(Hopefully) Not Another Bonds vs Bond Funds thread

[bUU]

I'm hopeful that we can focus on a much more limited question, the foundation of which are specific assumptions that need to remain intact:

1) Assume a broken three-fund portfolio:
- A total stock market index fund 45%
- A total international stock market index fund 10%
- FTBFX 35% (all in IRAs) + Global bonds 5% + Cash 5%

2) Assume the task at hand is only to reconsider FTBFX.

3) Assume an intractable rejection of "nothing beats the index" with regard to bonds (but only with regard to bonds). As such, assume that shifting FTBFX into VBTLX, VBMFX, BND, BMOIX, FXNAX, etc., is not being considered.

Growth of $10,000 for both FTBFX and all the listed total bond index funds are generally poor. FTBFX is the only one of the funds listed above that had growth over 5-years rather than loss ($10,420). The picture is better over 1 year, but FTBFX is still substantially better ($10,291 versus about $10,153 for all the rest). (This actually supports the aforementioned "intractable rejection".)

So... given that the best we can reasonably expect from any of these funds over 1 to 10 year period seems to be about 1% per year on average, 3% at best (correct?), the question is this: Why wouldn't it be advisable to pull bits and small (perhaps $5k-$25k bonds per bond) pieces out of the FTBFX holding in order to use that money to cherry-pick individual; A-rated and better; proportionally spread across treasury, corporate and agency bonds, with 2-5 year maturity dates, fully intending to hold until maturity (i.e., there would be enough money left in FTBFX over the duration of these bonds to cover RMDs as well as [currently unexpected] other withdrawals should those become necessary). It seems that that tactic could assure that "at best" 3% return, if not better.

After maturity, some of this money would go into cash flow and the rest back in FTBFX, or perhaps back into another set of short-term bonds.

Again: The aim isn't to scuttle the entire portfolio and rebuild it in some kind of idyllic vision, but rather to determine the rationality of this very narrow tactic.

[Hector]

It depends whom do you ask.
I prefer individual bonds over bond funds.
Why spread them across 2-5 year maturity dates especially considering you are holding total bond fund right now? Why not have average maturity similar to total bond fund OR accordingly expected RMD?

[bUU]

Why not have average maturity similar to total bond fund OR accordingly expected RMD?

Lack of confidence in the "when needed" date for these funds, beyond 5 years.

It doesn't "hurt" as much to pull money out of a bond fund at the "wrong" time as compared to having to sell a bond at a discount because you misjudged the timing of the use of those funds for expenses.

I'm also not sure how far off what I suggest will be from that: Only about 20% of the fund are bonds identified as having a maturity date of 10 years or greater, and only about 10% as having a maturity date of 20 years or greater.

[tibbitts]

So... given that the best we can reasonably expect from any of these funds over 1 to 10 year period seems to be about 1% per year on average, 3% at best (correct?)

Are you talking real or nominal? And are you talking before or after tax; if after-tax, what tax rate are you assuming (federal plus state where applicable)?

I think you're talking about doing a lot of work for little, no, or negative reward.

[bUU]

Are you talking real or nominal? And are you talking before or after tax; if after-tax, what tax rate are you assuming (federal plus state where applicable)?

I'm talking about what the respective, apples-to-apples, yields. Regardless, I don't think it matters since those affects will be the same whether the money is in the fund or in bonds, and I'm trying to remain laser focused only on that one aspect.

[Hector]

Why not have average maturity similar to total bond fund OR accordingly expected RMD?

Lack of confidence in the "when needed" date for these funds, beyond 5 years.

It doesn't "hurt" as much to pull money out of a bond fund at the "wrong" time as compared to having to sell a bond at a discount because you misjudged the timing of the use of those funds for expenses.

I'm also not sure how far off what I suggest will be from that: Only about 20% of the fund are bonds identified as having a maturity date of 10 years or greater, and only about 10% as having a maturity date of 20 years or greater.

You are going to “lose” regardless of if you pull money out from bond fund or from individual bonds if interest rates are risen and you are selling before maturity. I understand that maturity date generally keeps moving forward in index bond funds. We have heard that if you hold bond fund for 2X the time compared to the average maturity, you probably will be fine. That is why folks go (or move some money) from long to intermediate and to short duration as/when they anticipate selling them.

I personally hold only individual bonds and don't match bond index.

[bUU]

We have heard that if you hold bond fund for 2X the time compared to the average maturity, you probably will be fine.

Interesting. So for FTBFX that would be 11 years. So technically I have 4 years to go. Yet, I'm showing a 12.70% loss over those 7 years.

