37% drawdown in real dollars IIRC, and long-term bonds suffered even more. That's the kind of hit people associate with stocks.

Jeremy Siegel found that over 20+ year periods, stocks have almost universally provided better inflation protection than nominal bonds. TIPS are a different story, but by bond standards, they are very volatile.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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vineviz
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Re: Total Bond Market Fund - interest rates rising!

Post by vineviz » Sat Oct 20, 2018 1:29 pm

restingonmylaurels wrote:
Sat Oct 20, 2018 12:07 pm
Unfair? Although the particular dates I am using are personal to my investment, NAV is a perfectly valid metric to use.

Bond investors would likely hope that NAV is constant over time and their return comes entirely from the income distributions.
NAV is a terrible way to measure the performance of any investment, especially bonds.

Any investor who hopes for NAV to remain constant deserves a better education about the fundamentals of investing.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

onourway
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Re: Total Bond Market Fund - interest rates rising!

Post by onourway » Sat Oct 20, 2018 1:33 pm

restingonmylaurels wrote:
Sat Oct 20, 2018 12:32 pm
Three thoughts arise in reading this post.

First, this would be worse if the bond fund was held in taxable, which is unavoidable when assets reach a certain point.

Second, it is not only the rise in the Fed funds rates but the change in inflation expectations that have impacted TBM's NAV of late.

Third, is the point of investing to tread water? Just calling it two years for simplicity's sake, you have an annual return of around 0.4% on your TBM investment since January 2017. A bit above cash in the mattress but surely nothing to write home about.
Fortunately I am not concerned about my returns on these funds in the 2 year time span. I will hold these funds for many decades yet. And now I'm already starting to see the benefits of the much higher yields, which, if TBM behaves like it has in previous periods of rising rates, it should start picking up steam any time now.

Austintatious
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Re: Total Bond Market Fund - interest rates rising!

Post by Austintatious » Sat Oct 20, 2018 1:50 pm

This thread really highlights the question we in this household have been pondering over the past few years as we've transitioned to full retirement mode. One constantly hear that bonds are for safety, a concept we've generally ascribed to, but we've decided to ask ourselves just what "safety" means to us now. As for me, I'd be comfortable with the phrase if stated "Bonds are for relative safety."

The question, in my mind, is how much (if any) risk one wants to assume with the fixed income, the so called and intended to be safe or at least safer, portion of one's life savings. At this time in our lives, I do not consider an investment, the returns from which are subject to the day-to-day influences of "the market" and which could easily remain flat or in negative territory for long periods of time, to be safe. On the other hand, I do consider an investment that will not only maintain principal but generate positive returns for a time certain to be a safe investment, perfectly suited for one's fixed income portfolio in retirement. For now, we've sort of split the baby on TBM v. CDs but I'm feeling a lot more comfortable these days with the latter comprising a greater percentage of our "safe" investments.

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vineviz
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Re: Total Bond Market Fund - interest rates rising!

Post by vineviz » Sat Oct 20, 2018 2:23 pm

Austintatious wrote:
Sat Oct 20, 2018 1:50 pm

The question, in my mind, is how much (if any) risk one wants to assume with the fixed income, the so called and intended to be safe or at least safer, portion of one's life savings.
I’d suggest you take a step back and ask how risk you can take at the level of the portfolio.

Your investment horizon primarily determines the amount of risk you can take with you take, and the easiest way to control that is the overall stock/bond allocation.

Within that allocation, both stocks and bonds should be working together to maximize risk-adjusted return.

I see many investors make unforced errors because they’ve focused too much on their asset behavior and not enough on their portfolio behavior.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Total Bond Market Fund - interest rates rising!

Post by Austintatious » Sat Oct 20, 2018 3:10 pm

vineviz wrote:
Sat Oct 20, 2018 2:23 pm
Austintatious wrote:
Sat Oct 20, 2018 1:50 pm

The question, in my mind, is how much (if any) risk one wants to assume with the fixed income, the so called and intended to be safe or at least safer, portion of one's life savings.
I’d suggest you take a step back and ask how risk you can take at the level of the portfolio.

Your investment horizon primarily determines the amount of risk you can take with you take, and the easiest way to control that is the overall stock/bond allocation.

Within that allocation, both stocks and bonds should be working together to maximize risk-adjusted return.

I see many investors make unforced errors because they’ve focused too much on their asset behavior and not enough on their portfolio behavior.
Thanks. I think that's good advice. I believe we've given a great deal of thought to the big picture relative to our specific situation and that we've not focused unduly on the recent performance of specific assets (TBM, for example). Because at least one of us may very well be looking at a retirement of 30 years or more and because we hope to leave a little something for our kids, we plan to maintain a somewhat greater percentage in equities than we'd earlier thought. At the same time, we've chosen to eliminate some of the risk on the FI side.

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aspirit
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Re: Total Bond Market Fund - interest rates rising!

Post by aspirit » Sat Oct 20, 2018 3:33 pm

restingonmylaurels wrote:
Sat Oct 20, 2018 12:12 pm
aspirit wrote:
Sat Oct 20, 2018 10:30 am
restingonmylaurels wrote:
Sat Oct 20, 2018 9:42 am
HomerJ wrote:
Fri Oct 19, 2018 10:11 am
So I've seen plenty of people here and in the media warn about bond funds "crashing" when interest rates rise.

Just because I was curious, I checked Total Bond Market Index Fund since 12/14/2016 to today.

Why did I pick 12/14/2016? Because the Fed raised interest rates 0.25% on that day. In fact, including that day, the Fed has raised interest rates 0.25% SEVEN times in less than 2 years since that day. Up a total 1.75%.

Over that same period Total Bond Market lost sorry, gained 1.5% (including reinvested dividends of course). Not much of a gain, to be sure. But a gain. In a rising interest rate environment. Bonds are self-correcting.

When interest rates go up, bond fund values go down, but they start increasing their dividends.
When interest rates go down, dividends decrease, but the bond fund values go up.

Inflation is a real bond killer, not slowly rising interest rates.
Let me provide a personal and different perspective to this discussion.

After listening to the discussion on the board here for some time, I went with an allocation to TBM in the spring of 2016, two and half years ago.

My average buy-in price was 10.86.

The current TBM price is 10.26.

That is a NAV loss of 5.5% in 2.5 years, for a supposedly safe investment.

To make matters worse, that loss is a long-term capital loss but the higher income from rising yields that will supposedly make up for this loss is taxed at ordinary rates.

This has been my worst investment decision in some time. Fortunately, I only allocated a small part of my FI to TBM and made smarter choices like USB with larger allocations.

I will be TLHing this fund shortly. My only question is, when the wash sale period is over, should I move the funds back in or give up on TBM in favor of short term funds or direct T-bill or CD purchases.
U.S Bank-corp? A bank? Good luck!
USB is VG's Ultra-Short Bond fund, which if one needs to be in bond funds during this time of rising rates and inflation expectations, I cannot say enough good things about.
Hopefully you purchased VUSFX/VUBSX.
My understanding is -USB- is U.S.Bank corps ticker.
I agree w/your advocacy on STBonds. No big deal unless you made a oversight and actually purchased USB. https://www.nasdaq.com/symbol/usb/historical
Good Luck!
Time & tides wait for no one. A man has to know his limitations.

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Taylor Larimore
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A History of Total Bond Market, Inflation and S&P 500 Stocks

Post by Taylor Larimore » Sat Oct 20, 2018 4:09 pm

Bogleheads:

I purchased Vanguard's Total Bond Market for our personal portfolio in 1986. In 2000, I again selected Vanguard Total Bond Market Index Fund for The Three-Fund Portfolio. Vanguard Total Bond Market Index Fund has served investors well and it is now the largest bond fund in the world.

