bond fund help

[hudson4351]

I use VWIUX as my only bond fund and have some questions:

The SEC yield is 3.48% and the yield to maturity is 3.5%. VMFXX has a 7-day SEC yield of 5.27%. It seems like I'm better off just putting new bond investment money into VMFXX until the yield on VWIUX rises to exceed (1-marginal_tax_rate)*VMFXX_yield. Am I missing something here?

My understanding is that regardless of the price at which you buy into a bond fund, you receive the same monthly dividend calculated from the yield to maturity. The share price only becomes relevant if you want to sell your shares in the fund, at which point you could realize either a gain or a loss depending on what price you bought and sold at. Bond funds tend to realize most of their gains from dividends rather than price appreciation. Is all of that correct?

[Call_Me_Op]

I use VWIUX as my only bond fund and have some questions:

The SEC yield is 3.48% and the yield to maturity is 3.5%. VMFXX has a 7-day SEC yield of 5.27%. It seems like I'm better off just putting new bond investment money into VMFXX until the yield on VWIUX rises to exceed (1-marginal_tax_rate)*VMFXX_yield. Am I missing something here?

My understanding is that regardless of the price at which you buy into a bond fund, you receive the same monthly dividend calculated from the yield to maturity. The share price only becomes relevant if you want to sell your shares in the fund, at which point you could realize either a gain or a loss depending on what price you bought and sold at. Bond funds tend to realize most of their gains from dividends rather than price appreciation. Is all of that correct?

You are comparing apples and oranges. VWIUX is an intermediate-term tax-exempt bond fund. VMFXX is a federal money market fund. The former is federal tax exempt and has an intermediate duration. The latter is (at least partially) state tax exempt and has zero duration. You really need to understand these two very different investments before you can confidently place money in either.

[hudson4351]

I use VWIUX as my only bond fund and have some questions:

The SEC yield is 3.48% and the yield to maturity is 3.5%. VMFXX has a 7-day SEC yield of 5.27%. It seems like I'm better off just putting new bond investment money into VMFXX until the yield on VWIUX rises to exceed (1-marginal_tax_rate)*VMFXX_yield. Am I missing something here?

My understanding is that regardless of the price at which you buy into a bond fund, you receive the same monthly dividend calculated from the yield to maturity. The share price only becomes relevant if you want to sell your shares in the fund, at which point you could realize either a gain or a loss depending on what price you bought and sold at. Bond funds tend to realize most of their gains from dividends rather than price appreciation. Is all of that correct?

You are comparing apples and oranges. VWIUX is an intermediate-term tax-exempt bond fund. VMFXX is a federal money market fund. The former is federal tax exempt and has an intermediate duration. The latter is (at least partially) state tax exempt and has zero duration. You really need to understand these two very different investments before you can confidently place money in either.

I understand the difference between a money market fund (VMFXX) and a bond fund (VWIUX), generally speaking. My portfolio's bond allocation has always been 100% VWIUX. It just seems that currently, the after-tax yield of VMFXX is higher than VWUIX given my marginal tax rate and the fact that I live in a state with no income tax. Unless I'm missing something here (and maybe I am - see questions above), it seems I would earn a higher yield (and with no risk to principal) by putting money in VMFXX that I would otherwise put toward my portfolio's bond allocation (VWIUX). Once the yield on VWIUX exceeds that of VMFXX, then I would move the money in VMFXX to VWIUX and future contributions toward the bond portion of my portfolio would once again go toward VWIUX. What specifically am I missing here?

I can't recall a time in my investing lifetime where money markets were yielding more than intermediate term bond funds, which is why I've never been faced with this choice before.

[rossington]

I use VWIUX as my only bond fund and have some questions:

The SEC yield is 3.48% and the yield to maturity is 3.5%. VMFXX has a 7-day SEC yield of 5.27%. It seems like I'm better off just putting new bond investment money into VMFXX until the yield on VWIUX rises to exceed (1-marginal_tax_rate)*VMFXX_yield. Am I missing something here?

My understanding is that regardless of the price at which you buy into a bond fund, you receive the same monthly dividend calculated from the yield to maturity. The share price only becomes relevant if you want to sell your shares in the fund, at which point you could realize either a gain or a loss depending on what price you bought and sold at. Bond funds tend to realize most of their gains from dividends rather than price appreciation. Is all of that correct?

