Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

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millennialinvestor
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Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by millennialinvestor »

I have heard conflicting things on this. I thought that bond etfs and funds would become more attractive because the managers would be purchasing bonds with higher yields.
Last edited by millennialinvestor on Wed Jun 09, 2021 8:13 pm, edited 1 time in total.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by Thesaints »

Both cases, inflation increasing and rates climbing, would reduce the value of bonds and bond funds.
Yes, the managers will be able to buy higher yielding bonds, but for the time being they have got lower yielding ones.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by dbr »

The answer is both yes and no.

Read here: https://www.bogleheads.org/wiki/Bonds:_ ... s#Duration

For the long term investor you are essentially correct that funds will hold bonds paying more in interest meaning the return on bonds in the long run will be more attractive. Short run bond prices behave very differently as you can read in the reference.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by BHawks87 »

Interest rates and the NAV of your bond fund are inversely correlated.

So when rates go up the value of your fund goes down.
When rates go down the value of your fund goes up.

A rough rule of thumb is that your bond fund will increase or decrease (the percentage change) x (the duration)

So if you have a Total Bond Fund with a duration of 6 years then a 1% increase in rates will drop the value by 6 percent.

The fund is then buying new bonds at the higher interest rate so the yield of the fund will go up thus making up for your loss in value. You come out about even after the duration of your fund. So in the example above using a Total Bond Fund the value drops 6% when the rates change but then 6 years later the increase in yield made up for the drop. Vice versa for a drop in rates. You gain value right away but then new bonds yield less.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by retired@50 »

millennialinvestor wrote: Wed Jun 09, 2021 7:52 pm I have head conflicting things on this. I thought that bond etfs and funds would become more attractive because the managers would be purchasing bonds with higher yields.
This is the funny thing about bond funds.
When the bond fund share price is high, the monthly interest payment is low.
When the bond fund share price is low, the monthly interest payment is high. :shock:

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millennialinvestor
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by millennialinvestor »

So when should one get into bonds assuming rates are going up?
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by 000 »

Inflation is a permanent loss of purchasing power of the current securities held. Possibly getting higher coupons in the future from different securities is a red herring. If you take $100 to the casino and lose $10 playing craps, you're down to $90. You lost money. The result of the next roll of the dice - if you choose to play again - does not change this fact.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by NiceUnparticularMan »

millennialinvestor wrote: Wed Jun 09, 2021 7:52 pm I have heard conflicting things on this. I thought that bond etfs and funds would become more attractive because the managers would be purchasing bonds with higher yields.
If there was a lot of competition to buy those bonds, they wouldn't have higher yields. Competition would drive the price up and yields down.

But if expected inflation increases over the relevant period, any given nominal bond will thereby become less attractive because it will have a lower real yield.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by NiceUnparticularMan »

millennialinvestor wrote: Wed Jun 09, 2021 8:16 pm So when should one get into bonds assuming rates are going up?
If you KNOW the rates on the nominal bonds you want to buy are about to go up, then the answer is you should wait until that happens.

Knowing that is quite the trick, though.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by rockstar »

Rates go up. Bonds go down.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by Thesaints »

millennialinvestor wrote: Wed Jun 09, 2021 8:16 pm So when should one get into bonds assuming rates are going up?
In order to make money by trading bonds you have to know something in advance twice.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by retired@50 »

millennialinvestor wrote: Wed Jun 09, 2021 8:16 pm So when should one get into bonds assuming rates are going up?
My advice would be to build a position in bonds over many years, by contributing regularly in your 401k plan.

Paying close attention to the bond fund share price is not worth the trouble. The Vanguard Total Bond Market Index fund (VBTLX) has traded between $9.58 and $11.79 per share since the fund inception in 2001. So, that's nearly 20 years where the fund share price was somewhere inside that small price range.

The vast majority of return in a bond fund is made by receiving the monthly interest payments, and by re-investing those payments into more shares. This monthly re-investment creates "interest on interest" which adds up over time.

In other words, build up your bond wealth slowly, patiently, in a very boring way.

