Total Bond Market Fund - interest rates rising!

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

Post by patrick013 » Mon Oct 22, 2018 12:52 pm

HomerJ wrote:
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.
Well I'm talking about the Fed publications and secondarily what
the investors do with them. Otherwise we are just accepting losses
and below average returns in any type of fixed income. People
say why did the returns go up and down when the FFR did not change.
Well read the Fed, they are the experts, they have the answers to
that. They are the best advisors. You get what you pay for.
Otherwise there is no answer. Another blank. Another know nothing.

Emergency low rates really caused low rates. Bill Gross couldn't
believe the rates were kept so low for so long. Now normalization
is actively discussed with some rising FFR rates as indication of that.
Will the normalized rate be 4.5%, a very long term average, or 6.5%,
a more current average, as a target YTM for the TRSY 10 note when
traded in the market ? I'd stay abreast of that, way ahead of the crowd.

Better returns staying short term for awhile should add to total returns.
age in bonds, buy-and-hold, 10 year business cycle

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

Post by vineviz » Mon Oct 22, 2018 1:21 pm

patrick013 wrote:
Mon Oct 22, 2018 12:52 pm
Well read the Fed, they are the experts, they have the answers to
that. They are the best advisors. You get what you pay for.
"Read the Fed" is not coherent investment strategy: market timing doesn't work, plain and simple. Anyone who says differently is selling something.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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

Post by willthrill81 » Mon Oct 22, 2018 2:07 pm

catalina355 wrote:
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.
TBM is basically a very well diversified intermediate-term fund of investment-grade bonds. It does have short- and long-term bonds, but it behaves like an intermediate-term fund. For an in-depth explanation of TBM, see the stickied thread at the top of this section.
“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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Taylor Larimore
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Re: A History of Total Bond Market, Inflation and S&P 500 Stocks

Post by Taylor Larimore » Mon Oct 22, 2018 2:30 pm

rich126 wrote:
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.
Bogleheads:

It is important to understand that nearly ALL investments are affected negatively by inflation.

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

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Re: Total Bond Market Fund - interest rates rising!

Post by 2pedals » Mon Oct 22, 2018 2:37 pm

patrick013 wrote:
Mon Oct 22, 2018 12:52 pm
HomerJ wrote:
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.
Well I'm talking about the Fed publications and secondarily what
the investors do with them. Otherwise we are just accepting losses
and below average returns in any type of fixed income. People
say why did the returns go up and down when the FFR did not change.
Well read the Fed, they are the experts, they have the answers to
that. They are the best advisors. You get what you pay for.
Otherwise there is no answer. Another blank. Another know nothing.

Emergency low rates really caused low rates. Bill Gross couldn't
believe the rates were kept so low for so long. Now normalization
is actively discussed with some rising FFR rates as indication of that.
Will the normalized rate be 4.5%, a very long term average, or 6.5%,
a more current average, as a target YTM for the TRSY 10 note when
traded in the market ? I'd stay abreast of that, way ahead of the crowd.

Better returns staying short term for awhile should add to total returns.
So, what the Fed experts have said is not already priced in the bond market. I find that very hard to believe.

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

Post by Kevin M » Mon Oct 22, 2018 2:53 pm

Two myths being propagated here.

First is that if you will earn the initial yield if you hold a bond fund for a time period equal to its duration. This is demonstrably false. I have done the research on this, and published the results in this forum several years ago. Return of TBM over 5 or 10 years could easily be +/- 0.5% and as much as +/- 1% annualized over these holding periods. One percent over 10 years is more than 10% cumulative difference.

Some forum members have posted math (in other threads) indicating that if you hold for two times the duration with continuously rising yields, that you will earn at least the initial yield. I haven't checked, but with duration of TBM at about 6 years, that would be 12 years, and 12 isn't much more than 10, but yields generally don't rise continuously, so perhaps harder to check.

Second is that you will earn more from intermediate-term or long-term bonds than from short-term bonds if you hold for a period equal to the duration of the intermediate-term or long-term bonds. For the 10-year period from 1972-1981, a period of generally increasing rates (and inflation), cumulative nominal return for short, intermediate, and long term Treasuries was 88%, 51%, and 23% respectively.

Even more importantly, cumulative 10-year real returns were -7%, -18%, and -34% respectively. As has been pointed out, prolonged, unexpected inflation is the real bond killer. And unless there are artificial caps on nominal yields, as there were in the 1940s, prolonged, unexpected inflation hurts longer-term nominal bonds more than it does shorter-term nominal bonds, as it did in the 1970s.

Here I am not recommending trying to time the bond market, just trying to correct some misinformation.

Kevin
Wiki ||.......|| Suggested format for Asking Portfolio Questions (edit original post)

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

Post by vineviz » Mon Oct 22, 2018 3:14 pm

Kevin M wrote:
Mon Oct 22, 2018 2:53 pm
For the 10-year period from 1972-1981, a period of generally increasing rates (and inflation), cumulative nominal return for short, intermediate, and long term Treasuries was 88%, 51%, and 23% respectively.
Unfortunately, a retrospective analysis of this period involves several distinct but important entangled issues.

Not only was this a period of increasing rates (and inflation), it was also a period of Federal Reserve policy that has dramatically and vocally been abandoned. The stop-and-go approach that the Fed used from the late 1960s to the early 1980s directly affected the relative returns of short and long term bonds, in a manner that is essentially unrelated to whether rates were high/rising.

I've detailed this in other threads (I'll see if I can find a link), but here's a snapshot of the data.

Image

It clearly illustrates that the weak relative performance of long bonds in the pre-Volcker era was due to the Fed policy and NOT to inflation.

When you take a look at the (admittedly limited) periods since 1981 in which the federal funds rate was risin you'll find that long bonds sill outperformed short bonds, which is counter to the "sky is falling" arguments you can read in the popular press.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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

Post by wfrobinette » Mon Oct 22, 2018 4:15 pm

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.
Or you can buy one at Vanguard :D

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

Post by patrick013 » Mon Oct 22, 2018 6:17 pm

2pedals wrote:
Mon Oct 22, 2018 2:37 pm
patrick013 wrote:
Mon Oct 22, 2018 12:52 pm

Better returns staying short term for awhile should add to total returns.
So, what the Fed experts have said is not already priced in the bond market. I find that very hard to believe.
Well it isn't.
age in bonds, buy-and-hold, 10 year business cycle

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

Post by HEDGEFUNDIE » Mon Oct 22, 2018 6:19 pm

patrick013 wrote:
Mon Oct 22, 2018 6:17 pm
2pedals wrote:
Mon Oct 22, 2018 2:37 pm
patrick013 wrote:
Mon Oct 22, 2018 12:52 pm

Better returns staying short term for awhile should add to total returns.
So, what the Fed experts have said is not already priced in the bond market. I find that very hard to believe.
Well it isn't.
Hahahahahahahaha.

Really needed a good laugh today, thanks patrick.

