The Prime Money Market vs the Short Term Investment Grade bond fund question

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zaplunken
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The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by zaplunken » Sun Feb 04, 2018 8:30 pm

I did a search on Prime Money Market (PMM) and found viewtopic.php?f=10&t=239399&hilit=prime+money+market which is really just discussing the alternatives Larry suggested in his blog of a week ago. I read the thread and Larry's article. Other threads I found were not comparing the use of the PPM vs the Short Term Investment Grade Bond Fund (STIG) so here's my question.

I have held the STIG Admiral shares for about 2+ years for it's lower duration in my rollover IRA at Vanguard. I usually have all of my 401k (last year I moved 1/3 of it into the S&P 500 in my 401k) in the Stable Value fund which yields in the 2.25-2.35%% range over the past few years. My AA is usually 50/50 but right now it is is 65% equities and 35% fixed income. I like the Stable Value fund for it's reasonable yield with no duration issues ie nav loss and I selected the STIG fund for the lower duration as well. Rates have moved very quickly this year and now I'm wondering about the PMM.

So YTD the PMM SEC yield increased from 1.37% to 1.45% with no duration and nav change while the STIG SEC yield increased from 2.3% to 2.45% with a duration of 2.7 years and a nav change from $10.63 to $10.56. I have approximately 10,350 shares of the STIG and YTD I lost about $700 in the fund but that is offset by the increased yield so it nets to a $400 in loss YTD. This is not a major loss by any means but what concerns me is over the next year, 2 years if rates increase this could be thousands of dollars. Again not a major loss but why not opt for the no duration lower yield of the PMM vs losing money in the STIG bond fund? I understand the aspect of holding through the fund's duration which generally has you break even on the nav loss re the duration but that bugs me seeing how my Stable Value has no nav loss with a decent yield.

Any thoughts as to why the STIG bond fund is the better place to hold this portion of my fixed income allocation vs the PMM?

Thanks!

onourway
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by onourway » Sun Feb 04, 2018 8:40 pm

If this is in a retirement fund with a horizon of many years or decades, you are indifferent to losses in NAV. You prefer the higher yields that will pay (literally) dividends over the coming years.

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welderwannabe
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by welderwannabe » Sun Feb 04, 2018 8:43 pm

What you are really asking is whether to hold cash or bonds. One of the goals of holding bonds is the 'sometimes' negative correlation to stocks. That said, many times that happens is in a 'flight to quality' scenario. The VFSUX fund is corporate bond heavy so it may not act this way versus say a treasury bond fund.

18 months ago I made the decision not to hold any short term bond funds. I replaced all my short term bond fund holdings with money markets and CD ladders. The slight duration premium the short term bond funds were paying did not offset the risk of rising rates I perceived.

I do hold plenty of intermediate term bonds however, but that is for money I don't plan on needed for many (10+) years.

A stable value is a special beast. They have their place in a portfolio, but sometimes their risks can be concentrated and often not easily understood. They are quite opaque. I have some money in one in a MegaCorp 401k (soon to be transferred to a new plan), but I limit it to 50% of my bond holdings in my IPS.

Good luck with your decision!
I am not an investment professional, but I did stay at a Holiday Inn Express last night.

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zaplunken
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by zaplunken » Sun Feb 04, 2018 8:47 pm

Thank you to both of you.

Most of my portfolio is in taxed deferred, that's where all the fixed income is. I'm retired with no need for the income of the bond fund. A long term investment is not the same time frame as it used to be! I'm close to 70 and while I used to think in multiple decades re investing I now think in years. A decade is a long time at this point - just about the end of the road if I get those 10 years. Health is OK just stating my view on time at this point of my life.

smectym
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by smectym » Sun Feb 04, 2018 8:57 pm

In general I am a fan of Short Term Investment Grade, and own it, but as the fed has tightened recently, with more of the same ahead, money market fund rates have risen quite a bit and therefore the interest spread between MMF and short term bond funds has narrowed. So the argument for taking on the additional volatility of VFSUX in order to get additional reward is weaker now. While the rate hike cycle stays intact, the argument for MMF's looks more persuasive than even six months ago.