I'm used to being an exception to rules.

[Chief_Engineer]

So... given that the best we can reasonably expect from any of these funds over 1 to 10 year period seems to be about 1% per year on average, 3% at best (correct?)

This would not be correct, no. The SEC yield for FTBFX is 5.01% and is what you can reasonably expect going forward. Interest rate risk means you might get less or more depending on what interest rates do while you hold the fund. You have to remember that we exited a decade a 0% Fed rate that pushed yields down followed by a rapid rise in interest rates that killed the NAV on bonds. Trailing 10 year returns are not a good predictor of what bond funds will do over the next 10 years since we are in a completely different interest rate environment.

[bUU]

I personally hold only individual bonds and don't match bond index.

Conceptually, that's the direction I'm suggesting moving in. There's no easy way to snap fingers have get from where I am to where you are, is there? Even if I could overcome the concern about time horizon, a portfolio of bonds that effectively replaces FTBFX would have to be acquired over a long period of time, with an eye toward better understanding ("better" than me, at least) how to accomplish diversification.

[bUU]

This would not be correct, no. The SEC yield for FTBFX is 5.01% and is what you can reasonably expect going forward. Interest rate risk means you might get less or more depending on what interest rates do while you hold the fund. You have to remember that we exited a decade a 0% Fed rate that pushed yields down followed by a rapid rise in interest rates that killed the NAV on bonds. Trailing 10 year returns are not a good predictor of what bond funds will do over the next 10 years since we are in a completely different interest rate environment.

I'm not hearing anything from any of financial news types that I'm listening to about the next 10 years being substantially better in terms of yields. The closest to that I've heard is from those who say that no one knows anything. To have faith in an approach there has to be something underlying a hope I would have that the current 30-day yield of 5.01% is what is "reasonable" to expect over any significant timeframe... 1 year, 3 year, 5 year, 10 year. Absent that, it seems merely theoretical and likely to lead an investor in the wrong direction.

[bUU]

This would not be correct, no. The SEC yield for FTBFX is 5.01% and is what you can reasonably expect going forward. Interest rate risk means you might get less or more depending on what interest rates do while you hold the fund. You have to remember that we exited a decade a 0% Fed rate that pushed yields down followed by a rapid rise in interest rates that killed the NAV on bonds. Trailing 10 year returns are not a good predictor of what bond funds will do over the next 10 years since we are in a completely different interest rate environment.

More to the point though: How does this specifically change the answer to the question I'm trying to answer? Specifically, how does this affect whether or not it would be advisable to pull bits and small pieces out of the FTBFX holding in order to use that money to cherry-pick individual; A-rated and better; proportionally spread across treasury, corporate and agency bonds, with 2-5 year maturity dates, fully intending to hold until maturity?

[alluringreality]

I read this as you're interested in shortening duration, and you're using past performance to estimate bond fund expected performance. Immediate market rates are probably the best way to estimate future returns, but that sort of outlook might generally presume individual bonds being held to maturity. It's always possible to trade a fund for a mix of bonds with similar maturity, now or in the future, such as if you decide that you no longer want to continue to roll your bonds using a fund. If you don't have an immediate need for the holding, one way to shorten duration might be to trade a portion of the fund for one or more individual bonds. Target Maturity Bond Funds could also serve a similar purpose. Using similar duration for the two positions may limit the difference in holdings, and across time the individual bond(s) could approach maturity to shorten duration for the entire position. This sort of change might limit the effects caused by market rates having risen across your holding period. I'm sure some people would prefer to just take the loss and immediately shorten the position, but trading a fund for individual bonds might also work to shorten duration with time.

[Thesaints]

There is a diffused misconception that a total bond fund is the best solution for bonds just because a total stock market fund is the best solution for stocks.
The two are instead quite different
As stocks are concerned, by and large there is not really a way to pick winners. At most one can try to separate more volatile from less volatile stocks, with a huge gray area in between
Bonds are another thing entirely: for IG bonds one can basically ignore the risk of default and each bond comes with a contractually well defined maturity and interest rate. Their total market is mostly defined by big institutional players and by their needs in terms of maturity and rate.
It doesn’t quite make sense for an individual investor to have a large chunk of 30-year bonds just because the Harvard endowment fund does.
Of course, bond funds still have a role for the individual investor, but one should chose an appropriate mix of corporate and treasuries, short, medium and long term tailored to their specific situation.

[bUU]

I read this as you're interested in shorting duration,

I'm actually not interested in doing that. Rather, Hector made clear early on in the thread that one weakness in my suggestion was that I would end up shorting duration. That weakness is shaped by lack of confidence, not intention, and likely some part of the answer to my question will involve moving past my lack of confidence and remedying the fact that what I'm suggestion would short duration.