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

Post by patrick013 » Mon Oct 22, 2018 6:34 pm

vineviz wrote:
Mon Oct 22, 2018 1:21 pm
patrick013 wrote:
Mon Oct 22, 2018 12:52 pm
Well read the Fed, they are the experts, they have the answers to
that. They are the best advisors. You get what you pay for.
"Read the Fed" is not coherent investment strategy: market timing doesn't work, plain and simple. Anyone who says differently is selling something.
I'd rather have the information than not. Making good informed buying
decisions is very important. Static advise isn't always the best. The
answer to your question is in the information not without it.
age in bonds, buy-and-hold, 10 year business cycle

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

Post by vineviz » Mon Oct 22, 2018 6:38 pm

patrick013 wrote:
Mon Oct 22, 2018 6:34 pm
vineviz wrote:
Mon Oct 22, 2018 1:21 pm
patrick013 wrote:
Mon Oct 22, 2018 12:52 pm
Well read the Fed, they are the experts, they have the answers to
that. They are the best advisors. You get what you pay for.
"Read the Fed" is not coherent investment strategy: market timing doesn't work, plain and simple. Anyone who says differently is selling something.
I'd rather have the information than not. Making good informed buying
decisions is very important. Static advise isn't always the best. The
answer to your question is in the information not without it.
If reading notes from reserve board meetings is interesting to you then go for it. Everyone needs hobbies.

Making investment decisions based on reading tea leaves or guesses about which way the wind will blow on Friday is foolish. It’s your money, but let’s not pretend that it amounts to anything more than a naive attempt at timing the market.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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

Post by patrick013 » Mon Oct 22, 2018 7:08 pm

vineviz wrote:
Mon Oct 22, 2018 6:38 pm
Making investment decisions based on reading tea leaves or guesses about which way the wind will blow on Friday is foolish. It’s your money, but let’s not pretend that it amounts to anything more than a naive attempt at timing the market.
I don't define dynamic asset allocation as market timing. Nor the Fed and it's
watchers as naive. It's like buying the best bond at the time with all the available
information. It's more flexible than trying to beat Spiva in some maturity and
category. So in that respect it really isn't market timing but is better than
market timing, I mean just reading the Fed. So I don't see market timing as
reading the Fed and making a purchase decision.

I wish they just raise the rates and get it over with anyway. Alot more enjoyable
in fixed income when rates are higher than scrounging around with target dates,
ladders, and a few tea leaves.
age in bonds, buy-and-hold, 10 year business cycle

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

Post by 2pedals » Mon Oct 22, 2018 10:10 pm

patrick013 wrote:
Mon Oct 22, 2018 7:08 pm
vineviz wrote:
Mon Oct 22, 2018 6:38 pm
Making investment decisions based on reading tea leaves or guesses about which way the wind will blow on Friday is foolish. It’s your money, but let’s not pretend that it amounts to anything more than a naive attempt at timing the market.
I don't define dynamic asset allocation as market timing. Nor the Fed and it's
watchers as naive. It's like buying the best bond at the time with all the available
information. It's more flexible than trying to beat Spiva in some maturity and
category. So in that respect it really isn't market timing but is better than
market timing, I mean just reading the Fed. So I don't see market timing as
reading the Fed and making a purchase decision.

I wish they just raise the rates and get it over with anyway. Alot more enjoyable
in fixed income when rates are higher than scrounging around with target dates,
ladders, and a few tea leaves.
Both bonds and stocks are assets. Since you don't define dynamic asset allocation as market timing, do you define stock market trading as a form of market timing? I do.

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catalina355
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Re: Total Bond Market Fund - interest rates rising!

Post by catalina355 » Mon Oct 22, 2018 10:36 pm

willthrill81 wrote:
Mon Oct 22, 2018 2:07 pm
catalina355 wrote:
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.
TBM is basically a very well diversified intermediate-term fund of investment-grade bonds. It does have short- and long-term bonds, but it behaves like an intermediate-term fund. For an in-depth explanation of TBM, see the stickied thread at the top of this section.
I understand the composition of TBM. In a retirement situation and with stocks and bonds both falling or stocks flat and bonds falling, I don't see how TBM can serve as the only FI investment. And this scenario could continue for 10 years as has happened in the past.

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Re: Total Bond Market Fund - interest rates rising!

Post by willthrill81 » Mon Oct 22, 2018 10:44 pm

catalina355 wrote:
Mon Oct 22, 2018 10:36 pm
willthrill81 wrote:
Mon Oct 22, 2018 2:07 pm
catalina355 wrote:
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


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.
TBM is basically a very well diversified intermediate-term fund of investment-grade bonds. It does have short- and long-term bonds, but it behaves like an intermediate-term fund. For an in-depth explanation of TBM, see the stickied thread at the top of this section.
I understand the composition of TBM. In a retirement situation and with stocks and bonds both falling or stocks flat and bonds falling, I don't see how TBM can serve as the only FI investment. And this scenario could continue for 10 years as has happened in the past.
Why not? Due to rising rates? Over the last two years, the Fed has increased the overnight lending rate many times, yet TBM has still outperformed short-term Treasuries by 1% annually. That might not happen consistently going forward, but it definitely demonstrates that rising rates don't necessitates that short-term bonds outperform TBM.

If you want something other than TBM, what would you want? A stable-value fund? CDs? Bonds of a different duration than TBM? All of these are reasonable, but none except the latter are likely to be significantly different (better or worse) than TBM over the long-term.

With regard to varying the duration, there are different schools of thought. One is that short-term rates are both more stable and may better track inflation than longer term bonds, which may really lag inflation for long periods of time (e.g. 1970s and early 1980s). Another is that long-term bonds have historically provided more diversification to a portfolio with mostly stocks, often when stocks are doing poorly, than short-term bonds. TBM is basically a combination of both.
“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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nedsaid
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Re: Total Bond Market Fund - interest rates rising!

Post by nedsaid » Mon Oct 22, 2018 10:50 pm

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.
Homer, this is a good post. It reminds me a lot of the famous Taylor Larimore post where he lists the year by year return of Vanguard Total Bond Market Index since inception. Yes the big, scary bond bear market hasn't been that scary at all. Inflation is public enemy number one for investors and for bonds in particular. That is why I have a good helping of TIPS also.

Bonds are self-correcting for a couple of reasons. First as rates rise, the yield on bonds increases and with reinvestment of the dividends greatly cushions the damage. In fact, Vanguard says that given enough time and reinvestment, that rising rates actually increase returns for the Bond investor. Secondly, though rising rates cause the value of bonds to fall, as bonds get closer and closer to maturity, the value of the bonds will slowly climb back to par value. So the fall in bond value is only temporary.

What kills bonds is higher levels of inflation. The 1970's stagflation was tough on both stocks and bonds, if you waited long enough, everything turned out okay. But you had to wait at least a decade. Patience is a virtue, particularly in investing.
A fool and his money are good for business.