Also, keep in mind that while VFSUX is fairly stable it did take a 10% hit in a fairly rapid move during the financial crisis. So, in a high-volatility environment (even well short of Financial Crisis extremes) there is a risk of loss of principal which should not be present in MMF.

Finally, this has been mentioned in other threads, but if you do decide to go the money market fund route, consider Vanguard Treasury Money Market as an alternative to Prime. Due to recent SEC regs, in high-volatility scenarios where MMF liquidity is perceived to be at risk, Prime funds may be exposed to required "gates" (restrictions on withdrawals) and "fees" (actual haircuts on money withdrawn) requirements that funds solely invested in short-term treasuries are not exposed to. (While such funds may still *voluntarily* impose such restrictions, Vanguard has explicitly stated it does not intend to do so.) Here is Vanguard's little primer on the subject: https://institutional.vanguard.com/VGAp ... rketReform

And while Vanguard Prime's interest rate is a bit higher than the Treasury-only fund, note that Treasury is exempt from state income tax. If you're in a high-tax state that narrows Prime's rate advantage quite a bit.

Smectym

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zaplunken
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by zaplunken » Sun Feb 04, 2018 9:03 pm

I haven't paid a penny in state income tax since I retired over 10 years ago but RMDs will definitely cause that to happen. I'll look at your link and the Treasury Money Market fund. I prefer to park the STIG money for a number of years, I don't see any reason to allocate it to something else but who knows?

smectym
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by smectym » Sun Feb 04, 2018 10:13 pm

Fair enough, Of course the longer the time horizon the less you need to be concerned about volatility.

rerod
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by rerod » Sat Feb 10, 2018 2:09 pm

smectym wrote:
Sun Feb 04, 2018 8:57 pm
Consider Vanguard Treasury Money Market as an alternative to Prime. Due to recent SEC regs, in high-volatility scenarios where MMF liquidity is perceived to be at risk, Prime funds may be exposed to required "gates" (restrictions on withdrawals) and "fees" (actual haircuts on money withdrawn) requirements that funds solely invested in short-term treasuries are not exposed to. (While such funds may still *voluntarily* impose such restrictions, Vanguard has explicitly stated it does not intend to do so.) Here is Vanguard's little primer on the subject: https://institutional.vanguard.com/VGAp ... rketReform

And while Vanguard Prime's interest rate is a bit higher than the Treasury-only fund, note that Treasury is exempt from state income tax. If you're in a high-tax state that narrows Prime's rate advantage quite a bit.

Smectym
Thanks for that smectym. Do you feel Vanguard might impose "gates" (restrictions on withdrawals) and "fees" (actual haircuts on money withdrawn)?

I have used Prime in the past in my taxable because of better rates than my bank can offer. But I'm wondering if Vanguard Treasury Money Market would be a safer option. I used total bond 6 years ago as a bank account and have learned the hard way about rate hikes.

Thanks

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zaplunken
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by zaplunken » Sat Feb 10, 2018 10:00 pm

The 10 year Treasury note shot up about 20-25 bp in a week and the effect on the STIG fund was noticeable in the January statement. I made $219 in dividends for January but the balance dropped by $400 so that's a $619 loss in nav offset a bit by the dividend. If the 10 year goes up a few bp per month the STIG fund would probably be better than the Prime Money Market. But if rates rise fast, like from the 2.6 to 2.85% level, then the PMM probably is better because had I moved the money in the STIG fund on 1/1/18 I would have made $131 in dividends and not lost $400 to the drop in the nav even while getting $219 in dividends.

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zaplunken
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by zaplunken » Tue Feb 13, 2018 4:39 pm

I came across this quote from another thread
Since the rule of thumb is interest rate change X years of duration = NAV change, we can reasonable expect three interest rate increases of .25% to decrease a fund with a 2.76 year duration an additional 2.07% of NAV or so this coming year.


The duration of the Short Term Investment Grade bond fund is 2.7 years so since we expect three 0.25% Fed rate hikes it is reasonable to think that the STIG fund will also increase in it's yield and experience a drop in nav. So (0.25% * 3) * 2.7 year duration = 2.02% reducing the STIG return from the current 2.64% SEC yield - 2% nav loss = 0.64% yield.

The Prime Money Market will also probably increase in it's yield with 3 Fed hikes and currently the SEC yield is 1.46% with no nav loss.

