Question on mechanics of bond funds

[lvswts]

Just trying to learn something.

I understand that if I have a bond or a bond ladder, I can pretty much ignore the ups and downs of the value of the bonds based on interest rate changes. Assuming that I ignore the possibility of default, if I hold the bonds to maturity, I will get the principle back plus the agreed upon interest.
Seems pretty safe and easy to match my need for the money with my timeframe.

What I don't understand are bond funds. I have heard people say that a bond fund is like a bond ladder of the same maturity but I don't see how.

Let's say I get an intermediate term bond fund with an average duration of 10 years. I presume as the bonds age that the bond fund doesn't hold these bonds to maturity (or do they?). If I have an intermediate term bond fund it would seem to me that as bonds get closer to maturity they probably have to sell those bonds to buy new ones to keep with the attributes of the fund. Seems to me then that they are pretty tied to interest rates since at the time they are buying or selling the cost they pay will depend on the interest rates that exist at that time.

If I buy and hold a bond fund until I need the money how does the fund give me similar characteristics to actually buying a bond or ladder?

So if I need $10,000 in 10 years. I could buy a $10000 bond and with interest I could pretty much be guaranteed to get $10,000 in 10 years plus some interest along the way.
If I buy $10,000 in a bond fund that has a 10 year average duration, it seems to me that what I will have in 10 years depends on the prevalent interest rates at the time I sell and the movements of interest rates over that 10 year period.

Would I have to be the one to sell my intermediate term bond fund to buy a short term bond fund as time moves forward towards that 10 year period?
What am I missing? Does the varying interest along the way make up the difference?

Thanks for your insight.

[typical.investor]

Let's say I get an intermediate term bond fund with an average duration of 10 years.

10 years is more of a long fund but I quibble...

Would I have to be the one to sell my intermediate term bond fund to buy a short term bond fund as time moves forward towards that 10 year period?
What am I missing? Does the varying interest along the way make up the difference?

From a simplicity point of view, you can just fund spending from the intermediate fund. Maybe sometimes you are selling after a rate hike and taking a loss, and maybe sometime you are selling after a rate jump and seeing a gain. And yes, the higher interest from an intermediate fund earned over time should help offset any sales at a loss.

If that doesn't satisfy you because sharp rate hikes and large spending needs might coincide to have you selling at too much of a loss, then yes you would need to sell the intermediate in advance of your spending. However, jumping from an intermediate to a short fund is a bit of a jump. While it will mitigate the risk of loss, it will not eliminate it.

Actually what you would want to do is to buy an individual bond with the same duration as the bond fund. So if your intermediate bond fund is six years, then buy a bond with a six year duration. You can figure out the duration of an individual bond using google sheets or other calculator, or you can approximate it by buying a bond that matures in six years. Of course the coupon on the bond will affect maturity (higher coupon will lower duration) so using maturity in place of a duration calculation is just a simplification. You could use a zero coupon bond as well.

Of course, corporates will have credit risk so that doesn't work as well. You could substitute treasuries instead since you wouldn't want to face any default risk for needed spending.

So in summary, you could (higher number is more ideal):

1) spend from the intermediate
2) switch to a shorter bond fund
3) switch to an individual bond whose maturity matches the fund duration (simplified approximation)
4) switch to an individual bond whose duration matches the fund duration (more accurate but calculation required). Or use a zero coupon bond.

[jeffyscott]

What I don't understand are bond funds. I have heard people say that a bond fund is like a bond ladder of the same maturity but I don't see how.

A fund is equivalent to a rolling bond ladder.
https://www.bogleheads.org/wiki/Individ ... nd_ladders

For example Vanguard intermediate treasury index fund (VSIGX) holds 3-10 year treasuries. So it's more or less the same thing as if you bought a 4, 5, 6, 7, 8, 9, and 10 year treasury today, then in a year you sell the now 3 year and buy another 10 year, then keep repeating each year.

For a comparison with a fund that generally holds to maturity, I'll use the short term TIPS fund (VTAPX). In this case the fund would be more or less equivalent to you buying a 5, 4, 3, 2, and 1 year TIPS. When the 1 year matures, you buy another 5 year, repeat each year.

My comparisons are not exact because the funds are market weighted, while the individual bond holdings that I compared the funds to are equal weighted.

[typical.investor]

What I don't understand are bond funds. I have heard people say that a bond fund is like a bond ladder of the same maturity but I don't see how.

For a comparison with a fund that generally holds to maturity, I'll use the short term TIPS fund (VTAPX). In this case the fund would be more or less equivalent to you buying a 5, 4, 3, 2, and 1 year TIPS. When the 1 year matures, you buy another 5 year, repeat each year.

More or less equivalent? Perhaps, but with a duration of 2.6, you would still see around a 2.6% NAV loss with a rate hike of 1%.

For an equivalent 5, 4, 3, 2, and 1 year TIPs ladder, you'd spend from the 1 year upon maturity and not have a potential NAV loss.

There has been so much angst and anger at Bogleheads over bond losses in the recent rate hikes and accusations that nobody explained bond funds clearly that I feel compelled to mention this difference. I think it comes down to people misunderstanding the wording in the wiki that says "In real life, people should hold bond funds (high grade, short or intermediate term, and a mix of nominal and inflation-adjusted), and just ignore the NAV. All that matters is total return, and if you hold the fund longer than the duration, your total return will be just fine".

[rossington]

If I buy $10,000 in a bond fund that has a 10 year average duration, it seems to me that what I will have in 10 years depends on the prevalent interest rates at the time I sell and the movements of interest rates over that 10 year period.

Hello lvswts,
Correct, interest rate movements will affect the value of a bond fund. If rates go up the fund will lose value and vice versa. For example you will see the value of bond funds rise in the near future (as they have been recently) if the Fed follows through with rate cuts.

Would I have to be the one to sell my intermediate term bond fund to buy a short term bond fund as time moves forward towards that 10 year period?

Not necessarily (unless you think interest rates will move higher) that doesn’t always work so:

Does the varying interest along the way make up the difference?

This definitely helps to level out any loss of NAV in a higher rate environment because the fund’s yield will increase. You could reinvest the monthly interest or redirect it but either way it adds to your total return for the fund. Remember it’s best to hold a bond fund in a tax deferred account because the interest is taxed as ordinary income.