You are comparing apples and oranges. VWIUX is an intermediate-term tax-exempt bond fund. VMFXX is a federal money market fund. The former is federal tax exempt and has an intermediate duration. The latter is (at least partially) state tax exempt and has zero duration. You really need to understand these two very different investments before you can confidently place money in either.

I understand the difference between a money market fund (VMFXX) and a bond fund (VWIUX), generally speaking. My portfolio's bond allocation has always been 100% VWIUX. It just seems that currently, the after-tax yield of VMFXX is higher than VWUIX given my marginal tax rate and the fact that I live in a state with no income tax. Unless I'm missing something here (and maybe I am - see questions above), it seems I would earn a higher yield (and with no risk to principal) by putting money in VMFXX that I would otherwise put toward my portfolio's bond allocation (VWIUX). Once the yield on VWIUX exceeds that of VMFXX, then I would move the money in VMFXX to VWIUX and future contributions toward the bond portion of my portfolio would once again go toward VWIUX. What specifically am I missing here?

I can't recall a time in my investing lifetime where money markets were yielding more than intermediate term bond funds, which is why I've never been faced with this choice before.

I tend to agree with you but how significant is the after tax yield for you between the 2 funds?

[toddthebod]

The SEC yield is 3.48% and the yield to maturity is 3.5%. VMFXX has a 7-day SEC yield of 5.27%. It seems like I'm better off just putting new bond investment money into VMFXX until the yield on VWIUX rises to exceed (1-marginal_tax_rate)*VMFXX_yield. Am I missing something here?

There are two questions here: duration and taxes. Tax-wise, why did you invest in VWIUX in the first place? There are other money market funds that have similar taxation.

Second is duration. An intermediate total market fund like BND is yielding 4.6%. The reason to invest in an intermediate fund instead of a money market fund is to "lock in" that interest rate. Imagine if, in the next year, interest rates plunged back to near zero. Would you rather have 5.27% for one year followed by 0.5% for six years, or just 4.6% for seven years?

[CenTexan]

The SEC yield is 3.48% and the yield to maturity is 3.5%. VMFXX has a 7-day SEC yield of 5.27%. It seems like I'm better off just putting new bond investment money into VMFXX until the yield on VWIUX rises to exceed (1-marginal_tax_rate)*VMFXX_yield. Am I missing something here?

There are two questions here: duration and taxes. Tax-wise, why did you invest in VWIUX in the first place? There are other money market funds that have similar taxation.

Second is duration. An intermediate total market fund like BND is yielding 4.6%. The reason to invest in an intermediate fund instead of a money market fund is to "lock in" that interest rate. Imagine if, in the next year, interest rates plunged back to near zero. Would you rather have 5.27% for one year followed by 0.5% for six years, or just 4.6% for seven years?

Please explain. When I looked just now (8/24/23) at Yahoo Finance page for BND, it shows a yield of 2.82% - not the 4.6% you mention. What am I missing?

[ruralavalon]

Duplicate post deleted.

[ruralavalon]

The SEC yield is 3.48% and the yield to maturity is 3.5%. VMFXX has a 7-day SEC yield of 5.27%. It seems like I'm better off just putting new bond investment money into VMFXX until the yield on VWIUX rises to exceed (1-marginal_tax_rate)*VMFXX_yield. Am I missing something here?

There are two questions here: duration and taxes. Tax-wise, why did you invest in VWIUX in the first place? There are other money market funds that have similar taxation.

Second is duration. An intermediate total market fund like BND is yielding 4.6%. The reason to invest in an intermediate fund instead of a money market fund is to "lock in" that interest rate. Imagine if, in the next year, interest rates plunged back to near zero. Would you rather have 5.27% for one year followed by 0.5% for six years, or just 4.6% for seven years?

Please explain. When I looked just now (8/24/23) at Yahoo Finance page for BND, it shows a yield of 2.82% - not the 4.6% you mention. What am I missing?

Yahoo is giving you the past distribution yield (TTM, trailing twelve months), not the 30-day SEC Yield which is a prediction of future yield using a formula prescribed by the SEC based on the most recent 30 days.

You can see both TTM yield and SEC Yield for Vanguard Total Bond Market ETF (BND) on Morningstar.

[CenTexan]

The SEC yield is 3.48% and the yield to maturity is 3.5%. VMFXX has a 7-day SEC yield of 5.27%. It seems like I'm better off just putting new bond investment money into VMFXX until the yield on VWIUX rises to exceed (1-marginal_tax_rate)*VMFXX_yield. Am I missing something here?