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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by Northern Flicker »

millennialinvestor wrote: Wed Jun 09, 2021 8:16 pm So when should one get into bonds assuming rates are going up?
Nobody knows the answer to that. It depends on how steep the rate of increase is. Nobody even knows if rates are going up, down, or neither.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by Mel Lindauer »

rockstar wrote: Wed Jun 09, 2021 9:04 pm Rates go up. Bonds go down.
And when rates go down, bond values go up.

Think of bond rates and values as two people named Rates and Values, sitting on opposite ends of a seesaw. When the person on one side goes down, the other side goes up and vice-versa.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by Northern Flicker »

There is one more feature. The loss of value of a bond from rising rates dissipates gradually over time as time marches forward toward the maturity date of the bond. This is true for bonds held directly by an investor and true for bonds held by a bond fund.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by NiceUnparticularMan »

Northern Flicker wrote: Thu Jun 10, 2021 1:33 am There is one more feature. The loss of value of a bond from rising rates dissipates gradually over time as time marches forward toward the maturity date of the bond. This is true for bonds held directly by an investor and true for bonds held by a bond fund.
I think there is an important nuance here.

If market rates for a particular nominal bond increase due to increased inflation expectations, and then in fact inflation is higher than expected over the life of the bond, then the loss of REAL value from that nominal bond's payments (versus what the investor originally expected they would get when buying the bond) are accumulating over time. But because all this is expected (by hypothesis), the change in the price of the bond is immediate, and then that change in price decreases over time as bond payments move into the past, since they are no longer being included in that price calculation. However, the accumulating loss of real value has still happened, it has just moved into something the investor already experienced rather than being something they are expected to experience in the future.

The point is the loss of real value doesn't go away over time, given these assumptions. But eventually by the time the end of the bond is approaching, it has mostly already been locked in as a real loss for the investor in terms of reduced real value of past payments.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by vineviz »

millennialinvestor wrote: Wed Jun 09, 2021 8:16 pm So when should one get into bonds assuming rates are going up?
A) Don't assume rates are going up. They don't need to and might not.
B) One should "get into bonds" whenever they help the investor achieve their financial goals. This will not depend on guessing about what might happen to rates in the future.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by vineviz »

NiceUnparticularMan wrote: Thu Jun 10, 2021 6:57 am
Northern Flicker wrote: Thu Jun 10, 2021 1:33 am There is one more feature. The loss of value of a bond from rising rates dissipates gradually over time as time marches forward toward the maturity date of the bond. This is true for bonds held directly by an investor and true for bonds held by a bond fund.
I think there is an important nuance here.

If market rates for a particular nominal bond increase due to increased inflation expectations, and then in fact inflation is higher than expected over the life of the bond, then the loss of REAL value from that nominal bond's payments (versus what the investor originally expected they would get when buying the bond) are accumulating over time.
This is only true for nominal bonds.

Inflation-linked bonds (e.g. TIPS and Series I savings bonds) do not carry the same inflation risk as nominal Treasuries and Series EE savings bonds).
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by NiceUnparticularMan »

vineviz wrote: Thu Jun 10, 2021 7:03 am
millennialinvestor wrote: Wed Jun 09, 2021 8:16 pm So when should one get into bonds assuming rates are going up?
A) Don't assume rates are going up. They don't need to and might not.
B) One should "get into bonds" whenever they help the investor achieve their financial goals. This will not depend on guessing about what might happen to rates in the future.
I agree with both of these points but again want to acknowledge a nuance.

As I see it, bonds are specialized risk management tools. If you have a particular risk you want to manage and a specific bond will help you do that at an acceptable cost, great, go ahead and buy it. The thought that maybe if you wait a bit you can get it a bit cheaper than now is indeed the sort of market timing I think personal investors should avoid.

However, I think that bit about acceptable costs is still important. And the implied cost of the risk management provided by a given type of bond may change over time. And so, you might rationally be willing to buy a certain type of bond for a certain type of risk management purpose at one price, but not another, because at that the second price the cost might be too high.

