Clarification about the maturity of bond funds

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timetraveler
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Clarification about the maturity of bond funds

Post by timetraveler » Sun Nov 17, 2019 1:51 pm

Hello :happy

When you buy a single (non-fund) bond such as a treasury, you know that you would get back the principle value at a certain date (maturity date).

It is not clear to me what the maturity in the context of a bond fund such as BND means. There are so many different bonds in this ETF, each with their own maturity date, but these dates don't necessarily align with each other. So if you bought $1000 worth of BND etf, when exactly do you expect to get back that principle?

Geologist
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Re: Clarification about the maturity of bond funds

Post by Geologist » Sun Nov 17, 2019 1:55 pm

There is no date when all the bonds in most bond funds will mature and there is no guarantee that you will be able to redeem your shares at the price you paid for them. The NAV fluctuates with interest rates and you may get more or less than what you paid for them.

Most bond funds have an average maturity and has a portfolio of bonds for that average (it may change somewhat within limits).

lack_ey
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Re: Clarification about the maturity of bond funds

Post by lack_ey » Sun Nov 17, 2019 1:56 pm

Maturity stats for most bond funds like that are a weighted average over the holdings. This is one measure that can tell you about the kinds of bonds the fund has and the overall sensitivity to interest rates and so on.

The bond fund itself does not mature and pay out an amount at maturity. Individual bonds that the fund holds may mature, but the fund would then turn around and buy new bonds with any cash lying around. (Actually, for a total bond market index fund like BND, because the index mostly excludes bonds with less than 1 year remaining, it may be selling most bonds before maturity anyway.)

The bond fund is just a perpetual entity that pays out dividends over time from the underlying interest payments. The fund manager does all the portfolio maintenance for you, for an index fund to attempt to largely track the index.

Geologist
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Re: Clarification about the maturity of bond funds

Post by Geologist » Sun Nov 17, 2019 1:58 pm


dbr
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Re: Clarification about the maturity of bond funds

Post by dbr » Sun Nov 17, 2019 2:03 pm

Geologist wrote:
Sun Nov 17, 2019 1:55 pm
There is no date when all the bonds in most bond funds will mature and there is no guarantee that you will be able to redeem your shares at the price you paid for them. The NAV fluctuates with interest rates and you may get more or less than what you paid for them.
Exactly. But to add, the question is why would one care? An investor in a long term portfolio of stocks and bonds has no need to care about whether one asset or another in the portfolio exactly gives back what was invested. What that investor does do is look at the range of possible return and evaluate how much uncertainty there is in his future outcomes. Risky, higher returning portfolios return a higher and wider spread of possible outcomes while less risky portfolios are more certain but range over a lower set of outcomes for wealth attained. If a person wants to make sure that a certain amount of money will be returned at a certain date and there is no tolerance for shortfall, then that person would buy a bond, a CD, or put money in a savings account and not own a bond fund. If he is concerned with purchasing power that investment has to be in TIPS or I bonds. How much money for which people these concerns amount to may be few and far between, but it is legitimate when it is.

ChrisBenn
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Re: Clarification about the maturity of bond funds

Post by ChrisBenn » Sun Nov 17, 2019 2:39 pm

As an exception to the standard bond funds which sell and re-invest to maintain a target maturity, Invesco does offer the bulletshares product line: https://www.invesco.com/bulletshares/un ... shares/faq which simply purchase a bundle of bonds and hold them to maturity (i.e. each etf has a date by which it will expire and return all principal to the holders). (See the maturity vs. time plots in the link above)

If you were considering buying an individual corporate bond an argument could be made for this being better as you would have diversified down your default risk.

(Note: I am note recommending (or warning against) these, I just find them an interesting financial instrument)

MotoTrojan
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Re: Clarification about the maturity of bond funds

Post by MotoTrojan » Sun Nov 17, 2019 2:43 pm

If there is a one-time step change in yields then you’ll break even after the fund duration; note that break even doesn’t mean just getting your principal back, it means getting your earnings based on yield at purchase date.

In reality yields don’t make step changes then hold steady so there is no one answer. Theoretically rates can steadily go up and you’ll never even break even in principal, but if/when they stop you’d eventually even out and then earn even more.

Maturity and duration are different in most funds. You care more about duration.

If you buy $1000 of BND then the duration tells you nothing about when you’ll make $1000 back. You get you’d principal back by selling that $1000 of BND.

