Effect of interest rates on my bond funds

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Seneca3
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Effect of interest rates on my bond funds

Post by Seneca3 » Sun Mar 11, 2018 4:32 pm

Hi everyone,

I have been a long-time fan of this page, and this is my first post here. I am currently in my late 30s and have my allocated my portfolio with 15-20% bond funds currently (mostly Vanguard intermediate muni bond funds since I'm in the 33% tax bracket).

My question is:

With the rising interest rates, how will this affect the bond price and yields?
Should I change my allocation and invest in cash/CDs instead if I was originally looking for stability in bonds?

Forgive me as I am new to investing as of this year - thank you again for all your help.

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patrick013
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Re: Effect of interest rates on my bond funds

Post by patrick013 » Sun Mar 11, 2018 6:31 pm

Bond Duration - How to Calculate Interest Rate Risk on a Bond

Interest Rates and Bond Prices: An Inverse Relationship

The above should explain it. They're pretty basic. Buyers like higher rates and
sellers do not.
age in bonds, buy-and-hold, 10 year business cycle

mega317
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Re: Effect of interest rates on my bond funds

Post by mega317 » Sun Mar 11, 2018 6:48 pm

However, the coming rate increases are already priced in. Look at the NAV of some bond funds over the last 6 months. What you are proposing is market timing like any other, which can't be successfully done. This has been discussed a lot recently, search for something like "shorten duration".

If you wanted so much stability in your fixed income that the current environment makes you uncomfortable, then you probably should have been in less volatile funds all along.

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Clever_Username
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Re: Effect of interest rates on my bond funds

Post by Clever_Username » Sun Mar 11, 2018 7:39 pm

How long are you holding the bonds for?

Short of a rapid jump in rates, it's unlikely there's a significant change in the value of your bonds. Rates go up, yields go up, NAV goes down a bit. Bonds come due, face value gets reinvested in the new higher rate bonds, NAV goes up as the bonds become more valuable.

From your age, it's unlikely you need the money from the bond funds soon. They're much less volatile than stock funds and will serve their purpose.
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_

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Re: Effect of interest rates on my bond funds

Post by AlohaJoe » Sun Mar 11, 2018 8:08 pm

Seneca3 wrote:
Sun Mar 11, 2018 4:32 pm
With the rising interest rates, how will this affect the bond price and yields?
I don't feel you got a very good answer to this question, so let me give it a shot.

The Federal Reserve only affects the interest rate of overnight loans between banks. It shouldn't be a surprise to learn that there isn't a perfect relationship between the rates of an 8-hour loan and a 1-year loan or a 10-year loan or a 30-year loan. There are other factors in play that affect the market price for a bond besides the interest rate on an 8-hour loan between banks. Sure, that is important information. But it isn't the only information.

This is the yield on 10-year US government Treasures during 2017:

Image

You can see that every day it was changing. The Fed certainly wasn't changing rates every day. Other factors caused it to change. When you look at that chart try to guess what actions the Fed was taking? What did they do between July 7 and September 7 that caused yields to drop by 0.34%? Yields started the year at 2.45% and ended the year at 2.40%...despite three rate increases.

So while the Federal funds rate is an important driver of longer bond rates, it isn't the only thing.
Should I change my allocation and invest in cash/CDs instead if I was originally looking for stability in bonds?
No, you shouldn't.

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patrick013
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Re: Effect of interest rates on my bond funds

Post by patrick013 » Sun Mar 11, 2018 8:30 pm

mega317 wrote:
Sun Mar 11, 2018 6:48 pm
However, the coming rate increases are already priced in.
If pricing was efficient the yield on the 10 year TRSY would be way
over 3%. I don't think the market believes the rate increases will
actually happen.
AlohaJoe wrote:
Sun Mar 11, 2018 8:08 pm
So while the Federal funds rate is an important driver of longer bond rates,
it isn't the only thing.
The FFR has a correlation to the 10 year TRSY of .90 and a mean spread
of over 1%. Supply and demand are important. Right now yields are
climbing because of fewer buyers. If one was to take a strategy long term
bonds certainly wouldn't be it.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Effect of interest rates on my bond funds

Post by AlohaJoe » Sun Mar 11, 2018 9:30 pm

AlohaJoe wrote:
Sun Mar 11, 2018 8:08 pm
Seneca3 wrote:
Sun Mar 11, 2018 4:32 pm
Should I change my allocation and invest in cash/CDs instead if I was originally looking for stability in bonds?
No, you shouldn't.
I wanted to edit this to add: no one ever said that bonds are "stable". They are just "more stable" than stocks. They have volatility, though it is significantly smaller. The vast majority of books that Bogleheads recommend go over this and talk about how bonds can lose money and have lost money. If you aren't able to handle any volatility in your principle then yes, go ahead and invest in cash and CDs. This forum has its fair share of people who freak out when their bond fund drops 2%. But that isn't about "rising rates". That's just that bonds were always the wrong investment for their personal psychology.