The distinction is if you think like that, you should be fully prepared to never buy that type of bond for that purpose. Meaning you are not expecting the price to get better soon. You are just reasoning that at the available price, it is too costly to use.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by NiceUnparticularMan »

vineviz wrote: Thu Jun 10, 2021 7:05 am
NiceUnparticularMan wrote: Thu Jun 10, 2021 6:57 am
Northern Flicker wrote: Thu Jun 10, 2021 1:33 am There is one more feature. The loss of value of a bond from rising rates dissipates gradually over time as time marches forward toward the maturity date of the bond. This is true for bonds held directly by an investor and true for bonds held by a bond fund.
I think there is an important nuance here.

If market rates for a particular nominal bond increase due to increased inflation expectations, and then in fact inflation is higher than expected over the life of the bond, then the loss of REAL value from that nominal bond's payments (versus what the investor originally expected they would get when buying the bond) are accumulating over time.
This is only true for nominal bonds.

Inflation-linked bonds (e.g. TIPS and Series I savings bonds) do not carry the same inflation risk as nominal Treasuries and Series EE savings bonds).
Correct. I was very careful to specify I was discussing nominal bonds, but I agree it is worth emphasizing that IPS work differently.
Last edited by NiceUnparticularMan on Thu Jun 10, 2021 7:13 am, edited 1 time in total.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by vineviz »

NiceUnparticularMan wrote: Thu Jun 10, 2021 7:12 am
vineviz wrote: Thu Jun 10, 2021 7:03 am
millennialinvestor wrote: Wed Jun 09, 2021 8:16 pm So when should one get into bonds assuming rates are going up?
A) Don't assume rates are going up. They don't need to and might not.
B) One should "get into bonds" whenever they help the investor achieve their financial goals. This will not depend on guessing about what might happen to rates in the future.
I agree with both of these points but again want to acknowledge a nuance.
What's the nuance you wanted to acknowledge?

Aren't we both saying "buy the bonds you need when you need them"?
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by vineviz »

NiceUnparticularMan wrote: Thu Jun 10, 2021 7:13 am
vineviz wrote: Thu Jun 10, 2021 7:05 am
NiceUnparticularMan wrote: Thu Jun 10, 2021 6:57 am
Northern Flicker wrote: Thu Jun 10, 2021 1:33 am There is one more feature. The loss of value of a bond from rising rates dissipates gradually over time as time marches forward toward the maturity date of the bond. This is true for bonds held directly by an investor and true for bonds held by a bond fund.
I think there is an important nuance here.

If market rates for a particular nominal bond increase due to increased inflation expectations, and then in fact inflation is higher than expected over the life of the bond, then the loss of REAL value from that nominal bond's payments (versus what the investor originally expected they would get when buying the bond) are accumulating over time.
This is only true for nominal bonds.

Inflation-linked bonds (e.g. TIPS and Series I savings bonds) do not carry the same inflation risk as nominal Treasuries and Series EE savings bonds).
Correct. I was very careful to specify I was discussing nominal bonds, but I agree it is worth emphasizing that TIPS work differently.
Sorry! My coffee-starved brain read right past your (repeated!) use of the word "nominal".
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by NiceUnparticularMan »

vineviz wrote: Thu Jun 10, 2021 7:13 am
NiceUnparticularMan wrote: Thu Jun 10, 2021 7:12 am
vineviz wrote: Thu Jun 10, 2021 7:03 am
millennialinvestor wrote: Wed Jun 09, 2021 8:16 pm So when should one get into bonds assuming rates are going up?
A) Don't assume rates are going up. They don't need to and might not.
B) One should "get into bonds" whenever they help the investor achieve their financial goals. This will not depend on guessing about what might happen to rates in the future.
I agree with both of these points but again want to acknowledge a nuance.
What's the nuance you wanted to acknowledge?

Aren't we both saying "buy the bonds you need when you need them"?
Well, no. I am saying you can consider buying specific bonds if they address your risk management needs at an acceptable cost.