[gammalaser]

So if I need $10,000 in 10 years. I could buy a $10000 bond and with interest I could pretty much be guaranteed to get $10,000 in 10 years plus some interest along the way.
If I buy $10,000 in a bond fund that has a 10 year average duration, it seems to me that what I will have in 10 years depends on the prevalent interest rates at the time I sell and the movements of interest rates over that 10 year period.

I would summarize the choices for this scenario in this way:

• If you go with a $10000 bond, you will get your principle back with interest in 10 years. To avoid any default risk, go with a Treasury. The downside of this is, if you change your mind for some reason, such as you have some more urgent need for this money before then, you may have to sell this bond at a loss, depending on the interest rate changes. Note: If you want the $10000 to be adjusted for inflation, use TIPS instead of nominal Treasury.
• If you choose to go with a fund, then you may experience losses depending on the interest rate changes. But you can mitigate this by choosing a shorter duration fund. In the extreme case, you can choose a money market fund, which is a bond fund of ultra short duration and the NAV pegged at $1. In this case, you will almost certainly NOT lose your principle after 10 years, at the expense of less total return than if you had invested that $10000 in a single 10-year treasury. As you increase the duration of the fund towards 10 years, then you can get more total return but add risk that after 10 years, the principle is less because of the interest rate changes.

So the choices tend to be based on:

• If you cannot tolerate loss of principle, you should go with individual bonds or ultrashort bond funds/money market funds. The more you can tolerate a loss, means the more duration you can go.
• If you need flexibility in case your plan changes, you should go with the money market funds/ultrashort bond funds, or implement your own ladder of bonds of short duration (e.g. Tbills). High duration fund such as 10 years is not appropriate for money that you might need to use in the near term unless you are willing to capture a loss when liquidating the fund.

You can start with longer duration bond fund and move shorter as time passes, but this doesn't prevent you from potentially losing principle at the beginning of the time period if there happens to be rate increases.

The longer duration funds, such as those of 10 years or more, are more useful when you don't have a specific amount of money you need or timing of an expense.

[Beensabu]

What I don't understand are bond funds. I have heard people say that a bond fund is like a bond ladder of the same maturity but I don't see how.

A bond fund is like a perpetually rolling bond ladder that never matures.

Let's say I get an intermediate term bond fund with an average duration of 10 years. I presume as the bonds age that the bond fund doesn't hold these bonds to maturity (or do they?).

Some they will, some they won't, some will get close to maturity, and some won't at all.

Seems to me then that they are pretty tied to interest rates since at the time they are buying or selling the cost they pay will depend on the interest rates that exist at that time.

Yes.

Would I have to be the one to sell my intermediate term bond fund to buy a short term bond fund as time moves forward towards that 10 year period?

Yes, because the bond fund maintains the same/similar average duration. A bond fund with an average duration of ~10 years will still have an average duration of ~10 years 9 years later. As your horizon for needing the money approaches, you need to shorten the overall duration of your invested money that you will need then to match your timeline.

[Parkinglotracer]

Sounds like you understand bond funds. I personally use a 5 year treasury ladder for my fixed income portfolio in retirement as I like the transparency and control and predictability. While the bonds in the ladder fluctuate in value just like funds bonds do, one can redeem at maturity for full value. It takes a little more effort buying a few bonds a year. A rung matures, I either buy another bond, rebalance to equities, or leave it on my mm fund to spend. So easy a caveman or cavewoman can do it.

[jeffyscott]

What I don't understand are bond funds. I have heard people say that a bond fund is like a bond ladder of the same maturity but I don't see how.

For a comparison with a fund that generally holds to maturity, I'll use the short term TIPS fund (VTAPX). In this case the fund would be more or less equivalent to you buying a 5, 4, 3, 2, and 1 year TIPS. When the 1 year matures, you buy another 5 year, repeat each year.

More or less equivalent? Perhaps, but with a duration of 2.6, you would still see around a 2.6% NAV loss with a rate hike of 1%.

For an equivalent 5, 4, 3, 2, and 1 year TIPs ladder, you'd spend from the 1 year upon maturity and not have a potential NAV loss.

As I (and the wiki) said: A fund is equivalent to a rolling bond ladder.

What you have described is a non-rolling bond ladder.

[Florida Orange]

I personally use a 5 year treasury ladder for my fixed income portfolio in retirement as I like the transparency and control and predictability.

I would just point out that the relative lack of control and predictability in a bond fund could work out favorably or unfavorably for you. What you're really doing is narrowing the range of possible outcomes. That may be desirable for a person in your situation but I don't think you can say it's universally better. I know you didn't say it is universally better, but it's worth noting that the control and predictability of a bond ladder does come at a slight cost.

[lvswts]

Thank you all. This is very helpful to me.

I now understand better that a bond fund is like a rolling ladder, but I think a key description would be "perpetual".

So unless I just want to live off the interest, as I start to get on later in life and want to start spending some of that principle, rather than continually reinvest in the "ladder", different strategies might have to be taken such as individual bonds, MMF, or shorter duration funds.

I will put some thought into a strategy where the duration gets shorter as I get older if bond funds are going to be a primary vehicle.

Thanks again. Very insightful by all.

[jeffyscott]

So unless I just want to live off the interest, as I start to get on later in life and want to start spending some of that principle, rather than continually reinvest in the "ladder", different strategies might have to be taken such as individual bonds, MMF, or shorter duration funds.

Typically using a fund is going mean an intermediate bond fund, while a ladder to cover expenses will likely have a much longer duration. For example, if I am going to hold TIPS, it's probably going to be a TIPS index fund with a duration around 7. A TIPS ladder that goes out 30 years is going to have a longer duration than that, presumably something close to 15 years . (I realize that a longer term fund could be used to equalize the durations, but my guess is that actually doing that is not very common.)

So, at least initially, the risk with the fund would seem to be the risk that you will have to reinvest at lower interest rates in the future, rather than the risk that that the NAV declines due to an increase in interest rates that everyone fixates on.

In the end, my guess would be that there will most likely be little difference between holding an intermediate fund and withdrawing a small percentage of it (say 3-4%) each year and using a ladder of individual bonds.