Seneca3
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Re: Effect of interest rates on my bond funds

Post by Seneca3 » Sun Mar 11, 2018 9:37 pm

Wow - thanks everyone, AlohaJoe, Patrick, Clever - that was very helpful! You all explained it to me in a way that made a lot more sense.

Clever, I currently have the Vanguard Intermediate-Term Tax-Exempt Fund Admiral Shares (VWIUX) - according to the Vanguard site it says the average duration is about 5-6 years, and I intend to hold the fund for that amount of time or longer.

It says the fund is actively managed so I'm assuming maybe the managers are buying more short term bonds in the fund in response to the interest rate increase? Anyways, thanks again for your help - I think I will stick with this fund for now.

alex_686
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Re: Effect of interest rates on my bond funds

Post by alex_686 » Sun Mar 11, 2018 9:56 pm

Seneca3 wrote:
Sun Mar 11, 2018 9:37 pm
It says the fund is actively managed so I'm assuming maybe the managers are buying more short term bonds in the fund in response to the interest rate increase? Anyways, thanks again for your help - I think I will stick with this fund for now.
Welcome to the forum. Without doing any research I am going to say no. From a strict theoretical view all future expected interest rates changes are already priced in. This is mostly born out on the practical side. The bond market is brutal and efficient. There is some debate if this is fully captured with longer term bonds and their might be some extra premium there.

Seneca3
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Re: Effect of interest rates on my bond funds

Post by Seneca3 » Sun Mar 11, 2018 10:40 pm

Thank you Alex! That makes sense - there is more information available so it is more efficient.

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patrick013
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Re: Effect of interest rates on my bond funds

Post by patrick013 » Tue Mar 13, 2018 11:19 am

Seneca3 wrote:
Sun Mar 11, 2018 4:32 pm

With the rising interest rates, how will this affect the bond price and yields?
Image

The start and end of a major long term trend.

If an investor was clairvoyant or had good forecasts from the FED he would
like longer term maturities when rates are falling and shorter term when
rates are rising so new bonds have the higher coupons.

Even with small but steady rate increases observed returns will be smaller
I think in the current trend.
age in bonds, buy-and-hold, 10 year business cycle

hudson
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Re: Effect of interest rates on my bond funds

Post by hudson » Tue Mar 13, 2018 11:51 am

Seneca3 wrote:
Sun Mar 11, 2018 9:37 pm
Clever, I currently have the Vanguard Intermediate-Term Tax-Exempt Fund Admiral Shares (VWIUX) - according to the Vanguard site it says the average duration is about 5-6 years, and I intend to hold the fund for that amount of time or longer.
It says the fund is actively managed so I'm assuming maybe the managers are buying more short term bonds in the fund in response to the interest rate increase? Anyways, thanks again for your help - I think I will stick with this fund for now.
I would say that the fund managers are buying and selling bonds to meet their goals of being an intermediate term fund.
You probably already know about Vanguard's short term and limited term munis. Consider those if worried about rising rates.
I'm not convinced that rates are rising. Nobody knows where the stock or bond markets are going. My plan is to buy and hold VWIUX or the like and disregard talk of rising rates.

rkhusky
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Re: Effect of interest rates on my bond funds

Post by rkhusky » Tue Mar 13, 2018 12:48 pm

Go to morningstar.com and make a plot of Vanguard Total Stock Market, versus Total Bond Market and Prime Money Market over the past 20+ years. It is a good depiction of the difference in risk and return between stocks, bonds and cash.

billyt
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Re: Effect of interest rates on my bond funds

Post by billyt » Tue Mar 13, 2018 2:06 pm

OK, just want to weight in on the chart that Patrick013 posted: the so-called bond market 'bear' and 'bull'. I think there is a major misunderstanding here. The bond returns shown have little to do with the 'trends' (rising and falling) in interest rates, but rather with the interest rate at the beginning of the observed period. With bonds, and bond funds, you get approximately what you sign up for. If you invested in 1950, when rates were 2%, you subsequently got about a 2% return. If you invested in bonds around 1980, when rates were about 14%, your subsequent returns were around 14%. If rates had continued to rise, or stay the same after 1980, it would not have much effect on the returns of the bonds (or band funds)nyou bought then. If anything, you would have had an even better return with a bond fund under rising rates after 1980.

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patrick013
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Re: Effect of interest rates on my bond funds

Post by patrick013 » Tue Mar 13, 2018 5:20 pm

billyt wrote:
Tue Mar 13, 2018 2:06 pm
If rates had continued to rise, or stay the same after 1980, it would not have much effect on the returns of the bonds (or band funds)nyou bought then. If anything, you would have had an even better return with a bond fund under rising rates after 1980.
The total returns observed for each period were from a 10 year TRSY
bond index the author monitors. A 30 year period starting in 1950
and another 30 year period starting in 1981. I don't know if the index
was 100% buy and hold, it doesn't say. Probably just a 10 year average
based on annual purchases and later interest and NAV's before maturity
to calc a total return. Here's the article if you want to review it.