So, whether you should buy a specific bond at a specific time is rationally not just a function of the risk management benefits you expect, but also of the cost of that bond at that time.

And to me, that is not the same thing as "buy the bonds you need when you need them" as that slogan does not appear to contain any sort of provision for considering costs.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by NiceUnparticularMan »

vineviz wrote: Thu Jun 10, 2021 7:15 am
NiceUnparticularMan wrote: Thu Jun 10, 2021 7:13 am
vineviz wrote: Thu Jun 10, 2021 7:05 am
NiceUnparticularMan wrote: Thu Jun 10, 2021 6:57 am
Northern Flicker wrote: Thu Jun 10, 2021 1:33 am There is one more feature. The loss of value of a bond from rising rates dissipates gradually over time as time marches forward toward the maturity date of the bond. This is true for bonds held directly by an investor and true for bonds held by a bond fund.
I think there is an important nuance here.

If market rates for a particular nominal bond increase due to increased inflation expectations, and then in fact inflation is higher than expected over the life of the bond, then the loss of REAL value from that nominal bond's payments (versus what the investor originally expected they would get when buying the bond) are accumulating over time.
This is only true for nominal bonds.

Inflation-linked bonds (e.g. TIPS and Series I savings bonds) do not carry the same inflation risk as nominal Treasuries and Series EE savings bonds).
Correct. I was very careful to specify I was discussing nominal bonds, but I agree it is worth emphasizing that TIPS work differently.
Sorry! My coffee-starved brain read right past your (repeated!) use of the word "nominal".
Seriously, no problem. I think this is the sort of point that can't really be emphasized too much.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by nisiprius »

What is often missed is that the "interest rates up, bonds down" relationship is a short-term relationship. Long-term, of course higher interest rates are better for the investor, just as intuition suggests. The bond fund's duration is the approximate breakeven point.

Here's the key point. Imagine that interest rates rise for a while. The value of the bond fund gets knocked down. Now suppose that interest rates stabilize and stop rising. What happens then?

The value of the fund represents the present value of a collection of future payments, coupon interest payments and the final return of principal at maturity. The details don't matter. It's a collection of known dollar amounts at known future times. The prevailing interest rate is X%. From this point on, the due date of every payment is getting closer and closer. Every future payment is becoming more valuable because it is getting closer. The present value of every one of those payments is going to be rising... how fast? At the prevailing interest rate, exactly X% per year.

So when interest rates rise, the value of bond fund is first knocked down, then--as soon as rates stop rising--it begins climbing at the new, faster interest rate. The duration of the collection is, roughly, the point at which the faster climb pays back the initial decline. From that point on, you are ahead of where you'd have been if interest rates had not risen.

Note that th new, faster rise begins as soon as interest rates stabilize. It has nothing to do with old bonds maturing and being replaced by new ones. It is bond math based on the fact that the market values have already been knocked down, and therefore can and do rise faster than the old interest rate locked into the coupon payments.

You can complain about oversimplification. For example, because of the yield curve there is no single "prevailing interest rate." But as a general idea, "once interest rates stop rising, the value of the bond fund begins to climb at the new, current interest rate"--is just as good conceptually as "initial drop = interest rate rise x duration."

To see what this looks like, here is a theoretical calculation for a rolling bond ladder with a 6.2-year duration, assuming that interest rates rise from 1.3% to 3.3% over a two-year period and then stabilize.

Image
Last edited by nisiprius on Thu Jun 10, 2021 8:37 am, edited 2 times in total.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by dbr »

nisiprius wrote: Thu Jun 10, 2021 7:48 am What is often missed is that the "interest rates up, bonds down" relationship is a short-term relationship. Long-term, of course higher interest rates are better for the investor, just as intuition suggests. The bond fund's duration is the approximate breakeven point.

Yep, that is what I wanted people to understand in my post as well, but thanks for showing the actual mechanics so people can see how it works. I referred to the Wiki article on duration.

