The Eight Great Misconceptions About Bonds

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Taylor Larimore
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The Eight Great Misconceptions About Bonds

Post by Taylor Larimore »

Bogleheads:

Allan Roth, CPA, CFP, Advisor and Director of The Jack C. Bogle Center for Financial Literacy, has written a very important article about our bond "misconceptions":

https://www.advisorperspectives.com/art ... bout-bonds

Thank you, Allan.

Best wishes.
Taylor
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Re: The Eight Great Misconceptions About Bonds

Post by Miriam2 »

Thank you Taylor for posting this article.

Allan Roth will be the featured guest at the San Antonio Bogleheads chapter zoom meeting on Thur May 20, 2021, at 7:00 pm ET.
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Re: The Eight Great Misconceptions About Bonds

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Thanks Taylor, I continue to look forward to your posts.
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Re: The Eight Great Misconceptions About Bonds

Post by climber2020 »

Enjoyed reading the article. Thanks for sharing!
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Re: The Eight Great Misconceptions About Bonds

Post by random_walker_77 »

Thank you, that's an interesting article.

I thought Point 8 was particularly interesting, about harvesting capital gains on bonds in order to take advantage of lower tax rates on long term capital gains, rather than waiting for those gains to be returned as interest which is ordinary income.

Does anyone have a pointer to the specific rules regarding bond funds that was alluded to here:
"This can be done for a bond fund as well, but it’s more complex. You can’t just buy the bond fund back or buy a similar bond fund as the tax treatment is different for bond fund interest than the bond itself. "
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Re: The Eight Great Misconceptions About Bonds

Post by UpperNwGuy »

Finally! A straighforward, commonsense article about bonds. Thanks to Allan Roth for writing it. Thanks to Taylor for posting it. Many bogleheads need this article badly.
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Re: The Eight Great Misconceptions About Bonds

Post by Astones »

Number 4) is my favorite.
So many people have this misconception, that individual bonds are supposedly safer than bond ETFs because you can just keep them until expiration date.

There surely is a psychological component in this. Even if you had no intention to sell a bond in the close future, it's still painful to see its value going down.
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Re: The Eight Great Misconceptions About Bonds

Post by Allan Roth »

Astones wrote: Wed May 05, 2021 1:29 pm Number 4) is my favorite.
So many people have this misconception, that individual bonds are supposedly safer than bond ETFs because you can just keep them until expiration date.

There surely is a psychological component in this. Even if you had no intention to sell a bond in the close future, it's still painful to see its value going down.
I agree that it feels better knowing you have a bond that will mature at par at a certain amount. But investing isn't about feeling good - it would have felt great to get out of the stock market on 3/23/20 and felt awful to buy more to rebalance. In fact, when it comes to investing, most things that feel good are bad.
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Re: The Eight Great Misconceptions About Bonds

Post by Allan Roth »

random_walker_77 wrote: Wed May 05, 2021 12:56 pm
Does anyone have a pointer to the specific rules regarding bond funds that was alluded to here:
"This can be done for a bond fund as well, but it’s more complex. You can’t just buy the bond fund back or buy a similar bond fund as the tax treatment is different for bond fund interest than the bond itself. "
Unfortunately, when it comes to taxes, there are very few rules and they are dependent upon one's individual circumstances.
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Re: The Eight Great Misconceptions About Bonds

Post by Stinky »

Very interesting article. Thanks for posting.
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Re: The Eight Great Misconceptions About Bonds

Post by trinc »

Misconception about misconception ? or adding to it ?

imo:

stating that my bond lost value because another bond was sold at a different point of time only adds to confusion. My bond is worth exactly the same to me as the day i purchased it regardless of what the market does.

If you are talking about selling before maturity then that it a different vehicle and should be discussed separately.

Tim
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Re: The Eight Great Misconceptions About Bonds

Post by Allan Roth »

trinc wrote: Wed May 05, 2021 3:01 pm Misconception about misconception ? or adding to it ?

imo:

stating that my bond lost value because another bond was sold at a different point of time only adds to confusion. My bond is worth exactly the same to me as the day i purchased it regardless of what the market does.