Now I have looked at month end statements and my STIG amount is decreasing a few hundred dollars a month and that means the $220 in interest is holding that up by $220 and the loss is several hundred dollars.

I did some simple math and the PMM isn't suffering any nav loss and despite getting just a pinch more than half the STIG yield I'd be ahead each month without the nav loss in the STIG fund. I am looking at this in a rollover IRA whose money I don't need to take distributions for income or an RMD and just this year alone, much less rate hikes in 2019, I think the PMM makes more sense.

Again this seems like a no brainer to me but I wonder if I am missing something?

Hogan773
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by Hogan773 » Tue Feb 13, 2018 5:45 pm

zaplunken wrote:
Tue Feb 13, 2018 4:39 pm
I came across this quote from another thread
Since the rule of thumb is interest rate change X years of duration = NAV change, we can reasonable expect three interest rate increases of .25% to decrease a fund with a 2.76 year duration an additional 2.07% of NAV or so this coming year.


The duration of the Short Term Investment Grade bond fund is 2.7 years so since we expect three 0.25% Fed rate hikes it is reasonable to think that the STIG fund will also increase in it's yield and experience a drop in nav. So (0.25% * 3) * 2.7 year duration = 2.02% reducing the STIG return from the current 2.64% SEC yield - 2% nav loss = 0.64% yield.

The Prime Money Market will also probably increase in it's yield with 3 Fed hikes and currently the SEC yield is 1.46% with no nav loss.

Now I have looked at month end statements and my STIG amount is decreasing a few hundred dollars a month and that means the $220 in interest is holding that up by $220 and the loss is several hundred dollars.

I did some simple math and the PMM isn't suffering any nav loss and despite getting just a pinch more than half the STIG yield I'd be ahead each month without the nav loss in the STIG fund. I am looking at this in a rollover IRA whose money I don't need to take distributions for income or an RMD and just this year alone, much less rate hikes in 2019, I think the PMM makes more sense.

Again this seems like a no brainer to me but I wonder if I am missing something?
I have been having similar thoughts

What you (and we) are "missing" is that the rate increases aren't a given. The Fed MIGHT keep increasing rates and that is at the very short end, and the rest of the yield curve MIGHT also rise in lockstep, or more (steeper) or less (shallower). Is the current yield curve already baking in those expectations? Maybe. So if market rates DON'T increase as you "know" they will, then the higher yielding option will outperform with no decline in NAV. And as we've seen in the past, rates could even go down, in which case the bond fund would really outperform.

If you "know" that rates are rising then you should absolutely be 100% in Stable Value or Money Market. But I have "known" rates were going to rise for like 4 years and only recently has it been happening.

MotoTrojan
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by MotoTrojan » Tue Feb 13, 2018 5:51 pm

Rate increases are priced into bonds with a likelihood of probability. When they actually occur, that probability goes to 100%, so you will see some change, but not the theoretical full change in NAV per % interest rate increase.

In your situation though, a money-market might not be a terrible place to be for a shorter horizon. I wonder if there are other options within your IRA, like a brokered CD, that would have a more predictable payout that exceeds the MM account? Taking your RMD's you probably come out ahead getting a taxable CD ladder in place even, over the ~1.5% you are getting in PMM.

lack_ey
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by lack_ey » Tue Feb 13, 2018 6:40 pm

There's a 0.76% spread between the 1-month and 2-year Treasury rates because the market expects some further rate hikes. You can furthermore see it in the futures pricing.

In 2017 we had three rate hikes, and long Treasury bonds beat intermediate, which beat T-bills, with short-term being the worst. The answer is that it really depends on what happens relative to expectations and then how things are priced in the future. Timing interest rates is difficult for a lot of reasons.

I will say that if you don't require actually stable NAV, Vanguard has a shorter-duration fund in the form of Vanguard Ultra-Short-Term Bond Fund (VUSFX, VUBFX) if you want to potentially squeeze something out of today's relatively compressed credit spreads and hope that doesn't backfire.