A general point is that interest rates are changing all the time. "Interest rates go up" is not a single event constituting some kind of disaster. What the fate of investors will be over the next 20 or 30 or 40 years from owning bonds is completely unknown at this time. For a person worried only about the next 2 or 3 or 5 years bonds would not be an investment except at short terms.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by vineviz »

NiceUnparticularMan wrote: Thu Jun 10, 2021 7:17 am Well, no. I am saying you can consider buying specific bonds if they address your risk management needs at an acceptable cost.

So, whether you should buy a specific bond at a specific time is rationally not just a function of the risk management benefits you expect, but also of the cost of that bond at that time.
I'm guilty of assuming the "at an acceptable cost" is enough of a universal concept that it is implicitly included in "need" but I understand the rationale for stating it explicitly.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by NiceUnparticularMan »

nisiprius wrote: Thu Jun 10, 2021 7:48 am What is often missed is that the "interest rates up, bonds down" relationship is a short-term relationship. Long-term, of course higher interest rates are better for the investor, just as intuition suggests. The bond fund's duration is the approximate breakeven point.

Here's the key point. Imagine that interest rates rise for a while. The value of the bond fund gets knocked down. Now suppose that interest rates stabilize and stop rising. What happens then?

The value of the fund represents the present value of a collection of future payments, coupon interest payments and the final return of principal at maturity. The details don't matter. It's a collection of known dollar amounts at known future times. The prevailing interest rate is X%. From this point on, the due date of every payment is getting closer and closer. Every future payment is becoming more valuable because it is getting closer. The present value of every one of those payments is going to be rising... how fast? At the prevailing interest rate, exactly X% per year.

So when interest rates rise, the value of bond fund is first knocked down, then--as soon as rates stop rising--it begins climbing at the new, faster interest rate. The duration of the collection is, roughly, the point at which the faster climb pays back the initial decline. From that point on, you are ahead of where you'd have been if interest rates had not risen.

Note that th new, faster rise begins as soon as interest rates stabilize. It has nothing to do with old bonds maturing and being replaced by new ones. It is bond math based on the fact that the market values have already been knocked down, and therefore can and do rise faster than the old interest rate locked into the coupon payments.

You can complain about oversimplification. For example, because of the yield curve there is no single "prevailing interest rate." But as a general idea, "once interest rates stop rising, the value of the bond fund begins to climb at the new, current interest rate"--is just as good conceptually as "initial drop = interest rate rise x duration."

To see what this looks like, here is a theoretical calculation for a rolling bond ladder with a 6.2-year duration, assuming that interest rates rise from 1.3% to 3.3% over a two-year period and then stabilize.

Image
Again, this is true, but I do think people should understand that (assuming nominal bonds) if the rate increase is caused by an increase in inflation expectations, and if inflation is in fact higher than expected, then they will in fact permanently lose real value as a result.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by NiceUnparticularMan »

vineviz wrote: Thu Jun 10, 2021 8:39 am
NiceUnparticularMan wrote: Thu Jun 10, 2021 7:17 am Well, no. I am saying you can consider buying specific bonds if they address your risk management needs at an acceptable cost.

So, whether you should buy a specific bond at a specific time is rationally not just a function of the risk management benefits you expect, but also of the cost of that bond at that time.
I'm guilty of assuming the "at an acceptable cost" is enough of a universal concept that it is implicitly included in "need" but I understand the rationale for stating it explicitly.
I think the tricky bit is distinguishing that concept from market timing. They are in fact distinct, but without clear explanation of the reasoning in question, and its possible consequences, the distinction may not always be immediately clear.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by nisiprius »

And before someone says "inflation,"--oops, niceunparticularman said it while I was preparing this posting--we can take inflation out of the analysis just by assuming you invest in TIPS, and doing the calculations in real (inflation-adjusted) terms. The general picture remains the same.

This assumes real interest rates rise from 0% to 2% over a period of two years. For this calculation I tweaked the bond maturities to get a slightly longer duration, 8 years, to roughly match the 7.4-year duration of the Vanguard VIPS fund, VAIPX.