If you are talking about selling before maturity then that it a different vehicle and should be discussed separately.

Tim
I respectfully disagree. If you buy a ten year bond yielding 2% and rates go to 3%, you earn a percentage point less a year for the remaining term. That opportunity cost is exactly how much the bond declined in value. Holding the bond to maturity doesn't change anything. Here's the math.
https://www.cbsnews.com/news/bonds-vs- ... sy-choice/
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Re: The Eight Great Misconceptions About Bonds

Post by BJJ_GUY »

Allan Roth wrote: Wed May 05, 2021 4:51 pm
trinc wrote: Wed May 05, 2021 3:01 pm Misconception about misconception ? or adding to it ?

imo:

stating that my bond lost value because another bond was sold at a different point of time only adds to confusion. My bond is worth exactly the same to me as the day i purchased it regardless of what the market does.

If you are talking about selling before maturity then that it a different vehicle and should be discussed separately.

Tim
I respectfully disagree. If you buy a ten year bond yielding 2% and rates go to 3%, you earn a percentage point less a year for the remaining term. That opportunity cost is exactly how much the bond declined in value. Holding the bond to maturity doesn't change anything. Here's the math.
https://www.cbsnews.com/news/bonds-vs- ... sy-choice/
I agree that many seem to under appreciate either the opportunity cost of individual bonds, as well as the impact of mark-to-market changes (and fund flows) on mutual funds -- especially the case when rates unexpectedly change etc.

However, If someone is holding an individual bond that was purchased at a 3% yield (by which I'm referring to YTM, or expected total return), the change in rates, or any reason that would cause a mark-to-market change, does not alter the fact that this person will still get a 3% return on their bond.

The math you point out in that article simply explains the downside to thinking in an insular fashion, where one eschews the opportunity cost of choices B, C, or D that could have resulted in a higher return at the end of the period. I agree with you, I prefer to think about opportunity cost etc. as well, but bond ladder folks aren't receiving an altered nominal return unless there is a credit event or they have to sell.
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Re: The Eight Great Misconceptions About Bonds

Post by trinc »

Allan Roth wrote: Wed May 05, 2021 4:51 pm
trinc wrote: Wed May 05, 2021 3:01 pm Misconception about misconception ? or adding to it ?

imo:

stating that my bond lost value because another bond was sold at a different point of time only adds to confusion. My bond is worth exactly the same to me as the day i purchased it regardless of what the market does.

If you are talking about selling before maturity then that it a different vehicle and should be discussed separately.

Tim
I respectfully disagree. If you buy a ten year bond yielding 2% and rates go to 3%, you earn a percentage point less a year for the remaining term. That opportunity cost is exactly how much the bond declined in value. Holding the bond to maturity doesn't change anything. Here's the math.
https://www.cbsnews.com/news/bonds-vs- ... sy-choice/
Allan,

please show me on a personal financial spreadsheet how a purchased bond @2% held for duration lost value after the market moved to 3%.

Tim
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Re: The Eight Great Misconceptions About Bonds

Post by Astones »

trinc wrote: Wed May 05, 2021 5:39 pm Allan,

please show me on a personal financial spreadsheet how a purchased bond @2% held for duration lost value after the market moved to 3%.

Tim
In simple terms, while your money are invested in the lower rate bond, waiting for expiration, you can't use them to buy the higher rate bonds that are available. So, that is, at all effects, value that you have lost.
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Re: The Eight Great Misconceptions About Bonds

Post by trinc »

Astones wrote: Wed May 05, 2021 5:46 pm
trinc wrote: Wed May 05, 2021 5:39 pm Allan,

please show me on a personal financial spreadsheet how a purchased bond @2% held for duration lost value after the market moved to 3%.

Tim
In simple terms, while your money are invested in the lower rate bond, waiting for expiration, you can't use them to buy the higher rate bonds that are available. So, that is, at all effects, value that you have lost.
not ' lost ' it's didn't ' gain '. big difference.

