Vanguard Short-Term Bond Index Fund Investor Shares vs. CD

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rec7
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Vanguard Short-Term Bond Index Fund Investor Shares vs. CD

Post by rec7 » Fri Jan 27, 2012 7:12 pm

Vanguard Short-Term Bond Index Fund Investor Shares vs. a 2 year CD for 2%

Which would you buy and why looking out two years?
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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by hsv_climber » Fri Jan 27, 2012 7:17 pm

CD.
You always have to match duration with the need for money.

rec7
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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by rec7 » Fri Jan 27, 2012 7:23 pm

Well I don't need the money in two years but which to you think would do better?
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alanf56
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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by alanf56 » Fri Jan 27, 2012 7:29 pm

Where did you find a 2 year CD for 2%???

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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by hsv_climber » Fri Jan 27, 2012 7:49 pm

rec7 wrote:Well I don't need the money in two years but which to you think would do better?
Better for what? "Better" is a relative term.
For example, I use VG ST Index Fund, because I know that I can rebalance to/from this fund on any given day. So, it is better for me for rebalancing.
I also use 5-year PenFed CDs because they provide me with a guaranteed return over 5 years for the money that I won't need for more than 5 years.

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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by john94549 » Fri Jan 27, 2012 10:17 pm

alanf56 wrote:Where did you find a 2 year CD for 2%???
NavyArmy Federal Credit Union in Corpus Christi, Texas (very limited field of membership) currently is listed on Ken's blog as having this term and rate. Perhaps the OP is one of those in the field of membership.

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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by ejvyas » Fri Jan 27, 2012 10:41 pm

alanf56 wrote:Where did you find a 2 year CD for 2%???
Local credit Unions like DCU offer 2.5%

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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by rec7 » Fri Jan 27, 2012 11:12 pm

[quote="hsv_climber"][quote="rec7"]Well I don't need the money in two years but which to you think would do better?[/quote]

Better for what? "Better" is a relative term.
For example, I use VG ST Index Fund, because I know that I can rebalance to/from this fund on any given day. So, it is better for me for rebalancing.
I also use 5-year PenFed CDs because they provide me with a guaranteed return over 5 years for the money that I won't need for more than 5 years.[/quote]

Better as in better return at the end of two years.
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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by rec7 » Fri Jan 27, 2012 11:17 pm

[quote="ejvyas"][quote="alanf56"]Where did you find a 2 year CD for 2%???[/quote]

Local credit Unions like DCU offer 2.5%[/quote]

Looks like DCU is at 1.2% they dropped not so long ago.
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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by ejvyas » Fri Jan 27, 2012 11:26 pm

rec7 wrote:
ejvyas wrote:
alanf56 wrote:Where did you find a 2 year CD for 2%???
Local credit Unions like DCU offer 2.5%
Looks like DCU is at 1.2% they dropped not so long ago.
Sorry I meant 5 yr : https://www.dcu.org/prodserv/r_certificate.html#c

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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by Kevin M » Sat Jan 28, 2012 7:01 am

2-year CD at 2% in a heartbeat. Higher yield and minimal interest rate risk, depending on the early withdrawal terms. This would assume I won't need it for rebalancing, unless the early withdrawal penalties are really minimal --like 60 days of interest.
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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by nisiprius » Sat Jan 28, 2012 7:32 am

Oddly, as it happens, we have both, and in roughly equal amounts. Not planned, "just grew."

The problem(s) with CDs for me are the clumsiness and lack of convenience. In my personal opinion, it's hopelessly messy trying to manage a random collection of CDs obtained from different banks at different times based on rate-chasing. A ladder or collection of CDs at a single institution is manageable--especially in These Modern Times when each "certificate" it is just a line on a combined statement, rather than a separate, physical bankbook as in Ye Olde Days--but it is astonishing (and frustrating) how quickly the deals offered by any bank revert to the mean. (ING Direct is currently offering CDs with rates that are 0.75% lower then the small-town "old school" brick-and-mortar bank on the corner where we've been banking for decades).
rec7 wrote:Local credit Unions like DCU offer 2.5%... Looks like DCU is at 1.2% they dropped not so long ago.
There's a lot of that going around.

