Bond index funds question

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satboggle2021
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Joined: Tue Jun 29, 2021 11:58 pm

Bond index funds question

Post by satboggle2021 »

Hello Everyone,
I have a question on bond index funds in general. We have seen the bond index funds fell over 10% or more in the recent times due to feds interest increase. I understand it is to adjust the bonds value for the increasing yields for new bonds in future. But the face value of bond index funds are falling much higher that the increased fed rate. Is this due to markets trying to adjust for the overall possible rate increase for the year now itself?

When the index funds for bond will recover its face value or how long it normally takes for any retirees to cash out funds from bonds without loosing a lot of inherent value.
yules
Posts: 453
Joined: Wed Nov 27, 2019 10:31 am

Re: Bond index funds question

Post by yules »

satboggle2021 wrote: Mon Jun 20, 2022 3:36 pm Hello Everyone,
I have a question on bond index funds in general. We have seen the bond index funds fell over 10% or more in the recent times due to feds interest increase. I understand it is to adjust the bonds value for the increasing yields for new bonds in future. But the face value of bond index funds are falling much higher that the increased fed rate. Is this due to markets trying to adjust for the overall possible rate increase for the year now itself?

When the index funds for bond will recover its face value or how long it normally takes for any retirees to cash out funds from bonds without loosing a lot of inherent value.
I'm not bond savant, but yes, many people here use the term "priced in" to an asset which means that prices for bonds and stocks are forward looking and if the market "expects" a certain event to occur, then the price should be reflected now instead of waiting. So that's part of it, if the bonds fall more than the interest rate increases. Also, know that bond funds with different durations act in different ways. Wit perfect infromation, a short-term fund with a duration of 1.5 years will react different from a long-term bond fund with a duration of 15 years. This is due to bond math that I only kind of understand, so you're best bet is to search the wiki. But the point is that if the fed increases rates by, say, 1%, you shouldn't really expect any bond funds to change 1%.

As far as "recovering its face value" first of all it again really depends on the fund's duration.

Yules
sycamore
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Re: Bond index funds question

Post by sycamore »

My understanding is that "recovery" of your fund's value will come primarily in the form of increased dividends due as the fund buys newer bonds with their higher coupon rates.

The fund's net asset value would recover if "rates" go back down. No way of knowing when that'll happen without knowing how and when rates will rise/fall over the coming years.
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Beensabu
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Re: Bond index funds question

Post by Beensabu »

It kind of depends on how long rates keep going up before stabilizing and then how long they remain stable before going down. If rates keep going up for the entire average duration of a bond fund but then start going down, it won't take much longer than that average duration.

Take a look at this historical returns calculator for the 10-year treasury (with dividend reinvestment, so it's like a bond fund):

https://dqydj.com/treasury-return-calculator/

Start: Oct 1971
End: Oct 1981

That's a period where rates just keep trending up for 10 years (the duration of a 10-year treasury) while we had super high inflation. The inflation-adjusted return over that period was not great.

Change the end date to Oct 1982 (once rates have spent a year coming down), and the inflation-adjusted return is suddenly positive. And it kept being more positive each year.

But really, for that historically terrible period for bonds, rates actually started going up in 1965 (so they went up for 1.6x the duration). If you change the start date to Oct 1965, you still have to wait until 1982 for a positive inflation-adjusted return.

So... the lesson I take from playing around with this is that you kind of have to wait for rates to go down for recovery of bond fund values. But not by much, and not for long.

If you're in an aggregate bond market fund like BND/VBTLX, the average duration is ~7 years. Obviously, nobody knows the future, but what do you think is the likelihood of rates continuing to trend up for 7 entire years, especially with the 5-year breakeven inflation rate looking like it may have topped out around 3.5% back in March?
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
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FoundingFather
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Re: Bond index funds question

Post by FoundingFather »

satboggle2021 wrote: Mon Jun 20, 2022 3:36 pm Hello Everyone,
I have a question on bond index funds in general. We have seen the bond index funds fell over 10% or more in the recent times due to feds interest increase. I understand it is to adjust the bonds value for the increasing yields for new bonds in future. But the face value of bond index funds are falling much higher that the increased fed rate. Is this due to markets trying to adjust for the overall possible rate increase for the year now itself?

When the index funds for bond will recover its face value or how long it normally takes for any retirees to cash out funds from bonds without loosing a lot of inherent value.
I will give you two rules of thumb that I think address your question, with places where you can go to read more:

1) For a one time interest rate increase, the value of a bond fund will drop by an amount approximately equal to the interest rate increase multiplied by the duration of the fund. For example, if you own a standard total bond market fund with a duration of 7 years , and the interest rate goes up 1%, your investment in the fund should drop by ~7%. The amount of time you will need to wait for the higher interest payments to make up for the drop in price is equal to the duration of the fund. So, for total bond, at 7 years you will have made as much money as if the interest rate had never increased. https://www.bogleheads.org/wiki/Bonds:_ ... s#Duration

2. For an ongoing, constant increase in interest rates, it will take approximately twice the duration of the fund for you to make as much as if the interest rates had never increased. Here is a post in which there is a good discussion on this topic: viewtopic.php?p=6577071#p6577071

In sum, it takes a period of time equal to the duration of the bond fund for a fund holder to be made whole after a one time interest rate increase. It takes about twice the duration (commonly stated as 2D-1) for a fund holder to be made whole during a period of gradual, constant rate increases. In our current environment in which there are likely to be a few interest rate increases, instead of just one, but probably not an ongoing 7 years of increases, the length of time you will have to wait to be made whole is probably best estimated somewhere between 1x duration and 2x duration.