This is a history of TBM during times of U.S. inflation and stock fluctuations:

YEAR--INFLATION--BOND INDEX--S&P 500
1976-------4.9%--------15.6%--------23.8%
1977-------6.7-----------3.0---------(-7.0)
1978-------9.0-----------1.4-----------6.5
1979------13.3-----------1.9---------18.5
1980------12.5-----------2.7---------31.7
1981-------8.9-----------6.3---------(-4.7)
1982-------3.8----------32.6---------20.4
1983-------3.8-----------8.4---------22.3
1984-------3.9----------15.2----------6.1
1985-------3.8----------22.1---------31.2
1986-------1.1----------15.2---------18.5
1987-------4.4-----------2.8-----------5.8
1988-------4.4-----------7.9----------16.5
1989-------4.6----------14.5----------31.5
1990-------6.1-----------8.9----------(-3.1)
1991-------3.1----------16.0----------30.2
1992-------2.9-----------7.4------------7.5
1993-------2.7-----------9.7-----------10.0
1994-------2.7---------(-2.9)-----------1.3
1995-------2.5----------18.5----------37.2
1996-------3.3-----------3.6----------22.7
1997-------1.7-----------9.7----------33.1
1998-------1.6-----------8.7----------28.3
1999-------2.7---------(-0.8)---------20.9
2000-------3.4----------11.6---------(-9.0)
2001-------1.6-----------8.4--------(-11.5)
2002-------2.4----------10.3--------(-22.0)
2003-------1.9-----------4.1----------28.4
2004-------3.3-----------4.3----------10.7
2005-------3.4-----------2.4-----------4.8
2006-------2.5-----------4.3----------15.6
2007-------4.1-----------7.0-----------5.5
2008-------0.1-----------5.2--------(-36.6)
2009-------2.7-----------5.9----------25.9
2010-------1.5-----------6.5----------14.8
2011-------3.0-----------7.7-----------2.1
2012-------1.7-----------4.3----------16.0
2013-------1.5---------(-2.0)---------32.2
2014-------1.6-----------6.0----------13.5
2015-------0.7-----------0.5-----------1.4
2016-------2.1-----------2.6----------12.3
2017-------2.1-----------3.5----------21.8

Source: U.S. Department of Labor, Barclays, Dow Jones Indices and Seeking Alpha

Observations:

* Inflation increased from 4.9% in 1976 to 13.3% in 1979; nevertheless Total Bond Market Index Fund had positive returns during that entire period of high inflation.

* The Aggregate Bond Index had only three negative years (all small) reflecting very low risk.

* Stocks are much riskier than bonds.

Best wishes
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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vineviz
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Re: Total Bond Market Fund - interest rates rising!

Post by vineviz » Sat Oct 20, 2018 4:49 pm

Austintatious wrote:
Sat Oct 20, 2018 3:10 pm
Thanks. I think that's good advice. I believe we've given a great deal of thought to the big picture relative to our specific situation and that we've not focused unduly on the recent performance of specific assets (TBM, for example). Because at least one of us may very well be looking at a retirement of 30 years or more and because we hope to leave a little something for our kids, we plan to maintain a somewhat greater percentage in equities than we'd earlier thought. At the same time, we've chosen to eliminate some of the risk on the FI side.
I think this kind of drives at my point, though: your 40+ year time horizon for the retirement portfolio should be the primary factor driving your asset allocation decisions. That affect not just the stock/bond ratio but also the duration of your fixed income assets.

When you say "we've chosen to eliminate some of the risk on the FI side" I presume that means choosing either short-term bonds or possibly cash instruments (like CDs or money markets).

The counter-intuitive fact that trips up many investors, including many Bogleheads, is that making this kind of move is both reducing the expected return of your overall portfolio and INCREASING its riskiness (as measured by volatility).
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Austintatious
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Re: Total Bond Market Fund - interest rates rising!

Post by Austintatious » Sat Oct 20, 2018 5:01 pm

vineviz wrote:
Sat Oct 20, 2018 4:49 pm
Austintatious wrote:
Sat Oct 20, 2018 3:10 pm
Thanks. I think that's good advice. I believe we've given a great deal of thought to the big picture relative to our specific situation and that we've not focused unduly on the recent performance of specific assets (TBM, for example). Because at least one of us may very well be looking at a retirement of 30 years or more and because we hope to leave a little something for our kids, we plan to maintain a somewhat greater percentage in equities than we'd earlier thought. At the same time, we've chosen to eliminate some of the risk on the FI side.
I think this kind of drives at my point, though: your 40+ year time horizon for the retirement portfolio should be the primary factor driving your asset allocation decisions. That affect not just the stock/bond ratio but also the duration of your fixed income assets.

When you say "we've chosen to eliminate some of the risk on the FI side" I presume that means choosing either short-term bonds or possibly cash instruments (like CDs or money markets).

The counter-intuitive fact that trips up many investors, including many Bogleheads, is that making this kind of move is both reducing the expected return of your overall portfolio and INCREASING its riskiness (as measured by volatility).
In our case, we've swapped a portion of our TBM for CDs. Would you please explain how we can now know that doing so will reduce return and increase risk as measured by volatility?

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vineviz
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Re: Total Bond Market Fund - interest rates rising!

Post by vineviz » Sat Oct 20, 2018 6:15 pm

Austintatious wrote:
Sat Oct 20, 2018 5:01 pm
In our case, we've swapped a portion of our TBM for CDs. Would you please explain how we can now know that doing so will reduce return and increase risk as measured by volatility?
The primary factors that drive returns in fixed income are term risk (i.e. the risks associated with hold longer term investments) and credit risk (i.e. the risks associated with the chance the issuer of the bond will default). Pretty much by definition, the only way to get a higher return is to take on more of those risks and CDs - as a glorified bank account - have pretty much none of either of them. That's why they are perceived as safe, but it's also why they will have lower return over the long-run than an intermediate-term or long-term bond fund.

The counterintuitive part is that BECAUSE of the lower price volatility (short-term bonds have less price volatility than long-term bonds, and CDs have no price volatility) and higher correlations with equities, low-risk assets provide less diversification when added to an equity-heavy portfolio.

Because they aren't actually capital assets, CDs are hard to analyze over history so let's look at the performance of Vanguard Total Bond Market versus Vanguard Short-Term Bond as the fixed income piece of an 80/20 portfolio. Pick 10 years as a period.

An 80/20 portfolio (80% Vanguard Total Stock market and 20% Vanguard Total Bond Market) from 1/2009 to 9/2018 returned 12.90% with a standard deviation of 10.79%/

An 80/20 portfolio with Vanguard Short-Term Bond instead has returns of 12.57% and a standard deviation of 10.83%.

This difference is admittedly small in magnitude, but I think it is worth commenting on because people have a hard time grasping it: the "riskier" bond fund actually made the portfolio less risky than the "safer" bond fund.

The other thing people have a hard time figuring out is that "interest rate risk" isn't the same for everyone. If you're not planning to spend your invested money for 30-40 years, it's not clear why avoiding the price risk of an intermediate total bond market fund is worth giving up ANY expected return and taking on more portfolio volatility.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Total Bond Market Fund - interest rates rising!