Just my peculiar paranoia but I continue to be bothered by the issue of whether you have the right to break a CD before maturity. This is important because all discussions of them as investments implicitly assume that you do. CDs are treated as if they are liquid. The bank says they are time deposits but we all think they are really de facto demand deposits. Clearly some CDs have terms and conditions that explicitly state that early withdrawal requires the bank's permission, and clearly some do not.

I think most of 'em say that the terms can be changed, with notice. If interest rates rise and the number of people breaking CDs becomes a nuisance for the banks, I think there a lot of people will be getting inconspicuous fine-print notices--maybe in the same mailing as the privacy policy--saying that the terms and conditions now require permission for early withdrawal.
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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by magellan » Sat Jan 28, 2012 9:18 am

IMO, the free lunch in FDIC insured CDs has been greatly eroded. They still offer something of a free lunch when compared to similarly termed treasury securities, but they no longer offer yields that match riskier but similarly termed short term investment grade corporate bonds.

Last year, when 2 yr CDs were yielding the same as the Vanguard ST IG fund, I moved some ST corp bond funds into CDs to capture the market inefficiency. Today similarly termed IG Corporates are offering 60-80 basis points more yield than CDs. That seems like a reasonable payment for taking on short term investment grade credit risk. That particular free lunch seems to be gone.

So now, the decision between CDs and short term corporate bonds should probably revolve around how much credit risk you want/need in your portfolio.

Jim

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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by ruralavalon » Sat Jan 28, 2012 9:33 am

Vanguard Short-Term Bond Index Fund Admiral Shares (VBIRX).

Nice return, high credit quality, flexibility in rebalancing vs CDs, we use as a cash substitute instead of money market fund.

Edit: typo :( .
Last edited by ruralavalon on Sat Jan 28, 2012 1:28 pm, edited 1 time in total.
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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by Index Fan » Sat Jan 28, 2012 10:21 am

ruralavalon wrote:Vanguard Short-Term Bond Index Fund Admiral Shares (VBIRX).

Nice return, high credit quality, flexibility in rebalancing vs CDs, we use as a cash substitute inead of money market fund.

Same here.
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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by Geologist » Sat Jan 28, 2012 1:11 pm

I'm with nisiprius that I have a little of both bond mutual funds and CD's and that having CD's from too many institutions is a real nuisance.

Another thing to keep in mind is how big is the difference in interest earned based on difference in rates. I keep a spreadsheet where I list the current rates of Treasuries, Vgd brokered CD's and a couple of credit unions/banks I use. To remind me of how small interest rate differences are not material, I have written at the bottom of the list

.25% interest rate diff/1000/yr = $2.50

I use this so I don't obsess about even 0.5% difference in rates if I'm buying even a $10,000 CD.

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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by rec7 » Sat Jan 28, 2012 1:16 pm

[quote="Kevin M"]2-year CD at 2% in a heartbeat. Higher yield and minimal interest rate risk, depending on the early withdrawal terms. This would assume I won't need it for rebalancing, unless the early withdrawal penalties are really minimal --like 60 days of interest.[/quote]

There is a 180 days of interest penalty.
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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by Kevin M » Sat Jan 28, 2012 3:24 pm

rec7 wrote:There is a 180 days of interest penalty.
That's why I prefer the Ally 5-year at about 1.8% with 60 days of interest penalty. Of course there is the concern about them changing their terms, which is one reason I wouldn't keep all my fixed income in them if I really couldn't hold them for 5 years if necessary.

Even with 180 day penalty, you'll get 1% if hold for 1 year. How does that compare to SEC yield on short-term bond index?

Kevin
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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by Ted Kan » Sat Jan 28, 2012 5:23 pm

Index Fan wrote:
ruralavalon wrote:Vanguard Short-Term Bond Index Fund Admiral Shares (VBIRX).

