Is it time to go shorter in bonds ?

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ruralavalon
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Re: Is it time to go shorter in bonds ?

Post by ruralavalon » Tue Sep 04, 2018 11:29 am

Culbretd wrote:
Tue Sep 04, 2018 8:14 am
aristotelian wrote:
Tue Sep 04, 2018 6:10 am
Culbretd wrote:
Tue Sep 04, 2018 5:34 am
Knowing absolutely nothing about bonds (disclosure) would it not be better for someone in their early 30’s or 20’s to hold long term bonds in their Roth IRA along with their Stocks? We are assuming here that this is an investment that will not be touched for 30 to 40 years. Will the long term bonds not give them the most return at th end of 30 years? We are also under the assumption that they rebalance with new contributions too to keep align with the IPS. I know this would lead to a lot of volatility in the Roth IRA but if one could handle that wouldn’t the greatest return be from long term bonds?

If I’ve missed something please correct my thinking; as it seems that is what pension funds seem to do (going for long term bonds.... correct?). Now once the individual gets closer to retirement they would start to use a glide path on the bond and start to shortened the duration of course but would it not make sense to go long when you are younger?
Arguably yes. Backtesting says that you would outperform a portfolio with intermediate bonds, with lower volatility. The question is, with a long timeframe, why would you be in bonds in the first place? If you are seeking return and have a high risk tolerance, 100% stock would seem to be the ideal approach.

Most people want bonds for stability, so intermediate is the general recommendation.
Very valid point. Thank you for pointing that out. Everyday I read this sight I learn something new or think about things in a different way.
Intermediate-term bonds is the compromise between higher return and greater stability.

As such it never feels totally satisfactory.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

Kevin8696
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Re: Is it time to go shorter in bonds ?

Post by Kevin8696 » Thu Oct 11, 2018 10:56 am

Question relating to the impact of rising interest rates.

Rule of thumb that I have heard... to estimate the price impact of a rate/yield increase, multiply the increase by the bond fund duration.

Using this formula, a 1.00% increase in rates for VG Total Bond Fund (VBTLX) with a duration of around 6 years, would result in a 6% drop in the price of the bonds/portfolio/fund. I fully understand that the new bonds in the portfolio will reflect higher interest rates.

Question is this... Assuming rates stay constant after a 1.00% increase, when will I get to back to even on the 6% hit to principal ?

If the SEC yield goes up by 1.00% and stays there, does this mean it will take me 6 years to get back to even ?

Thanks to all.

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vineviz
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Re: Is it time to go shorter in bonds ?

Post by vineviz » Thu Oct 11, 2018 11:13 am

Kevin8696 wrote:
Thu Oct 11, 2018 10:56 am
Question is this... Assuming rates stay constant after the increase, when will I get to back to even on the 6% hit to principal ?

If the SEC yield goes up by 1.00% and stays there, does this mean it will take me 6 years to get back to even ?
Not exactly.

A duration of 6 years implies that it will take about six years for the effects of a hypothetical change in interest rates to balance out.

In other words, it's the breakeven point between the drop in price (from the yields going up) and the increased income (from the yields going up).
It's not the point at which you get back all your principal (which doesn't really exist anyway), but the point at which the change in interest rates gets neutralized.

Basically, your total return at the six year point (or whatever your duration is) can be expected to be the initial yield on the bond you purchased.

For a bond fund the impact is a little different because, unlike an individual bond that has a steadily declining duration, most bond funds are managed or indexed to be more-or-less duration neutral. That adds an additional layer, usually making the total return HIGHER than the initial yield. But this additional return depends on the convexity and other factors.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Kevin8696
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Re: Is it time to go shorter in bonds ?

Post by Kevin8696 » Thu Oct 11, 2018 11:44 am

vineviz wrote:
Thu Oct 11, 2018 11:13 am
Kevin8696 wrote:
Thu Oct 11, 2018 10:56 am
Question is this... Assuming rates stay constant after the increase, when will I get to back to even on the 6% hit to principal ?

If the SEC yield goes up by 1.00% and stays there, does this mean it will take me 6 years to get back to even ?
Not exactly.

A duration of 6 years implies that it will take about six years for the effects of a hypothetical change in interest rates to balance out.

In other words, it's the breakeven point between the drop in price (from the yields going up) and the increased income (from the yields going up).
It's not the point at which you get back all your principal (which doesn't really exist anyway), but the point at which the change in interest rates gets neutralized.

Basically, your total return at the six year point (or whatever your duration is) can be expected to be the initial yield on the bond you purchased.

For a bond fund the impact is a little different because, unlike an individual bond that has a steadily declining duration, most bond funds are managed or indexed to be more-or-less duration neutral. That adds an additional layer, usually making the total return HIGHER than the initial yield. But this additional return depends on the convexity and other factors.
Vineviz... Thanks for responding. Still trying to get my arms around the length of time that it takes to recoup the hit to principal.

Assume $100,000 in VBTLX with 6-yr duration.... a 1.00% pop in rates increases SEC yield from say 3.25% to 4.25%.

The estimated 6% hit to principal results in new account balance of $94,000 with new SEC yield of 4.25%.

When I grow $100,000 at 3.25%, and $94,000 at 4.25% the break-even point is just over 6 years, when both are at around $122,500.

Am I on the right track ? Looks like 6-yrs to recoup the hit to principal on the 1% rate increase for a 6-yr duration portfolio.

Thanks.

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vineviz
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Re: Is it time to go shorter in bonds ?