Tim
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Re: The Eight Great Misconceptions About Bonds

Post by ruud »

trinc wrote: Wed May 05, 2021 6:03 pm not ' lost ' it's didn't ' gain '. big difference.
If you own a stock that went up from $50 to $100; then subsequently went down to $80, did your portfolio lose $20 of value?
.
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Re: The Eight Great Misconceptions About Bonds

Post by willthrill81 »

It's a good list. My only issue is with regards to the comment made about inflation. We've known for a long time that an increased money supply alone is not a good predictor of inflation. Rather, inflation is a function of both the size of the money supply relative to GDP and the velocity of money, as noted in this thread. If the money supply increases faster than does GDP but people just hoard the additional money, there won't be meaningful inflation. And that's largely what we've seen over the last ~10 years.
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Re: The Eight Great Misconceptions About Bonds

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ruud wrote: Wed May 05, 2021 6:15 pm
trinc wrote: Wed May 05, 2021 6:03 pm not ' lost ' it's didn't ' gain '. big difference.
If you own a stock that went up from $50 to $100; then subsequently went down to $80, did your portfolio lose $20 of value?
It depends on the mode of comparison (e.g., the cost basis or the peak value). I know which one the IRS uses.
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Re: The Eight Great Misconceptions About Bonds

Post by jef »

Thanks for posting Taylor. I take comfort in my belief that a bad year in bonds is similar to a bad day in stocks.
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Re: The Eight Great Misconceptions About Bonds

Post by okwriter »

Image
Beginning in 2014, the Fed did a double whammy. It stopped buying back bonds (the end of quantitative easing) and raised the Fed funds rate. Many financial planners cried “bond bubble” and predicted an increase in rates, causing bonds to plummet. The reverse happened. Intermediate and long-term rates declined, and bonds did quite well.
This part is fascinating. Thanks for sharing.
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Re: The Eight Great Misconceptions About Bonds

Post by vineviz »

trinc wrote: Wed May 05, 2021 6:03 pm
Astones wrote: Wed May 05, 2021 5:46 pm
trinc wrote: Wed May 05, 2021 5:39 pm Allan,

please show me on a personal financial spreadsheet how a purchased bond @2% held for duration lost value after the market moved to 3%.

Tim
In simple terms, while your money are invested in the lower rate bond, waiting for expiration, you can't use them to buy the higher rate bonds that are available. So, that is, at all effects, value that you have lost.
not ' lost ' it's didn't ' gain '. big difference.

Tim
Indeed. The argument presented in the article makes a rookie error.
"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: The Eight Great Misconceptions About Bonds

Post by Taylor Larimore »

jef wrote: Wed May 05, 2021 6:25 pm Thanks for posting Taylor. I take comfort in my belief that a bad year in bonds is similar to a bad day in stocks.
jef:

Thank you for your post. I will point out one important difference: I have seen stocks decline -89%. The Total Bond Market's worst year was less than -3%.

Stocks let us eat well. Bonds let us sleep well.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Choose a balance of stocks and bonds according to your unique circumstances--your investment objective, your time horizon, your level of comfort with risk, and your financial resources."
Last edited by Taylor Larimore on Wed May 05, 2021 6:37 pm, edited 1 time in total.
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Re: The Eight Great Misconceptions About Bonds

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ruud wrote: Wed May 05, 2021 6:15 pm
trinc wrote: Wed May 05, 2021 6:03 pm not ' lost ' it's didn't ' gain '. big difference.
If you own a stock that went up from $50 to $100; then subsequently went down to $80, did your portfolio lose $20 of value?
The argument being made in the article weaker than this.

It's arguing that you own a stock whose price remained at $50, but some OTHER stock went from $50 to $100 so therefore you lost $50.
"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: The Eight Great Misconceptions About Bonds

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vineviz wrote: Wed May 05, 2021 6:35 pm
ruud wrote: Wed May 05, 2021 6:15 pm
trinc wrote: Wed May 05, 2021 6:03 pm not ' lost ' it's didn't ' gain '. big difference.
If you own a stock that went up from $50 to $100; then subsequently went down to $80, did your portfolio lose $20 of value?
The argument being made in the article weaker than this.