[And a few minutes later I backtracked a bit from this... see below.]

[bUU]

There is a diffused misconception that a total bond fund is the best solution for bonds just because a total stock market fund is the best solution for stocks.
The two are instead quite different
As stocks are concerned, by and large there is not really a way to pick winners. At most one can try to separate more volatile from less volatile stocks, with a huge gray area in between
Bonds are another thing entirely: for IG bonds one can basically ignore the risk of default and each bond comes with a contractually well defined maturity and interest rate. Their total market is mostly defined by big institutional players and by their needs in terms of maturity and rate.

Which is really what is driving my question... I feel that I could do better than the fund just by by picking funds that exceed the most optimistic predictions of the fund's future returns, when I find them, and in doing so I actually lock in those returns and make them legitimately predictable. It sounds like you're saying that this is a good idea.

It doesn’t quite make sense for an individual investor to have a large chunk of 30-year bonds just because the Harvard endowment fund does.
Of course, bond funds still have a role for the individual investor, but one should chose an appropriate mix of corporate and treasuries, short, medium and long term tailored to their specific situation.

And I'm going to pull back on something I just stated to alluringreality above... maybe the message is that I should be shortening duration. FTBFX is basically an intermediate-range bond fund. At this point in time, we have reached the point where we actually should be transitioning some of that money, staging it for RMDs in 2027, 2028, 2029 -- LESS than 5 years, and a lot less than the fund's average maturity duration.

[alluringreality]

And I'm going to pull back on something I just stated to alluringreality above... maybe the message is that I should be shortening duration. FTBFX is basically an intermediate-range bond fund. At this point in time, we have reached the point where we actually should be transitioning some of that money, staging it for RMDs in 2027, 2028, 2029 -- LESS than 5 years, and a lot less than the fund's average maturity duration.

In Unconventional Success, David Swensen suggested moving planned expenses two years in the future into cash, rather than having expected spending remain in his risk portfolio (bond funds and stocks). Getting there he suggested pulling 25% of planned expenses from the risk portfolio (bonds and stocks) every two years, so across 8 years the needed funds would be entirely moved to cash. It's a fairly similar idea to what I suggested, especially with how flat the current yield curve sits. Generally markets expect short-term rates to fall at this time, so breakeven expectations generally work out somewhat similar against say 2 year rates. It's possible that some forum opinions may disagree with my comments or Swensen's position, since many people expect higher portions of shorter-term assets to lead towards lower lifetime returns, so I tend to presume he may have at least partly discussed such things for behavioral reasons. In the book he noted how bond funds and stocks can potentially both decrease in value at the same time with rising interest rates, which is basically how I would summarize 2022, so I suppose some his recommendation might have been based around that sort of scenario. Overall I tend to suppose a mix of cash and a bond fund could probably be approximated as a shorter bond fund.

[rockstar]

I personally have TIPS out to three years. Thinking about increasing duration. I’m good for now with letting them ride.

[BirdFood]

a portfolio of bonds that effectively replaces FTBFX would have to be acquired over a long period of time

I'm not clear on why? Are you saying that you'd have to do a lot of research? Because the bonds themselves should be available to buy.

(Corrected broken quoting.)

[bUU]

It's possible that some forum opinions may disagree with my comments or Swensen's position, since many people expect higher portions of shorter-term assets to lead towards lower lifetime returns, so I tend to presume he may have at least partly discussed such things for behavioral reasons.

I recently ran our portfolio through that scenario. We ran out of money way too early. Instead, we keep three months of expenses in cash, and 2 years of expenses minus guaranteed income in cash, bonds or muni funds. That gives us an all clear with even the more conservative estimates of portfolio success.

[bUU]

I'm not clear on why? Are you saying that you'd have to do a lot of research? Because the bonds themselves should be available to buy.

Prior to September, I didn't have the slightest idea how to buy a bond, much less how to assess them. I know the basics -- enough to be dangerous -- enough to take some tentative steps. And while I'm gaining confidence in my ability to make good selections for short-term bonds, longer bonds have greater consequences and I feel the need to understand more than I do now. Maybe I'm wrong -- maybe I know enough now -- but we often don't know what we don't know, including that we already know enough.

[Kenkat]

We have heard that if you hold bond fund for 2X the time compared to the average maturity, you probably will be fine.

Interesting. So for FTBFX that would be 11 years. So technically I have 4 years to go. Yet, I'm showing a 12.70% loss over those 7 years.