The Cost of Waiting
age in bonds, buy-and-hold, 10 year business cycle

billyt
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Re: Effect of interest rates on my bond funds

Post by billyt » Wed Mar 14, 2018 10:25 am

Again, the returns of bonds or bond funds are known in advance. You get, more or less, the interest rate in effect at the time you buy. With a bond fund (or a rolling bond ladder), you returns will follow the evolving changes in interest rates. You can confirm this for yourself by looking at the rolling returns of any bond fund, which mimic, with a lag on the order of the fund duration, the changes in interest rates for that specific type of bond over the time period you are looking at. It has little or nothing to do with 'rising or falling rate environments' (interest rate trends) creating 'bear' and 'bull' markets in bonds. I stress this because there seems to be a significant misunderstanding by many, as evidenced by all the 'should I buy bonds in a rising rate environment' threads. Yes, interest rates appear historically low now, which tells you returns going forward for bonds or bond funds purchased today will be lower than the historic average. However, an investor can only collect the returns that the market offers.

Interestingly, the paper you linked came to a couple of primary conclusions:
1) Trying to time the bond market is futile.
2) One should match bond duration to the timing of spending needs.

I think most bogleheads agree with these principles.

dbr
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Re: Effect of interest rates on my bond funds

Post by dbr » Wed Mar 14, 2018 10:33 am

billyt wrote:
Wed Mar 14, 2018 10:25 am

2) One should match bond duration to the timing of spending needs.

I think most bogleheads agree with these principles.
Yes, but the caveat is that most of us, meaning people accumulating wealth during our working years and then spending that wealth in retirement don't have a specific timing of our spending needs. Accumulation is thirty years or more of not spending and retirement is probably planned to be another thirty years of small increments of withdrawals. The result is that there is no timing of spending needs in the sense of matching a duration. That is why it is perfectly reasonable to just invest in some diversified collection of on average intermediate term bonds and leave it alone.

I guess I would actually suggest that 2) above does not apply almost all the time.

Angst
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Re: Effect of interest rates on my bond funds

Post by Angst » Wed Mar 14, 2018 11:00 am

patrick013 wrote:
Tue Mar 13, 2018 11:19 am
Seneca3 wrote:
Sun Mar 11, 2018 4:32 pm
With the rising interest rates, how will this affect the bond price and yields?
Image

The start and end of a major long term trend.
[snip...]

I prefer to call it the "ending" rather than the "end"; time will eventually let us know once it has actually ended. And whether it takes 5 to 10 yrs to actually bottom out, or perhaps 50 to 100 yrs to do so (let alone for rates to significantly rise again!), I can't really justify my expecting one over the other. I do love all the pics though:

Image


A couple more interesting graphics, too large for BB to display:

https://static1.squarespace.com/static/ ... 1941669998
https://philebersole.files.wordpress.co ... suries.png

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Re: Effect of interest rates on my bond funds

Post by triceratop » Wed Mar 14, 2018 11:15 am

alex_686 wrote:
Sun Mar 11, 2018 9:56 pm
Seneca3 wrote:
Sun Mar 11, 2018 9:37 pm
It says the fund is actively managed so I'm assuming maybe the managers are buying more short term bonds in the fund in response to the interest rate increase? Anyways, thanks again for your help - I think I will stick with this fund for now.
Welcome to the forum. Without doing any research I am going to say no. From a strict theoretical view all future expected interest rates changes are already priced in. This is mostly born out on the practical side. The bond market is brutal and efficient. There is some debate if this is fully captured with longer term bonds and their might be some extra premium there.
Isn't the debate about long-term bonds more that they're overpriced due to pension funds with fixed long-term nominal liabilities?
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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patrick013
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Re: Effect of interest rates on my bond funds

Post by patrick013 » Wed Mar 14, 2018 1:32 pm

Angst wrote:
Wed Mar 14, 2018 11:00 am

A couple more interesting graphics, too large for BB to display:
Yes, thanks for the pics, shows the full story.
age in bonds, buy-and-hold, 10 year business cycle

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Abe
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Re: Effect of interest rates on my bond funds

Post by Abe » Wed Mar 14, 2018 2:56 pm

billyt wrote:
Tue Mar 13, 2018 2:06 pm
OK, just want to weight in on the chart that Patrick013 posted: the so-called bond market 'bear' and 'bull'. I think there is a major misunderstanding here. The bond returns shown have little to do with the 'trends' (rising and falling) in interest rates, but rather with the interest rate at the beginning of the observed period. With bonds, and bond funds, you get approximately what you sign up for. If you invested in 1950, when rates were 2%, you subsequently got about a 2% return. If you invested in bonds around 1980, when rates were about 14%, your subsequent returns were around 14%. If rates had continued to rise, or stay the same after 1980, it would not have much effect on the returns of the bonds (or band funds)nyou bought then. If anything, you would have had an even better return with a bond fund under rising rates after 1980.
Guess I'll show my ignorance here. I've always had a problem understanding this concept. Are you saying if I buy an individual bond and lets say the rate is 2%, then if I hold that bond to maturity, my return will be 2%. This seems so obvious that it hardly seems necessary to mention. It's got to be more complicated than that. What am I missing?
Slow and steady wins the race.