It's arguing that you own a stock whose price remained at $50, but some OTHER stock went from $50 to $100 so therefore you lost $50.
Oh I think I understand: even though your bond is worth less due to rising rates, by holding to maturity you don't lose anything, not even opportunity cost. (The fact that it was temporarily worth less while it was maturing doesn't matter if you hold to maturity)

Did I understand correctly?
.
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Re: The Eight Great Misconceptions About Bonds

Post by Astones »

vineviz wrote: Wed May 05, 2021 6:35 pm
The argument being made in the article weaker than this.

It's arguing that you own a stock whose price remained at $50, but some OTHER stock went from $50 to $100 so therefore you lost $50.
This analogy can't be done for stocks because in your thought experiment you could simply sell your stock at 50, whereas you couldn't sell the bond at the price you paid it. You have your money frozen, unless you accept the loss.
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Re: The Eight Great Misconceptions About Bonds

Post by vineviz »

ruud wrote: Wed May 05, 2021 6:41 pm
vineviz wrote: Wed May 05, 2021 6:35 pm
ruud wrote: Wed May 05, 2021 6:15 pm
trinc wrote: Wed May 05, 2021 6:03 pm not ' lost ' it's didn't ' gain '. big difference.
If you own a stock that went up from $50 to $100; then subsequently went down to $80, did your portfolio lose $20 of value?
The argument being made in the article weaker than this.

It's arguing that you own a stock whose price remained at $50, but some OTHER stock went from $50 to $100 so therefore you lost $50.
Oh I think I understand: even though your bond is worth less due to rising rates, by holding to maturity you don't lose anything, not even opportunity cost. (The fact that it was temporarily worth less while it was maturing doesn't matter if you hold to maturity)

Did I understand correctly?
I think so.

Moreover, I think it's probably more constructive to look at a bond for what it is: a fixed and known set of payments you'll receive.

IfI buy a 5 year bond today at a price of $1,000 with a yield of 2% then I know what I'm going to get paid back and when: $20/year for five years PLUS the $1,000 in exactly five years.

Regardless of what happens to bond yields tomorrow, whether they go to 3% of 1%, that stream of $20/year is still what I'll get. Long-term bond investors care about the cashflows of the bond, not the price.
"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: The Eight Great Misconceptions About Bonds

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Astones wrote: Wed May 05, 2021 6:46 pm
vineviz wrote: Wed May 05, 2021 6:35 pm
The argument being made in the article weaker than this.

It's arguing that you own a stock whose price remained at $50, but some OTHER stock went from $50 to $100 so therefore you lost $50.
This analogy can't be done for stocks because in your thought experiment you could simply sell your stock at 50, whereas you couldn't sell the bond at the price you paid it. You have your money frozen, unless you accept the loss.
The analogy works just fine: with the bond, I'm getting the same cash flows regardless of what happens.
"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: The Eight Great Misconceptions About Bonds

Post by finite_difference »

vineviz wrote: Wed May 05, 2021 6:52 pm
Astones wrote: Wed May 05, 2021 6:46 pm
vineviz wrote: Wed May 05, 2021 6:35 pm
The argument being made in the article weaker than this.

It's arguing that you own a stock whose price remained at $50, but some OTHER stock went from $50 to $100 so therefore you lost $50. The
This analogy can't be done for stocks because in your thought experiment you could simply sell your stock at 50, whereas you couldn't sell the bond at the price you paid it. You have your money frozen, unless you accept the loss.
The analogy works just fine: with the bond, I'm getting the same cash flows regardless of what happens.
In nominal terms.

If your bond pays 3% and inflation is 2%, that’s 1% real. Not bad.

If suddenly inflation hits 3.5%, now you’re at -0.5% real. Not great.