[gavinsiu]

A typical strategy of using just bond is to create a collapsing bond ladder. Let's say you have retire ad know how much you need. You can commit a chunk of your bond so that each rung is a year in retirement. For example, you need $40K of income for 30 years, you can buy a TIP for each rung and lock in the income you receive. The means you will get $40K of inflation adjusted income for 30 years consuming your portfolio each year without exposure to the stock market. This seems to fit into your duration shortening suggestion.

For bond fund, I often see a strategy where the person divert usually the distribution to a money market to be used and any leftover are just reinvested to rebalance the portfolio. If stocks fall, then more money goes into stock. If bonds fall, money goes back into bonds.

Some BH members managed their own bonds, preferring to have more precision on which bond to sell.

I don't have enough knowledge to determine which method has a higher return overtime, but I feel that each strategy is more due to the person's personality. People who do a collapsing bond ladder want to emphasize getting a reliable source of income similar to a pension. People who do bond fund tend to emphasize total return. It may also be due to the firm managing your account. Some of the advisors like Vanguard PAS for example don't do individual bonds. My mom's advisors also only want to deal with bond funds. The limitation is that they don't have enough staff to construct bond ladders for each client. Some of the more expensive advisors might do it, but I feel that paying someone more money to create a bond ladder is counterproductive since you won't make enough to justify it.

[dbr]

A general strategy to invest a store of wealth is to own a simple portfolio of stock and bond funds allocated appropriately and rebalanced.

The investor can withdraw whatever he wants and needs when he wants and needs it by any number of choices of transactions, attending only to not spending money too fast if the investor wants the portfolio to last.

This has been pretty much the typical way of holding assets here on Bogleheads (see Three Fund Portfolio) until some people got freaked out by what for them were shocking negative returns in a couple of years (actually one year -- see below). Since then bond engineering has become an obsession, not that there is anything wrong with that.

Annual returns for VBMFX 2015-2024
CAGR for the period +1.33%

2015 0.30%
2016 2.50%
2017 3.46%
2018 -0.13%
2019 8.61%
2020 7.61%
2021 -1.77%
2022 -13.25%
2023 5.60%
2024 1.63%

Also the classic option to replace a store of wealth with a source of predictable withdrawals is to buy an SPIA. An alternative that removes inflation risk but abandons pooling of longevity risk would be a long ladder of TIPS liquidated annually.

[BirdFood]

What I don't understand are bond funds. I have heard people say that a bond fund is like a bond ladder of the same maturity but I don't see how.

A bond fund is like a perpetually rolling bond ladder that never matures.

In terms of coupon income, yes. Not in terms of taking principal.

[Beensabu]

What I don't understand are bond funds. I have heard people say that a bond fund is like a bond ladder of the same maturity but I don't see how.

A bond fund is like a perpetually rolling bond ladder that never matures.

In terms of coupon income, yes. Not in terms of taking principal.

I considered that part covered by "never matures".

[BirdFood]

What I don't understand are bond funds. I have heard people say that a bond fund is like a bond ladder of the same maturity but I don't see how.

A bond fund is like a perpetually rolling bond ladder that never matures.

In terms of coupon income, yes. Not in terms of taking principal.

I considered that part covered by "never matures".

So many people dismiss the very idea of waiting for maturity that I didn’t get that.

I’d see it as like a bond fund, minus the option of selectively taking principal based on maturity.

[windaar]

If you're looking to lose 15+% of your money and not break even for probably 6 years then a medium-duration bond fund like BND is for you.

[Parkinglotracer]

I personally use a 5 year treasury ladder for my fixed income portfolio in retirement as I like the transparency and control and predictability.

I would just point out that the relative lack of control and predictability in a bond fund could work out favorably or unfavorably for you. What you're really doing is narrowing the range of possible outcomes. That may be desirable for a person in your situation but I don't think you can say it's universally better. I know you didn't say it is universally better, but it's worth noting that the control and predictability of a bond ladder does come at a slight cost.

Not a financial cost because it’s free! Yes each person gets to decide what is best for them. Many are upset and confused why total bond fund went down 13% in 2022. An odd event but obviously a possibility in a rising rate environment. It could go up 13% too.

[Silverado]

If you're looking to lose 15+% of your money and not break even for probably 6 years then a medium-duration bond fund like BND is for you.

I’ll take it. And have, to the tune of about a half million dollars worth in the last year or so, with more following every month. I’m only 53, so have 7 or 8 of that 6 years waiting period ahead of me. Simple.

[Beensabu]

I personally use a 5 year treasury ladder for my fixed income portfolio in retirement as I like the transparency and control and predictability.

I would just point out that the relative lack of control and predictability in a bond fund could work out favorably or unfavorably for you. What you're really doing is narrowing the range of possible outcomes.

Narrowing the range of possible outcomes is creating more certainty. More certainty = less risk.

A ladder of individual treasuries is less risky than a treasury bond fund because there is more certainty in both the return and the timing of the return.

Not everyone needs or wants that level of certainty in their fixed income. But if you do, then that is how you get it.

So unless I just want to live off the interest, as I start to get on later in life and want to start spending some of that principle, rather than continually reinvest in the "ladder", different strategies might have to be taken such as individual bonds, MMF, or shorter duration funds.

You got it.

[Florida Orange]

I personally use a 5 year treasury ladder for my fixed income portfolio in retirement as I like the transparency and control and predictability.

I would just point out that the relative lack of control and predictability in a bond fund could work out favorably or unfavorably for you. What you're really doing is narrowing the range of possible outcomes. That may be desirable for a person in your situation but I don't think you can say it's universally better. I know you didn't say it is universally better, but it's worth noting that the control and predictability of a bond ladder does come at a slight cost.

Not a financial cost because it’s free! Yes each person gets to decide what is best for them. Many are upset and confused why total bond fund went down 13% in 2022. An odd event but obviously a possibility in a rising rate environment. It could go up 13% too.

Right. By "cost" I meant that if you have a bond ladder and you hold the bonds to maturity you miss out on the (usually slight) volatility of a bond fund. Whether you perceive that as a cost or a benefit depends on what you want out of bonds.

[chem6022]

What I don't understand are bond funds. I have heard people say that a bond fund is like a bond ladder of the same maturity but I don't see how.