I'm used to being an exception to rules.

I don’t think you are including dividends in that 12.70% loss.

[Thesaints]

]Which is really what is driving my question... I feel that I could do better than the fund just by by picking funds that exceed the most optimistic predictions of the fund's future returns, when I find them, and in doing so I actually lock in those returns and make them legitimately predictable. It sounds like you're saying that this is a good idea.

Well, I never said that one can predict future returns. I don’t think one can predict future rates, nor when a manager decides to replace bonds. As such, returns for a bond fund are never “locked”.

And I'm going to pull back on something I just stated to alluringreality above... maybe the message is that I should be shortening duration. FTBFX is basically an intermediate-range bond fund. At this point in time, we have reached the point where we actually should be transitioning some of that money, staging it for RMDs in 2027, 2028, 2029 -- LESS than 5 years, and a lot less than the fund's average maturity duration.

TBF actually stands for total bond fund. It’s intermediate maturity is deceptive, since it is just the average of its portfolio and indeed 50% of it has either shorter maturity than 4 years, or longer than 8.
If you have immediate needs, I would use a short-term fund to cover those plus an actual intermediate term fund and a long term fund for the rest, apportioned as suitable to you. Also, you know your tax situation and can decide between corporate, treasuries, muni according to what is best for you, not what makes sense for Harvard+Cigna+Allianz

[bUU]

I don’t think you are including dividends in that 12.70% loss.

Yes; you're correct. It's actually a 0.54% gain.

[Taylor Larimore]

bUU:

It may be helpful to see exactly how Vanguard Total Bond Market Index Fund (VBTLX) has performed in The Three-Fund Portfolio during the past 49 years. Note that in every year the S&P 500 Index had negative returns (in parentheses) Total Bond Market reduced the portfolio loss.

Past rate of inflation (CPU) and annual fund returns in The Three-Fund Portfolio:

YEAR--INFLATION--BOND INDEX--S&P 500 INDEX------MSCI EAFE INDEX
1976-------4.9%--------15.6%------------23.8%--------------------3.6%
1977-------6.7-----------3.0-------------(-7.2)-------------------17.5
1978-------9.0-----------1.4---------------6.6--------------------33.1
1979------13.3-----------1.9-------------18.4--------------------10.9 (Highest Annual Inflation Rate)
1980------12.5-----------2.7-------------32.4--------------------25.4
1981-------8.9-----------6.3-------------(-4.9)------------------(-2.5)
1982-------3.8----------32.6--------------21.6------------------(-0.3) (Highest Bond Index Return)
1983-------3.8-----------8.4--------------22.6-------------------24.8
1984-------3.9----------15.2---------------6.3--------------------3.5
1985-------3.8----------22.1--------------31.7-------------------51.4
1986-------1.1----------15.2--------------18.7-------------------65.8 (Highest Stock Return)
1987-------4.4-----------2.8----------------5.2-------------------24.6
1988-------4.4-----------7.9---------------16.6-------------------27.8
1989-------4.6----------14.5---------------31.7------------------11.4
1990-------6.1-----------8.9---------------(-3.1)---------------(-22.8)
1991-------3.1----------16.0---------------30.5------------------12.4
1992-------2.9-----------7.4-----------------7.6----------------(-11.9)
1993-------2.7-----------9.7----------------10.1------------------32.6
1994-------2.7---------(-2.9)----------------1.3--------------------7.6
1995-------2.5----------18.5---------------37.6-------------------11.8 (Highest S&P Index Return)
1996-------3.3-----------3.6----------------23.0--------------------7.2
1997-------1.7-----------9.7----------------33.4--------------------2.6
1998-------1.6-----------8.7----------------28.6-------------------19.1
1999-------2.7---------(-0.8)---------------21.0-------------------28.3
2000-------3.4----------11.6---------------(-9.1)----------------(-15.8)
2001-------1.6-----------8.4--------------(-11.9)----------------(-19.8)
2002-------2.4----------10.3-------------(-22.1)----------------(-15.3)
2003-------1.9-----------4.1----------------28.7-------------------40.4
2004-------3.3-----------4.3----------------10.9-------------------20.9
2005-------3.4-----------2.4-----------------4.9-------------------15.8
2006-------2.5-----------4.3----------------15.8------------------26.8
2007-------4.1-----------7.0-----------------5.5------------------11.6
2008-------0.1-----------5.2--------------(-37.0)---------------(-43.1) (Lowest U.S. and International Stock Returns)
2009-------2.7-----------5.9----------------26.5------------------32.5
2010-------1.5-----------6.5----------------15.1-------------------8.2
2011-------3.0-----------7.7-----------------2.1----------------(-11.7)
2012-------1.7-----------4.3----------------16.0------------------17.9
2013-------1.5---------(-2.0)---------------32.4------------------23.3
2014-------1.6-----------6.0----------------13.7-----------------(-4.5)
2015-------0.7-----------0.5-----------------1.4-----------------(-0.4)
2016-------2.1-----------2.6----------------12.0-------------------1.5
2017-------2.1-----------3.5----------------21.8------------------25.6
2018-------2.5---------(-0.1)--------------(-4.4)---------------(-13.4)
2019-------2.3-----------8.7----------------31.5------------------22.7
2020-------1.4-----------7.7----------------18.4------------------11.3
2021-------7.0---------(-1.7)---------------25.7-------------------8.6
2022-------6.5--------(-13.2)------------(-19.4)---------------(-16.0) (Lowest Bond Index Return)
2023-------3.4-----------5.7----------------26.2------------------15.5
2024-------n.a.----------1.2----------------23.7-------------------5.1