Image

This is not a greed-inspiring picture, but it's not terrifying. We are seeing a -13% drawdown, which is unpleasant in a bond fund, but not much worse than investment-grade corporate fell in 2008-2009, and as expected recovery time was about equal to duration.

The answer to the original poster's question, then, is that a TIPS fund is expected to appreciate in value a) eventually, and b) only if real interest rates rise. And, as always, the appropriate holding period is roughly equal to the duration.

Finally, of course, "assuming inflation increases and rates climb" is making not just one but two predictions, and even when everyone seems to be saying so, predictions that everyone seem to be making often do not come true. Surprisingly often. I would not make any really important portfolio changes based on two predictions both coming true.
Last edited by nisiprius on Thu Jun 10, 2021 9:03 am, edited 5 times in total.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by aristotelian »

As others said, bond values would go down when rates rise. However, their yield as a % of their value will go up because the denominator has gone down. Overall, the interest payments will stay the same as before (in absolute dollars) and the principal will be paid back when the bond matures.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by prd1982 »

nisiprius wrote: Thu Jun 10, 2021 7:48 am What is often missed is that the "interest rates up, bonds down" relationship is a short-term relationship. Long-term, of course higher interest rates are better for the investor, just as intuition suggests. The bond fund's duration is the approximate breakeven point.
I'm assuming this response and the chart apply to the overall return of the fund, which I understand is what really counts. But what happens to the NAV?
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by alluringreality »

retired@50 wrote: Wed Jun 09, 2021 11:41 pm In other words, build up your bond wealth slowly, patiently, in a very boring way.
This is basically my line of thought. I figure that I might as well just make a plan and buy bonds across time. Since I bonds currently offer better rates than most of the real yield curve for TIPS, and EE bonds held for 20 years offer better rates than the entire nominal yield curve, I figure savings bonds make sense for the money that I don't want to put into stocks at this time. I have assets in taxable, a mortgage rate that is higher than marketable bond rates, and various items like my 401K options also play into my thinking about marketable bonds. Many of my considerations could be different for others, and paying down a mortgage before buying any bonds may make sense.

My EE bond money is hopefully set for 20 years, unless fairly high inflation was to happen causing much higher market rates to offset the 0.1% rate for withdrawal between years 1-20. The I bond money could be withdrawn at any time between years 1-30, although the last three months of interest are forfeited before year 5. Savings bonds do not decline in value due to rising rates. If someone is worried about rising rates, I bonds are a decent choice for $10k per person per year plus tax returns up to $5k. Honestly I'm not worried about rising rates, since I wouldn't buy EE bonds if I expected inflation to average more than 3.5% over the next 20 years. Basically I expect EE bonds to return more than I bonds over the next 20 years, but I bonds will likely return more if sold between years 1-20 after purchase.
Last edited by alluringreality on Thu Jun 10, 2021 9:20 am, edited 1 time in total.
Targets: 15% I Bonds, 15% EE Bonds, 45% US Stock (Mid & Small Tilt), 25% Ex-US Stock (Small Tilt)
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by dbr »

prd1982 wrote: Thu Jun 10, 2021 9:03 am
nisiprius wrote: Thu Jun 10, 2021 7:48 am What is often missed is that the "interest rates up, bonds down" relationship is a short-term relationship. Long-term, of course higher interest rates are better for the investor, just as intuition suggests. The bond fund's duration is the approximate breakeven point.
I'm assuming this response and the chart apply to the overall return of the fund, which I understand is what really counts. But what happens to the NAV?
These calculations assume distributions are reinvested. That is implicit in return calculations as taking the distribution is a withdrawal and has to be accounted for as such. So now what you have is a changing (increasing) number of shares at a changing NAV and what happens to the NAV is not relevant. In the short run the NAV goes down and the yield goes up. In the short run the interest payment is unchanged.