New bonds might be paying 4.5% nominal at that point.
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Re: The Eight Great Misconceptions About Bonds

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finite_difference wrote: Wed May 05, 2021 7:12 pm
vineviz wrote: Wed May 05, 2021 6:52 pm
Astones wrote: Wed May 05, 2021 6:46 pm
vineviz wrote: Wed May 05, 2021 6:35 pm
The argument being made in the article weaker than this.

It's arguing that you own a stock whose price remained at $50, but some OTHER stock went from $50 to $100 so therefore you lost $50. The
This analogy can't be done for stocks because in your thought experiment you could simply sell your stock at 50, whereas you couldn't sell the bond at the price you paid it. You have your money frozen, unless you accept the loss.
The analogy works just fine: with the bond, I'm getting the same cash flows regardless of what happens.
In nominal terms.
Yes, if the bond is a nominal bond.
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Re: The Eight Great Misconceptions About Bonds

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vineviz wrote: Wed May 05, 2021 6:51 pm
ruud wrote: Wed May 05, 2021 6:41 pm
vineviz wrote: Wed May 05, 2021 6:35 pm
ruud wrote: Wed May 05, 2021 6:15 pm
trinc wrote: Wed May 05, 2021 6:03 pm not ' lost ' it's didn't ' gain '. big difference.
If you own a stock that went up from $50 to $100; then subsequently went down to $80, did your portfolio lose $20 of value?
The argument being made in the article weaker than this.

It's arguing that you own a stock whose price remained at $50, but some OTHER stock went from $50 to $100 so therefore you lost $50.
Oh I think I understand: even though your bond is worth less due to rising rates, by holding to maturity you don't lose anything, not even opportunity cost. (The fact that it was temporarily worth less while it was maturing doesn't matter if you hold to maturity)

Did I understand correctly?
I think so.

Moreover, I think it's probably more constructive to look at a bond for what it is: a fixed and known set of payments you'll receive.

IfI buy a 5 year bond today at a price of $1,000 with a yield of 2% then I know what I'm going to get paid back and when: $20/year for five years PLUS the $1,000 in exactly five years.

Regardless of what happens to bond yields tomorrow, whether they go to 3% of 1%, that stream of $20/year is still what I'll get. Long-term bond investors care about the cashflows of the bond, not the price.
The argument in the article is under misconception #4 entitled, "Bonds are better than bond funds as they eliminate interest rate risk." Do you agree that that is a misconception or not? I think trinc was challenging Allen Roth on this point.
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Re: The Eight Great Misconceptions About Bonds

Post by finite_difference »

vineviz wrote: Wed May 05, 2021 7:34 pm
finite_difference wrote: Wed May 05, 2021 7:12 pm
vineviz wrote: Wed May 05, 2021 6:52 pm
Astones wrote: Wed May 05, 2021 6:46 pm
vineviz wrote: Wed May 05, 2021 6:35 pm
The argument being made in the article weaker than this.

It's arguing that you own a stock whose price remained at $50, but some OTHER stock went from $50 to $100 so therefore you lost $50. The
This analogy can't be done for stocks because in your thought experiment you could simply sell your stock at 50, whereas you couldn't sell the bond at the price you paid it. You have your money frozen, unless you accept the loss.
The analogy works just fine: with the bond, I'm getting the same cash flows regardless of what happens.
In nominal terms.
Yes, if the bond is a nominal bond.
When I hear “bonds” I’m thinking nominal bonds, since the vast majority of the market and funds deal with nominal bond?

Otherwise I think it’s good to add “inflation-indexed bonds” for clarity.
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Re: The Eight Great Misconceptions About Bonds

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Taylor Larimore wrote: Wed May 05, 2021 9:41 am Bogleheads:

Allan Roth, CPA, CFP, Advisor and Director of The Jack C. Bogle Center for Financial Literacy, has written a very important article about our bond "misconceptions":

https://www.advisorperspectives.com/art ... bout-bonds

Thank you, Allan.