A bond fund is like a perpetually rolling bond ladder that never matures.

I thought about this a lot this year and I think this is a good take on it. A few more details are that the bond fund is like a perpetual rolling bond ladder of length 2x times its duration. An example of one I own is the intermediate duration TIPS funds SCHP with its current 6.7 year duration. That roughly acts like a rolling TIPS ladder 13.4 years long. Another aspect is that a bond fund is re-balancing the ladder often, which is more involved for a rolling bond ladder, especially as yields change over time. The re-balancing aspect gives the bond fund more flexibility in regards to adding or withdrawing money from the entire ladder.

[jeffyscott]

What I don't understand are bond funds. I have heard people say that a bond fund is like a bond ladder of the same maturity but I don't see how.

A bond fund is like a perpetually rolling bond ladder that never matures.

In terms of coupon income, yes. Not in terms of taking principal.

I considered that part covered by "never matures".

In addition to being covered by "perpetually rolling".

Rolling means reinvesting principal. As each rung matures or reaches your sell point, you buy another bond.

Bonds remain bonds when owned by a fund. Holding a fund is exactly the same as holding all the bonds in the fund. The difference is that when you sell, you can sell only a prorated share of each bond.

There's a way to exit this perpetually rolling ladder at any time. Sell the fund and buying a similar collection of individual bonds.

[BirdFood]

In addition to being covered by "perpetually rolling".

Rolling means reinvesting principal. As each rung matures or reaches your sell point, you buy another bond.

Bonds remain bonds when owned by a fund. Holding a fund is exactly the same as holding all the bonds in the fund. The difference is that when you sell, you can sell only a prorated share of each bond.

There's a way to exit this perpetually rolling ladder at any time. Sell the fund and buying a similar collection of individual bonds.

That is something that I tend to gloss over—taking principal can mean a loss when bonds are down, but if bonds are down, bonds are down, so re-buying the whole thing will mean buying the individual bonds at a similar discount.

[typical.investor]

What I don't understand are bond funds. I have heard people say that a bond fund is like a bond ladder of the same maturity but I don't see how.

A bond fund is like a perpetually rolling bond ladder that never matures.

In terms of coupon income, yes. Not in terms of taking principal.

I considered that part covered by "never matures".

In addition to being covered by "perpetually rolling".

Rolling means reinvesting principal. As each rung matures or reaches your sell point, you buy another bond.

Bonds remain bonds when owned by a fund. Holding a fund is exactly the same as holding all the bonds in the fund. The difference is that when you sell, you can sell only a prorated share of each bond.

There's a way to exit this perpetually rolling ladder at any time. Sell the fund and buying a similar collection of individual bonds.

Yes, in theory you could buy a similar collection of individual bonds, but I don't think anyone would go to that trouble.

What you could more easily do would be to buy a treasury zero whose duration matches (as close as possible) the duration of your fund. Alternatively, you could buy an individual treasury whose duration matches that of the fund. If you didn't want calculate the duration on an individual bond (not that difficult using something like google sheets), you could buy an individual treasury whose maturity matches the duration of the fund (but this is just an approximation as higher coupons will shorten the duration so an individual bond with a 5% coupon has a shorter duration that a bond with the same maturity but only a 1% coupon).

[Helium]

There has been so much angst and anger at Bogleheads over bond losses in the recent rate hikes and accusations that nobody explained bond funds clearly that I feel compelled to mention this difference. I think it comes down to people misunderstanding the wording in the wiki that says "In real life, people should hold bond funds (high grade, short or intermediate term, and a mix of nominal and inflation-adjusted), and just ignore the NAV. All that matters is total return, and if you hold the fund longer than the duration, your total return will be just fine".

Which part of this sentence is open to misunderstanding? Is the statement incorrect or misleading?

I've read this entire thread and still do not understand bond funds even though I am invested in them .

[jeffyscott]

"...and if you hold the fund longer than the duration...".

Which part of this sentence is open to misunderstanding? Is the statement incorrect or misleading?

I've read this entire thread and still do not understand bond funds even though I am invested in them .

I'd say something like: if you hold the fund significantly longer than the duration and will withdraw a small amount each year over a long time period.

What does not understanding bond funds actually mean? They are a fund that holds bonds.

Do people say that they don't understand bond funds, when what they really mean is that they don't understand bond math? No one thinks or talks much about stock math, is that what makes stocks supposedly easier to understand?

To me bonds are much easier to understand, unlike stocks the prices are nearly always logical and based on math. When stock prices go up and down, there's no explanation (or maybe there's dozens of different explanations), I don't understand stocks.

[dbr]

There has been so much angst and anger at Bogleheads over bond losses in the recent rate hikes and accusations that nobody explained bond funds clearly that I feel compelled to mention this difference. I think it comes down to people misunderstanding the wording in the wiki that says "In real life, people should hold bond funds (high grade, short or intermediate term, and a mix of nominal and inflation-adjusted), and just ignore the NAV. All that matters is total return, and if you hold the fund longer than the duration, your total return will be just fine".

Which part of this sentence is open to misunderstanding? Is the statement incorrect or misleading?

I've read this entire thread and still do not understand bond funds even though I am invested in them .

It is possible that the source of "not be able to understand" is that people don't know why interest rates do what they do over time because given known interest rates as a function of time the behavior of bonds is pure math. This includes that predicting what you will get from bonds over time requires that you predict what interest rates will be over time. The math takes a winding path through bond pricing, premium/discount, yield to maturity, coupon interest rates, understanding time value of cash flows, net present value, internal rate of return, and so on.

Here is an example of what is involved in understanding what interest rates do: https://stockcharts.com/freecharts/yiel ... pQQAvD_BwE

Perhaps you could be more specific as to what it is that is not understood.

I will grant you we are probably not going to see in public what are the daily transactions a bond fund manager carries out to manage a bond fund. If you want to see that in the same detail as you can see your personal ownership of a bunch of bonds you buy individually, I am not sure how to make that happen. Bond funds do publish a prospectus, an annual report, a summary of additional information, and indices of market performance, composition, and so on.

[muffins14]

Thank you all. This is very helpful to me.

I now understand better that a bond fund is like a rolling ladder, but I think a key description would be "perpetual".