There are two questions here: duration and taxes. Tax-wise, why did you invest in VWIUX in the first place? There are other money market funds that have similar taxation.

Second is duration. An intermediate total market fund like BND is yielding 4.6%. The reason to invest in an intermediate fund instead of a money market fund is to "lock in" that interest rate. Imagine if, in the next year, interest rates plunged back to near zero. Would you rather have 5.27% for one year followed by 0.5% for six years, or just 4.6% for seven years?

Please explain. When I looked just now (8/24/23) at Yahoo Finance page for BND, it shows a yield of 2.82% - not the 4.6% you mention. What am I missing?

Yahoo is giving you the past distribution yield (TTM, trailing twelve months), not the 30-day SEC Yield which is a prediction of future yield using a formula prescribed by the SEC based on the most recent 30 days.

You can see both TTM yield and SEC Yield for Vanguard Total Bond Market ETF (BND) on Morningstar.

Got it! Thanks so much.

[hudson4351]

I use VWIUX as my only bond fund and have some questions:

The SEC yield is 3.48% and the yield to maturity is 3.5%. VMFXX has a 7-day SEC yield of 5.27%. It seems like I'm better off just putting new bond investment money into VMFXX until the yield on VWIUX rises to exceed (1-marginal_tax_rate)*VMFXX_yield. Am I missing something here?

My understanding is that regardless of the price at which you buy into a bond fund, you receive the same monthly dividend calculated from the yield to maturity. The share price only becomes relevant if you want to sell your shares in the fund, at which point you could realize either a gain or a loss depending on what price you bought and sold at. Bond funds tend to realize most of their gains from dividends rather than price appreciation. Is all of that correct?

You are comparing apples and oranges. VWIUX is an intermediate-term tax-exempt bond fund. VMFXX is a federal money market fund. The former is federal tax exempt and has an intermediate duration. The latter is (at least partially) state tax exempt and has zero duration. You really need to understand these two very different investments before you can confidently place money in either.

I understand the difference between a money market fund (VMFXX) and a bond fund (VWIUX), generally speaking. My portfolio's bond allocation has always been 100% VWIUX. It just seems that currently, the after-tax yield of VMFXX is higher than VWUIX given my marginal tax rate and the fact that I live in a state with no income tax. Unless I'm missing something here (and maybe I am - see questions above), it seems I would earn a higher yield (and with no risk to principal) by putting money in VMFXX that I would otherwise put toward my portfolio's bond allocation (VWIUX). Once the yield on VWIUX exceeds that of VMFXX, then I would move the money in VMFXX to VWIUX and future contributions toward the bond portion of my portfolio would once again go toward VWIUX. What specifically am I missing here?

I can't recall a time in my investing lifetime where money markets were yielding more than intermediate term bond funds, which is why I've never been faced with this choice before.

I tend to agree with you but how significant is the after tax yield for you between the 2 funds?

Only 0.1%, so probably not too significant in the long run. I just wanted to make sure my understanding of how the two funds worked was correct.

[hudson4351]

The SEC yield is 3.48% and the yield to maturity is 3.5%. VMFXX has a 7-day SEC yield of 5.27%. It seems like I'm better off just putting new bond investment money into VMFXX until the yield on VWIUX rises to exceed (1-marginal_tax_rate)*VMFXX_yield. Am I missing something here?

There are two questions here: duration and taxes. Tax-wise, why did you invest in VWIUX in the first place? There are other money market funds that have similar taxation.

Can you elaborate on this? VWIUX is a bond fund, not a money market fund. I invested it it because I wanted one bond fund for my portfolio and given that VWIUX is free from federal income tax, it generally gives me a higher after-tax return than VBLTX (total bond market index). VMFXX is a money market fund that is apparently offering slightly higher yields than VWIUX right now (and at no risk to principal).

Second is duration. An intermediate total market fund like BND is yielding 4.6%. The reason to invest in an intermediate fund instead of a money market fund is to "lock in" that interest rate. Imagine if, in the next year, interest rates plunged back to near zero. Would you rather have 5.27% for one year followed by 0.5% for six years, or just 4.6% for seven years?

How are you "locking in" an interest rate by buying BND or VWIUX? Don't all investors of a bond fund like BND or VWIUX receive the current SEC yield regardless of when they bought their shares? It seems the price they bought in at only becomes relevant if they sell the shares.

If interest rates plunge back to near zero, then I can just move the money from VMFXX to VWIUX.