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Re: Effect of interest rates on my bond funds

Post by hudson » Wed Mar 14, 2018 2:58 pm

Abe wrote:
Wed Mar 14, 2018 2:56 pm
Are you saying if I buy an individual bond and lets say the rate is 2%, then if I hold that bond to maturity, my return will be 2%. This seems so obvious that it hardly seems necessary to mention. It's got to be more complicated than that. What am I missing?
You already know this...but maybe income taxes

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Re: Effect of interest rates on my bond funds

Post by aristotelian » Wed Mar 14, 2018 2:59 pm

Prices of existing bonds goes down, yield (relative to price) increases.

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Re: Effect of interest rates on my bond funds

Post by CantPassAgain » Wed Mar 14, 2018 4:18 pm

Abe wrote:
Wed Mar 14, 2018 2:56 pm
billyt wrote:
Tue Mar 13, 2018 2:06 pm
OK, just want to weight in on the chart that Patrick013 posted: the so-called bond market 'bear' and 'bull'. I think there is a major misunderstanding here. The bond returns shown have little to do with the 'trends' (rising and falling) in interest rates, but rather with the interest rate at the beginning of the observed period. With bonds, and bond funds, you get approximately what you sign up for. If you invested in 1950, when rates were 2%, you subsequently got about a 2% return. If you invested in bonds around 1980, when rates were about 14%, your subsequent returns were around 14%. If rates had continued to rise, or stay the same after 1980, it would not have much effect on the returns of the bonds (or band funds)nyou bought then. If anything, you would have had an even better return with a bond fund under rising rates after 1980.
Guess I'll show my ignorance here. I've always had a problem understanding this concept. Are you saying if I buy an individual bond and lets say the rate is 2%, then if I hold that bond to maturity, my return will be 2%. This seems so obvious that it hardly seems necessary to mention. It's got to be more complicated than that. What am I missing?
If you for some reason need to sell the bond before maturity and all your potential buyers can buy newer bonds with similar maturities yielding 2.5% then you will have to discount your stinky bond to get someone to buy it, so that the buyer will have an effective yield of at least 2.5%.

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Re: Effect of interest rates on my bond funds

Post by Clever_Username » Wed Mar 14, 2018 4:30 pm

CantPassAgain wrote:
Wed Mar 14, 2018 4:18 pm
Abe wrote:
Wed Mar 14, 2018 2:56 pm
billyt wrote:
Tue Mar 13, 2018 2:06 pm
OK, just want to weight in on the chart that Patrick013 posted: the so-called bond market 'bear' and 'bull'. I think there is a major misunderstanding here. The bond returns shown have little to do with the 'trends' (rising and falling) in interest rates, but rather with the interest rate at the beginning of the observed period. With bonds, and bond funds, you get approximately what you sign up for. If you invested in 1950, when rates were 2%, you subsequently got about a 2% return. If you invested in bonds around 1980, when rates were about 14%, your subsequent returns were around 14%. If rates had continued to rise, or stay the same after 1980, it would not have much effect on the returns of the bonds (or band funds)nyou bought then. If anything, you would have had an even better return with a bond fund under rising rates after 1980.
Guess I'll show my ignorance here. I've always had a problem understanding this concept. Are you saying if I buy an individual bond and lets say the rate is 2%, then if I hold that bond to maturity, my return will be 2%. This seems so obvious that it hardly seems necessary to mention. It's got to be more complicated than that. What am I missing?
If you for some reason need to sell the bond before maturity and all your potential buyers can buy newer bonds with similar maturities yielding 2.5% then you will have to discount your stinky bond to get someone to buy it, so that the buyer will have an effective yield of at least 2.5%.
Yes, but that bond has a shorter duration now, right? I know there's some math to it, and I could probably figure it out.

Say I held an individual bond -- say, a 10 year 3% yield. 5 years from now, it's basically a 5 year bond left if I try to sell it, and the then-current interest rate on 5 year bonds would be the issue, right?

I could be totally off on this.
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_

CantPassAgain
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Re: Effect of interest rates on my bond funds