So unless I just want to live off the interest, as I start to get on later in life and want to start spending some of that principle, rather than continually reinvest in the "ladder", different strategies might have to be taken such as individual bonds, MMF, or shorter duration funds.

I will put some thought into a strategy where the duration gets shorter as I get older if bond funds are going to be a primary vehicle.

Thanks again. Very insightful by all.

If you need money in 10 years and have a bond fund with duration 10 years, you just need to buy another bond fund of shorter duration and mix the two.

When your need is 9 years away, mix the 10-year fund with a shorter fund so the average duration is 9

When you have 5 years to go, mix the two so your duration is 5

When you have 2 to go, mix so your duration is 2

Don’t continue to hold a 10-year duration bond fund when your need is 2 or 5 years away.

Then you’re all set

[muffins14]

If you're looking to lose 15+% of your money and not break even for probably 6 years then a medium-duration bond fund like BND is for you.

Stocks went down like 35% in 2008. Much worse

[dbr]

Indeed.

Here are the actual annual returns on BND the last few years:

2015 0.56%
2016 2.53%
2017 3.57%
2018 -0.11%
2019 8.84%
2020 7.54%
2021 -2.01%
2022 -13.11%
2023 5.65%
2024 3.23%
Annual return for 2024 is from 01/01/2024 to 08/31/2024

The return for 2015-2024 has been 1.54%/year, not a loss. The return for 2019-2024 has been 1.48%, not a loss. The return for 2022-2024 has been -2.00%, a loss but not a severe loss. If you invested exactly Aug 2020 and looked at your loss exactly Oct 2022 you would indeed have a loss of 17.54%. Those dates are coincident with a 100 year global pandemic that disrupted everything. Between Oct 2018 and Oct 2022 stocks had sequential drawdowns of 14.20%, 20.85%, and 24.81%.

An investor should not be investing in bond funds of that duration unless expecting to hold the fund with some investments or withdrawals over periods of time of perhaps 10 or 15 to upwards of 80 years. I don't like people citing rules about "multiple of duration" but the FYI is the duration of that fund is 6 years.

[rkhusky]

Bonds in 2022 didn’t bother me a bit. I had no plans to sell all or even a majority of my bonds in the next five years. In fact, if stocks keep rising, I will likely be buying bonds. Even if I sell some, it will be a very small fraction. The increased interest on the rest of my bond funds will more than make up for the loss on the fraction that I do sell.

[jeffyscott]

...If you invested exactly Aug 2020 and looked at your loss exactly Oct 2022 you would indeed have a loss of 17.54%. Those dates are coincident with a 100 year global pandemic that disrupted everything.
...
An investor should not be investing in bond funds of that duration unless expecting to hold the fund with some investments or withdrawals over periods of time of perhaps 10 or 15 to upwards of 80 years. I don't like people citing rules about "multiple of duration" but the FYI is the duration of that fund is 6 years.

At that time an alternative for a shorter time frame, say, 5 years was a 5 year treasury yielding about 0.4%. Total bond has a total cumulative return of about -7.25% since 7/31/2020. By next Aug, that might be around -3%. That would not be great for 5 years, but that's an annualized return of about -0.3% or only about 0.7% below the 5 year treasury's yield.

Of course, I do agree with your minimum holding time of about 10 years for total bond*, but it will likely turn out not to be a disaster even when bought at the worst possible time and held for an inappropriately short period, when compared to buying the individual bond that matched the time frame.

*Even that is based on an assumption that you don't need all the money in a lump sum. If you need all the money in year 10, then you would need to either reduce duration as you go or buy something that matures in 10 years.

[dbr]

...If you invested exactly Aug 2020 and looked at your loss exactly Oct 2022 you would indeed have a loss of 17.54%. Those dates are coincident with a 100 year global pandemic that disrupted everything.
...
An investor should not be investing in bond funds of that duration unless expecting to hold the fund with some investments or withdrawals over periods of time of perhaps 10 or 15 to upwards of 80 years. I don't like people citing rules about "multiple of duration" but the FYI is the duration of that fund is 6 years.

At that time an alternative for a shorter time frame, say, 5 years was a 5 year treasury yielding about 0.4%. Total bond has a total cumulative return of about -7.25% since 7/31/2020. By next Aug, that might be around -3%. That would not be great for 5 years, but that's an annualized return of about -0.3% or only about 0.7% below the 5 year treasury's yield.

Of course, I do agree with your minimum holding time of about 10 years for total bond*, but it will likely turn out not to be a disaster even when bought at the worst possible time and held for an inappropriately short period, when compared to buying the individual bond that matched the time frame.

*Even that is based on an assumption that you don't need all the money in a lump sum. If you need all the money in year 10, then you would need to either reduce duration as you go or buy something that matures in 10 years.

Yes.

I think the essence of this whole bond problem is between investors who have a clear concept of bonds as a component of a long term stock and bond portfolio and those who are operating with a concept of bonds as a way to hold cash, earn interest, and then recover the invested cash. It is not that there is anything wrong with either point of view. It is just a question of fitting what one does to what one's objectives are. One should attend when reading and discussing the topic that people are clear what they are trying to do and why.

PS One could say that the difference is between "Cash, bonds, whatever -- it's all fixed income." and "Bonds are cash. That's all there is."

[Beensabu]

Which part of this sentence is open to misunderstanding? Is the statement incorrect or misleading?

I've read this entire thread and still do not understand bond funds even though I am invested in them .

"if you hold the fund longer than the duration"

The duration of Total Bond is usually ~7 years.

The NAV of Total Bond started falling in 2021 and really nosedived in 2022 (max drawdown still less than 20%), so it's currently been a bit over 3.5 years and an initial investment at the start of 2021 is still down ~7%. In another 4-5 years or so, total return will be fine.

An initial investment made at the start of 2020 is already nearly back to even, and one made at the start of 2019 has a positive nominal return.

[dbr]

Which part of this sentence is open to misunderstanding? Is the statement incorrect or misleading?

I've read this entire thread and still do not understand bond funds even though I am invested in them .

"if you hold the fund longer than the duration"

The duration of Total Bond is usually ~7 years.