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Re: Total Bond Market Fund - interest rates rising!

Post by restingonmylaurels » Tue Oct 23, 2018 7:15 am

onourway wrote:
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.
2.5 years is not necessarily a very short period of time. It is just as likely that there will be another 1% rise in across the curve interest rates due to unexpected inflation, over the next 3.5 years, meaning the NAV will drop another 5.5%. So my fund would then have experienced a total drop of 11%, offset by the coupon payments to some extent, during the 6 year duration period of TBM.

Again, while my personal investment horizon far exceeds the duration of TBM, I am forced to TLH this fund this year for tax purposes. So my open question much further up this thread is whether I should return those funds to TBM after the wash sale period, as given the varied dynamics in the investment world, more unexpected rises in inflation and more speculative behavior are likely to futher impact the value of its portfolio.

As an example of the latter, the market is placing a 20% probability that there will be no rise in the Fed funds rate in December. I personally think that is wrong, considering all of the Fed statements of late. So when the Fed does hike the Fed funds rate in December, the short-term market will need to adjust to the 100% certainty. Do I know more than the market? No, I am just not placing speculative bets against it trying to make a killing.

Unfortunately, those speculative bets affect the value of TBM's portfolio. As such, I would be leery of reinvesting in it post-TLH, until the market has more clear expectations of where inflation is going and buys in more fully to the dot plot from the Fed.

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

Post by vineviz » Tue Oct 23, 2018 7:41 am

restingonmylaurels wrote:
Tue Oct 23, 2018 7:15 am
2.5 years is not necessarily a very short period of time.
It's a short period of time relative to both your investment horizon and the appropriate investment horizon for the fund.

Would you sell your stock funds if they drop by 3% tomorrow? I hope not, but why sell your bond fund if it drops by 0.3%?
restingonmylaurels wrote:
Tue Oct 23, 2018 7:15 am
Unfortunately, those speculative bets affect the value of TBM's portfolio. As such, I would be leery of reinvesting in it post-TLH, until the market has more clear expectations of where inflation is going and buys in more fully to the dot plot from the Fed.
Expectations "of where inflation is going" are NEVER clear. Never.

This is the hardest thing for some investors to grasp, in my opinion, and some just can't tame their impulses enough to get it: the future of the markets is never obvious, despite all the evolutionary impulses telling you otherwise. The future path of markets is effectively random, and making active bets that you are smarter than everyone you are bidding against is a sure-fire way to sacrifice returns over time.
"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 onourway » Tue Oct 23, 2018 7:43 am

restingonmylaurels wrote:
Tue Oct 23, 2018 7:15 am

2.5 years is not necessarily a very short period of time. It is just as likely that there will be another 1% rise in across the curve interest rates due to unexpected inflation, over the next 3.5 years, meaning the NAV will drop another 5.5%. So my fund would then have experienced a total drop of 11%, offset by the coupon payments to some extent, during the 6 year duration period of TBM.

Again, while my personal investment horizon far exceeds the duration of TBM, I am forced to TLH this fund this year for tax purposes. So my open question much further up this thread is whether I should return those funds to TBM after the wash sale period, as given the varied dynamics in the investment world, more unexpected rises in inflation and more speculative behavior are likely to futher impact the value of its portfolio.

As an example of the latter, the market is placing a 20% probability that there will be no rise in the Fed funds rate in December. I personally think that is wrong, considering all of the Fed statements of late. So when the Fed does hike the Fed funds rate in December, the short-term market will need to adjust to the 100% certainty. Do I know more than the market? No, I am just not placing speculative bets against it trying to make a killing.

Unfortunately, those speculative bets affect the value of TBM's portfolio. As such, I would be leery of reinvesting in it post-TLH, until the market has more clear expectations of where inflation is going and buys in more fully to the dot plot from the Fed.
2.5 years is an exceedingly short period of time for most investment horizons. And it's far too short of a period of time to worry about your bond fund with an average duration of over 6 years.

Let's look at a similar period in history and find out what happened. Between June 2003 and June 2006 the 5 year Treasury rate rose from just over 2% to just over 5%. How did Total Bond Market do during this 'bond slaughter?' A CAGR of 1.81%...

Image

Your short-term focus on NAV is clouding your view of what's important. The reality is that your bond/fixed income portion of your portfolio is unlikely to grow from interest so much to materially affect your goals. Whether you choose short term bonds, medium-term, treasuries, CD's, or a money market fund, for the VAST majority of people it's the equity side of their holdings where the growth will come from. The differences between various reasonable choices on the fixed income size amounts to nothing more than noise.

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Re: Total Bond Market Fund - interest rates rising!

Post by patrick013 » Tue Oct 23, 2018 2:11 pm

2pedals wrote:
Mon Oct 22, 2018 10:10 pm
patrick013 wrote:
Mon Oct 22, 2018 7:08 pm

I wish they just raise the rates and get it over with anyway. Alot more enjoyable
in fixed income when rates are higher than scrounging around with target dates,
ladders, and a few tea leaves.
Both bonds and stocks are assets. Since you don't define dynamic asset allocation as market timing, do you define stock market trading as a form of market timing? I do.
It may or may not be. Usually short term trading is done per market timing
but long term allocations are done to better the portfolio in some way.

Here's some interesting movements whether they be market timing or just
portfolio re-allocations I don't know.

According to Lipper for Q3 2018.......

The money market funds (+$43.4 billion) and short-/intermediate-term bond
funds (+$30.4 billion) macro-groups had the largest draws of net new money
for Q3 2018, while the large-cap funds (-$26.7 billion) and multi-cap funds
(-$12.0 billion) macro-groups witnessed the largest net redemptions.

Long term taxable bond funds had positive net flows of +$7.47 billion for the
period.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Total Bond Market Fund - interest rates rising!

Post by Kevin M » Tue Oct 23, 2018 2:43 pm

HomerJ wrote:
Fri Oct 19, 2018 10:11 am
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.
willthrill81 wrote:
Mon Oct 22, 2018 10:44 pm
<snip>
Over the last two years, the Fed has increased the overnight lending rate many times, yet TBM has still outperformed short-term Treasuries by 1% annually.
Even though it already has been pointed out multiple times so far in this thread, intermediate-term and long-term yields, and even short-term yields other than the very shortest, don't necessarily increase when the federal funds rate (FFR) increases. Yet people keep referring to "rising rates" as increases in the FFR.

It is misleading to look at the performance of intermediate-term vs. short-term bond funds during the entire period of increasing FFR since Dec 2016. Let's compare the FFR to 5-year and 10-year Treasury yields, as relevant to an intermediate-term bond fund, and the 2-year as relevant to a short-term bond fund (average maturity of short-term Treasury index is about 2 years), since 12/14/2016 (the start date mentioned in the OP):

Image

Both the 5-year and 10-year yields were lower in early September 2017 than they were on 12/14/2016, and even the September 2017 low of the 2-year yield was the same as it was on 12/14/2016. So intermediate-term yields actually declined, and short-term yields were flat, during the first part of the period. The declining yields of intermediate-term bonds actually would have boosted their performance relative to short bonds during this initial part of the period.