Post by CantPassAgain » Wed Mar 14, 2018 4:34 pm

Clever_Username wrote:
Wed Mar 14, 2018 4:30 pm
CantPassAgain wrote:
Wed Mar 14, 2018 4:18 pm
Abe wrote:
Wed Mar 14, 2018 2:56 pm
billyt wrote:
Tue Mar 13, 2018 2:06 pm
OK, just want to weight in on the chart that Patrick013 posted: the so-called bond market 'bear' and 'bull'. I think there is a major misunderstanding here. The bond returns shown have little to do with the 'trends' (rising and falling) in interest rates, but rather with the interest rate at the beginning of the observed period. With bonds, and bond funds, you get approximately what you sign up for. If you invested in 1950, when rates were 2%, you subsequently got about a 2% return. If you invested in bonds around 1980, when rates were about 14%, your subsequent returns were around 14%. If rates had continued to rise, or stay the same after 1980, it would not have much effect on the returns of the bonds (or band funds)nyou bought then. If anything, you would have had an even better return with a bond fund under rising rates after 1980.
Guess I'll show my ignorance here. I've always had a problem understanding this concept. Are you saying if I buy an individual bond and lets say the rate is 2%, then if I hold that bond to maturity, my return will be 2%. This seems so obvious that it hardly seems necessary to mention. It's got to be more complicated than that. What am I missing?
If you for some reason need to sell the bond before maturity and all your potential buyers can buy newer bonds with similar maturities yielding 2.5% then you will have to discount your stinky bond to get someone to buy it, so that the buyer will have an effective yield of at least 2.5%.
Yes, but that bond has a shorter duration now, right? I know there's some math to it, and I could probably figure it out.

Say I held an individual bond -- say, a 10 year 3% yield. 5 years from now, it's basically a 5 year bond left if I try to sell it, and the then-current interest rate on 5 year bonds would be the issue, right?

I could be totally off on this.
Yeah. Just think about what you would do if you were shopping for 5 year bond. 10 year bond with 5 years left at 2% or a similar risk instrument with 5 years left that pays 2.5%. You are gonna do some math to price out the 2% bond, right?

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Re: Effect of interest rates on my bond funds

Post by Abe » Wed Mar 14, 2018 4:35 pm

CantPassAgain wrote:
Wed Mar 14, 2018 4:18 pm
Abe wrote:
Wed Mar 14, 2018 2:56 pm
billyt wrote:
Tue Mar 13, 2018 2:06 pm
OK, just want to weight in on the chart that Patrick013 posted: the so-called bond market 'bear' and 'bull'. I think there is a major misunderstanding here. The bond returns shown have little to do with the 'trends' (rising and falling) in interest rates, but rather with the interest rate at the beginning of the observed period. With bonds, and bond funds, you get approximately what you sign up for. If you invested in 1950, when rates were 2%, you subsequently got about a 2% return. If you invested in bonds around 1980, when rates were about 14%, your subsequent returns were around 14%. If rates had continued to rise, or stay the same after 1980, it would not have much effect on the returns of the bonds (or band funds)nyou bought then. If anything, you would have had an even better return with a bond fund under rising rates after 1980.
Guess I'll show my ignorance here. I've always had a problem understanding this concept. Are you saying if I buy an individual bond and lets say the rate is 2%, then if I hold that bond to maturity, my return will be 2%. This seems so obvious that it hardly seems necessary to mention. It's got to be more complicated than that. What am I missing?
If you for some reason need to sell the bond before maturity and all your potential buyers can buy newer bonds with similar maturities yielding 2.5% then you will have to discount your stinky bond to get someone to buy it, so that the buyer will have an effective yield of at least 2.5%.
Yes, I understand that. If rates go up I would have to discount my bond and therefore my yield would be reduced. By the same token, if interest rates go down, I would get a premium if I sold it, so my yield would be more, right? But this is what I don't understand, billyt wrote: "With bonds, and bond funds, you get approximately what you sign up for". In either of the two cases above, I'm not getting what I signed up for, I'm getting either more or less than I signed up for. The only way I would be getting what I signed up for would be if interest rates stayed the same, yes/no?
Slow and steady wins the race.

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Re: Effect of interest rates on my bond funds

Post by CantPassAgain » Wed Mar 14, 2018 4:38 pm

Abe wrote:
Wed Mar 14, 2018 4:35 pm
CantPassAgain wrote:
Wed Mar 14, 2018 4:18 pm
Abe wrote:
Wed Mar 14, 2018 2:56 pm
billyt wrote:
Tue Mar 13, 2018 2:06 pm
OK, just want to weight in on the chart that Patrick013 posted: the so-called bond market 'bear' and 'bull'. I think there is a major misunderstanding here. The bond returns shown have little to do with the 'trends' (rising and falling) in interest rates, but rather with the interest rate at the beginning of the observed period. With bonds, and bond funds, you get approximately what you sign up for. If you invested in 1950, when rates were 2%, you subsequently got about a 2% return. If you invested in bonds around 1980, when rates were about 14%, your subsequent returns were around 14%. If rates had continued to rise, or stay the same after 1980, it would not have much effect on the returns of the bonds (or band funds)nyou bought then. If anything, you would have had an even better return with a bond fund under rising rates after 1980.
Guess I'll show my ignorance here. I've always had a problem understanding this concept. Are you saying if I buy an individual bond and lets say the rate is 2%, then if I hold that bond to maturity, my return will be 2%. This seems so obvious that it hardly seems necessary to mention. It's got to be more complicated than that. What am I missing?
If you for some reason need to sell the bond before maturity and all your potential buyers can buy newer bonds with similar maturities yielding 2.5% then you will have to discount your stinky bond to get someone to buy it, so that the buyer will have an effective yield of at least 2.5%.
Yes, I understand that. If rates go up I would have to discount my bond and therefore my yield would be reduced. By the same token, if interest rates go down, I would get a premium if I sold it, so my yield would be more, right? But this is what I don't understand, billyt wrote: "With bonds, and bond funds, you get approximately what you sign up for". In either of the two cases above, I'm not getting what I signed up for, I'm getting either more or less than I signed up for. The only way I would be getting what I signed up for would be if interest rates stayed the same, yes/no?
I guess so. I don't think you are missing anything. I would just say that if you bought a bond with a maturity and rate that you were satisfied with, and held to maturity, then barring default it's pretty fair to say you "got what you signed up for."