[toddthebod]

The SEC yield is 3.48% and the yield to maturity is 3.5%. VMFXX has a 7-day SEC yield of 5.27%. It seems like I'm better off just putting new bond investment money into VMFXX until the yield on VWIUX rises to exceed (1-marginal_tax_rate)*VMFXX_yield. Am I missing something here?

There are two questions here: duration and taxes. Tax-wise, why did you invest in VWIUX in the first place? There are other money market funds that have similar taxation.

Can you elaborate on this? VWIUX is a bond fund, not a money market fund. I invested it it because I wanted one bond fund for my portfolio and given that VWIUX is free from federal income tax, it generally gives me a higher after-tax return than VBLTX (total bond market index). VMFXX is a money market fund that is apparently offering slightly higher yields than VWIUX right now (and at no risk to principal).

Second is duration. An intermediate total market fund like BND is yielding 4.6%. The reason to invest in an intermediate fund instead of a money market fund is to "lock in" that interest rate. Imagine if, in the next year, interest rates plunged back to near zero. Would you rather have 5.27% for one year followed by 0.5% for six years, or just 4.6% for seven years?

How are you "locking in" an interest rate by buying BND or VWIUX? Don't all investors of a bond fund like BND or VWIUX receive the current SEC yield regardless of when they bought their shares? It seems the price they bought in at only becomes relevant if they sell the shares.

If interest rates plunge back to near zero, then I can just move the money from VMFXX to VWIUX.

There are tax-free money market funds. Why are income taxes a concern for your bond fund but not for your money market fund?

Bond funds are collections of bonds. If the bond fund holds a bond yielding 4% for 7 years, it will yield 4% for 7 years, regardless of what happens to market interest rates.

Consider the difference between a T-bills maturing in 4 weeks and a note maturing in 7 years. After 4 weeks passes, you are at the mercy of the market for what yield you might earn on your T-bills principal, but your 7 year bond still earns the same yield.

[CenTexan]

The SEC yield is 3.48% and the yield to maturity is 3.5%. VMFXX has a 7-day SEC yield of 5.27%. It seems like I'm better off just putting new bond investment money into VMFXX until the yield on VWIUX rises to exceed (1-marginal_tax_rate)*VMFXX_yield. Am I missing something here?

There are two questions here: duration and taxes. Tax-wise, why did you invest in VWIUX in the first place? There are other money market funds that have similar taxation.

Can you elaborate on this? VWIUX is a bond fund, not a money market fund. I invested it it because I wanted one bond fund for my portfolio and given that VWIUX is free from federal income tax, it generally gives me a higher after-tax return than VBLTX (total bond market index). VMFXX is a money market fund that is apparently offering slightly higher yields than VWIUX right now (and at no risk to principal).

Second is duration. An intermediate total market fund like BND is yielding 4.6%. The reason to invest in an intermediate fund instead of a money market fund is to "lock in" that interest rate. Imagine if, in the next year, interest rates plunged back to near zero. Would you rather have 5.27% for one year followed by 0.5% for six years, or just 4.6% for seven years?

How are you "locking in" an interest rate by buying BND or VWIUX? Don't all investors of a bond fund like BND or VWIUX receive the current SEC yield regardless of when they bought their shares? It seems the price they bought in at only becomes relevant if they sell the shares.

If interest rates plunge back to near zero, then I can just move the money from VMFXX to VWIUX.

There are tax-free money market funds. Why are income taxes a concern for your bond fund but not for your money market fund?

Bond funds are collections of bonds. If the bond fund holds a bond yielding 4% for 7 years, it will yield 4% for 7 years, regardless of what happens to market interest rates.

Consider the difference between a T-bills maturing in 4 weeks and a note maturing in 7 years. After 4 weeks passes, you are at the mercy of the market for what yield you might earn on your T-bills principal, but your 7 year bond still earns the same yield.

But the bond fund is continuosly buying new bonds, right? So it is adding LOWER rate bonds to the fund, which means you do not get the "4%" (which you would with an individual bond) but a diluted amount (accounting for the lower yield of the newer bonds). . . . right?

I've got some BND but am giving up on buying any more until I understand it better. As is said, don't buy it if you don't understand it . . .

[Marseille07]

But the bond fund is continuosly buying new bonds, right? So it is adding LOWER rate bonds to the fund, which means you do not get the "4%" (which you would with an individual bond) but a diluted amount (accounting for the lower yield of the newer bonds). . . . right?