The relatively sustained period of increased intermediate-term and short-term yields began in early September 2017 (and the 10-year yield was essentially flat for a major portion of this period, as was the 5-year yield to a slightly lesser extent). For September 2017 through Sep 2018, the short-term Treasury index fund did indeed outperform the intermediate-term Treasury index fund, and TBM as well. Here are the annualized returns (aka CAGR) for Admiral shares of those funds during the period of relatively sustained increasing Treasury yields:

-0.27% short-term Treasury index (Portfolio 1)
-2.75% interm-term Treasury index (Portfolio 2)
-1.61% TBM (Portfolio 3)

And here is the chart:

Image
Source: Portfolio Visualizer Backtest

My goal for contributions to threads like this is to help find a balance between alarmist pessimism and pollyannic complacency. One should not necessarily exchange their intermediate-term fund for a short-term fund because of worse returns of the former over some relatively-recent past period (I'm not doing that), but one also should not assume that the intermediate-term fund will necessarily outperform the short-term fund over some particular period going forward, unless perhaps that period is at least two times the duration of the intermediate-term fund (still not sure about this).

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Re: Total Bond Market Fund - interest rates rising!

Post by restingonmylaurels » Wed Oct 24, 2018 6:09 am

Kevin M wrote:
Mon Oct 22, 2018 2:53 pm
Two myths being propagated here.

First is that if you will earn the initial yield if you hold a bond fund for a time period equal to its duration. This is demonstrably false. I have done the research on this, and published the results in this forum several years ago. Return of TBM over 5 or 10 years could easily be +/- 0.5% and as much as +/- 1% annualized over these holding periods. One percent over 10 years is more than 10% cumulative difference.

Some forum members have posted math (in other threads) indicating that if you hold for two times the duration with continuously rising yields, that you will earn at least the initial yield. I haven't checked, but with duration of TBM at about 6 years, that would be 12 years, and 12 isn't much more than 10, but yields generally don't rise continuously, so perhaps harder to check.

Kevin
Kevin, those threads about two times duration to earn the initial yield in times of rising rates would be an interesting read and would also be something more people should understand. Can you provide the links?

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Re: Total Bond Market Fund - interest rates rising!

Post by vineviz » Wed Oct 24, 2018 7:11 am

Kevin M wrote:
Tue Oct 23, 2018 2:43 pm
. . . . one also should not assume that the intermediate-term fund will necessarily outperform the short-term fund over some particular period going forward, unless perhaps that period is at least two times the duration of the intermediate-term fund (still not sure about this).
The Leibowitz et al. research to which you are referring is interesting, but it is important to keep in mind the economic significance of their findings: realized total return was within 2% of the initial YTM approximately 91% of the time over a period equal to duration for 75 month treasury bonds. That improves to 99% of the time at 2x duration, but at current rates of 3.1%, a 2% forecast error is just 0.06%.

In other words, someone buying constant maturity bond fund with an initial YTM of 3.1% can expect to receive a 7-year total return of between 3.04% and 3.16% about ninety percent of the time.

Is there a very small chance that 3 year treasuries will beat 7 year treasuries over the next 7 years? Yes, but I don't think people grasp just how infinitesimally small that chance is.
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Re: Total Bond Market Fund - interest rates rising!

Post by HEDGEFUNDIE » Wed Oct 24, 2018 7:21 am

Kevin M wrote:
Mon Oct 22, 2018 2:53 pm
Two myths being propagated here.

First is that if you will earn the initial yield if you hold a bond fund for a time period equal to its duration. This is demonstrably false. I have done the research on this, and published the results in this forum several years ago. Return of TBM over 5 or 10 years could easily be +/- 0.5% and as much as +/- 1% annualized over these holding periods. One percent over 10 years is more than 10% cumulative difference.

Some forum members have posted math (in other threads) indicating that if you hold for two times the duration with continuously rising yields, that you will earn at least the initial yield. I haven't checked, but with duration of TBM at about 6 years, that would be 12 years, and 12 isn't much more than 10, but yields generally don't rise continuously, so perhaps harder to check.

Second is that you will earn more from intermediate-term or long-term bonds than from short-term bonds if you hold for a period equal to the duration of the intermediate-term or long-term bonds. For the 10-year period from 1972-1981, a period of generally increasing rates (and inflation), cumulative nominal return for short, intermediate, and long term Treasuries was 88%, 51%, and 23% respectively.

Even more importantly, cumulative 10-year real returns were -7%, -18%, and -34% respectively. As has been pointed out, prolonged, unexpected inflation is the real bond killer. And unless there are artificial caps on nominal yields, as there were in the 1940s, prolonged, unexpected inflation hurts longer-term nominal bonds more than it does shorter-term nominal bonds, as it did in the 1970s.

Here I am not recommending trying to time the bond market, just trying to correct some misinformation.

Kevin
All this hand wringing about duration and expected yields is puzzling to me.

If I buy a dividend paying stock that yields 3% at the time of purchase, do I really expect to earn 3% return every year? Of course not, the fundamentals of the company and the broader economy change every day and so do expectations for total return for my stock. Same goes for bonds.

What does tend to be true is that more volatile stocks return more over time. At the cost of higher risk. Again, same goes for bonds.

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Re: Total Bond Market Fund - interest rates rising!

Post by Austintatious » Wed Oct 24, 2018 12:51 pm

Here's a timely article by Jonathan Clements regarding bonds in times of rising interest rates.

https://humbledollar.com/money-guide/ri ... d-returns/

A portion of the text:
What if you stay put and interest rates do indeed increase? You might focus on the silver lining: Rising rates will ultimately help your bond portfolio, as you invest new savings—and reinvest interest payments and the proceeds from maturing bonds—at the higher yields. One rule of thumb: If you’re reinvesting your interest payments, you will benefit over the long haul if interest rates rise, provided your investment time horizon is longer than the duration of your bonds or bond funds.

In that scenario—where your time horizon is longer than your bonds’ duration—falling interest rates will, by contrast, work against you. Yes, the price of your bonds will get a short-term boost from an interest-rate decline. But your long-run return will be hurt because you will be reinvesting interest payments at the lower yield.

What if you would rather not see your bond portfolio roughed up by rising rates? Instead of a portfolio with, say, 60% stocks and 40% bonds, you might opt for 75% stocks and 25% cash investments—or, alternatively, close-to-cash investments, in the guise of short-term bonds and certificates of deposit. The expected long-run return of those two portfolios should be similar. Indeed, historically, shorter-term bonds have delivered much of the yield of longer-term bonds, but with significantly less risk.
The more I think of all this, and I do appreciate all the contributions, the more I wonder if this post by onourway has it essentially correct:
Your short-term focus on NAV is clouding your view of what's important. The reality is that your bond/fixed income portion of your portfolio is unlikely to grow from interest so much to materially affect your goals. Whether you choose short term bonds, medium-term, treasuries, CD's, or a money market fund, for the VAST majority of people it's the equity side of their holdings where the growth will come from. The differences between various reasonable choices on the fixed income size amounts to nothing more than noise.