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patrick013
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Re: Effect of interest rates on my bond funds

Post by patrick013 » Wed Mar 14, 2018 4:46 pm

billyt wrote:
Wed Mar 14, 2018 10:25 am
However, an investor can only collect the returns that the market offers.

Interestingly, the paper you linked came to a couple of primary conclusions:
1) Trying to time the bond market is futile.
2) One should match bond duration to the timing of spending needs.

I think most bogleheads agree with these principles.
Well the author has some nice tables, etc. but he's selling his
products too. We'll see what happens. Some investors are
better served by bond funds for the long term. Others like
myself are Fed Watchers by design. If information is perfect
then certain things will happen. If information is slow and
uncertain then the cost of waiting can pile up. But I think
current info is fragmented and slow but leading to higher
rates for a long time. So half of my money is targeted for that
and I have no interest in long term maturities at present. Bogle's
last bond AA was 50-50 short and intermediate term bond funds
likewise.

I could end up being several years ahead in yield escaping bad
duration timing so I don't agree 100% with the author there either.
Just have to wait and see if the info becomes reality then.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Effect of interest rates on my bond funds

Post by alex_686 » Wed Mar 14, 2018 4:49 pm

triceratop wrote:
Wed Mar 14, 2018 11:15 am
Isn't the debate about long-term bonds more that they're overpriced due to pension funds with fixed long-term nominal liabilities?
Yes, and I think this is true.

My point was on forward rates.

In theory a 2 year bond yield should equal a 1 year bond plus a 1 year forward on a 1 year bond. That is, I buy a 1 year bond today, let it mature, and then buy another 1 year bond. Thanks to the forward and future markets I can actually do that. In practice this holds.

If that is true - and it is - then I can build a ladder of forward rates. After all, any long bond can be chopped down into smaller bonds. A 10 year bond can be viewed as 20 6-month bonds. This holds for maturities between 3 to 5 years. We can derive what the market expectations are and they are fairly accurate. However after this point theory and practice diverge. Why? Market segmentation is one answer - which you mention. Tail risk and liquidity risk is another.

Anyway, for whatever reason expected future changes are not fully incorporated in long bonds.

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Re: Effect of interest rates on my bond funds

Post by Clever_Username » Wed Mar 14, 2018 6:34 pm

CantPassAgain wrote:
Wed Mar 14, 2018 4:34 pm
Yeah. Just think about what you would do if you were shopping for 5 year bond. 10 year bond with 5 years left at 2% or a similar risk instrument with 5 years left that pays 2.5%. You are gonna do some math to price out the 2% bond, right?
This makes sense, thanks!
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_

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Re: Effect of interest rates on my bond funds

Post by stocknoob4111 » Wed Mar 14, 2018 7:20 pm

I know NAV/Yield has an inverse relationship when it comes to bonds however I have found past prices that are not in the same relationship that it is today. For instance VBTLX on 6/13/2003 had a NAV of 10.68 @ 4.44% yield, on 1/11/2018 it had a NAV of 10.69 @ 2.61% yield which proves that there are other factors affecting NAV besides interest rates.

I am guessing the NAV will go up irrespective of interest rate rises ultimately? I am confused by this though.

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Re: Effect of interest rates on my bond funds

Post by grabiner » Wed Mar 14, 2018 9:51 pm

stocknoob4111 wrote:
Wed Mar 14, 2018 7:20 pm
I know NAV/Yield has an inverse relationship when it comes to bonds however I have found past prices that are not in the same relationship that it is today. For instance VBTLX on 6/13/2003 had a NAV of 10.68 @ 4.44% yield, on 1/11/2018 it had a NAV of 10.69 @ 2.61% yield which proves that there are other factors affecting NAV besides interest rates.
The fund didn't hold the same bonds on those two dates. It sold bonds for a capital gain, and when this capital gain was distributed, it reduced the NAV but gave money to the investors which was not part of the reported yield.

In addition, if a bond is trading at a premium, its price will decline even if interest rates don't change. The reason the bond is at a premium is that it pays coupons higher than the market rate. As you receive these coupons, you use up the premium, and the bond price will fall towards the par value. When a bond matures, it will always be worth the par value.