Sources: Vanguard, U.S. Labor Department (CPI-U), Standard & Poors, Bloomberg Barclays Aggregate Bond Index, and DFTurner

Past performance does not forecast future performance.

Best wishes.
Taylor

Jack Bogle's Words of Wisdom: “Why would an intelligent investor hold any bonds at all? Because the long-run is a series of short-runs, and during many short periods, bonds have provided higher returns than stocks. -- And perhaps more important, reducing the volatility of your portfolio can give you downside protection during large market declines."

[bUU]

It may be helpful to see exactly how Vanguard Total Bond Market Index Fund (VBTLX) has performed in The Three-Fund Portfolio during the past 49 years.

The fact that we would have to go back at least 30 years to show an average return better than what's available for IG bonds available today supports the contention that the bond market has radically changed.

Past performance does not forecast future performance.

Of course, but we have to make decisions on hard data, somehow.

[tibbitts]

It may be helpful to see exactly how Vanguard Total Bond Market Index Fund (VBTLX) has performed in The Three-Fund Portfolio during the past 49 years.

The fact that we would have to go back at least 30 years to show an average return better than what's available for IG bonds available today supports the contention that the bond market has radically changed.

Past performance does not forecast future performance.

Of course, but we have to make decisions on hard data, somehow.

What would you have done if you had come to his epiphany several years ago when IG bonds were paying more like 2%? How will you feel if you buy 4-5% bonds now and a few years from now they're paying 8%?

You're making this much more complicated than it has to be. In any tax-advantaged account you can sell all your bond funds and replace them with individual bonds with the same characteristics as the fund had and there's no difference in how they'll perform going forward. That may be more work than you think in terms of the corporate and agency bonds in particular, but whatever, it's your choice. You won't lose or gain anything, except - and this may be important to you - the ability to selectively redeem or simply wait for bonds to mature. If that matters to you then the only price to do that (well, without considering transaction costs) is your time. Otherwise it just doesn't matter. How/why do you feel the bond market has changed, and what would have prevented you from doing the same thing (possibly with higher costs) decades ago?

[Thesaints]

Sources: Vanguard, U.S. Labor Department (CPI-U), Standard & Poors, Bloomberg Barclays Aggregate Bond Index, and DFTurner

Past performance does not forecast future performance.

Best wishes.
Taylor

Jack Bogle's Words of Wisdom: “Why would an intelligent investor hold any bonds at all? Because the long-run is a series of short-runs, and during many short periods, bonds have provided higher returns than stocks. -- And perhaps more important, reducing the volatility of your portfolio can give you downside protection during large market declines."

The point, I believe, is not whether to hold bonds, or not, but whether to replicate the overall bond market, or not

[BirdFood]

I'm not clear on why? Are you saying that you'd have to do a lot of research? Because the bonds themselves should be available to buy.

Prior to September, I didn't have the slightest idea how to buy a bond, much less how to assess them. I know the basics -- enough to be dangerous -- enough to take some tentative steps. And while I'm gaining confidence in my ability to make good selections for short-term bonds, longer bonds have greater consequences and I feel the need to understand more than I do now. Maybe I'm wrong -- maybe I know enough now -- but we often don't know what we don't know, including that we already know enough.

No, that makes sense. I was wondering if you were assuming, oh, that ordinary investors couldn't buy them, or that you had to buy them when issued, or something. Something that wasn't true.

[rkhusky]

There is no bond selection that will get you the best return in all possible futures. You will have different results depending on whether interest rates go up or down and whether inflation is low or high. So, searching for the magic investment is futile.