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Re: Total Bond Market Fund - interest rates rising!

Post by Kevin M » Wed Oct 24, 2018 7:27 pm

restingonmylaurels wrote:
Wed Oct 24, 2018 6:09 am
Kevin M wrote:
Mon Oct 22, 2018 2:53 pm
Two myths being propagated here.

First is that if you will earn the initial yield if you hold a bond fund for a time period equal to its duration. This is demonstrably false. I have done the research on this, and published the results in this forum several years ago. Return of TBM over 5 or 10 years could easily be +/- 0.5% and as much as +/- 1% annualized over these holding periods. One percent over 10 years is more than 10% cumulative difference.

Some forum members have posted math (in other threads) indicating that if you hold for two times the duration with continuously rising yields, that you will earn at least the initial yield. I haven't checked, but with duration of TBM at about 6 years, that would be 12 years, and 12 isn't much more than 10, but yields generally don't rise continuously, so perhaps harder to check.

Kevin
Kevin, those threads about two times duration to earn the initial yield in times of rising rates would be an interesting read and would also be something more people should understand. Can you provide the links?
You can find at least some of the threads with Google searches like:

math "two times" duration site:bogleheads.org

2x duration site:bogleheads.org

etc.

A similar search on "initial SEC yield" will find at least one of the threads in which I showed how much subsequent 5-year and 10-year yields can diverge from the initial SEC yield. From this Jan 2015 post in one of those threads:
Kevin M wrote:I think it's also informative to view the subsequent 10-year return minus the initial SEC yield:

Image

From this it looks that it's more likely for subsequent annualized return to be greater than +/- 50 basis points relative to initial SEC yield than it is to be equal to initial SEC yield, and a deviation of 100 basis points shouldn't be particularly surprising. I think this is more informative than a single number like correlation of 0.82.
If your initial SEC yield is 5% and your 10-year annualized return is 4%, that one percentage point (100 basis points) delta in absolute terms is 20% in relative terms. That's a difference between earning 480,244 instead of 628,895 on an initial investment of $1,000,000, which is 24% less.

We haven't had any 10-year periods for Vanguard intermediate-term bond funds since initial yields have been in the 2% or even 3% ballpark, so we can't say empirically that we'll see the same kind of variance in Vanguard bond fund returns starting from these lower yields, but if we did, the relative differences would of course be larger. A one percentage point difference starting at 2% is a 50% relative difference. Expecting 2% but earning 1% for 10 years results in a 52% shortfall relative to expectations.

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Re: Total Bond Market Fund - interest rates rising!

Post by restingonmylaurels » Thu Oct 25, 2018 6:46 am

I found those posts that explained why its takes nearly twice the duration of a bond fund to make the initial yield in a time of rising rates. Not sure why everyone still seems to quote that it is the duration one has to wait for to earn the initial yield, not twice the duration. I included a skeptic's viewpoint at the end, after the math. Does anyone disagree with the math?
ogd wrote:
Thu Dec 01, 2016 12:57 pm
White Coat Investor wrote: But if rates are "rising" meaning continually going up, no, that's not good for the returns of bonds or their funds, because they're continually taking capital losses.
Eventually though, it still turns positive, it just takes longer. For example, if the yield rose at a steady pace (e.g. 1%/year), forever, you'd be better off after about 2x duration. While you do keep taking capital losses, the rising and accumulating yield eventually overwhelms even the ongoing losses every year, in addition to those of the past. What's easy to miss when thinking in terms of the "duration as point of indifference" rule is that the second rise will be "indifferent" to a higher base yield than the first, the third to a higher yield still. When looking back to the original expectation, though, the later increases are paid for much, much quicker.

If the yield increase was not constant but accelerating steadily (e.g. +1%, +2%, +3%), you'd still be better off after about 3x duration. It would take exponential increases with a pretty high base to outmuscle the accumulating yield effect, leading very quickly to unrealistic yields exceeding 100%/year. This is just fun math at this point, but there's a basis in calculus -- when does the integral of a function over (0,x) cross above the function itself f(x).
White Coat Investor wrote:
Thu Dec 01, 2016 1:02 pm
longinvest wrote:
White Coat Investor wrote:But if rates are "rising" meaning continually going up, no, that's not good for the returns of bonds or their funds, because they're continually taking capital losses.
White Coat Investor,

Not really. If I remember correctly, the investor will be in as good as a position as if rates had never risen within 2 times duration in a continuously increasing yield scenario. After that, it's all gravy. :wink:
First, it's 1X duration.

Second, right, but if yields increase 3 or 4 more times between now and "duration" you're still behind. Continually rising rates will continually give you capital losses.

Now, if you have a duration of 5 years, and rates go up 1% and then stop going up, after 5 years it's all gravy. If rates go up 1% a year for decades, I'm not sure how long it takes to come out ahead. Eventually I suppose you would, even with the capital losses, but it'll be a lot longer than 5 years. Let's do the math.

$100 in the investment, 5 years duration, rates start at 2% and go up 1% at the beginning of each year.

So at the beginning, you have $95.
At end of year 1, you would have $98
At beginning of year 2, you would have $93
At end of year 2, you would have $97
At beginning of year 3, you would have $92
At end of year 3, you would have $97
At beginning of year 4, you would have $92
At end of year 4, you would have $98
At beginning of year 5, you would have $93
At end of year 5 you would have $100.
At beginning of year 6 you would have $95
At end of year 6 you would have $103.
At beginning of year 7 you would have $98
At end of year 7 you would have $107
At beginning of year 8 you would have $102
At end of year 8 you would have $112
At beginning of year 9 you would have $107
At end of year 9 you would have $118, which is about what you would have if rates had never gone up at all.

So, 9 years for an investment with a duration of 5 years to break even with continually rising rates. The cool thing at that point is that your investment is now paying 11%. So in the long run, a massive rise in rates is a very good thing.

It would be a shorter time period for a shorter duration fund and a longer time period for a longer duration fund.
longinvest wrote:
Thu Dec 01, 2016 1:20 pm
White Coat Investor wrote:
longinvest wrote:
White Coat Investor wrote:But if rates are "rising" meaning continually going up, no, that's not good for the returns of bonds or their funds, because they're continually taking capital losses.
White Coat Investor,

Not really. If I remember correctly, the investor will be in as good as a position as if rates had never risen within 2 times duration in a continuously increasing yield scenario. After that, it's all gravy. :wink:
First, it's 1X duration.

Second, right, but if yields increase 3 or 4 more times between now and "duration" you're still behind. Continually rising rates will continually give you capital losses.
White Coat Investor,

I wrote "in a continuously increasing yield scenario" when I said 2 times duration.