The NAV of Total Bond started falling in 2021 and really nosedived in 2022 (max drawdown still less than 20%), so it's currently been a bit over 3.5 years and an initial investment at the start of 2021 is still down ~7%. In another 4-5 years or so, total return will be fine.

An initial investment made at the start of 2020 is already nearly back to even, and one made at the start of 2019 has a positive nominal return.

Exactly. I posted some data upthread for people to contemplate about that.

The real concern before was that fixed income had low returns. Higher (real) interest rates should be welcomed by savers and investors.

But I am not making any predictions about what happens next.

[typical.investor]

There has been so much angst and anger at Bogleheads over bond losses in the recent rate hikes and accusations that nobody explained bond funds clearly that I feel compelled to mention this difference. I think it comes down to people misunderstanding the wording in the wiki that says "In real life, people should hold bond funds (high grade, short or intermediate term, and a mix of nominal and inflation-adjusted), and just ignore the NAV. All that matters is total return, and if you hold the fund longer than the duration, your total return will be just fine".

Which part of this sentence is open to misunderstanding? Is the statement incorrect or misleading?

I've read this entire thread and still do not understand bond funds even though I am invested in them .

Well the phrase "if you hold the fund longer than the duration, your total return will be just fine" is surely misleading and not necessarily true. If you hold a long fund for 9 years, and then see 3% in rate hikes over the next couple years, you will be sitting on a big loss despite having held the fund longer than the duration.

I know it's been said perhaps ad nauseam in the threads I've read that time to recover after a rate hike resets every rate hike. Other posters claim they have never seen such statements and that their retirement is on delay as they chose an intermediate fund to fund the gap between retirement and social security only to be hit by rate hikes.

Actually, the whole "Zero-coupon example" in the wiki is simply misleading, poorly written and I'd argue factually incorrect. https://www.bogleheads.org/wiki/Individ ... _bond_fund

It says:

zero coupon bonds ... show that Fred (using a bond fund) is never worse off than Larry (using a bond ladder): a bond fund is no riskier than a bond ladder

That is simply incorrect. To see how, look at the previous explanation:

Now, the only difference between Fred (using a bond fund) and Larry (using a bond ladder) is that Larry has two options for getting his money back and Fred has one. Fred can sell his bond fund and buy a zero coupon bond with a maturity value equal to his initial capital investment. Larry can likewise sell his bond ladder and buy a zero coupon bond. Larry's additional option is to hold all of his bonds until maturity. However, this second option is unambiguously worse for Larry. He would need to hold his longest bonds twice as long as the zero coupon bond to get his money back. Due to the opportunity cost of having his money unnecessarily locked up, this means he would actually be losing money versus the zero coupon option. In addition, for taxable accounts, selling their holdings to buy zero coupon bonds would let Larry and Fred take advantage of tax loss harvesting.

It states that holding a maturing ladder is unambiguously worse. I absolutely disagree with the assessment and argue that if one needed to spend after a rate hike, that spending out of maturing bonds instead of a bond fund (or selling some off of the zero coupon bond you replaced it with) is unambiguously better.

Note the wiki also goes on to say about that example:

Please note that this whole example is artificial, because it is extremely rare for a bond holder to decide that he needs to immediately liquidate all of his principal.

I 100% completely agree with that. The whole notion that bond funds are "unambiguously better" as stated in the wiki is based on the unrealistic assumption that the entire bond holding needs immediate liquidation. Of course it reasons that allowing a bond ladder to mature is "unambiguously worse" when you need to immediately liquidate. That though, is not the most likely real world scenario that actual investors are concerned about. We are concerned about being able to spend the value showing in our bond holdings next weak, next year, and every year of our expenses. Clearly, a ladder addresses the risk of NAV loss due to rate hikes in the middle of spending.

However, the wiki argues:

The whole argument for individual bonds being less risky is based on this completely artificial concept that you will one day decide you need all of your money back, and then happily wait 20 years to get it back (all in nominal terms, meaning the money has been eaten away by inflation in the meantime).

It is simply untrue that individual bonds are best for needing all your money back at one time. They are best for earning a term premium while being able to spend safely and avoid realizing a NAV loss as you do so.

I feel like the terms "opportunity cost" and "money has been eaten away by inflation" used to discredit bond ladders in the wiki are simply red herrings. I fail to see the "opportunity cost" in holding a ladder and allowing bonds to mature in order to fund spending. Simply liquidate your individual bonds if you need the money at once. Also, inflation affects individual bonds and bond funds equally. Holding fixed income in a bond fund is not going to protect you against inflation relative to holding individual bonds. The wiki in those spots reads to me like a propaganda piece in support of the books selling a three fund portfolio. Sorry.

I actually argued vehemently with a poster accusing Bogleheads of misrepresenting how bond funds work, and said that a correct understanding was to be found over and over again in so many of the bond threads that I was perplexed by their misunderstanding. They countered by saying the wiki had deceived them. In hindsight, I can see how so.

It is possible that the source of "not be able to understand" is that people don't know why interest rates do what they do over time because given known interest rates as a function of time the behavior of bonds is pure math. This includes that predicting what you will get from bonds over time requires that you predict what interest rates will be over time. The math takes a winding path through bond pricing, premium/discount, yield to maturity, coupon interest rates, understanding time value of cash flows, net present value, internal rate of return, and so on.

I agree with you but don't see the need to explain or consider bond pricing anymore than we consider individual stock pricing.

But yeah, it's difficult to easily say how rate movements affect bonds other than the sort of generalize rule that a 1% change in rates up/down results in a 1% loss/gain per year of duration. While not exact and stronger at lower rates, it gives people an idea. Some claim they have never heard such a thing. We all know stocks can drop 50% and plan our spending around the possibility. Shouldn't bond funds be treated the same way?

Funds are convenient and I know many will say use a shorter fund, but why have a two year duration when spending is 20 years or more away. As time goes by and spending approaches, it is easy enough to sell from an intermediate fund of six year duration in anticipation of spending six years down the road. You could get a zero coupon bond or you get an individual bond whose duration matches.

[BirdFood]

Well the phrase "if you hold the fund longer than the duration, your total return will be just fine" is surely misleading and not necessarily true. If you hold a long fund for 9 years, and then see 3% in rate hikes over the next couple years, you will be sitting on a big loss despite having held the fund longer than the duration.