This whole thing is why it is much easier to analyze investing by attending to the return and to contributions and withdrawals rather then to yields alone or prices of shares alone or numbers of shares alone.
Last edited by dbr on Thu Jun 10, 2021 9:22 am, edited 1 time in total.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by nisiprius »

prd1982 wrote: Thu Jun 10, 2021 9:03 am
nisiprius wrote: Thu Jun 10, 2021 7:48 am What is often missed is that the "interest rates up, bonds down" relationship is a short-term relationship. Long-term, of course higher interest rates are better for the investor, just as intuition suggests. The bond fund's duration is the approximate breakeven point.
I'm assuming this response and the chart apply to the overall return of the fund, which I understand is what really counts. But what happens to the NAV?
Focussing on bond fund prices is a mistake. In this forum, some posters have looked at a price chart for Total Bond and seen that it has stayed within about a dollar of $10/share for 35 years, and concluded that basically bond funds don't make money. It is curious that the importance of stock dividends in total return is not only appreciated but often exaggerated, while the importance of coupon interest, which in the long run almost the only contributor in bond total return, is almost ignored.

The answer to your question is that every bond's value approaches its original value as it reaches maturity, so in our first example, this is what you would have if you threw away all the coupon interest (= bond fund dividends) or donated it all to charity. The rising rate puts downward pressure on the price while it is rising, but the further downward the price is pushed, the stronger the pull to maturity becomes. When the rate stops rising, the pull to maturity takes over immediately. The pull to maturity is driven by the difference between market value and face value, so it is strongest at first when the difference is greatest. As the bond's market value rises, the pull becomes weaker, the rate of rise ebbs, and the fund does not recover fully until all the bonds in it have matured. So, yes, that is a much longer process, and it is not complete until all the old bonds have matured and been replaced with new ones.

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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by prd1982 »

nisiprius wrote: Thu Jun 10, 2021 9:20 am Focussing on bond fund prices is a mistake.
I wasn't. As I said, I understood that total return is what counts. I have some bonds in taxable that have a small gain. I would like to sell them, and buy bonds in my IRA. I realize that the taxes on the gains would not be huge. But I was curious if a rise in rates would turn my gains into a small loss. Thanks for the update.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by dbr »

prd1982 wrote: Thu Jun 10, 2021 9:30 am
nisiprius wrote: Thu Jun 10, 2021 9:20 am Focussing on bond fund prices is a mistake.
I wasn't. As I said, I understood that total return is what counts. I have some bonds in taxable that have a small gain. I would like to sell them, and buy bonds in my IRA. I realize that the taxes on the gains would not be huge. But I was curious if a rise in rates would turn my gains into a small loss. Thanks for the update.
That could happen, yes. But then a fall in rates could increase your gains. If you are wanting to make a decision for this year, for example, it is not a given that holding rather than selling now will be a better decision.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by alluringreality »

prd1982 wrote: Thu Jun 10, 2021 9:30 am
nisiprius wrote: Thu Jun 10, 2021 9:20 am Focussing on bond fund prices is a mistake.
I wasn't. As I said, I understood that total return is what counts. I have some bonds in taxable that have a small gain. I would like to sell them, and buy bonds in my IRA. I realize that the taxes on the gains would not be huge. But I was curious if a rise in rates would turn my gains into a small loss. Thanks for the update.
One item that may be relevant to your consideration is that the Fed continues buying at this time. It's difficult to say how things might play out in the future, presuming at some point they stop buying. Basically no one can say if future taper might go more smoothly than 2013, where rates generally increased and prices fell.
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Last edited by alluringreality on Thu Jun 10, 2021 10:10 am, edited 1 time in total.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by NiceUnparticularMan »

nisiprius wrote: Thu Jun 10, 2021 8:49 am And before someone says "inflation,"--oops, niceunparticularman said it while I was preparing this posting--we can take inflation out of the analysis just by assuming you invest in TIPS, and doing the calculations in real (inflation-adjusted) terms. The general picture remains the same.
I of course agree TIPS do in fact address the issue of permanently losing real value in the event of unexpectedly high inflation (as measured by the CPI).