Post by stlutz » Sat Oct 20, 2018 6:56 pm

A few years back I did a backtest using the Simba/Siamond spreadsheet and concluded that in a 60/40 portfolio, bank CDs historically would have needed to yield 1.2% above a 5 year Treasury to provide the equivalent portfolio return and volatility as an intermediate term Treasury fund.

viewtopic.php?t=176932#p2681356

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Re: Total Bond Market Fund - interest rates rising!

Post by Kevin M » Sat Oct 20, 2018 7:18 pm

Kenkat wrote:
Sat Oct 20, 2018 10:33 am
Rates have been purported to rise for the last 7 years. Now that it has finally happened, after 5 years of it not happening, it becomes news. And still not a major calamity; returns are still positive but just not as high as we’d like. It’s easy to forget that bonds earned interest at a higher rate than CDs for those 5 years we were all waiting for rates to rise.
Not necessarily (the underlined part). As already mentioned, some of us bought 5-year CDs at 3.0% about five years ago. I have a batch maturing in December. The 5-year total return of Total Bond Market Admiral Shares as of 9/30/2018 was 2.09%.

At the time I bought my first batch of 5-year CDs at 3.0%, in December 2013, the 5-year Treasury yield, which is a better comparison than TBM yield, was about 1.4%.

Kevin
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Re: Total Bond Market Fund - interest rates rising!

Post by AlphaLess » Sat Oct 20, 2018 7:59 pm

HomerJ wrote:
Fri Oct 19, 2018 10:11 am
Why did I pick 12/14/2016?

Because the Fed raised interest rates 0.25% on that day.
I remember Dec.17.2015 (https://www.federalreserve.gov/monetary ... market.htm).
FOMC did the first 25 bps increase after years of zero.

In a couple of weeks, analysts from big investments banks came out and said: price in another 4 rate increases this (2016) year.
And stock market took a dive (of course, another reason was lower earnings that earning season).

But there were no other raises that year (2016), except for the December hike.
"You can get more with a kind word and a gun than with just a kind word." George Washington

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Re: Total Bond Market Fund - interest rates rising!

Post by HomerJ » Sat Oct 20, 2018 10:08 pm

restingonmylaurels wrote:
Sat Oct 20, 2018 12:07 pm
Unfair? Although the particular dates I am using are personal to my investment, NAV is a perfectly valid metric to use.
Ignoring dividends is always incorrect. ALWAYS incorrect. You are absolutely wrong to just look at NAV. It is not a valid metric to use.

Any other point you make may be correct.
The J stands for Jay

Austintatious
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Re: Total Bond Market Fund - interest rates rising!

Post by Austintatious » Sun Oct 21, 2018 8:58 am

vineviz wrote:
Sat Oct 20, 2018 6:15 pm
Austintatious wrote:
Sat Oct 20, 2018 5:01 pm
In our case, we've swapped a portion of our TBM for CDs. Would you please explain how we can now know that doing so will reduce return and increase risk as measured by volatility?
The primary factors that drive returns in fixed income are term risk (i.e. the risks associated with hold longer term investments) and credit risk (i.e. the risks associated with the chance the issuer of the bond will default). Pretty much by definition, the only way to get a higher return is to take on more of those risks and CDs - as a glorified bank account - have pretty much none of either of them. That's why they are perceived as safe, but it's also why they will have lower return over the long-run than an intermediate-term or long-term bond fund.

The counterintuitive part is that BECAUSE of the lower price volatility (short-term bonds have less price volatility than long-term bonds, and CDs have no price volatility) and higher correlations with equities, low-risk assets provide less diversification when added to an equity-heavy portfolio.

Because they aren't actually capital assets, CDs are hard to analyze over history so let's look at the performance of Vanguard Total Bond Market versus Vanguard Short-Term Bond as the fixed income piece of an 80/20 portfolio. Pick 10 years as a period.

An 80/20 portfolio (80% Vanguard Total Stock market and 20% Vanguard Total Bond Market) from 1/2009 to 9/2018 returned 12.90% with a standard deviation of 10.79%/

An 80/20 portfolio with Vanguard Short-Term Bond instead has returns of 12.57% and a standard deviation of 10.83%.

This difference is admittedly small in magnitude, but I think it is worth commenting on because people have a hard time grasping it: the "riskier" bond fund actually made the portfolio less risky than the "safer" bond fund.

The other thing people have a hard time figuring out is that "interest rate risk" isn't the same for everyone. If you're not planning to spend your invested money for 30-40 years, it's not clear why avoiding the price risk of an intermediate total bond market fund is worth giving up ANY expected return and taking on more portfolio volatility.
Thank you for taking the time to respond. Since having bought into the concept of the basic 3 fund portfolio and deciding on our asset allocation, I've given little thought to the volatility of our very basic portfolio other than to assume that, in general, the greater the percentage of equities in one's portfolio, the greater the potential for volatility. Frankly, I'd have thought that moving some of our FI from TBM to CDs would mitigate rather than enhance the potential for volatility simply because the returns generated by CDs are always headed north. That still seems "logical" to me.

Now, I certainly can see where CDs might easily generate lower returns over time than TBM, although considering the posts of stlutz and KevinM just above (thank you), it may be a 3% return from CDs over the trailing 5 years provided the higher return. Though looking at Taylor's returns schedule, maybe not.

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Re: Total Bond Market Fund - interest rates rising!

Post by HEDGEFUNDIE » Sun Oct 21, 2018 9:26 am

Austintatious wrote:
Sun Oct 21, 2018 8:58 am
vineviz wrote:
Sat Oct 20, 2018 6:15 pm
Austintatious wrote:
Sat Oct 20, 2018 5:01 pm
In our case, we've swapped a portion of our TBM for CDs. Would you please explain how we can now know that doing so will reduce return and increase risk as measured by volatility?
The primary factors that drive returns in fixed income are term risk (i.e. the risks associated with hold longer term investments) and credit risk (i.e. the risks associated with the chance the issuer of the bond will default). Pretty much by definition, the only way to get a higher return is to take on more of those risks and CDs - as a glorified bank account - have pretty much none of either of them. That's why they are perceived as safe, but it's also why they will have lower return over the long-run than an intermediate-term or long-term bond fund.

The counterintuitive part is that BECAUSE of the lower price volatility (short-term bonds have less price volatility than long-term bonds, and CDs have no price volatility) and higher correlations with equities, low-risk assets provide less diversification when added to an equity-heavy portfolio.

Because they aren't actually capital assets, CDs are hard to analyze over history so let's look at the performance of Vanguard Total Bond Market versus Vanguard Short-Term Bond as the fixed income piece of an 80/20 portfolio. Pick 10 years as a period.

An 80/20 portfolio (80% Vanguard Total Stock market and 20% Vanguard Total Bond Market) from 1/2009 to 9/2018 returned 12.90% with a standard deviation of 10.79%/

An 80/20 portfolio with Vanguard Short-Term Bond instead has returns of 12.57% and a standard deviation of 10.83%.

This difference is admittedly small in magnitude, but I think it is worth commenting on because people have a hard time grasping it: the "riskier" bond fund actually made the portfolio less risky than the "safer" bond fund.

The other thing people have a hard time figuring out is that "interest rate risk" isn't the same for everyone. If you're not planning to spend your invested money for 30-40 years, it's not clear why avoiding the price risk of an intermediate total bond market fund is worth giving up ANY expected return and taking on more portfolio volatility.
Thank you for taking the time to respond. Since having bought into the concept of the basic 3 fund portfolio and deciding on our asset allocation, I've given little thought to the volatility of our very basic portfolio other than to assume that, in general, the greater the percentage of equities in one's portfolio, the greater the potential for volatility. Frankly, I'd have thought that moving some of our FI from TBM to CDs would mitigate rather than enhance the potential for volatility simply because the returns generated by CDs are always headed north. That still seems "logical" to me.