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timetraveler
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Re: Clarification about the maturity of bond funds

Post by timetraveler » Mon Nov 18, 2019 12:44 am

Thank you all for participating.
dbr wrote:
Sun Nov 17, 2019 2:03 pm
Geologist wrote:
Sun Nov 17, 2019 1:55 pm
There is no date when all the bonds in most bond funds will mature and there is no guarantee that you will be able to redeem your shares at the price you paid for them. The NAV fluctuates with interest rates and you may get more or less than what you paid for them.
Exactly. But to add, the question is why would one care? An investor in a long term portfolio of stocks and bonds has no need to care about whether one asset or another in the portfolio exactly gives back what was invested. What that investor does do is look at the range of possible return and evaluate how much uncertainty there is in his future outcomes. Risky, higher returning portfolios return a higher and wider spread of possible outcomes while less risky portfolios are more certain but range over a lower set of outcomes for wealth attained. If a person wants to make sure that a certain amount of money will be returned at a certain date and there is no tolerance for shortfall, then that person would buy a bond, a CD, or put money in a savings account and not own a bond fund. If he is concerned with purchasing power that investment has to be in TIPS or I bonds. How much money for which people these concerns amount to may be few and far between, but it is legitimate when it is.
Yes, that would have been my next question. Is the expected return of a bond fund such as BND generally more than that of individual bonds (e.g. treasury) so that sacrificing not getting back the same principal makes sense?

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Stinky
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Re: Clarification about the maturity of bond funds

Post by Stinky » Mon Nov 18, 2019 7:10 am

timetraveler wrote:
Mon Nov 18, 2019 12:44 am
Is the expected return of a bond fund such as BND generally more than that of individual bonds (e.g. treasury) so that sacrificing not getting back the same principal makes sense?
No, that's not the way that it works. The return of a bond fund is the aggregate of the returns of the underlying bonds within the fund, reduced by the expenses of the bond fund.

There is no "discount" to the return for the fact that the bond fund does not have a "maturity date".
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dbr
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Re: Clarification about the maturity of bond funds

Post by dbr » Mon Nov 18, 2019 9:25 am

timetraveler wrote:
Mon Nov 18, 2019 12:44 am


Yes, that would have been my next question. Is the expected return of a bond fund such as BND generally more than that of individual bonds (e.g. treasury) so that sacrificing not getting back the same principal makes sense?
No, the point is that in balanced portfolios of stocks and bonds getting back exactly the same principal is not necessary and has no value in particular. The point of bonds in a portfolio is that the variability in return is much less than that of stocks so portfolio risk can be managed by adding more or less in bonds. The expectation that returns will generally on average be positive is important, but it is not necessary to guarantee that for specific holdings at specific times.

The importance of getting back the principal on a date arises when the purpose of having the money in bonds is that there really is a consequence to not having an exact balance at an exact point in time. I think most individual investors that worry about that do so for psychological reasons rather than for an actual financial purpose. I can't think of any reason I would need any investments deliver an exactly known principal at any particular time or even across all times, as with cash equivalents. The exception would be my checking account where it would be awkward for the balance to vary unpredictably from day to day while I am writing checks for things. (Actually most of the checks are electronic debits, but the idea is the same.)

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JoMoney
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Re: Clarification about the maturity of bond funds

Post by JoMoney » Mon Nov 18, 2019 9:35 am

FWIW, I prefer to think of a bond funds 'duration' as it would compare to a portfolio of laddered bonds. A bond ladder that had a average duration of 5 years would be something close to a ladder of bonds maturing from 1 to 10 years out. If you a had a mixture of funds with different durations you could roughly simulate a laddered portfolio by adjusting your portfolio of funds duration to match that of a laddered portfolios duration as it moved closer to each ladders rung maturing.
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Topic Author
timetraveler
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Re: Clarification about the maturity of bond funds

Post by timetraveler » Tue Nov 19, 2019 11:04 am

dbr wrote:
Mon Nov 18, 2019 9:25 am
timetraveler wrote:
Mon Nov 18, 2019 12:44 am


Yes, that would have been my next question. Is the expected return of a bond fund such as BND generally more than that of individual bonds (e.g. treasury) so that sacrificing not getting back the same principal makes sense?
No, the point is that in balanced portfolios of stocks and bonds getting back exactly the same principal is not necessary and has no value in particular. The point of bonds in a portfolio is that the variability in return is much less than that of stocks so portfolio risk can be managed by adding more or less in bonds. The expectation that returns will generally on average be positive is important, but it is not necessary to guarantee that for specific holdings at specific times.

The importance of getting back the principal on a date arises when the purpose of having the money in bonds is that there really is a consequence to not having an exact balance at an exact point in time. I think most individual investors that worry about that do so for psychological reasons rather than for an actual financial purpose. I can't think of any reason I would need any investments deliver an exactly known principal at any particular time or even across all times, as with cash equivalents. The exception would be my checking account where it would be awkward for the balance to vary unpredictably from day to day while I am writing checks for things. (Actually most of the checks are electronic debits, but the idea is the same.)
Good point.

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