Here's an illustration, assuming a flat yield curve (a pretty pessimistic assumption) where I initially invest $1,000 into a 5-year bond (at par), one year later get one coupon and sell the bond on the open market where yields have risen 1%, buy a new 5-year bond (at par), and repeat the process (I also show a parallel scenario with a constant yield):

Code: Select all

       Year      Yield      Value      Yield      Value
          0         2%  $1,000.00         2%  $1,000.00
          1         3%    $982.83         2%  $1,020.00
          2         4%    $976.64         2%  $1,040.40
          3         5%    $981.07         2%  $1,061.21
          4         6%    $996.13         2%  $1,082.43
          5         7%  $1,022.16         2%  $1,104.08
          6         8%  $1,059.85         2%  $1,126.16
          7         9%  $1,110.31         2%  $1,148.69
          8        10%  $1,175.04         2%  $1,171.66
          9        11%  $1,256.09         2%  $1,195.09
         10        12%  $1,356.10         2%  $1,218.99
Image

Note that the lowest annual balance of the portfolio was $976.64, representing a -2.3% loss relative to the initial $1,000 investment.
vineviz wrote:
Sun Aug 12, 2018 7:10 pm
jmk wrote:
Sun Aug 12, 2018 7:01 pm
How accurate is the rule of thumb "in rising rate environment it takes 2 times duration minus 1 to earn the current yield on a bond fund"?

For instance, might it take 11.2 years to earn 3.14% on TBM? Can it be much longer or shorter?
I’ve never heard of that rule of thumb and can’t think of why anyone woul espouse it.

Generally speaking, duration itself is a measure of the “break even” point on a bond.

But this 2x-1 thing seems baseless to me.

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Re: Total Bond Market Fund - interest rates rising!

Post by vineviz » Thu Oct 25, 2018 7:10 am

restingonmylaurels wrote:
Thu Oct 25, 2018 6:46 am
I found those posts that explained why its takes nearly twice the duration of a bond fund to make the initial yield in a time of rising rates. Not sure why everyone still seems to quote that it is the duration one has to wait for to earn the initial yield, not twice the duration. I included a skeptic's viewpoint at the end, after the math. Does anyone disagree with the math?
It's not the math that is off, so much, as that the premise is shaky.

For starters, the definition of duration is that it is the time required a bond to return its initial YTM after an immediate one-time change in interest rates.

The studies cited in the "twice duration" discussions involve either a theoretical series of interest rate changes or an empirical evaluation of actual results.

The former has the problem of being unactionable (since we can't know the series of future interest rate changes ahead of time) and conceptually problematic (evaluating a statistic predicated on a particular condition being true under scenarios where it is defined to be untrue).

The latter is interesting but, as I mentioned before, turns out to put an error band around realized returns that is statistically significant but economically unimportant.
In other words, someone buying constant maturity bond fund with an initial YTM of 3.1% can expect to receive a 7-year total return of between 3.04% and 3.16% about ninety percent of the time.
When people say you can expect a total return of the initial YTM when a bond fund is held for its duration, it's fair to say that this is an approximation. Although bond funds do have an average effective duration, that duration isn't constantly declining as would the duration of an individual bond because aging bonds are generally replaced with newer ones. Add in the complication that the mathematics of duration are such that a change in interest rate itself will change the duration of a bond and it should be evident that predicting the EXACT future return of a bond fund is not what people who say "hold for the duration" are actually proposing.
"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 donaldfair71 » Thu Oct 25, 2018 7:45 am

Kevin M wrote:
Mon Oct 22, 2018 2:53 pm


First is that if you will earn the initial yield if you hold a bond fund for a time period equal to its duration. This is demonstrably false. I have done the research on this, and published the results in this forum several years ago. Return of TBM over 5 or 10 years could easily be +/- 0.5% and as much as +/- 1% annualized over these holding periods. One percent over 10 years is more than 10% cumulative difference.
Kevin,

Is it fair to say that, since returns could be +/- .5, or even 1%, that we could treat it as noise over the long term? In other words, if I buy ETFs monthly, I can expect that about half the time I will buy at a premium and about half the time I will probably buy at a discount. These two are out of my control, and will tend to balance each other out over time. Could we treat this +/- amount the same in your opinion?

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Re: Total Bond Market Fund - interest rates rising!

Post by Kevin M » Thu Oct 25, 2018 3:46 pm

donaldfair71 wrote:
Thu Oct 25, 2018 7:45 am
Kevin M wrote:
Mon Oct 22, 2018 2:53 pm
First is that if you will earn the initial yield if you hold a bond fund for a time period equal to its duration. This is demonstrably false. I have done the research on this, and published the results in this forum several years ago. Return of TBM over 5 or 10 years could easily be +/- 0.5% and as much as +/- 1% annualized over these holding periods. One percent over 10 years is more than 10% cumulative difference.
Kevin,

Is it fair to say that, since returns could be +/- .5, or even 1%, that we could treat it as noise over the long term? In other words, if I buy ETFs monthly, I can expect that about half the time I will buy at a premium and about half the time I will probably buy at a discount. These two are out of my control, and will tend to balance each other out over time. Could we treat this +/- amount the same in your opinion?
Possibly. Others certainly have made this argument in other threads in which this has been discussed. It's hard to say based just on the limited data from Vanguard funds--there's just not enough history. However, we can do some analysis using simulated returns. Here's a thread in which I did some of this (others contributed as well): Initial yield and subsequent N-year return.

From this post toward the end of that thread:
And here is a chart showing 5-year annualized return minus initial yield of the 5-year CMT (which I've concluded is much more informative than a chart showing initial yield and subsequent return):

Image

So as with other data sets, this does not show initial yield as a particularly good predictor of subsequent 5-year return. Note also that bias is positive on average since 1980 (falling rates), but negative on average before 1980 (rising rates)
Digging up my old spreadsheet and doing a little more analysis of the last statement ...

For the 24-year period of generally rising yields from 1954 through 1977, the average of the subsequent 5-year returns minus initial 5-year yields was -0.51 percentage points . For the 33-year period of generally falling yields from 1978 through 2010, the average of the subsequent 5-year returns minus initial 5-year yields was +1.10 percentage points.

So I guess it depends on what you mean by "long term", and it certainly depends on the path of yields over that period.

Also, your question represents the point of view of an accumulator, and as others have said, the variance of your stock returns is likely to dominate the variance of your bond returns--assuming you have a fairly high allocation to stocks--so for you, this may not be a particularly important topic. Some of us are decumulators, and/or may have relatively low stock allocations, due to lower ability and/or need and/or willingness to take risk, and for us this may be a more important topic.

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Re: Total Bond Market Fund - interest rates rising!