Best wishes.
Taylor
Good article, thanks for posting. The only thing I'd take exception to is the statement "Bonds are far simpler than stocks..." :happy
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Re: The Eight Great Misconceptions About Bonds

Post by willthrill81 »

Elric wrote: Wed May 05, 2021 9:11 pmThe only thing I'd take exception to is the statement "Bonds are far simpler than stocks..." :happy
Ditto that. The intricacies of bonds make my mind swim.
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Re: The Eight Great Misconceptions About Bonds

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BJJ_GUY wrote: Wed May 05, 2021 5:33 pm However, If someone is holding an individual bond that was purchased at a 3% yield (by which I'm referring to YTM, or expected total return), the change in rates, or any reason that would cause a mark-to-market change, does not alter the fact that this person will still get a 3% return on their bond.
They will get a 3% annualized return on their bond over the overall holding period. But if interest rates have risen to 5% halfway through the term, they will get 5% from now on, and thus must have a return of 1% up to now. It has lost value, even though you haven't realized the loss.

They can continue to hold the bond to maturity, but this leaves them no better off than if they sold the bond for a capital loss and bought a new bond with the same maturity date and a 5% yield.
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Re: The Eight Great Misconceptions About Bonds

Post by BJJ_GUY »

grabiner wrote: Wed May 05, 2021 9:34 pm
BJJ_GUY wrote: Wed May 05, 2021 5:33 pm However, If someone is holding an individual bond that was purchased at a 3% yield (by which I'm referring to YTM, or expected total return), the change in rates, or any reason that would cause a mark-to-market change, does not alter the fact that this person will still get a 3% return on their bond.
They will get a 3% annualized return on their bond over the overall holding period. But if interest rates have risen to 5% halfway through the term, they will get 5% from now on, and thus must have a return of 1% up to now. It has lost value, even though you haven't realized the loss.

They can continue to hold the bond to maturity, but this leaves them no better off than if they sold the bond for a capital loss and bought a new bond with the same maturity date and a 5% yield.
I'm not sure what you're actually disputing.

For simplicity, let's assume this is a zero coupon bond they bought at issuance with a 3% yield. If, halfway to maturity, interest rates move to 5%, then yes the price of the initial bond will adjust down such that it trades near the yield of new issue matching the same remaining maturity date for both. This doesn't change the total return I'm getting on that bond. And the only reason I'm getting a higher yield on the back half is because I took a major mark-to-market hit when rates jumped 2%.

I don't see how this is inconsistent with anything you or I have said?
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Re: The Eight Great Misconceptions About Bonds

Post by Astones »

grabiner wrote: Wed May 05, 2021 9:34 pm
They can continue to hold the bond to maturity, but this leaves them no better off than if they sold the bond for a capital loss and bought a new bond with the same maturity date and a 5% yield.
I don't think this is correct. What they receive in interests would be the same, but if they realize the loss they'd get back a smaller amount at expiration, wouldn't they ?
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Re: The Eight Great Misconceptions About Bonds

Post by vineviz »

UpperNwGuy wrote: Wed May 05, 2021 9:02 pm The argument in the article is under misconception #4 entitled, "Bonds are better than bond funds as they eliminate interest rate risk." Do you agree that that is a misconception or not? I think trinc was challenging Allen Roth on this point.
I honestly can't tell. I mean, "bonds are better than bond funds as they eliminate interest rate risk" is an untrue statement . But the article doesn't really talk about interest rate risk in the explanation, and injects a LADDER of bonds into the discussion which makes the whole bullet point rather murky and hard to parse.
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Re: The Eight Great Misconceptions About Bonds

Post by grabiner »

Astones wrote: Wed May 05, 2021 9:54 pm
grabiner wrote: Wed May 05, 2021 9:34 pm
They can continue to hold the bond to maturity, but this leaves them no better off than if they sold the bond for a capital loss and bought a new bond with the same maturity date and a 5% yield.
I don't think this is correct. What they receive in interests would be the same, but if they realize the loss they'd get back a smaller amount at expiration, wouldn't they ?
No, because the new bond would have higher coupon payments, making up for the loss.
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Re: The Eight Great Misconceptions About Bonds