Nice return, high credit quality, flexibility in rebalancing vs CDs, we use as a cash substitute inead of money market fund.

Same here.
Me too.

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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by Kevin M » Sun Jan 29, 2012 3:31 am

magellan wrote:IMO, the free lunch in FDIC insured CDs has been greatly eroded. They still offer something of a free lunch when compared to similarly termed treasury securities, but they no longer offer yields that match riskier but similarly termed short term investment grade corporate bonds.

Last year, when 2 yr CDs were yielding the same as the Vanguard ST IG fund, I moved some ST corp bond funds into CDs to capture the market inefficiency. Today similarly termed IG Corporates are offering 60-80 basis points more yield than CDs. That seems like a reasonable payment for taking on short term investment grade credit risk. That particular free lunch seems to be gone.

So now, the decision between CDs and short term corporate bonds should probably revolve around how much credit risk you want/need in your portfolio.

Jim
SEC yield for VG short-term inv-grade bond fund: 1.87%
APY on Ally 5-year CD: 1.79%
- after 60 day interest penalty on withdrawal after 2 years: about 1.65%

With bond fund, you're taking term risk in addition to credit risk. So I view the CD as giving up about 20 basis points to eliminate credit and term risk, but taking on the risk that Ally will change their terms. I like the CD better, but think the short-term inv-grade bond fund is OK too.

Kevin
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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by chipperd » Sun Jan 29, 2012 6:42 am

We use the VMLTX(Limited Term Tax Exempt) which currently yields .75% with full liquidity. Depends on your income/tax level and need for liquidity over those two years.
2% CD over two years sounds great, even if you have to sacrifice a few months interest to pull out your $ early.

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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by magellan » Sun Jan 29, 2012 8:27 am

Kevin M wrote:SEC yield for VG short-term inv-grade bond fund: 1.87%
APY on Ally 5-year CD: 1.79%
- after 60 day interest penalty on withdrawal after 2 years: about 1.65%

With bond fund, you're taking term risk in addition to credit risk. So I view the CD as giving up about 20 basis points to eliminate credit and term risk, but taking on the risk that Ally will change their terms. I like the CD better, but think the short-term inv-grade bond fund is OK too.
Kevin,

I basically agree with you. However, setting aside the risk of Ally changing the withdrawal terms, I wouldn't say the CD has no term risk. This is getting into the weeds, but exercising the CD early withdrawal option isn't cost-free. If you break the CD earlier than 2 years, the penalty will consume more of your interest earnings.

We could probably use the CD early withdrawal details and do some math to compute an effective duration on the CD. My guess is that the resulting 'equivalent' duration would be something like 1.5 years instead of 2 years. Of course, maybe I'm wrong and it's actually something like .5 years. Whatever it is, it would allow a cleaner comparison to the bond fund.

Anyone up for doing a funky duration calculation that incorporates the cost of the early withdrawal optionality? I don't have time to do it right now, but there's gotta be a way to quantify this.

Jim

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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by hsv_climber » Sun Jan 29, 2012 11:28 am

rec7 wrote:Better as in better return at the end of two years.
rec7 wrote:Well I don't need the money in two years but which to you think would do better?
These are 2 contradictory statements. With anything outside of CDs & FDIC insured accounts, you are taking risk, which might or might not show up on a specific date. It is pointless to discuss what return will ST bond funds have in exactly 2 years, since none of us has a crystal ball to predict the future. Looking at the current fund yield is not a good indicator of anything, since it does not take into account the rate of defaults and changes in the interest rates.
I know one thing for sure with ST bond funds - while you can make more money than a 2 year CD, there is also a chance that in exactly 2 years you might have less money than you have put into the fund. For example - take a look at the ST inv. grade fund performance in 2008.
So, it is up to you to decide.