And of course the current cost of that combination of attributes is reflected in current TIPS prices and the real return rates they would lock in.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by prd1982 »

dbr wrote: Thu Jun 10, 2021 9:51 am
That could happen, yes. But then a fall in rates could increase your gains. If you are wanting to make a decision for this year, for example, it is not a given that holding rather than selling now will be a better decision.
Thanks everyone for the possible effects of rising interest rates on NAV. It is a small gain. So I will wait for it to be a loss, or until the end of the year when I know my capital gains. The last thing I want is to have a small gain push us into the next higher IRMAA bracket.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by Northern Flicker »

NiceUnparticularMan wrote: Thu Jun 10, 2021 6:57 am
Northern Flicker wrote: Thu Jun 10, 2021 1:33 am There is one more feature. The loss of value of a bond from rising rates dissipates gradually over time as time marches forward toward the maturity date of the bond. This is true for bonds held directly by an investor and true for bonds held by a bond fund.
I think there is an important nuance here.

If market rates for a particular nominal bond increase due to increased inflation expectations, and then in fact inflation is higher than expected over the life of the bond, then the loss of REAL value from that nominal bond's payments (versus what the investor originally expected they would get when buying the bond) are accumulating over time. But because all this is expected (by hypothesis), the change in the price of the bond is immediate, and then that change in price decreases over time as bond payments move into the past, since they are no longer being included in that price calculation. However, the accumulating loss of real value has still happened, it has just moved into something the investor already experienced rather than being something they are expected to experience in the future.

The point is the loss of real value doesn't go away over time, given these assumptions. But eventually by the time the end of the bond is approaching, it has mostly already been locked in as a real loss for the investor in terms of reduced real value of past payments.
Agreed. The investor only gets the higher inflation compensation after the bond matures and is reinvested at the higher rate.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by NiceUnparticularMan »

Northern Flicker wrote: Thu Jun 10, 2021 11:15 am
NiceUnparticularMan wrote: Thu Jun 10, 2021 6:57 am
Northern Flicker wrote: Thu Jun 10, 2021 1:33 am There is one more feature. The loss of value of a bond from rising rates dissipates gradually over time as time marches forward toward the maturity date of the bond. This is true for bonds held directly by an investor and true for bonds held by a bond fund.
I think there is an important nuance here.

If market rates for a particular nominal bond increase due to increased inflation expectations, and then in fact inflation is higher than expected over the life of the bond, then the loss of REAL value from that nominal bond's payments (versus what the investor originally expected they would get when buying the bond) are accumulating over time. But because all this is expected (by hypothesis), the change in the price of the bond is immediate, and then that change in price decreases over time as bond payments move into the past, since they are no longer being included in that price calculation. However, the accumulating loss of real value has still happened, it has just moved into something the investor already experienced rather than being something they are expected to experience in the future.

The point is the loss of real value doesn't go away over time, given these assumptions. But eventually by the time the end of the bond is approaching, it has mostly already been locked in as a real loss for the investor in terms of reduced real value of past payments.
Agreed. The investor only gets the higher inflation compensation after the bond matures and is reinvested at the higher rate.
Yep. In a nutshell, this is how rolling shorter-term nominals can provide better real returns than longer-term nominals in the event of persistent unexpectedly high inflation.
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Re: Assuming inflation increases and rates climb (or are expected to) will bond funds appreciate in value?

Post by rockstar »

Mel Lindauer wrote: Wed Jun 09, 2021 11:52 pm
rockstar wrote: Wed Jun 09, 2021 9:04 pm Rates go up. Bonds go down.
And when rates go down, bond values go up.

Think of bond rates and values as two people named Rates and Values, sitting on opposite ends of a seesaw. When the person on one side goes down, the other side goes up and vice-versa.
Yep.

Now once you add those bonds to mutual funds or ETFs, it gets more complicated. My understanding is that an ETF can issue more shares whereas a mutual fund will have to buy more bonds. The transactions in/out of both is complicated. I can't say that I fully understand it, so I tend buy actual bonds, rather than funds. Right now, I'm not holding any bonds.
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