The TSP G Fund is close to magic because the Government subsidizes it. Stable value can be close to the G Fund but there are often restrictions.

[bUU]

What would you have done if you had come to his epiphany several years ago when IG bonds were paying more like 2%? How will you feel if you buy 4-5% bonds now and a few years from now they're paying 8%?

It wouldn't have come up because there was hard data showing that the funds have in recent years done better than what IG bonds were paying at the time.

[bUU]

this may be important to you - the ability to selectively redeem or simply wait for bonds to mature.

This is a big part of it. Effectively, what I'm thinking of doing is staging the IRA for its upcoming RMDs. Having to sell shares of the bond fund at a specific point of time in the future, regardless of the state of the market at the time, means perhaps pulling out more principal, as compared to taking the opportunity now to lock in a reasonably high yield in bonds that mature in the year that money needs to come out (and be spent, incidentally).

[alluringreality]

What would you have done if you had come to his epiphany several years ago when IG bonds were paying more like 2%? How will you feel if you buy 4-5% bonds now and a few years from now they're paying 8%?

It wouldn't have come up because there was hard data showing that the funds have in recent years done better than what IG bonds were paying at the time.

General commentary questions if future inflation and interest rates can be reliably predicted. Recent trends and future trends can differ. If longer or shorter duration outperforms across a particular timeframe, say ten years, that probably depends on luck. For example the period preceeding 2022 favored longer duration, while other periods such as much of the late 1960s through early 1980s favored shorter duration. This forum had some posts around 2020-2021 encouraging people to extend duration due to recent performance, and for some individuals following the recent trend ended up counterproductive, since they bailed on the suggestion when the trend changed in 2022.

this may be important to you - the ability to selectively redeem or simply wait for bonds to mature.

This is a big part of it. Effectively, what I'm thinking of doing is staging the IRA for its upcoming RMDs. Having to sell shares of the bond fund at a specific point of time in the future, regardless of the state of the market at the time, means perhaps pulling out more principal, as compared to taking the opportunity now to lock in a reasonably high yield in bonds that mature in the year that money needs to come out (and be spent, incidentally).

Since recent trends may or may not continue, personally I consider staging future expenses possibly as a reasonable approach. Aside from defined maturity bond funds, this potentially ends up at odds with the thread title, since rolling into new issues may not make sense if you prefer to have bonds mature. Personally I'm not very familiar with the iBonds and BulletShares products, which mature in particular years, but the following suggests potential reorganization fees from some brokers.
viewtopic.php?p=7100435#p7100435

[exodusing]

If I'm understanding your plan correctly, for this to be a good strategy you'd have to be better at picking individual bonds than a fund with a credit quality and average duration suitable for you and you would be able to avoid higher trading costs.

[tibbitts]

this may be important to you - the ability to selectively redeem or simply wait for bonds to mature.

This is a big part of it. Effectively, what I'm thinking of doing is staging the IRA for its upcoming RMDs. Having to sell shares of the bond fund at a specific point of time in the future, regardless of the state of the market at the time, means perhaps pulling out more principal, as compared to taking the opportunity now to lock in a reasonably high yield in bonds that mature in the year that money needs to come out (and be spent, incidentally).

It makes sense to have some fairly stable way to spend whatever amount you have to every year, whether related to RMDs or not. Some people do that with some years in cash, or a short-term bond fund, or individual bonds, etc. I agree that having everything in a total bond fund could be sub-optimal for the purpose of near/medium-term spending.

[Kenkat]

What would you have done if you had come to his epiphany several years ago when IG bonds were paying more like 2%? How will you feel if you buy 4-5% bonds now and a few years from now they're paying 8%?

It wouldn't have come up because there was hard data showing that the funds have in recent years done better than what IG bonds were paying at the time.

Historical returns are perhaps even less useful for bonds than they are for stocks. With an investment grade bond, you receive the interest rate when the bond was issued plus the principal amount of the bond when it matures. It’s a little more complicated than that for funds as there are bonds constantly maturing and new ones being added. But the basic principle holds.

For a very long time, ending in 2022, we were in a declining interest rate environment which ended in a low, 2% or lower, interest rate environment. So in 2022, when you looked back at 5 year or 10 year performance, that reflected the higher rates being paid over that time. When rates crashed in 2020 due to Covid, down below 1% for the 10 year treasury, there was a capital gain that made the backward looking returns look even better. But rates were now less than 1%, and remember, bonds will pay the interest stated when issued plus return principal when they mature. So now you have all these lower yielding bonds entering the portfolio.