A few quick notes: the rule works in reverse for rate decreases. Also, these rules of thumb only work as described if you reinvest the payments received from the bond fund.

Founding Father
"The future belongs to those who believe in the beauty of their dreams." -Addie Philko (writing in “The Times Herald” of Port Huron, Michigan in 1981)
Topic Author
satboggle2021
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Joined: Tue Jun 29, 2021 11:58 pm

Re: Bond index funds question

Post by satboggle2021 »

Thanks for the response.
Topic Author
satboggle2021
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Joined: Tue Jun 29, 2021 11:58 pm

Re: Bond index funds question

Post by satboggle2021 »

If any retired person who has a good 30% Bond and 70% Stock portfolio and caching out bonds / stocks every year for the living how they will be impacted during this down years where both stock and bonds were going down.

They might need to adjust based on the profit from earlier investment as it may reduce any tax burden in their retirement accounts?
Trance
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Re: Bond index funds question

Post by Trance »

satboggle2021 wrote: Wed Jun 22, 2022 6:52 pm If any retired person who has a good 30% Bond and 70% Stock portfolio and caching out bonds / stocks every year for the living how they will be impacted during this down years where both stock and bonds were going down.

They might need to adjust based on the profit from earlier investment as it may reduce any tax burden in their retirement accounts?
I'm new here but it was my understanding that we held bonds because they are more stable and even inversely correlated with stocks.

If both are going down, then what is going up? Is there anything I can work into my portfolio to offset this situation where both stocks and bonds fall?
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arcticpineapplecorp.
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Re: Bond index funds question

Post by arcticpineapplecorp. »

Trance wrote: Wed Jun 22, 2022 7:20 pm
satboggle2021 wrote: Wed Jun 22, 2022 6:52 pm If any retired person who has a good 30% Bond and 70% Stock portfolio and caching out bonds / stocks every year for the living how they will be impacted during this down years where both stock and bonds were going down.

They might need to adjust based on the profit from earlier investment as it may reduce any tax burden in their retirement accounts?
I'm new here but it was my understanding that we held bonds because they are more stable and even inversely correlated with stocks.

If both are going down, then what is going up? Is there anything I can work into my portfolio to offset this situation where both stocks and bonds fall?
to dispel some of these myths and answer a very similar question asked recently, may I suggest you read this post:

viewtopic.php?t=380220
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events. Asking Portfolio Questions | Wiki
dbr
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Re: Bond index funds question

Post by dbr »

satboggle2021 wrote: Wed Jun 22, 2022 6:52 pm If any retired person who has a good 30% Bond and 70% Stock portfolio and caching out bonds / stocks every year for the living how they will be impacted during this down years where both stock and bonds were going down.

They might need to adjust based on the profit from earlier investment as it may reduce any tax burden in their retirement accounts?
Bonds and stocks both going down at the same time is not uncommon. There is no reason this should not happen. People are probably taken aback by the suddenness and the degree at the present moment, but investment downturns are not as staggering at the moment as at many times in the past nor is inflation nearly as high as it has been in the lifetimes of some of us.

The occurrence of episodes of this is already accounted for when people are told that a safe rate of withdrawal is no more than 4% of initial portfolio value indexed by inflation. The catch is that when bad things don't happen then you can safely spend much more. Over the last century or so the lowest withdrawal rates happened for people retiring around 1966 being allowed a little less than 4% and people retiring in 1982 could have safely spent about 8%. Being able to know for sure what is going to be the outcome of a full retirement is difficult, but it is surely true that the great portfolio gains of the last ten years in both stocks and bonds make present losses of no consequence to actual retirees, at least for now.

If you want to ponder some methodology for adjusting withdrawals according to present results you can see here: https://www.bogleheads.org/wiki/Variabl ... withdrawal
exodusNH
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Re: Bond index funds question

Post by exodusNH »

Trance wrote: Wed Jun 22, 2022 7:20 pm
satboggle2021 wrote: Wed Jun 22, 2022 6:52 pm If any retired person who has a good 30% Bond and 70% Stock portfolio and caching out bonds / stocks every year for the living how they will be impacted during this down years where both stock and bonds were going down.

They might need to adjust based on the profit from earlier investment as it may reduce any tax burden in their retirement accounts?
I'm new here but it was my understanding that we held bonds because they are more stable and even inversely correlated with stocks.

If both are going down, then what is going up? Is there anything I can work into my portfolio to offset this situation where both stocks and bonds fall?
Unfortunately, bonds being negatively correlated to stocks is a persistent myth. The problem is that myth has mostly been held over the last 40 years. In truth, they're closer to uncorrelated, which means they move independently.

There's nothing you can do but set an asset allocation that you can live with, even knowing both can go down at the same time. (Though usually bonds usually lose less, and if you hold them for the proper duration, will recover most of their original value.)

Make sure the bonds you do hold are at the proper duration.
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