The short-term relationship between bond prices and yields is still valid, by definition. If a bond has a 5-year duration, and the yield on that bond rises by 1%, the bond will lose 5% of its value. But if the bond is held to maturity, it will get back the lost value.
Wiki David Grabiner

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Re: Effect of interest rates on my bond funds

Post by Phineas J. Whoopee » Thu Mar 15, 2018 4:24 pm

patrick013 wrote:
Sun Mar 11, 2018 8:30 pm
...
If pricing was efficient the yield on the 10 year TRSY would be way
over 3%. I don't think the market believes the rate increases will
actually happen.
...
Individually disagreeing with the most recent price has nothing to do with market efficiency. I wrote about it here for stocks. The bond market is more fragmented but the same basic principles apply.

PJW

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Re: Effect of interest rates on my bond funds

Post by patrick013 » Thu Mar 15, 2018 4:45 pm

Phineas J. Whoopee wrote:
Thu Mar 15, 2018 4:24 pm
patrick013 wrote:
Sun Mar 11, 2018 8:30 pm
...
If pricing was efficient the yield on the 10 year TRSY would be way
over 3%. I don't think the market believes the rate increases will
actually happen.
...
Individually disagreeing with the most recent price has nothing to do with market efficiency. I wrote about it here for stocks. The bond market is more fragmented but the same basic principles apply.

PJW
I don't believe it, that you can't profit by perfect information. The EMH is
certainly different than the Efficient Market Theory which acknowledges
info is profitable in either perfect or imperfect form. The day after theory
would state perfect info the day after it becomes perfect with resultant
pricing changes included would lead to future profits. The EMH is mostly
verbiage to me not a unified approach. I wouldn't even consider it.
age in bonds, buy-and-hold, 10 year business cycle

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Phineas J. Whoopee
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Re: Effect of interest rates on my bond funds

Post by Phineas J. Whoopee » Thu Mar 15, 2018 4:50 pm

That isn't what the Efficient Market Hypothesis says, and I've never heard of any Efficient Market Theory except from people who mistake the word theory for hypothesis.
PJW

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Re: Effect of interest rates on my bond funds

Post by patrick013 » Thu Mar 15, 2018 6:15 pm

Phineas J. Whoopee wrote:
Thu Mar 15, 2018 4:50 pm
I've never heard of any Efficient Market Theory except from people who mistake the word theory for hypothesis.
Well you just did and that's exactly what it said. :D I got an A in
Advanced Finance Theory so I know it. There's actually 2 of them
obviously, a hypothesis and a theory. I prefer the theory as well as
several other things I've heard. A little further, I would never go to a
university that taught the Efficient Market Hypothesis but would gladly
go to a university that taught the Efficient Market Theory. I've paraphrased
it several times and it's right in the middle of my old Advanced Finance
Theory book and the EMH reads nothing like it. EMH gets none of my
money. It's a different train of thought, a completely different school of
finance. When I refer to EMT in no way am I using the EMH.

Have a good one.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Effect of interest rates on my bond funds

Post by triceratop » Thu Mar 15, 2018 6:25 pm

patrick013 wrote:
Thu Mar 15, 2018 6:15 pm
Phineas J. Whoopee wrote:
Thu Mar 15, 2018 4:50 pm
I've never heard of any Efficient Market Theory except from people who mistake the word theory for hypothesis.
Well you just did and that's exactly what it said. :D I got an A in
Advanced Finance Theory so I know it. There's actually 2 of them
obviously, a hypothesis and a theory. I prefer the theory as well as
several other things I've heard. A little further, I would never go to a
university that taught the Efficient Market Hypothesis but would gladly
go to a university that taught the Efficient Market Theory. I've paraphrased
it several times and it's right in the middle of my old Advanced Finance
Theory book and the EMH reads nothing like it. EMH gets none of my
money. It's a different train of thought, a completely different school of
finance. When I refer to EMT in no way am I using the EMH.

Have a good one.
Do you have a specific reference that I can look up? You mentioned a book, perhaps just a mention of the title of the book would be sufficient, so I can search within it.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Effect of interest rates on my bond funds

Post by patrick013 » Thu Mar 15, 2018 6:43 pm

triceratop wrote:
Thu Mar 15, 2018 6:25 pm
Do you have a specific reference that I can look up? You mentioned a book, perhaps just a mention of the title of the book would be sufficient, so I can search within it.
I wish I did, it was just Advanced Finance Theory. Even the google
hits do not explain it the way I was taught. The academic books have
to be accurate then. I'm going to replace the books at a later date,
before I move, but that could be awhile. Some of them I really miss.
I'm sure some schools teach EMT. Gitman's Managerial Finance book
doesn't, he teaches EMH.

I think EMH is geared towards mutual funds but the EMT is a very comfortable
unified approach I want to continue. Hypothesis vs Theory ? Don't know.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Effect of interest rates on my bond funds

Post by stocknoob4111 » Fri Mar 23, 2018 3:05 pm

For all those dissing bonds, how are your bonds doing now eh? VBTLX/BND is actually slightly up last few days while equities are spiraling down, I guess it's a reminder why we have bonds in our portfolios.