Now, I certainly can see where CDs might easily generate lower returns over time than TBM, although considering the posts of stlutz and KevinM just above (thank you), it may be a 3% return from CDs over the trailing 5 years provided the higher return. Though looking at Taylor's returns schedule, maybe not.
Think about it in terms of correlation between your risky assets and risk-less assets. If you want the overall volatility of your portfolio to go down, it is pretty good to have your risk-less assets have a zero correlation with your risky assets, like what a CD does. But it is even better to have your risk-less asset have a negative correlation with your risky assets.

Longer term treasury bonds are more negatively correlated with the stock market, and the longer the term, the more negative the correlation.

Image

The longest term treasury bond fund that Vanguard offers is EDV with an average maturity of 25 years. Here is what happens when you compare an 80/20 Short Term Treasuries portfolio (a stand in for CDs) with an 80/20 EDV portfolio:

https://www.portfoliovisualizer.com/bac ... tion3_2=20

The portfolio with EDV delivers 1.1% per year higher return AND 0.8% per year lower volatility (standard deviation).

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Re: Total Bond Market Fund - interest rates rising!

Post by Kenkat » Sun Oct 21, 2018 9:42 am

Kevin M wrote:
Sat Oct 20, 2018 7:18 pm
Kenkat wrote:
Sat Oct 20, 2018 10:33 am
Rates have been purported to rise for the last 7 years. Now that it has finally happened, after 5 years of it not happening, it becomes news. And still not a major calamity; returns are still positive but just not as high as we’d like. It’s easy to forget that bonds earned interest at a higher rate than CDs for those 5 years we were all waiting for rates to rise.
Not necessarily (the underlined part). As already mentioned, some of us bought 5-year CDs at 3.0% about five years ago. I have a batch maturing in December. The 5-year total return of Total Bond Market Admiral Shares as of 9/30/2018 was 2.09%.

At the time I bought my first batch of 5-year CDs at 3.0%, in December 2013, the 5-year Treasury yield, which is a better comparison than TBM yield, was about 1.4%.

Kevin
Wow, where did you find those rates 5 years ago? This source shows the average 5 year CD rate from 5 years ago was 1.25% in Oct-2013. Even now, the best offers for 5 year CDs are in the 3% range:

https://www.depositaccounts.com/cd/5-year-cd-rates.html

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Re: Total Bond Market Fund - interest rates rising!

Post by restingonmylaurels » Sun Oct 21, 2018 10:11 am

rkhusky wrote:
Sat Oct 20, 2018 1:01 pm
If you can't stand any volatility, then you should invest in CD's or very short bond funds. But you can expect to have lower returns over the long term in exchange. There is a strong correlation between risk and return. For some, lower return is worth the lower volatility.

The average duration of Total Bond fund is 6.2 years. You should wait at least that long before passing judgement.

Looking at only NAV is a poor indicator of the quality of a bond fund, whose primary source of income is dividends. By that measure, my money market account hasn't returned anything for the past 20 years.
Yes, over time higher risk should bring higher return but that certainly is not guaranteed. It has not over the last 2.5 years with TBM.

When looking at a bond fund, one should consider that capital component, the income component, and the tax impact. In the examples above, while TBM had a higher income component than USB, that was more than offset by reduction in the capital component due to the lowering of the value of the bonds in its portfolio. And the higher income component is also partially offset by being taxed at ordinary income tax rates.

For the latest month, USB had a distribution yield 2.36% vs 2.84% for TBM. Assuming you are somewhere in the 22/24% marginal tax bracket, those 48 basis points are more like 37 basis points additional income to take on a duration risk 6 times as large.

So for what I have seen for the last 2.5 years and what I expect to hold for perhaps 12 more months or so is that TBM is a poor investment choice.

As mentioned above, when the expectations of rising rates and inflation expectations flatten out, TBM will more than likely start rewarding for its increased duration risk. But that is not certain and so why I am considering what to cycle those funds into 31 days post-TLH.

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Re: Total Bond Market Fund - interest rates rising!

Post by willthrill81 » Sun Oct 21, 2018 10:31 am

restingonmylaurels wrote:
Sun Oct 21, 2018 10:11 am
rkhusky wrote:
Sat Oct 20, 2018 1:01 pm
If you can't stand any volatility, then you should invest in CD's or very short bond funds. But you can expect to have lower returns over the long term in exchange. There is a strong correlation between risk and return. For some, lower return is worth the lower volatility.

The average duration of Total Bond fund is 6.2 years. You should wait at least that long before passing judgement.

Looking at only NAV is a poor indicator of the quality of a bond fund, whose primary source of income is dividends. By that measure, my money market account hasn't returned anything for the past 20 years.
Yes, over time higher risk should bring higher return but that certainly is not guaranteed. It has not over the last 2.5 years with TBM.

When looking at a bond fund, one should consider that capital component, the income component, and the tax impact. In the examples above, while TBM had a higher income component than USB, that was more than offset by reduction in the capital component due to the lowering of the value of the bonds in its portfolio. And the higher income component is also partially offset by being taxed at ordinary income tax rates.

For the latest month, USB had a distribution yield 2.36% vs 2.84% for TBM. Assuming you are somewhere in the 22/24% marginal tax bracket, those 48 basis points are more like 37 basis points additional income to take on a duration risk 6 times as large.

So for what I have seen for the last 2.5 years and what I expect to hold for perhaps 12 more months or so is that TBM is a poor investment choice.

As mentioned above, when the expectations of rising rates and inflation expectations flatten out, TBM will more than likely start rewarding for its increased duration risk. But that is not certain and so why I am considering what to cycle those funds into 31 days post-TLH.
Because of the 'higher risk' associated with TBM compared to short-duration bonds or CDs, TBM is not guaranteed to outperform the latter over any one, two, three, etc. period. Stocks are expected to outperform TBM, but from 2000-2009, they did not. That's part of what risk means.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Total Bond Market Fund - interest rates rising!

Post by vineviz » Sun Oct 21, 2018 10:37 am

restingonmylaurels wrote:
Sun Oct 21, 2018 10:11 am
For the latest month, USB had a distribution yield 2.36% vs 2.84% for TBM. Assuming you are somewhere in the 22/24% marginal tax bracket, those 48 basis points are more like 37 basis points additional income to take on a duration risk 6 times as large.

So for what I have seen for the last 2.5 years and what I expect to hold for perhaps 12 more months or so is that TBM is a poor investment choice.
It's important to understand that "duration risk" (by which I assume you mean interest rate risk, of which duration is a measure) isn't a quantity that can be described as being "X times as large" in any useful way.

One application of duration is as an estimate of the price impact on a bond of a 100 bps change in yield. In that sense, it's true a bond with a duration of 6 years would be expected to drop twice as much as a bond with a duration of 3 years. But the magnitude is so small (a 6% drop versus a 3% drop) that I question how useful it really is to say the first is twice as risky as the second given that we are talking about two hypothetical bonds that drop in price from $1,000 to $940 or $970 respectively.

The most important thing to remember, though, is that duration is measure of time: the time for the TWO components of interest rate risk to balance out. Those two components are price risk (which I just described) but also reinvestment risk. Those two risks have opposite impacts on the investor, and duration is the measure of how much time must pass for the two risk to precisely cancel each other out.