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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by Kevin M » Sun Jan 29, 2012 6:35 pm

magellan wrote:However, setting aside the risk of Ally changing the withdrawal terms, I wouldn't say the CD has no term risk. This is getting into the weeds, but exercising the CD early withdrawal option isn't cost-free. If you break the CD earlier than 2 years, the penalty will consume more of your interest earnings.

We could probably use the CD early withdrawal details and do some math to compute an effective duration on the CD. My guess is that the resulting 'equivalent' duration would be something like 1.5 years instead of 2 years. Of course, maybe I'm wrong and it's actually something like .5 years. Whatever it is, it would allow a cleaner comparison to the bond fund.

Anyone up for doing a funky duration calculation that incorporates the cost of the early withdrawal optionality? I don't have time to do it right now, but there's gotta be a way to quantify this.

Jim
Jim, yes, you could kind of characterize the early withdrawal penalty (EWP) as term risk of sorts, in that you suffer a reduction in effective yield if you withdraw early due to rising rates. But I don't think trying to come up with a duration measure makes sense, because the penalty is fixed, and not related to the interest rate change.

So, with the Ally CD I have a fixed, known risk of losing about 0.3% (60/365 x 1.8%). With a bond fund I have a risk of losing an unknown but possibly much larger amount, depending on duration and interest rate increase (and of course the possibility of a gain if interest rates decline further).

Of course the penalty has a variable effect on the effective yield, depending on when I do the early withdrawal. The effect is large early on, but after 4 months I'm already close to a high-yield savings account rate after the EWP, and the slope of the curve (effective yield vs. withdrawal month) rapidly declines around the 1-year time frame:

Code: Select all

Withdrawal  Effective
Month       Yield
2             0%
4             0.9%
6             1.0%
12            1.5%
24            1.64%
36            1.69%
48            1.72%
60            1.79%
This is just way different than using duration to evaluate term risk. But it's easy to quantify the different risks and compare them.

Kevin
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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by anncatchingup » Sun Jan 29, 2012 8:56 pm

This is kind of a side question, so please forgive me. I have Vanguard Short Term Federal Admiral fund shares (VSGDX) for taxable fixed income and a little Vanguard Prime MM (both my emergency funds). How does the VSGDX compare with the Vanguard Short-Term Bond Index Fund Admiral Shares (VBIRX) that are so highly recommended here? Should I put new money into VBIRX instead?

Thanks.

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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by jginseattle » Sun Jan 29, 2012 11:49 pm

anncatchingup wrote:This is kind of a side question, so please forgive me. I have Vanguard Short Term Federal Admiral fund shares (VSGDX) for taxable fixed income and a little Vanguard Prime MM (both my emergency funds). How does the VSGDX compare with the Vanguard Short-Term Bond Index Fund Admiral Shares (VBIRX) that are so highly recommended here? Should I put new money into VBIRX instead?

Thanks.
I wouldn't worry about it. You're certainly not going to get burned in the Vanguard Short-Term Federal fund.

The Federal Fund has a healthy amount of MBS (Mortgage Backed Securities), and the Short-Term Bond Index fund does not. The latter holds a mix of Treasuries and some high quality corporate bonds as well. I believe the fact that it's a true index fund is a plus. (Some of Vanguard's other offerings sometimes make interest rate and duration bets by altering their composition). Also, if you're interested in Admiral shares, the initial required minimum investment is much lower for index funds.

The riskiest of Vanguard's short-term taxable bond funds is the Investment Grade fund. Short-dated, high quality credits have been well rewarded in the past but there's some risk attached. For example, take a look at how this fund fared in 2008. I feel that Vanguard itself somewhat underestimates this risk when they rate the fund a 1 (lowest risk) on a 1 to 5 scale. (Disclosure: I have my mom in this fund, but stay away from intermediate and long-dated credits).

But again, the fund you're in is just fine. Worrying and switching funds isn't worth it.

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Re: Vanguard Short-Term Bond Index Fund Investor Shares vs.

Post by Gray » Mon Jan 30, 2012 6:07 am

It is in large part how much risk you are willing and able to take. In MD, I chose MDXBX.

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