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Re: Effect of interest rates on my bond funds

Post by mega317 » Fri Mar 23, 2018 3:20 pm

Last 6 months my stocks are up about 3%, bonds down 3%.

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Re: Effect of interest rates on my bond funds

Post by alex_686 » Fri Mar 23, 2018 3:23 pm

patrick013 wrote:
Thu Mar 15, 2018 6:43 pm
I think EMH is geared towards mutual funds but the EMT is a very comfortable
unified approach I want to continue. Hypothesis vs Theory ? Don't know.
IIRC Fischer Black, Nobel winner, said that the markets look efficient from the bank of Cambridge, where he taught at MIT, but less efficient from the banks of the Hudson, where he ran a hedger firm.

EMH does not say that the market is perfectly efficient, expect in its strong formulation. Rather it states that the market is efficient because individuals squeeze out the anomalies and free money from he system. How good the market is at doing is under debate. The low hanging fruit has been plucked - one needs skill and luck to pick the higher hanging fruit.

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Re: Effect of interest rates on my bond funds

Post by stocknoob4111 » Fri Mar 23, 2018 3:27 pm

mega317 wrote:
Fri Mar 23, 2018 3:20 pm
Last 6 months my stocks are up about 3%, bonds down 3%.
that may be so but we are just now starting to experience market turbulence so we will see 6 months from now. People were predicting yield shock but yields are actually being very stubborn on the way up.... I think we may be headed towards a recession soon enough and that does not make a strong case of yields going up.

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Re: Effect of interest rates on my bond funds

Post by mega317 » Fri Mar 23, 2018 3:51 pm

stocknoob4111 wrote:
Fri Mar 23, 2018 3:27 pm
so we will see 6 months from now.
Well sure, you could say that every single day.
People were predicting
I think we may be
Yes but no one knows.

I actually lost track of why I responded to your prior post in the first place. I agree that bonds are good.

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Re: Effect of interest rates on my bond funds

Post by patrick013 » Fri Mar 23, 2018 4:33 pm

alex_686 wrote:
Fri Mar 23, 2018 3:23 pm
patrick013 wrote:
Thu Mar 15, 2018 6:43 pm
I think EMH is geared towards mutual funds but the EMT is a very comfortable
unified approach I want to continue. Hypothesis vs Theory ? Don't know.
IIRC Fischer Black, Nobel winner, said that the markets look efficient from the bank of Cambridge, where he taught at MIT, but less efficient from the banks of the Hudson, where he ran a hedger firm.

EMH does not say that the market is perfectly efficient, expect in its strong formulation. Rather it states that the market is efficient because individuals squeeze out the anomalies and free money from he system. How good the market is at doing is under debate. The low hanging fruit has been plucked - one needs skill and luck to pick the higher hanging fruit.
Well it takes account of the info even later in the day. The EMH I think is a
financial statistics rendition where the EMT I was taught appears to be from
financial economic sources. Equilibrium theory, supply and demand, information
efficiencies, then their EMT statement. All authors have slightly different
renditions so I trust the textbook version whenever I replace the textbook.
No big deal.

Either looks at the information.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Effect of interest rates on my bond funds

Post by Call_Me_Op » Sat Mar 24, 2018 6:29 am

patrick013 wrote:
Sun Mar 11, 2018 8:30 pm
mega317 wrote:
Sun Mar 11, 2018 6:48 pm
However, the coming rate increases are already priced in.
If pricing was efficient the yield on the 10 year TRSY would be way
over 3%. I don't think the market believes the rate increases will
actually happen.
That doesn't imply inefficiency. An efficient market is one where information is widely disseminated and priced in. It doesn't require a specific outcome.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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Re: Effect of interest rates on my bond funds

Post by patrick013 » Sat Mar 24, 2018 11:01 am

Call_Me_Op wrote:
Sat Mar 24, 2018 6:29 am
patrick013 wrote:
Sun Mar 11, 2018 8:30 pm
mega317 wrote:
Sun Mar 11, 2018 6:48 pm
However, the coming rate increases are already priced in.
If pricing was efficient the yield on the 10 year TRSY would be way
over 3%. I don't think the market believes the rate increases will
actually happen.
That doesn't imply inefficiency. An efficient market is one where information is widely disseminated and priced in. It doesn't require a specific outcome.
In my book it does. The main concern is when the FFR reaches it's peak
what does the market discern will be it's longevity. 1 year or 15 years.
Sure nobody knows but the market will still have to decide if that rate
will be constant. That will decide a 0% spread, a 1% spread, or even a
2% spread according to liquidity preference thru market pricing. This
year should be interesting as rate increases are being talked about quite
often. Rates have been low for so long it seems like the market doesn't
believe rates will ever rise or wants to wait as long as possible to lower
prices keeping the spread low. I don't disagree that the market uses all
information available just observing how they're using it.
Have to wait and see of course.

I use a EMT BTW which is different than the common EMH.
age in bonds, buy-and-hold, 10 year business cycle

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