If your investment horizon is LONGER than the bond fund's duration, risking interest rates are GOOD for you in that your realized return will exceed the initial yield. If your investment horizon is SHORTER than the bond fund's duration, risking interest rates are BAD for you in that your realized return will be less than the initial yield. And if your investment horizon is EQUAL TO the bond fund's duration, risking interest rates are NEUTRAL for you in that your realized return will match the initial yield.

In this way, interest rate risk is not an absolute number: it depends entirely on each investor's time horizon. If you hold a bond for less than it's duration, price risk dominates reinvestment risk. This is why you should use short-term bonds for short-term goals, and long-term bonds for long-term goals.

The notion that an individual investor can predict the trajectory of future bond prices better than the market can is a myth that won't die. Many otherwise smart people, who espouse Boglehead beliefs in every other way, seem to cling to the notion that market timing is possible and even easy in fixed income investing. It isn't.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Total Bond Market Fund - interest rates rising!

Post by Austintatious » Sun Oct 21, 2018 11:10 am

Kenkat wrote:
Sun Oct 21, 2018 9:42 am
Kevin M wrote:
Sat Oct 20, 2018 7:18 pm
Kenkat wrote:
Sat Oct 20, 2018 10:33 am
Rates have been purported to rise for the last 7 years. Now that it has finally happened, after 5 years of it not happening, it becomes news. And still not a major calamity; returns are still positive but just not as high as we’d like. It’s easy to forget that bonds earned interest at a higher rate than CDs for those 5 years we were all waiting for rates to rise.
Not necessarily (the underlined part). As already mentioned, some of us bought 5-year CDs at 3.0% about five years ago. I have a batch maturing in December. The 5-year total return of Total Bond Market Admiral Shares as of 9/30/2018 was 2.09%.

At the time I bought my first batch of 5-year CDs at 3.0%, in December 2013, the 5-year Treasury yield, which is a better comparison than TBM yield, was about 1.4%.

Kevin
Wow, where did you find those rates 5 years ago? This source shows the average 5 year CD rate from 5 years ago was 1.25% in Oct-2013. Even now, the best offers for 5 year CDs are in the 3% range:

https://www.depositaccounts.com/cd/5-year-cd-rates.html
One of the threads discussing the PenFed CDs about 5 years ago :

viewtopic.php?f=10&t=127430

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Re: Total Bond Market Fund - interest rates rising!

Post by Kenkat » Sun Oct 21, 2018 11:37 am

Austintatious wrote:
Sun Oct 21, 2018 11:10 am
Kenkat wrote:
Sun Oct 21, 2018 9:42 am
Kevin M wrote:
Sat Oct 20, 2018 7:18 pm
Kenkat wrote:
Sat Oct 20, 2018 10:33 am
Rates have been purported to rise for the last 7 years. Now that it has finally happened, after 5 years of it not happening, it becomes news. And still not a major calamity; returns are still positive but just not as high as we’d like. It’s easy to forget that bonds earned interest at a higher rate than CDs for those 5 years we were all waiting for rates to rise.
Not necessarily (the underlined part). As already mentioned, some of us bought 5-year CDs at 3.0% about five years ago. I have a batch maturing in December. The 5-year total return of Total Bond Market Admiral Shares as of 9/30/2018 was 2.09%.

At the time I bought my first batch of 5-year CDs at 3.0%, in December 2013, the 5-year Treasury yield, which is a better comparison than TBM yield, was about 1.4%.

Kevin
Wow, where did you find those rates 5 years ago? This source shows the average 5 year CD rate from 5 years ago was 1.25% in Oct-2013. Even now, the best offers for 5 year CDs are in the 3% range:

https://www.depositaccounts.com/cd/5-year-cd-rates.html
One of the threads discussing the PenFed CDs about 5 years ago :

viewtopic.php?f=10&t=127430
Sounds like that was a somewhat limited above market rate spike as Penfed’s rates returned to 2% by January 2014. But still, it shows it pays to shop rates frequently as there are probably issuers that are interested in attracting deposits at certain times.

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Re: Total Bond Market Fund - interest rates rising!

Post by Austintatious » Sun Oct 21, 2018 11:55 am

Kenkat wrote:
Sun Oct 21, 2018 11:37 am
Austintatious wrote:
Sun Oct 21, 2018 11:10 am
Kenkat wrote:
Sun Oct 21, 2018 9:42 am
Kevin M wrote:
Sat Oct 20, 2018 7:18 pm
Kenkat wrote:
Sat Oct 20, 2018 10:33 am
Rates have been purported to rise for the last 7 years. Now that it has finally happened, after 5 years of it not happening, it becomes news. And still not a major calamity; returns are still positive but just not as high as we’d like. It’s easy to forget that bonds earned interest at a higher rate than CDs for those 5 years we were all waiting for rates to rise.
Not necessarily (the underlined part). As already mentioned, some of us bought 5-year CDs at 3.0% about five years ago. I have a batch maturing in December. The 5-year total return of Total Bond Market Admiral Shares as of 9/30/2018 was 2.09%.

At the time I bought my first batch of 5-year CDs at 3.0%, in December 2013, the 5-year Treasury yield, which is a better comparison than TBM yield, was about 1.4%.

Kevin
Wow, where did you find those rates 5 years ago? This source shows the average 5 year CD rate from 5 years ago was 1.25% in Oct-2013. Even now, the best offers for 5 year CDs are in the 3% range:

https://www.depositaccounts.com/cd/5-year-cd-rates.html
One of the threads discussing the PenFed CDs about 5 years ago :

viewtopic.php?f=10&t=127430
Sounds like that was a somewhat limited above market rate spike as Penfed’s rates returned to 2% by January 2014. But still, it shows it pays to shop rates frequently as there are probably issuers that are interested in attracting deposits at certain times.
You're right, rates in general were nowhere near 3% and PenFed went back to those much lower rates not long after. Just for fun, I'd love to know how much they pulled in with that little offer and how much of their haul came from Bogleheads. Lots of those CDs will be maturing and folks will be looking for new places to put the money. TBM just might be just the place :beer

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patrick013
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Re: Total Bond Market Fund - interest rates rising!

Post by patrick013 » Sun Oct 21, 2018 12:06 pm

vineviz wrote:
Sun Oct 21, 2018 10:37 am
The notion that an individual investor can predict the trajectory of future bond prices better than the market can is a myth that won't die. Many otherwise smart people, who espouse Boglehead beliefs in every other way, seem to cling to the notion that market timing is possible and even easy in fixed income investing. It isn't.
If you don't follow the Fed you will never win with
fixed income. Your returns will be average at best.
It isn't hard at all for the average person. Half
the time you will have the wrong AA.

The bond managers I'm reading today all agree on one
thing from following the Fed. Shorten maturity, shorten
duration. Some are managing tens of billions of dollars
in bonds and are not afraid to say so.

The constant misuse of duration, horizon, and investment
horizon in this country is most disturbing and just doesn't
crossfoot. Duration is more of a mathematical ploy than
anything reliable, correct, or even useful. I call it paper
filler. It's not hard being your own advisor concerning
fixed income. Just watch the Fed more than old statistics.
You'll do fine. The Fed wants us to buy bonds at higher
premiums not get stuck in some investment time horizon we
don't like. So I like being my own advisor.

What would you do today with 10 or 20 billion dollars ?
Calculate duration some more ?
age in bonds, buy-and-hold, 10 year business cycle

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Re: Total Bond Market Fund - interest rates rising!

Post by restingonmylaurels » Sun Oct 21, 2018 12:42 pm

vineviz wrote:
Sun Oct 21, 2018 10:37 am
restingonmylaurels wrote:
Sun Oct 21, 2018 10:11 am
For the latest month, USB had a distribution yield 2.36% vs 2.84% for TBM. Assuming you are somewhere in the 22/24% marginal tax bracket, those 48 basis points are more like 37 basis points additional income to take on a duration risk 6 times as large.