Exactly. I don't know what the "just fine" is supposed to mean. There are countless scenarios where you will not be just fine.

[Beensabu]

If you hold a long fund for 9 years, and then see 3% in rate hikes over the next couple years, you will be sitting on a big loss despite having held the fund longer than the duration.

Someone who invested in a long term treasury fund (average duration ~20 years) 9 years ago (in Aug 2015) and reinvested dividends currently has very nearly broken even (still has their original investment). If 10 years ago (Aug 2014), they have a positive nominal rate of return.

[rkhusky]

Well the phrase "if you hold the fund longer than the duration, your total return will be just fine" is surely misleading and not necessarily true. If you hold a long fund for 9 years, and then see 3% in rate hikes over the next couple years, you will be sitting on a big loss despite having held the fund longer than the duration.

Exactly. I don't know what the "just fine" is supposed to mean. There are countless scenarios where you will not be just fine.

You will also be sitting on a big loss with similar individual bonds too.

[BirdFood]

Well the phrase "if you hold the fund longer than the duration, your total return will be just fine" is surely misleading and not necessarily true. If you hold a long fund for 9 years, and then see 3% in rate hikes over the next couple years, you will be sitting on a big loss despite having held the fund longer than the duration.

Exactly. I don't know what the "just fine" is supposed to mean. There are countless scenarios where you will not be just fine.

You will also be sitting on a big loss with similar individual bonds too.

I won't. Not unless my method of taking a portion of the principal is to take a tiny bite from every single bond.

But that's not my method. I will be taking from the nearest-to-maturity bond. It will probably actually be mature, and therefore I will take no loss at all. The "loss" on the other bonds is purely paper loss. When I take principal from a bond fund, the loss that I take on that portion is an actual loss.

[rkhusky]

Well the phrase "if you hold the fund longer than the duration, your total return will be just fine" is surely misleading and not necessarily true. If you hold a long fund for 9 years, and then see 3% in rate hikes over the next couple years, you will be sitting on a big loss despite having held the fund longer than the duration.

Exactly. I don't know what the "just fine" is supposed to mean. There are countless scenarios where you will not be just fine.

You will also be sitting on a big loss with similar individual bonds too.

I won't. Not unless my method of taking a portion of the principal is to take a tiny bite from every single bond.

But that's not my method. I will be taking from the nearest-to-maturity bond. It will probably actually be mature, and therefore I will take no loss at all. The "loss" on the other bonds is purely paper loss. When I take principal from a bond fund, the loss that I take on that portion is an actual loss.

True if you have exquisitely planned your bonds so they mature exactly on time and for exactly the right amount. If you don’t plan things right, you will have to break bonds before maturity or leave money in cash for a time or endure reinvestment risk.

And losses in the fund are also paper losses.

[BirdFood]

Well the phrase "if you hold the fund longer than the duration, your total return will be just fine" is surely misleading and not necessarily true. If you hold a long fund for 9 years, and then see 3% in rate hikes over the next couple years, you will be sitting on a big loss despite having held the fund longer than the duration.

Exactly. I don't know what the "just fine" is supposed to mean. There are countless scenarios where you will not be just fine.

You will also be sitting on a big loss with similar individual bonds too.

I won't. Not unless my method of taking a portion of the principal is to take a tiny bite from every single bond.

But that's not my method. I will be taking from the nearest-to-maturity bond. It will probably actually be mature, and therefore I will take no loss at all. The "loss" on the other bonds is purely paper loss. When I take principal from a bond fund, the loss that I take on that portion is an actual loss.

True if you have exquisitely planned your bonds so they mature exactly on time and for exactly the right amount. If you don’t plan things right, you will have to break bonds before maturity or leave money in cash for a time or endure reinvestment risk.

And losses in the fund are also paper losses.

Yes, sometimes I might have to sell a not-yet-mature bond. But why is this worse than a fund, where I will always be selling portions of not-yet-mature bonds? Why should a modest chance of occasional imperfection mean that I should abandon the effort entirely?

(Edited to add: Also, we don't need "exactly on time". We need "soon enough". If a 20-year bond matures a year before I need the money, that is not such a terrible thing.)

Yes, in both cases the un-spent principal exhibits a paper loss. In the case of the fund, spent principal will also mean a real loss. In the case of the individual bonds, spent principal from a mature bond will not mean a real loss.

So far the conclusion seems to be that the advantages of individual bonds are not guaranteed, so I should abandon them altogether.

I can accept that bond funds are an excellent choice for dividends and for balancing against equities. I'm not arguing all the techniques you could use to instead use individual bonds for that purpose.

Why are so many people absolutely determined to twist and turn bond funds so that they're slightly more suitable for holding funds safe for fairly predictable future spending of the principal, rather than accepting that individual bonds are excellent for that purpose?

Twisty-turny analogy: I CAN use bananas as a substitute for eggs in baked goods. If my 401K doesn't offer eggs, I can do just that. But since the eggs are available, and I prefer eggs, why use bananas?

[rkhusky]

Exactly. I don't know what the "just fine" is supposed to mean. There are countless scenarios where you will not be just fine.

You will also be sitting on a big loss with similar individual bonds too.

I won't. Not unless my method of taking a portion of the principal is to take a tiny bite from every single bond.

But that's not my method. I will be taking from the nearest-to-maturity bond. It will probably actually be mature, and therefore I will take no loss at all. The "loss" on the other bonds is purely paper loss. When I take principal from a bond fund, the loss that I take on that portion is an actual loss.

True if you have exquisitely planned your bonds so they mature exactly on time and for exactly the right amount. If you don’t plan things right, you will have to break bonds before maturity or leave money in cash for a time or endure reinvestment risk.

And losses in the fund are also paper losses.

Yes, sometimes I might have to sell a not-yet-mature bond. But why is this worse than a fund, where I will always be selling portions of not-yet-mature bonds? Why should a modest chance of occasional imperfection mean that I should abandon the effort entirely?

(Edited to add: Also, we don't need "exactly on time". We need "soon enough". If a 20-year bond matures a year before I need the money, that is not such a terrible thing.)

Yes, in both cases the un-spent principal exhibits a paper loss. In the case of the fund, spent principal will also mean a real loss. In the case of the individual bonds, spent principal from a mature bond will not mean a real loss.