Post by Astones »

grabiner wrote: Wed May 05, 2021 10:02 pm No, because the new bond would have higher coupon payments, making up for the loss.
Larger interest rates will compensate the loss when it comes to the coupon payments you receive, but not when it comes to the amount given back at expiration, that inevitably will be the amount you started with, minus the loss after selling the first bond.
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Re: The Eight Great Misconceptions About Bonds

Post by grabiner »

Astones wrote: Wed May 05, 2021 10:09 pm
grabiner wrote: Wed May 05, 2021 10:02 pm
(bond yields rise halfway through the term; you can keep your old bond or sell for a new bond with the same maturity date)

No, because the new bond would have higher coupon payments, making up for the loss.
Larger interest rates will compensate the loss when it comes to the coupon payments you receive, but not when it comes to the amount given back at expiration, that inevitably will be the amount you started with, minus the loss after selling the first bond.
This is correct. The total return would be about the same, though (not quite the same because the replacement bond of the same maturity has a slightly different duration).

If you sell the old bond and buy a new one for the old bond's current value, your principal payment at maturity will be the old bond's current value. However, the higher coupons, if reinvested at the same rate, will cover the loss; this is what it means for the old and new bonds to have the same current value and yield to maturity.

The real point here is addressing the misconception that holding individual bonds protects you from interest-rate risk, in a way that bond funds don't. The effect of an interest-rate change on a bond or bond fund is the same; it just happens that holders of individual bonds usually let the duration decrease over time, while holders of bond funds usually let it stay constant. (This isn't necessary either way; holders of individual bonds can roll a ladder to keep a constant duration, and holders of bond funds can switch from longer-term to shorter-term funds as the time horizon approaches.)
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Re: The Eight Great Misconceptions About Bonds

Post by watchnerd »

Allan Roth wrote: Wed May 05, 2021 4:51 pm
trinc wrote: Wed May 05, 2021 3:01 pm Misconception about misconception ? or adding to it ?

imo:

stating that my bond lost value because another bond was sold at a different point of time only adds to confusion. My bond is worth exactly the same to me as the day i purchased it regardless of what the market does.

If you are talking about selling before maturity then that it a different vehicle and should be discussed separately.

Tim
I respectfully disagree. If you buy a ten year bond yielding 2% and rates go to 3%, you earn a percentage point less a year for the remaining term. That opportunity cost is exactly how much the bond declined in value. Holding the bond to maturity doesn't change anything. Here's the math.
https://www.cbsnews.com/news/bonds-vs- ... sy-choice/
Opportunity cost implies optionality.

If I don't have optionality, such as in a liability matched non-rolling bond ladder where the bond must be consumed for income at maturity, then I don't have opportunity cost.

If one wants to say the current portfolio value fluctuates as the individual bonds in the ladder are marked to market, I'll agree.

But as effective duration approaches zero, that fluctuation also disappears.
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Re: The Eight Great Misconceptions About Bonds

Post by secondopinion »

My thoughts:

1. I agree that rates cannot be predicted.
2. Agree on the non-implication of inflation with increase of debt. But I wonder why he said "But many things don’t follow what we learned in college." If the hypotheses are not all met, then why should the result follow? Maybe I took different courses.
3. Stability for current or future principal? So many talk about bonds doing the current. Long-term bonds do the exact opposite and only give stability of future principal.
4. Agreed. Match the bond fund to one's objective and be done with it.
5. If the interest rates go up, then the yields will increase. I am not worried.
6. I agree that municipals are not risk-free, but I think the discussion is a little shaky. A strong stock market is not the only way to fund the liabilities; cuts of future benefits, increasing taxes, government subsidy, and so on all work as well.
7. That is shady practice by some advisors; no wonder I do not use an advisor.
8. With some skill, funds can be swapped for tax benefits as well.