So for what I have seen for the last 2.5 years and what I expect to hold for perhaps 12 more months or so is that TBM is a poor investment choice.
It's important to understand that "duration risk" (by which I assume you mean interest rate risk, of which duration is a measure) isn't a quantity that can be described as being "X times as large" in any useful way.

One application of duration is as an estimate of the price impact on a bond of a 100 bps change in yield. In that sense, it's true a bond with a duration of 6 years would be expected to drop twice as much as a bond with a duration of 3 years. But the magnitude is so small (a 6% drop versus a 3% drop) that I question how useful it really is to say the first is twice as risky as the second given that we are talking about two hypothetical bonds that drop in price from $1,000 to $940 or $970 respectively.

The most important thing to remember, though, is that duration is measure of time: the time for the TWO components of interest rate risk to balance out. Those two components are price risk (which I just described) but also reinvestment risk. Those two risks have opposite impacts on the investor, and duration is the measure of how much time must pass for the two risk to precisely cancel each other out.

If your investment horizon is LONGER than the bond fund's duration, risking interest rates are GOOD for you in that your realized return will exceed the initial yield. If your investment horizon is SHORTER than the bond fund's duration, risking interest rates are BAD for you in that your realized return will be less than the initial yield. And if your investment horizon is EQUAL TO the bond fund's duration, risking interest rates are NEUTRAL for you in that your realized return will match the initial yield.

In this way, interest rate risk is not an absolute number: it depends entirely on each investor's time horizon. If you hold a bond for less than it's duration, price risk dominates reinvestment risk. This is why you should use short-term bonds for short-term goals, and long-term bonds for long-term goals.

The notion that an individual investor can predict the trajectory of future bond prices better than the market can is a myth that won't die. Many otherwise smart people, who espouse Boglehead beliefs in every other way, seem to cling to the notion that market timing is possible and even easy in fixed income investing. It isn't.
Great explanation and I totally understand this in theory.

What I am focusing on is not so much what happens in theory but what is happening right now in the U.S. fixed income markets.

If I follow the theory, then if I wait more than 3.5 more years, my current 2.5 year investment in TBM will then just exceed the duration of the fund and the reinvestment risk should exceed the price risk and I will come out ahead.

In the actual bond markets, following from what the Fed has prominently telegraphed, interest rates are likely to rise more than the market expects (that has been the ongoing case for the last two years), meaning the price risk will continue to be prominent, which may push out the equilibrium point.

Also, unlike the downward price risk force, the upward reinvestment risk force has to deal with paying tax on the increasing distributions, which I would think would also push out the equilibrium point.

Of course no one can time markets with any precision but in the case of the bond market, the Fed has signaled higher rates over the next several years which the market has not fully priced in. This seems like a pretty good reason to shorten up one's bond holdings and avoid TBM in the near term.

I don't see this as much different than Mr. Bogle advising restrained expectations for equities over the next ten years, due to current price levels. With current price levels of bonds, one should be advising restrained expectations until the price of bonds decrease.

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Re: Total Bond Market Fund - interest rates rising!

Post by vineviz » Sun Oct 21, 2018 1:05 pm

patrick013 wrote:
Sun Oct 21, 2018 12:06 pm
vineviz wrote:
Sun Oct 21, 2018 10:37 am
The notion that an individual investor can predict the trajectory of future bond prices better than the market can is a myth that won't die. Many otherwise smart people, who espouse Boglehead beliefs in every other way, seem to cling to the notion that market timing is possible and even easy in fixed income investing. It isn't.
If you don't follow the Fed you will never win with
fixed income. Your returns will be average at best.
It isn't hard at all for the average person. Half
the time you will have the wrong AA.

The bond managers I'm reading today all agree on one
thing from following the Fed. Shorten maturity, shorten
duration. Some are managing tens of billions of dollars
in bonds and are not afraid to say so.
You’d be better off flipping a coin than reading what those bond managers think. You’d be right about as often, and in the end you’d still have your coin.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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vineviz
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Re: Total Bond Market Fund - interest rates rising!

Post by vineviz » Sun Oct 21, 2018 1:16 pm

restingonmylaurels wrote:
Sun Oct 21, 2018 12:42 pm
Great explanation and I totally understand this in theory.

What I am focusing on is not so much what happens in theory but what is happening right now in the U.S. fixed income markets.
These two statements cannot both be true.

If you understand the theory then you understand that EVERYTHING you think “is happening right now in the U.S. fixed income markets” is already reflected in the current prices of all bonds of all durations.

You understand that there is no free lunch: you can’t expect to buy a 1 year bond now and a 4 year bond when that matures and magically beat the return on a 5 year bond. If that bet works out it’d be due to nothing but blind luck.

And betting on being lucky is not a reasonable investment strategy.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Total Bond Market Fund - interest rates rising!

Post by Nova1967 » Sun Oct 21, 2018 6:00 pm

I have 45% in Bonds and 5% in cash, I prefer to stay the course and not sell bond funds for CDs when interest rates go up. Yes you might lose 5% in a year but TBM index funds have better returns overall, I don't believe in selling and exchanging funds every time an event occurs. When the market dropped 50% in 2008 I did not sell my equities in favor of bonds funds because the market was down 50% and bond funds were up 5%. It seems like the majority on this post want to sell bond funds because they are down for 2 to 3% CDs.

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HomerJ
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Re: Total Bond Market Fund - interest rates rising!

Post by HomerJ » Mon Oct 22, 2018 1:03 am

patrick013 wrote:
Sun Oct 21, 2018 12:06 pm
The bond managers I'm reading today all agree on one
thing from following the Fed. Shorten maturity, shorten
duration. Some are managing tens of billions of dollars
in bonds and are not afraid to say so.
The bond managers were saying that 5-7 years ago... And they missed out.

Nobody's an expert.

Look at Bill Gross... He used to be considered the king of bonds. He's made bad bets on which way interest rates would go.
The J stands for Jay

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Re: Total Bond Market Fund - interest rates rising!

Post by restingonmylaurels » Mon Oct 22, 2018 7:40 am

vineviz wrote:
Sun Oct 21, 2018 1:16 pm
restingonmylaurels wrote:
Sun Oct 21, 2018 12:42 pm
Great explanation and I totally understand this in theory.

What I am focusing on is not so much what happens in theory but what is happening right now in the U.S. fixed income markets.
These two statements cannot both be true.

If you understand the theory then you understand that EVERYTHING you think “is happening right now in the U.S. fixed income markets” is already reflected in the current prices of all bonds of all durations.
Please use illustrative numbers to make your points. And it would help if you did not cherry pick certain phrases but addressed my whole post.
vineviz wrote:
Sun Oct 21, 2018 1:16 pm
You understand that there is no free lunch: you can’t expect to buy a 1 year bond now and a 4 year bond when that matures and magically beat the return on a 5 year bond. If that bet works out it’d be due to nothing but blind luck.

And betting on being lucky is not a reasonable investment strategy.
This just is not true if the value of the bonds is decreasing. In my ongoing example, I have just that situation, where the USB fund with a duration of 1 year has consistently had a higher total return than TBM with a duration of 6 years over the last 2.5 years.

This is not because the income portion is larger, as USB trails TBM on average by about 50 basis points or so. It is because the value of the bonds in TBM's portfolio have decreased much more than those in USB's portfolio.