Post by donaldfair71 » Fri Oct 26, 2018 7:48 am

Kevin M wrote:
Thu Oct 25, 2018 3:46 pm
donaldfair71 wrote:
Thu Oct 25, 2018 7:45 am
Kevin M wrote:
Mon Oct 22, 2018 2:53 pm
First is that if you will earn the initial yield if you hold a bond fund for a time period equal to its duration. This is demonstrably false. I have done the research on this, and published the results in this forum several years ago. Return of TBM over 5 or 10 years could easily be +/- 0.5% and as much as +/- 1% annualized over these holding periods. One percent over 10 years is more than 10% cumulative difference.
Kevin,

Is it fair to say that, since returns could be +/- .5, or even 1%, that we could treat it as noise over the long term? In other words, if I buy ETFs monthly, I can expect that about half the time I will buy at a premium and about half the time I will probably buy at a discount. These two are out of my control, and will tend to balance each other out over time. Could we treat this +/- amount the same in your opinion?
Possibly. Others certainly have made this argument in other threads in which this has been discussed. It's hard to say based just on the limited data from Vanguard funds--there's just not enough history. However, we can do some analysis using simulated returns. Here's a thread in which I did some of this (others contributed as well): Initial yield and subsequent N-year return.

From this post toward the end of that thread:
And here is a chart showing 5-year annualized return minus initial yield of the 5-year CMT (which I've concluded is much more informative than a chart showing initial yield and subsequent return):

Image

So as with other data sets, this does not show initial yield as a particularly good predictor of subsequent 5-year return. Note also that bias is positive on average since 1980 (falling rates), but negative on average before 1980 (rising rates)
Digging up my old spreadsheet and doing a little more analysis of the last statement ...

For the 24-year period of generally rising yields from 1954 through 1977, the average of the subsequent 5-year returns minus initial 5-year yields was -0.51 percentage points . For the 33-year period of generally falling yields from 1978 through 2010, the average of the subsequent 5-year returns minus initial 5-year yields was +1.10 percentage points.

So I guess it depends on what you mean by "long term", and it certainly depends on the path of yields over that period.

Also, your question represents the point of view of an accumulator, and as others have said, the variance of your stock returns is likely to dominate the variance of your bond returns--assuming you have a fairly high allocation to stocks--so for you, this may not be a particularly important topic. Some of us are decumulators, and/or may have relatively low stock allocations, due to lower ability and/or need and/or willingness to take risk, and for us this may be a more important topic.

Kevin
Thank you for your very detailed answer, and for going over the many elements/considerations within it. We are very, very, lucky to have you on this board, and I feel like your posts always give me the most understandable explanations regarding the mechanisms of fixed income.

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Re: Total Bond Market Fund - interest rates rising!

Post by Da5id » Fri Oct 26, 2018 8:14 am

Admiral wrote:
Fri Oct 19, 2018 11:58 am
Austintatious wrote:
Fri Oct 19, 2018 11:52 am
that bond returns will probably be depressed for a similar time.
Define "depressed"? Total Bond yield is now 2.73%, higher than it's been in ten years. Yes, it's not 4 or 5%. But it's not .5% either. Perhaps lower expectations are in order. Stocks are for risk and return, better to chase performance there.
Where is the 2.73% from? Currently even the non-Admiral fund VBMFX is 3.25% SEC yield.

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Re: Total Bond Market Fund - interest rates rising!

Post by Kevin M » Fri Oct 26, 2018 11:08 am

Da5id wrote:
Fri Oct 26, 2018 8:14 am
Admiral wrote:
Fri Oct 19, 2018 11:58 am
Austintatious wrote:
Fri Oct 19, 2018 11:52 am
that bond returns will probably be depressed for a similar time.
Define "depressed"? Total Bond yield is now 2.73%, higher than it's been in ten years. Yes, it's not 4 or 5%. But it's not .5% either. Perhaps lower expectations are in order. Stocks are for risk and return, better to chase performance there.
Where is the 2.73% from? Currently even the non-Admiral fund VBMFX is 3.25% SEC yield.
That's the most recent distribution yield, not the SEC yield.

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

Post by BW1985 » Fri Oct 26, 2018 11:15 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.
FYI it's free now to freeze/unfreeze credit reports.
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Re: Total Bond Market Fund - interest rates rising!

Post by HomerJ » Fri Oct 26, 2018 2:18 pm

restingonmylaurels wrote:
Tue Oct 23, 2018 7:15 am
So my fund would then have experienced a total drop of 11%, offset by the coupon payments to some extent, during the 6 year duration period of TBM.
Offset COMPLETELY and THEN SOME by the coupon payments.

6 years of rising yields, 2% a year recently, 3% a year now, 4% a year in the future (if your hypothetical interest rises continue) will more than make up for your NAV losses.

Ignoring the dividends from bond funds makes no sense.
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Re: Total Bond Market Fund - interest rates rising!

Post by Kevin M » Fri Oct 26, 2018 6:42 pm

I did some more investigation of this point:
Kevin M wrote:
Mon Oct 22, 2018 2:53 pm
Two myths being propagated here.
<snip>
Second is that you will earn more from intermediate-term or long-term bonds than from short-term bonds if you hold for a period equal to the duration of the intermediate-term or long-term bonds. For the 10-year period from 1972-1981, a period of generally increasing rates (and inflation), cumulative nominal return for short, intermediate, and long term Treasuries was 88%, 51%, and 23% respectively.
Using the Simba/siamond backtest spreadsheet data, I calculated the benefit of 10-year cumulative nominal returns for short-term Treasuries (STT) relative to that of intermediate-term Treasuries (ITT), using the formula STT/ITT - 1. For example, using the 10-year cumulative returns quoted above, the ratio would be 88/51-1 = 73%; I don't round intermediate values in the spreadsheet, so the calculated value actually is 75%. In other words, for the 10-year period 1972-1981, you would have earned about 75% more with STT than with ITT.

Here is a chart of STT/ITT - 1 for the nominal cumulative returns from start years 1871 through 2007.

Image

When the curve is above 0%, STT 10-year returns are higher than those of ITT, and vice versa. We see the peak value of 75%, discussed above, for start year 1972.

This shows that 10-year returns can be higher for STT for a long time, as they were for start years from 1949 through 1979. An even longer period of apparent superior STT 10-year returns was for start years 1872 through 1923, although arguments can be made against putting too much weight on older, simulated returns.

Interestingly, the average of all of the STT/ITT-1 values is +5%, indicating that on average short-term Treasuries have had higher 10-year returns than intermediate-term Treasuries. This is contrary to the view that has been most commonly propagated in this thread and others.

I wonder how much recency bias affects people's perceptions on this topic. Ten-year returns for ITT have been higher than for STT since 1980, a period of generally declining bond yields, and one for which we can examine actual Vanguard bond fund returns.

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

Post by abuss368 » Fri Oct 26, 2018 7:37 pm

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.
HomerJ -

Thank you for that very interesting investment fact concerning Total Bond Market in this rising interest rate environment. Total Bond Market Index is now the largest bond fund in the world and for good reason.
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Re: Total Bond Market Fund - interest rates rising!