C. "Take risks with stocks" again? Another one of those people who does not really explain a concrete position on duration risk and makes the statement blankly.
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Re: The Eight Great Misconceptions About Bonds

Post by secondopinion »

willthrill81 wrote: Wed May 05, 2021 9:21 pm
Elric wrote: Wed May 05, 2021 9:11 pmThe only thing I'd take exception to is the statement "Bonds are far simpler than stocks..." :happy
Ditto that. The intricacies of bonds make my mind swim.
They have more details, but I can control much of the risk by all the "complexity" that bonds have. I have not found stocks to be as workable...
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Re: The Eight Great Misconceptions About Bonds

Post by secondopinion »

watchnerd wrote: Wed May 05, 2021 10:36 pm Opportunity cost implies optionality.

If I don't have optionality, such as in a liability matched non-rolling bond ladder where the bond must be consumed for income at maturity, then I don't have opportunity cost.

If one wants to say the current portfolio value fluctuates as the individual bonds in the ladder are marked to market, I'll agree.

But as effective duration approaches zero, that fluctuation also disappears.
Agreed. One cannot claim an opportunity cost if there was not choice.

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Re: The Eight Great Misconceptions About Bonds

Post by willthrill81 »

secondopinion wrote: Thu May 06, 2021 7:02 pm
willthrill81 wrote: Wed May 05, 2021 9:21 pm
Elric wrote: Wed May 05, 2021 9:11 pmThe only thing I'd take exception to is the statement "Bonds are far simpler than stocks..." :happy
Ditto that. The intricacies of bonds make my mind swim.
They have more details, but I can control much of the risk by all the "complexity" that bonds have. I have not found stocks to be as workable...
It's true that with individual Treasuries at least, you know what you're going to get when you buy, and the same goes for TIPS in real dollars. But with funds, it's more complicated, corporate and muni bonds add another layer of complexity, and when you then start looking at how various factors all interact to affect the market price of bonds (e.g., interest rates, expected interest rates, expected inflation, credit risk), it quickly goes over my head.
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Re: The Eight Great Misconceptions About Bonds

Post by watchnerd »

willthrill81 wrote: Thu May 06, 2021 7:31 pm It's true that with individual Treasuries at least, you know what you're going to get when you buy, and the same goes for TIPS in real dollars. But with funds, it's more complicated, corporate and muni bonds add another layer of complexity, and when you then start looking at how various factors all interact to affect the market price of bonds (e.g., interest rates, expected interest rates, expected inflation, credit risk), it quickly goes over my head.
STRIPS are probably the easiest bonds of all. ;)
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The Eight Great Misconceptions About Bonds - Allan Roth - Vanguard Reference?

Post by excel »

[Thread merged into here --admin LadyGeek]

Allan Roth recently posted:
The Eight Great Misconceptions About Bonds
https://www.advisorperspectives.com/art ... bout-bonds

The article includes a chart under misconception 5. that shows the effect of rising interest rates on the annualized return of a bond fund or ETF like BND. The chart source is claimed to be Vanguard Group. I searched the Vanguard web site but I could not find any reference to this information. I sent an email to Vanguard asking for more information about the chart, but they said they had no comment on 3rd party information.

Where did this chart come from?
Has Vanguard published such an analysis?
Are there alternative sources available for such information?

Any sources for a spreadsheet calculating the impact of interest rate changes to NAV for various durations and yields?

Thanks much!
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Re: The Eight Great Misconceptions About Bonds - Allan Roth - Vanguard Reference?

Post by Eagle33 »

Did you email the article's firm? apviewpoint@advisorperspectives.com
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Re: The Eight Great Misconceptions About Bonds - Allan Roth - Vanguard Reference?

Post by international001 »

Good article

What does the below mean? If you can predict the rates are going to 6% tomorrow, you should be selling ...
But, remember the example above when rates rose from 4% to 6% and one collected $20 less than the market rate on that $100 10-year bond? The net present value of that $20 loss shows up in the market value of that bond and holding it until maturity does nothing since the opportunity cost shows up in collecting that lower rate.
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