While your theory has undoubtedly worked over longer periods of time based on past market history, it has not worked in very recent time periods and may not for another short period of time.

For reasons that are inexplicable to me, despite the rather emphatic nature of the Fed's future interest rate hike path, the market does not totally buy into it (and has not over the last two years).

Not sure if this is because the market is not a completely accurate reflection of majority expectations as it also is a reflection of some making bets against the majority opinion to seek a large reward for a minority position.

Because I have felt and do feel that those making minority position bets are (and have been) wrong, I would choose a different short-term path than what your theory espouses, until I believe the market as a whole is beginning to buy in more certainly.

onourway
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Re: Total Bond Market Fund - interest rates rising!

Post by onourway » Mon Oct 22, 2018 7:54 am

restingonmylaurels wrote:
Mon Oct 22, 2018 7:40 am
vineviz wrote:
Sun Oct 21, 2018 1:16 pm
You understand that there is no free lunch: you can’t expect to buy a 1 year bond now and a 4 year bond when that matures and magically beat the return on a 5 year bond. If that bet works out it’d be due to nothing but blind luck.

And betting on being lucky is not a reasonable investment strategy.
This just is not true if the value of the bonds is decreasing. In my ongoing example, I have just that situation, where the USB fund with a duration of 1 year has consistently had a higher total return than TBM with a duration of 6 years over the last 2.5 years.

This is not because the income portion is larger, as USB trails TBM on average by about 50 basis points or so. It is because the value of the bonds in TBM's portfolio have decreased much more than those in USB's portfolio.
You are continuing to look at the very short periods of time. If you hold those two investments to 6 years, the TBM investment will almost certainly generate more return than your method of hopping funds.

As outlined very clearly above - if your investment horizon is shorter than the funds average duration, you have chosen the wrong fund, but if your investment horizon is longer than the funds average duration you should be agnostic to NAV changes over the short term. When NAV falls, you should be buying more of that investment, not selling. This is exactly the classic 'buy high, sell low' behavior that is so harmful to individual investor's returns.

2pedals
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Re: Total Bond Market Fund - interest rates rising!

Post by 2pedals » Mon Oct 22, 2018 8:07 am

Raybo wrote:
Fri Oct 19, 2018 11:36 am
“Better” is a hard term to define, at times

A CD in taxable versus Total Bond in deferred might well be worse in the end. While CDs are guaranteed by the FDIC, they often come with a surrender charge if you need the money before the term is up. Bond funds can be sold quickly.

A CD at a bank requires a credit check. My credit is locked. To open a bank CD, I have to unlock it, which also costs a few bucks.
I believe credit freeze/unfreeze are now free. I just did a temporary lift last month for a new credit card for free.
https://www.consumer.ftc.gov/blog/2018/ ... s-are-here

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vineviz
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Re: Total Bond Market Fund - interest rates rising!

Post by vineviz » Mon Oct 22, 2018 8:18 am

restingonmylaurels wrote:
Mon Oct 22, 2018 7:40 am
vineviz wrote:
Sun Oct 21, 2018 1:16 pm
You understand that there is no free lunch: you can’t expect to buy a 1 year bond now and a 4 year bond when that matures and magically beat the return on a 5 year bond. If that bet works out it’d be due to nothing but blind luck.

And betting on being lucky is not a reasonable investment strategy.
This just is not true if the value of the bonds is decreasing. In my ongoing example, I have just that situation, where the USB fund with a duration of 1 year has consistently had a higher total return than TBM with a duration of 6 years over the last 2.5 years.
There are two perniciously common but dangerous problems in these two sentences.

The first is the use of the present tense in describing market behavior ("value of the bonds is decreasing"). I'm sometimes guilty of it, but it's a mental shortcut that can lead (as it seems to be doing here) to a fundamentally incorrect assessment of the role of information in investing. The value of bonds HAS decreased in the recent past, but NOTHING you can know with any degree of certainty can tell you what they will do in the immediate future. Nothing. A failure to grasp this essential point about market efficiency is one of the main reasons that investors have such poor returns relative to the market averages.

The second problem is somewhat related, and it is the reason I specifically used the word "luck" earlier. The fact that a particular strategy HAPPENED to work in one time period is not, on its own, sufficient evidence that it will work in the future. The question is not whether buying short term bonds was a good choice three years ago. Obviously, with the benefit of hindsight, it was. The question is whether buying short term bonds NOW is a better choice than buying long term bonds. And there is absolutely no way to know the answer to this question. Anyone who tells you they can outsmart the market is fooling you, fooling themselves, or both.
restingonmylaurels wrote:
Mon Oct 22, 2018 7:40 am
For reasons that are inexplicable to me, despite the rather emphatic nature of the Fed's future interest rate hike path, the market does not totally buy into it (and has not over the last two years).
I suspect another misconception at play here. The Federal Reserve does not determine the yield of ANY bonds. The only interest rate they control is the federal funds rate, which is just the overnight lending rate used by banks to lend to each other.

The federal funds rate is one piece of information that the market uses to set the price of bonds, but it is far from the only one. Long-term economic factors play a much larger role, and no one knows the "path" for those. This is why, for example, during the 2010-2014 period (when the federal funds rate was essentially flat the entire period) the monthly return of the longest-term treasury bonds varied from +13% to -7% with no action from the Fed.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Total Bond Market Fund - interest rates rising!

Post by cyclist » Mon Oct 22, 2018 10:15 am

onourway wrote:
Mon Oct 22, 2018 7:54 am
As outlined very clearly above - if your investment horizon is shorter than the funds average duration, you have chosen the wrong fund, but if your investment horizon is longer than the funds average duration you should be agnostic to NAV changes over the short term. When NAV falls, you should be buying more of that investment, not selling. This is exactly the classic 'buy high, sell low' behavior that is so harmful to individual investor's returns.
I'm looking forward to a long retirement, hopefully some of it very soon. Does that mean I've got a long time horizon, or does that mean I've got both short- and long-term needs for FI? I'm inclined towards McClung's approach of selling FI to meet needs in retirement, but does that imply that I should keep more than TBM in my FI portfolio?

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Re: Total Bond Market Fund - interest rates rising!

Post by willthrill81 » Mon Oct 22, 2018 10:21 am

cyclist wrote:
Mon Oct 22, 2018 10:15 am
onourway wrote:
Mon Oct 22, 2018 7:54 am
As outlined very clearly above - if your investment horizon is shorter than the funds average duration, you have chosen the wrong fund, but if your investment horizon is longer than the funds average duration you should be agnostic to NAV changes over the short term. When NAV falls, you should be buying more of that investment, not selling. This is exactly the classic 'buy high, sell low' behavior that is so harmful to individual investor's returns.
I'm looking forward to a long retirement, hopefully some of it very soon. Does that mean I've got a long time horizon, or does that mean I've got both short- and long-term needs for FI? I'm inclined towards McClung's approach of selling FI to meet needs in retirement, but does that imply that I should keep more than TBM in my FI portfolio?
TBM can definitely serve as your only FI investment.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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vineviz
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Re: Total Bond Market Fund - interest rates rising!