Post by vineviz » Thu Oct 11, 2018 11:56 am

Kevin8696 wrote:
Thu Oct 11, 2018 11:44 am
Vineviz... Thanks for responding. Still trying to get my arms around the length of time that it takes to recoup the hit to principal.
I think you're going to confuse yourself by trying to use the concept of principal at all when it comes to bonds and especially bond funds.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Kevin8696
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Re: Is it time to go shorter in bonds ?

Post by Kevin8696 » Thu Oct 11, 2018 12:03 pm

vineviz wrote:
Thu Oct 11, 2018 11:56 am
Kevin8696 wrote:
Thu Oct 11, 2018 11:44 am
Vineviz... Thanks for responding. Still trying to get my arms around the length of time that it takes to recoup the hit to principal.
I think you're going to confuse yourself by trying to use the concept of principal at all when it comes to bonds and especially bond funds.
Ok, let's use the term "account value" instead of principal, since bond principal has other connotations. How long to recoup the lost account value due to 1% increase in rates for a bond fund with a 6-yr duration... ?

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vineviz
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Re: Is it time to go shorter in bonds ?

Post by vineviz » Thu Oct 11, 2018 12:06 pm

Kevin8696 wrote:
Thu Oct 11, 2018 12:03 pm
vineviz wrote:
Thu Oct 11, 2018 11:56 am
Kevin8696 wrote:
Thu Oct 11, 2018 11:44 am
Vineviz... Thanks for responding. Still trying to get my arms around the length of time that it takes to recoup the hit to principal.
I think you're going to confuse yourself by trying to use the concept of principal at all when it comes to bonds and especially bond funds.
Ok, let's use the term "account value" instead of principal, since bond principal has other connotations. How long to recoup the lost account value due to 1% increase in rates for a bond fund with a 6-yr duration... ?
Assuming you reinvested your interest payments, your bond fund account value would be back to $100k in about 18 months.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Kevin8696
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Joined: Mon Oct 08, 2012 7:45 pm

Re: Is it time to go shorter in bonds ?

Post by Kevin8696 » Thu Oct 11, 2018 12:12 pm

vineviz wrote:
Thu Oct 11, 2018 12:06 pm
Kevin8696 wrote:
Thu Oct 11, 2018 12:03 pm
vineviz wrote:
Thu Oct 11, 2018 11:56 am
Kevin8696 wrote:
Thu Oct 11, 2018 11:44 am
Vineviz... Thanks for responding. Still trying to get my arms around the length of time that it takes to recoup the hit to principal.
I think you're going to confuse yourself by trying to use the concept of principal at all when it comes to bonds and especially bond funds.
Ok, let's use the term "account value" instead of principal, since bond principal has other connotations. How long to recoup the lost account value due to 1% increase in rates for a bond fund with a 6-yr duration... ?
Assuming you reinvested your interest payments, your bond fund account value would be back to $100k in about 18 months.
Thanks for confirming.

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patrick013
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Re: Is it time to go shorter in bonds ?

Post by patrick013 » Thu Oct 11, 2018 12:52 pm

DrivingFun wrote:
Sat Sep 01, 2018 9:32 am
Can someone who has been observing this touting since 09 explain to me how that related to overnight rates? In other words my guess is consensus on rate hikes couldn't have been very high in 09. But it is near certainty for 2 more this year and high probability of 2 more next year. I'm assuming touting in 09 was based on other factors, while now it's based on the fed funds rate. I know very little about these things but to me it seems the reasoning now is nearly full-proof. Near guarantee of rising short term rates (we're half way through this already it seems) can only result in either a flat yield curve, in which case you're not being compensated for duration risk. Or it results in the longer end of the curve having to rise to accommodate, in which case price drops are guaranteed. Long term it probably doesn't matter, but in the short term barring unforeseen circumstances I can't see how going longer duration makes any sense.
Increasing return by holding higher yield bonds when the yield
curve is upward-sloping, involves moving into longer term bonds.
To earn an higher term premium than short term bonds the investor
bears the interest rate risk. The investor with the longer bond
will earn a higher rate of return as long as the yield curve does not
shift up during the holding period. Of course, the longer maturity bond
will suffer a greater capital loss when the yield curve rises with rising
rates.

So, with current information and recent history of FFR increases
as well as the forecast of a FFR around 3.5% short term looks
good for several years in the future. NAV's are bound to be affected
as the market tries to decide what to do with the current trend.
Another option is to just ride it out with short and intermediate
maturity bond AA.

We can see the high statistical relationship of the FFR to TRSY
yields. Bonds selling below their mean spread over the FFR are
considered overpriced and bonds selling over their mean spread are
considered underpriced. Prices will go up and down around the
mean spread. An inversion is an aberration but could also happen
a small per cent of the time.
Image
I don't think this answers your whole question but the info is
there about what the market may do, up or down. Check the spreads
occasionally we see if the yield curve is upward, inverted, or upward
but rather flat.
age in bonds, buy-and-hold, 10 year business cycle

KJVanguard
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Re: Is it time to go shorter in bonds ?

Post by KJVanguard » Thu Oct 11, 2018 4:11 pm

My entire Vanguard portfolio not invested in stocks is parked in Short-Term Investment Grade Admiral.

With 75% in stocks I feel I am taking plenty of risk already. Thus I want my bond allocation to be safe in ST high-quality bonds. Yes, I recognize it can go down if 2008 comes back where everything other than a T-bond traded as if it were junk ready to default.

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