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zaplunken
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by zaplunken » Tue Feb 13, 2018 7:35 pm

True we don't know how the STIG or the PMM funds will behave when the Fed raises rates, isn't mid March the next meeting? I am thinking funds both will move a little, the increase from 2.6x% to 2.8x% was so fast that it was surprising and that was on inflation fears and the fear of a 4th rate hike. Both those funds being short term and the Fed controlling short term rate I'd think that they are more susceptible to an increased yield than not but that's an assumption.

The Vanguard Ultra-Short-Term Bond Fund Admiral Shares (VUSFX) is interesting, I was not aware of it. Maybe I didn't look close enough at the bond funds? It has an SEC yield of 1.98% which is just over a half percent more than the PMM and it has a very low duration of 0.9 years. This may well be a good option for a while! Thanks lack_ey!

smectym
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by smectym » Tue Feb 13, 2018 11:43 pm

Rerod, Vanguard Prime is a very safe and well-run fund. Nevertheless, on the blackboard the Treasury fund is a safer option. It’s the option I would go with, and my reasoning doesn’t go beyond Vanguard’s own disclosures: Prime is potentially subject to “mandatory” gates and fees under certain extreme market conditions; Treasury is not subject to those mandates.

This consideration applies chiefly to money parked long-term in a money market fund as part of the “safety corner” of ones portfolio. If safety is the overriding objective, go for “safest” over “safe” or “safer.”

Smectym


rerod wrote:
Sat Feb 10, 2018 2:09 pm
smectym wrote:
Sun Feb 04, 2018 8:57 pm
Consider Vanguard Treasury Money Market as an alternative to Prime. Due to recent SEC regs, in high-volatility scenarios where MMF liquidity is perceived to be at risk, Prime funds may be exposed to required "gates" (restrictions on withdrawals) and "fees" (actual haircuts on money withdrawn) requirements that funds solely invested in short-term treasuries are not exposed to. (While such funds may still *voluntarily* impose such restrictions, Vanguard has explicitly stated it does not intend to do so.) Here is Vanguard's little primer on the subject: https://institutional.vanguard.com/VGAp ... rketReform

And while Vanguard Prime's interest rate is a bit higher than the Treasury-only fund, note that Treasury is exempt from state income tax. If you're in a high-tax state that narrows Prime's rate advantage quite a bit.

Smectym
Thanks for that smectym. Do you feel Vanguard might impose "gates" (restrictions on withdrawals) and "fees" (actual haircuts on money withdrawn)?

I have used Prime in the past in my taxable because of better rates than my bank can offer. But I'm wondering if Vanguard Treasury Money Market would be a safer option. I used total bond 6 years ago as a bank account and have learned the hard way about rate hikes.

Thanks

smectym
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by smectym » Wed Feb 14, 2018 12:07 am

Rerod, to more specifically answer your direct question, Vanguard states that it “is prepared to impose gates and fees on non-government money funds if it becomes necessary.” So, yes, I think they “might.”

Smectym

smectym
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by smectym » Wed Feb 14, 2018 11:10 pm

zaplunken wrote:
Tue Feb 13, 2018 7:35 pm
True we don't know how the STIG or the PMM funds will behave when the Fed raises rates, isn't mid March the next meeting? I am thinking funds both will move a little, the increase from 2.6x% to 2.8x% was so fast that it was surprising and that was on inflation fears and the fear of a 4th rate hike. Both those funds being short term and the Fed controlling short term rate I'd think that they are more susceptible to an increased yield than not but that's an assumption.

The Vanguard Ultra-Short-Term Bond Fund Admiral Shares (VUSFX) is interesting, I was not aware of it. Maybe I didn't look close enough at the bond funds? It has an SEC yield of 1.98% which is just over a half percent more than the PMM and it has a very low duration of 0.9 years. This may well be a good option for a while! Thanks lack_ey!
Zaplunken, Another approach to consider: Vanguard Short Term Treasury ETF. Current SEC yield 2.04%; ER .07%

https://advisors.vanguard.com/web/cf/fa ... 2/overview

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zaplunken
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Re: The Prime Money Market vs the Short Term Investment Grade bond fund question

Post by zaplunken » Thu Feb 15, 2018 7:58 am

Safer than some of the others being a treasury fund but the duration is high with basically the same yield as the Ultra Short Term fund. Duration is something I am trying to avoid but thanks for the info.

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