Post by Kevin M » Fri Oct 26, 2018 7:52 pm

abuss368 wrote:
Fri Oct 26, 2018 7:37 pm
Thank you for that very interesting investment fact concerning Total Bond Market in this rising interest rate environment.
People still aren't understanding "rising rate environment", with respect to intermediate-term bonds. Let's work on this ...

Is this a rising rate environment, with respect to intermediate-term bonds?
Image

Anyone?

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

Post by abuss368 » Sat Oct 27, 2018 9:54 am

Kevin M wrote:
Fri Oct 26, 2018 7:52 pm
abuss368 wrote:
Fri Oct 26, 2018 7:37 pm
Thank you for that very interesting investment fact concerning Total Bond Market in this rising interest rate environment.
People still aren't understanding "rising rate environment", with respect to intermediate-term bonds. Let's work on this ...

Is this a rising rate environment, with respect to intermediate-term bonds?
Image

Anyone?

Kevin
The effective federal funds rate increased from 1.50% to 4.50%? Could you walk us through that graph?
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Re: Total Bond Market Fund - interest rates rising!

Post by vineviz » Sat Oct 27, 2018 10:03 am

Kevin M wrote:
Fri Oct 26, 2018 6:42 pm
For the 10-year period from 1972-1981, a period of generally increasing rates (and inflation), cumulative nominal return for short, intermediate, and long term Treasuries was 88%, 51%, and 23% respectively.
I’ve previously shown that neither increasing rates nor inflation was the primary cause of these relationships. Rather, from 1951 to 1981 the Fed was actively managing (some say distorting) the relative returns of long and short Treasury bonds. They no longer do this.

It’s a danger to completely ignore historical data, but it is also dangerous to ignore the fundamentals that drove that data.

The “normal” relationship is the one we’ve seen for the past 40 years, in which long-term bonds have higher expected returns than short term bonds.
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Re: Total Bond Market Fund - interest rates rising!

Post by abuss368 » Sat Oct 27, 2018 10:40 am

vineviz wrote:
Sat Oct 27, 2018 10:03 am
The “normal” relationship is the one we’ve seen for the past 40 years, in which long-term bonds have higher expected returns than short term bonds.
And higher risk! Investors of long term bonds should be compensated for that higher risk.
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Re: Total Bond Market Fund - interest rates rising!

Post by Austintatious » Sat Oct 27, 2018 11:22 am

abuss368 wrote:
Sat Oct 27, 2018 9:54 am
Kevin M wrote:
Fri Oct 26, 2018 7:52 pm
abuss368 wrote:
Fri Oct 26, 2018 7:37 pm
Thank you for that very interesting investment fact concerning Total Bond Market in this rising interest rate environment.
People still aren't understanding "rising rate environment", with respect to intermediate-term bonds. Let's work on this ...

Is this a rising rate environment, with respect to intermediate-term bonds?
Image

Anyone?

Kevin
The effective federal funds rate increased from 1.50% to 4.50%? Could you walk us through that graph?
I've been hoping, Kevin, that some other Bhead would answer your question, given that my old Sarge told me way more than once "Under no circumstances do you ever, ever volunteer. Are ya hearin me, son?" But it appears that there'll be no other volunteers so I'll do it, if only to further advance the education of the forum. Yes, the graph reflects a continually rising rate environment with regard to intermediate term bonds and, for that matter, just about everything else of a financial and economic nature.

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Re: Total Bond Market Fund - interest rates rising!

Post by vineviz » Sat Oct 27, 2018 11:25 am

abuss368 wrote:
Sat Oct 27, 2018 10:40 am
vineviz wrote:
Sat Oct 27, 2018 10:03 am
The “normal” relationship is the one we’ve seen for the past 40 years, in which long-term bonds have higher expected returns than short term bonds.
And higher risk! Investors of long term bonds should be compensated for that higher risk.
Of course! Longer-term bonds are definitely going to be more volatile than short-term bonds, but long-term investors shouldn't care much about that (though, obviously, many do).

I think it's also worth pointing out once more that interest rate risks (which are the ones many people seem to fear most as of late) are minimized by holding bonds with a duration that closely matches your investment horizon.
"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 peppers » Sat Oct 27, 2018 12:12 pm

Kevin M wrote:
Fri Oct 26, 2018 7:52 pm
abuss368 wrote:
Fri Oct 26, 2018 7:37 pm
Thank you for that very interesting investment fact concerning Total Bond Market in this rising interest rate environment.
People still aren't understanding "rising rate environment", with respect to intermediate-term bonds. Let's work on this ...

Is this a rising rate environment, with respect to intermediate-term bonds?
Image

Anyone?

Kevin
Looking at the US ten treasury yield at that time frame:

07/04 4.57
01/06 4.37

It's always "interesting" when Kevin M posts. :)
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Re: Total Bond Market Fund - interest rates rising!

Post by Kevin M » Sat Oct 27, 2018 12:24 pm

Kevin M wrote:
Fri Oct 26, 2018 7:52 pm
Is this a rising rate environment, with respect to intermediate-term bonds?
Image
(I see that peppers posted a relevant observation while I was writing the following).

To answer the question, let's add some yields for various maturity Treasuries to the chart:

Image
Although the 2-year yield increased during this period of a generally increasing federal funds rate (FFR) (although not by as much), the 10-year yield was basically flat, and the 20-year yield actually declined. This is just emphasizing the point that's already been made several times in this thread, which is that the an increasing FFR does not necessarily result in increasing Treasury yields. The capital return component of a bond fund depends on changes in the yields of the bonds the fund holds, not on changes in the FFR.

Here's a chart showing the returns of the short-term (Portfolio 1), intermediate-term (Portfolio 2), and long-term (Portfolio 3) Treasury funds during this period.

Image
Source: PV backtest (click Logarithmic scale under the chart to see the view shown here)

It shouldn't be surprising that the long-term Treasury fund had the best performance, with a capital return boost from falling longer-term yields, followed by the intermediate-term fund with basically flat 10-year yield and slightly rising 5-year yield (not shown in the chart). It is worth noting, in support of the theme of the OP, that the short-term fund had a positive return despite the increasing short-term (2-year) Treasury yield.

Kevin

(Edited to add link to PV backtest for the funds performance chart)
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Re: Total Bond Market Fund - interest rates rising!

Post by sergeant » Sat Oct 27, 2018 9:08 pm

Thank you to the contributors of this thread. I have learned a bunch.
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Re: Total Bond Market Fund - interest rates rising!

Post by jmk » Sun Oct 28, 2018 2:41 pm

restingonmylaurels wrote:
Wed Oct 24, 2018 6:09 am
Kevin, those threads about two times duration to earn the initial yield in times of rising rates would be an interesting read and would also be something more people should understand. Can you provide the links?
Advocates for 2 x duration minus 1:

https://www.etf.com/sections/etf-strate ... tf-returns

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