Post by vineviz » Mon Oct 22, 2018 10:33 am

cyclist wrote:
Mon Oct 22, 2018 10:15 am
onourway wrote:
Mon Oct 22, 2018 7:54 am
As outlined very clearly above - if your investment horizon is shorter than the funds average duration, you have chosen the wrong fund, but if your investment horizon is longer than the funds average duration you should be agnostic to NAV changes over the short term. When NAV falls, you should be buying more of that investment, not selling. This is exactly the classic 'buy high, sell low' behavior that is so harmful to individual investor's returns.
I'm looking forward to a long retirement, hopefully some of it very soon. Does that mean I've got a long time horizon, or does that mean I've got both short- and long-term needs for FI? I'm inclined towards McClung's approach of selling FI to meet needs in retirement, but does that imply that I should keep more than TBM in my FI portfolio?
If you I was currently in retirement and looking for a relatively simple way to keep everything in balance, here's how I'd approach it:

1) Every year move the amount I expect to withdraw from the portfolio into a money market fund, taking the money from whichever asset class was MOST overweight relative to my IPS;
2) Keep the rest of my bond allocation in either total bond market (for ultimate simplicity) or some mix of short/intermediate/long term bonds (for 'optimal' control), and rebalance the overall portfolio based on my IPS.

I don't know the details of McClung's approach, but if you sell fixed income to fund withdrawals without then rebalancing you'll end up with an all-equity portfolio pretty quickly.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Total Bond Market Fund - interest rates rising!

Post by catalina355 » Mon Oct 22, 2018 11:21 am

willthrill81 wrote:
Mon Oct 22, 2018 10:21 am
cyclist wrote:
Mon Oct 22, 2018 10:15 am
onourway wrote:
Mon Oct 22, 2018 7:54 am
As outlined very clearly above - if your investment horizon is shorter than the funds average duration, you have chosen the wrong fund, but if your investment horizon is longer than the funds average duration you should be agnostic to NAV changes over the short term. When NAV falls, you should be buying more of that investment, not selling. This is exactly the classic 'buy high, sell low' behavior that is so harmful to individual investor's returns.
I'm looking forward to a long retirement, hopefully some of it very soon. Does that mean I've got a long time horizon, or does that mean I've got both short- and long-term needs for FI? I'm inclined towards McClung's approach of selling FI to meet needs in retirement, but does that imply that I should keep more than TBM in my FI portfolio?
TBM can definitely serve as your only FI investment.
Can you explain how TBM can serve as the only FI investment during retirement? I'm almost retired and looking for advice on the FI aspects.

mariezzz
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Re: Total Bond Market Fund - interest rates rising!

Post by mariezzz » Mon Oct 22, 2018 11:46 am

restingonmylaurels wrote:
Sat Oct 20, 2018 9:42 am
Let me provide a personal and different perspective to this discussion.

After listening to the discussion on the board here for some time, I went with an allocation to TBM in the spring of 2016, two and half years ago.

My average buy-in price was 10.86.

The current TBM price is 10.26.

That is a NAV loss of 5.5% in 2.5 years, for a supposedly safe investment.

To make matters worse, that loss is a long-term capital loss but the higher income from rising yields that will supposedly make up for this loss is taxed at ordinary rates.

This has been my worst investment decision in some time. Fortunately, I only allocated a small part of my FI to TBM and made smarter choices like USB with larger allocations.

I will be TLHing this fund shortly. My only question is, when the wash sale period is over, should I move the funds back in or give up on TBM in favor of short term funds or direct T-bill or CD purchases.
Precisely. VBTLX is down for the year currently. Since Jan 22, 2013 - 5.75 years, it's value according to Morningstar's 'growth' parameter has gone up just 8%, largely because VBTLX hasn't really done much in the last 2+ years (as observed above).

That being said, bonds would have won out over equities during the first 9 or so years of the 21st century.

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Earl Lemongrab
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Re: Total Bond Market Fund - interest rates rising!

Post by Earl Lemongrab » Mon Oct 22, 2018 12:14 pm

From the time I developed my portfolio in 2007, I have been 50/50 aggregate bond index and stable value. All along, the values of the two allocations have been close to each other. Bonds have been more volatile of course. Right now, bonds are about 3% less than the SV.

Had I been 100% bonds it wouldn't have made a lot of difference. The future will be something yet to see.
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

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Re: A History of Total Bond Market, Inflation and S&P 500 Stocks

Post by rich126 » Mon Oct 22, 2018 12:31 pm

Taylor Larimore wrote:
Sat Oct 20, 2018 4:09 pm
Bogleheads:

I purchased Vanguard's Total Bond Market for our personal portfolio in 1986. In 2000, I again selected Vanguard Total Bond Market Index Fund for The Three-Fund Portfolio. Vanguard Total Bond Market Index Fund has served investors well and it is now the largest bond fund in the world.

This is a history of TBM during times of U.S. inflation and stock fluctuations:

YEAR--INFLATION--BOND INDEX--S&P 500
1976-------4.9%--------15.6%--------23.8%
1977-------6.7-----------3.0---------(-7.0)
1978-------9.0-----------1.4-----------6.5
1979------13.3-----------1.9---------18.5
1980------12.5-----------2.7---------31.7
1981-------8.9-----------6.3---------(-4.7)
1982-------3.8----------32.6---------20.4
1983-------3.8-----------8.4---------22.3
1984-------3.9----------15.2----------6.1
1985-------3.8----------22.1---------31.2
1986-------1.1----------15.2---------18.5
1987-------4.4-----------2.8-----------5.8
1988-------4.4-----------7.9----------16.5
1989-------4.6----------14.5----------31.5
1990-------6.1-----------8.9----------(-3.1)
1991-------3.1----------16.0----------30.2
1992-------2.9-----------7.4------------7.5
1993-------2.7-----------9.7-----------10.0
1994-------2.7---------(-2.9)-----------1.3
1995-------2.5----------18.5----------37.2
1996-------3.3-----------3.6----------22.7
1997-------1.7-----------9.7----------33.1
1998-------1.6-----------8.7----------28.3
1999-------2.7---------(-0.8)---------20.9
2000-------3.4----------11.6---------(-9.0)
2001-------1.6-----------8.4--------(-11.5)
2002-------2.4----------10.3--------(-22.0)
2003-------1.9-----------4.1----------28.4
2004-------3.3-----------4.3----------10.7
2005-------3.4-----------2.4-----------4.8
2006-------2.5-----------4.3----------15.6
2007-------4.1-----------7.0-----------5.5
2008-------0.1-----------5.2--------(-36.6)
2009-------2.7-----------5.9----------25.9
2010-------1.5-----------6.5----------14.8
2011-------3.0-----------7.7-----------2.1
2012-------1.7-----------4.3----------16.0
2013-------1.5---------(-2.0)---------32.2
2014-------1.6-----------6.0----------13.5
2015-------0.7-----------0.5-----------1.4
2016-------2.1-----------2.6----------12.3
2017-------2.1-----------3.5----------21.8

Source: U.S. Department of Labor, Barclays, Dow Jones Indices and Seeking Alpha

Observations:

* Inflation increased from 4.9% in 1976 to 13.3% in 1979; nevertheless Total Bond Market Index Fund had positive returns during that entire period of high inflation.

* The Aggregate Bond Index had only three negative years (all small) reflecting very low risk.

* Stocks are much riskier than bonds.

Best wishes
Taylor
While I appreciate seeing the numbers a comment such as
* Inflation increased from 4.9% in 1976 to 13.3% in 1979; nevertheless Total Bond Market Index Fund had positive returns during that entire period of high inflation.

* The Aggregate Bond Index had only three negative years (all small) reflecting very low risk.
seems questionable to me.

Sure it had up years during high inflation but relative to inflation (which is all people should care about) it had some consecutive rough years in real returns.
-7.6%
-11.4%
-9.8%
-3.6%
In consecutive years from 78 through 81. So $10,000 ended up worth $7,119 in real terms. Still a loss of nearly 30%. Fortunately the fund then had some nice returns.

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