Then rates spiked in 2022, up over 4%. This caused an immediate capital loss, because all of the bonds held by the funds were paying a rate lower than the currently available yield. That makes historical returns look even worse. But those bonds will eventually return their full principal when they mature, so that capital loss will slowly disappear over time and in the end, you will receive back your principal plus whatever interest the bonds were scheduled to pay. Eventually, but you have to wait for it.

So ultimately, the bonds purchased in 2010-2022 were low returning bonds, so the historical returns will be low. Now, however, the 30 day SEC yield of VBTLX is a little over 4.54%, so going forward, that’s a decent estimate of future expected returns over the duration of that fund.

Because it’s a fund, if rates go up again, the clock gets reset, but the bonds the fund is buying today are going to pay out their stated interest (10 yield treasury is at 4.75%) and their principal when they mature.

It was a surprise, shock, revelation - pick your favorite - when bonds lost 15% of their value in 2022, but held long enough, that loss will eventually disappear in long term returns if rates stay the same. If rates rise, the clock gets reset as mentioned above. If you plan to hold the fund a long time, you can ignore these fluctuations, at least that’s the theory. If you have plans for that money at a set time in the future, or a drawing it down over a shorter time frame, that has to be considered in your strategy.

So... given that the best we can reasonably expect from any of these funds over 1 to 10 year period seems to be about 1% per year on average, 3% at best (correct?), the question is this: Why wouldn't it be advisable to pull bits and small (perhaps $5k-$25k bonds per bond) pieces out of the FTBFX holding in order to use that money to cherry-pick individual; A-rated and better; proportionally spread across treasury, corporate and agency bonds, with 2-5 year maturity dates, fully intending to hold until maturity (i.e., there would be enough money left in FTBFX over the duration of these bonds to cover RMDs as well as [currently unexpected] other withdrawals should those become necessary). It seems that that tactic could assure that "at best" 3% return, if not better.

After all that tldr, I realized maybe it doesn’t really answer the question directly.

If you sell off FTBFX and buy bonds yielding 4.5% for example, it basically matches what we can expect FTBFX to return from this point forward. If you need the money to spend in 2-5 years, that could make a lot of sense due to the open ended nature of bond funds. But if you are planning to just cycle that money back into FTBFX, it’s probably going to be a wash.

[Hector]

I personally hold only individual bonds and don't match bond index.

Conceptually, that's the direction I'm suggesting moving in. There's no easy way to snap fingers have get from where I am to where you are, is there? Even if I could overcome the concern about time horizon, a portfolio of bonds that effectively replaces FTBFX would have to be acquired over a long period of time, with an eye toward better understanding ("better" than me, at least) how to accomplish diversification.

It depends on your goal. When I decided to make that move, I sold funds (at loss) and moved to individuals at once. I was in a short term treasury fund when I did it. I didn't like intermediate or long term funds or any other bond fund that is not 100% Treasuries. Now that I am into individual bonds and interest rates are higher, I have been buying some 10 year bonds. I am also adding TIPS and Corporate bonds.

If you were going to effectively replace FTBFX with individuals based on whatever you decide, why does it need to be done over a long period of time?
I think the key is to decide what you want in terms of mix. After that, why does it matter if you do it at once or over a long period of time?

[Hector]

bUU:

It may be helpful to see exactly how Vanguard Total Bond Market Index Fund (VBTLX) has performed in The Three-Fund Portfolio during the past 49 years. Note that in every year the S&P 500 Index had negative returns (in parentheses) Total Bond Market reduced the portfolio loss.

Past rate of inflation (CPU) and annual fund returns in The Three-Fund Portfolio:

YEAR--INFLATION--BOND INDEX--S&P 500 INDEX------MSCI EAFE INDEX
1976-------4.9%--------15.6%------------23.8%--------------------3.6%
1977-------6.7-----------3.0-------------(-7.2)-------------------17.5
1978-------9.0-----------1.4---------------6.6--------------------33.1
1979------13.3-----------1.9-------------18.4--------------------10.9 (Highest Annual Inflation Rate)
1980------12.5-----------2.7-------------32.4--------------------25.4
1981-------8.9-----------6.3-------------(-4.9)------------------(-2.5)
1982-------3.8----------32.6--------------21.6------------------(-0.3) (Highest Bond Index Return)
1983-------3.8-----------8.4--------------22.6-------------------24.8
1984-------3.9----------15.2---------------6.3--------------------3.5
1985-------3.8----------22.1--------------31.7-------------------51.4
1986-------1.1----------15.2--------------18.7-------------------65.8 (Highest Stock Return)
1987-------4.4-----------2.8----------------5.2-------------------24.6
1988-------4.4-----------7.9---------------16.6-------------------27.8
1989-------4.6----------14.5---------------31.7------------------11.4
1990-------6.1-----------8.9---------------(-3.1)---------------(-22.8)
1991-------3.1----------16.0---------------30.5------------------12.4
1992-------2.9-----------7.4-----------------7.6----------------(-11.9)
1993-------2.7-----------9.7----------------10.1------------------32.6
1994-------2.7---------(-2.9)----------------1.3--------------------7.6
1995-------2.5----------18.5---------------37.6-------------------11.8 (Highest S&P Index Return)
1996-------3.3-----------3.6----------------23.0--------------------7.2
1997-------1.7-----------9.7----------------33.4--------------------2.6
1998-------1.6-----------8.7----------------28.6-------------------19.1
1999-------2.7---------(-0.8)---------------21.0-------------------28.3
2000-------3.4----------11.6---------------(-9.1)----------------(-15.8)
2001-------1.6-----------8.4--------------(-11.9)----------------(-19.8)
2002-------2.4----------10.3-------------(-22.1)----------------(-15.3)
2003-------1.9-----------4.1----------------28.7-------------------40.4
2004-------3.3-----------4.3----------------10.9-------------------20.9
2005-------3.4-----------2.4-----------------4.9-------------------15.8
2006-------2.5-----------4.3----------------15.8------------------26.8
2007-------4.1-----------7.0-----------------5.5------------------11.6
2008-------0.1-----------5.2--------------(-37.0)---------------(-43.1) (Lowest U.S. and International Stock Returns)
2009-------2.7-----------5.9----------------26.5------------------32.5
2010-------1.5-----------6.5----------------15.1-------------------8.2
2011-------3.0-----------7.7-----------------2.1----------------(-11.7)
2012-------1.7-----------4.3----------------16.0------------------17.9
2013-------1.5---------(-2.0)---------------32.4------------------23.3
2014-------1.6-----------6.0----------------13.7-----------------(-4.5)
2015-------0.7-----------0.5-----------------1.4-----------------(-0.4)
2016-------2.1-----------2.6----------------12.0-------------------1.5
2017-------2.1-----------3.5----------------21.8------------------25.6
2018-------2.5---------(-0.1)--------------(-4.4)---------------(-13.4)
2019-------2.3-----------8.7----------------31.5------------------22.7
2020-------1.4-----------7.7----------------18.4------------------11.3
2021-------7.0---------(-1.7)---------------25.7-------------------8.6
2022-------6.5--------(-13.2)------------(-19.4)---------------(-16.0) (Lowest Bond Index Return)
2023-------3.4-----------5.7----------------26.2------------------15.5
2024-------n.a.----------1.2----------------23.7-------------------5.1

Sources: Vanguard, U.S. Labor Department (CPI-U), Standard & Poors, Bloomberg Barclays Aggregate Bond Index, and DFTurner

Past performance does not forecast future performance.

Best wishes.
Taylor

Jack Bogle's Words of Wisdom: “Why would an intelligent investor hold any bonds at all? Because the long-run is a series of short-runs, and during many short periods, bonds have provided higher returns than stocks. -- And perhaps more important, reducing the volatility of your portfolio can give you downside protection during large market declines."

I have learned a lot from you and there is no doubt that you are wiser, at least compared to me. One issue with bond funds is that it certainly can do worse than previous worst over last 3-4 decades. I think for folks who are withdrawing, ladder bond portfolio (for next few year at least) might be less risky.

[gavinsiu]

So you are feeling you feel your fixed income portion of your portfolio hasn't done well and is attempting to increase fixed income return by reducing the fund to shorter terms bond because those are the one that did well recently and by buying individual bonds.

First bond return for the past 10 years or so hasn't been great, so the reason bond return hasn't been great is because bonds can do poorly in 10 years and we also had the worse bond market in history in 2022. However, if you go back 10 more year, bond did better than stock, so they kind of cycle back and forth. Yields in generate for bonds have been pretty good compare to the past couple of years.

Reducing bond duration to a shorter duration will reduce your interest rate sensitivity. Having shorter duration is good for people who don't like volatility but the price is reduced long term return. Short term bonds have done well recently because the yield curve is inverted, but now it appears to be de-inverting.

I don't think picking your own bonds are going to yield you the result you want. You should realistically only buy treasuries. Corporate bonds can default wiping out a good chunk of your profit. It's still bond so even if you are good, you are not going to earn a considerable premium over the bond fund.