So far the conclusion seems to be that the advantages of individual bonds are not guaranteed, so I should abandon them altogether.

I can accept that bond funds are an excellent choice for dividends and for balancing against equities. I'm not arguing all the techniques you could use to instead use individual bonds for that purpose.

Why are so many people absolutely determined to twist and turn bond funds so that they're slightly more suitable for holding funds safe for fairly predictable future spending of the principal, rather than accepting that individual bonds are excellent for that purpose?

Twisty-turny analogy: I CAN use bananas as a substitute for eggs in baked goods. If my 401K doesn't offer eggs, I can do just that. But since the eggs are available, and I prefer eggs, why use bananas?

The point is that bond funds and individual bonds have their pluses and minuses and it’s impossible to predict which will do better in the future for each individual investor. So, it’s mostly a matter of personal preference. However, because of 2022, some seem to feel like individual bonds are universally better than bond funds, which is incorrect.

[BirdFood]

The point is that bond funds and individual bonds have their pluses and minuses and it’s impossible to predict which will do better in the future for each individual investor. So, it’s mostly a matter of personal preference. However, because of 2022, some seem to feel like individual bonds are universally better than bond funds, which is incorrect.

It seems to me that we far more often hear people who argue the opposite--that bond funds are universally better than individual bonds. But it sounds like you're not one of those people, so, cool.

[Helium]

"...and if you hold the fund longer than the duration...".

Which part of this sentence is open to misunderstanding? Is the statement incorrect or misleading?

I've read this entire thread and still do not understand bond funds even though I am invested in them .

I'd say something like: if you hold the fund significantly longer than the duration and will withdraw a small amount each year over a long time period.

What does not understanding bond funds actually mean? They are a fund that holds bonds.

Do people say that they don't understand bond funds, when what they really mean is that they don't understand bond math? No one thinks or talks much about stock math, is that what makes stocks supposedly easier to understand?

To me bonds are much easier to understand, unlike stocks the prices are nearly always logical and based on math. When stock prices go up and down, there's no explanation (or maybe there's dozens of different explanations), I don't understand stocks.

It is possible that the source of "not be able to understand" is that people don't know why interest rates do what they do over time because given known interest rates as a function of time the behavior of bonds is pure math. This includes that predicting what you will get from bonds over time requires that you predict what interest rates will be over time. The math takes a winding path through bond pricing, premium/discount, yield to maturity, coupon interest rates, understanding time value of cash flows, net present value, internal rate of return, and so on.

Here is an example of what is involved in understanding what interest rates do: https://stockcharts.com/freecharts/yiel ... pQQAvD_BwE

Perhaps you could be more specific as to what it is that is not understood.

I will grant you we are probably not going to see in public what are the daily transactions a bond fund manager carries out to manage a bond fund. If you want to see that in the same detail as you can see your personal ownership of a bunch of bonds you buy individually, I am not sure how to make that happen. Bond funds do publish a prospectus, an annual report, a summary of additional information, and indices of market performance, composition, and so on.

I would guess that the average Boglehead like myself thinks of bond funds as something similar to a MMF or savings account where it has a bunch of bonds in it, generates interest, is pretty safe money. We know it's not exactly like that, but that's the general idea.

Equities are easy to understand. You buy it at price A, it goes to price B due to what the market thinks it should be, B-A is your gains or loss.

Bond funds...so it is a bundle of bonds at different durations, but the bonds are not always held to its full duration as the managers buy and sell them behind the scenes, and the value is affected by interest rates...all of this is confusing.

But then again, is understanding them necessary to effectively invest like a Boglehead? We're told to park our fixed income allocation in a total bond fund, which is maybe just fine.

[StillGoing]

While there are some differences in the mechanics of a DIY rolling bond ladder and an equivalent (in terms of maturity range) bond fund (see viewtopic.php?t=438577), the overall duration is a more important factor.

For example, results are presented using bond funds of different durations in the Simba data set for backtesting in the thread at viewtopic.php?p=7463791 (towards the end of that thread there is also some testing for duration matching using two funds, with no significant improvements over holding a single fund). Over a retirement period of 30 years, sometimes the shortest durations (T-bills) did best and sometimes the longest durations (over 10 years) did best depending on whether yields are generally rising or falling, respectively. STT (maturities 1 to 5 years) and TBM (maturities 3 to 10 years) did best overall since they were neither worst nor (usually) best performing. I also did a similar analysis for the UK (https://papers.ssrn.com/sol3/papers.cfm ... id=4742456) and for both US and Uk with percentage of portfolio withdrawals (https://papers.ssrn.com/sol3/papers.cfm ... id=4827947) with similar results (although the best maturity range was somewhat longer for the UK than the US - showing that the 'intermediate' in intermediate bond funds is not a law of physics!)

One other point is that while the maturity range of a bond fund is fixed (e.g., maturities of between 1 and 5 years), neither the weight maturity nor the weighted duration are fixed because
1) The duration of individual bonds change with yield and, for the same maturity, are different for different coupons
2) The relative weight of bonds in the bond fund will change as the US government issues new bonds - depending on the index, the holdings are often proportional to the number of bonds in issue). This changes both weighted maturity and weighted duration.

cheers
StillGoing

[erma]

So in summary, you could (higher number is more ideal):

1) spend from the intermediate
2) switch to a shorter bond fund
3) switch to an individual bond whose maturity matches the fund duration (simplified approximation)
4) switch to an individual bond whose duration matches the fund duration (more accurate but calculation required). Or use a zero coupon bond.

What is the point of 4)? If the duration of a bond (or a bond fund) describes its risk, wouldn't the two accomplish the same risk?
I would say instead that option 3) would at least eliminate the risk of a lower returned principal and since its maturity is long as the duration of the bond fund, then its duration is lower than the duration of the individual bond in 4) and so is its risk.

[rossington]

While there are some differences in the mechanics of a DIY rolling bond ladder and an equivalent (in terms of maturity range) bond fund (see viewtopic.php?t=438577), the overall duration is a more important factor.

Hello StillGoing,
I would say that interest rate movements are the primary determining factor of price/yield and how this affects bonds/funds of different duration.