I've got some BND but am giving up on buying any more until I understand it better. As is said, don't buy it if you don't understand it . . .

Yes, constant maturity means your BND exposure is always 7 years give or take. They don't hold the same bond for 7 years until maturity.

[tibbitts]

It's interesting that nobody worries about understanding bond funds when they're yielding 2%, with a recent annual return of 5%.

[toddthebod]

The SEC yield is 3.48% and the yield to maturity is 3.5%. VMFXX has a 7-day SEC yield of 5.27%. It seems like I'm better off just putting new bond investment money into VMFXX until the yield on VWIUX rises to exceed (1-marginal_tax_rate)*VMFXX_yield. Am I missing something here?

There are two questions here: duration and taxes. Tax-wise, why did you invest in VWIUX in the first place? There are other money market funds that have similar taxation.

Can you elaborate on this? VWIUX is a bond fund, not a money market fund. I invested it it because I wanted one bond fund for my portfolio and given that VWIUX is free from federal income tax, it generally gives me a higher after-tax return than VBLTX (total bond market index). VMFXX is a money market fund that is apparently offering slightly higher yields than VWIUX right now (and at no risk to principal).

Second is duration. An intermediate total market fund like BND is yielding 4.6%. The reason to invest in an intermediate fund instead of a money market fund is to "lock in" that interest rate. Imagine if, in the next year, interest rates plunged back to near zero. Would you rather have 5.27% for one year followed by 0.5% for six years, or just 4.6% for seven years?

How are you "locking in" an interest rate by buying BND or VWIUX? Don't all investors of a bond fund like BND or VWIUX receive the current SEC yield regardless of when they bought their shares? It seems the price they bought in at only becomes relevant if they sell the shares.

If interest rates plunge back to near zero, then I can just move the money from VMFXX to VWIUX.

There are tax-free money market funds. Why are income taxes a concern for your bond fund but not for your money market fund?

Bond funds are collections of bonds. If the bond fund holds a bond yielding 4% for 7 years, it will yield 4% for 7 years, regardless of what happens to market interest rates.

Consider the difference between a T-bills maturing in 4 weeks and a note maturing in 7 years. After 4 weeks passes, you are at the mercy of the market for what yield you might earn on your T-bills principal, but your 7 year bond still earns the same yield.

But the bond fund is continuosly buying new bonds, right? So it is adding LOWER rate bonds to the fund, which means you do not get the "4%" (which you would with an individual bond) but a diluted amount (accounting for the lower yield of the newer bonds). . . . right?

I've got some BND but am giving up on buying any more until I understand it better. As is said, don't buy it if you don't understand it . . .

Here's my grossly over-simplified explanation:

Imagine interest rates were constant across all maturities at 5%. Now imagine a bond fund that holds one bond maturing each year from 2024 through 2038. This is an intermediate bond fund with a yield to maturity of 5% and an average maturity of 8 years. We are going to compare this fund with your money market fund that largely invests in treasuries and repurchase agreements that mature in 1-2 months.

Okay, now over the course of the next year, interest rates fall across the board from 5% to 3%. The intermediate bond fund replaces the maturing bond with a new 15 year bond paying 3%. But it still holds the other 14 bonds. So now the bond fund is yielding an average of ~4.9%, while your money market fund is yielding 3%, since everything has matured and been replaced with lower yielding instruments.

[CenTexan]

There are two questions here: duration and taxes. Tax-wise, why did you invest in VWIUX in the first place? There are other money market funds that have similar taxation.

Can you elaborate on this? VWIUX is a bond fund, not a money market fund. I invested it it because I wanted one bond fund for my portfolio and given that VWIUX is free from federal income tax, it generally gives me a higher after-tax return than VBLTX (total bond market index). VMFXX is a money market fund that is apparently offering slightly higher yields than VWIUX right now (and at no risk to principal).

Second is duration. An intermediate total market fund like BND is yielding 4.6%. The reason to invest in an intermediate fund instead of a money market fund is to "lock in" that interest rate. Imagine if, in the next year, interest rates plunged back to near zero. Would you rather have 5.27% for one year followed by 0.5% for six years, or just 4.6% for seven years?

How are you "locking in" an interest rate by buying BND or VWIUX? Don't all investors of a bond fund like BND or VWIUX receive the current SEC yield regardless of when they bought their shares? It seems the price they bought in at only becomes relevant if they sell the shares.

If interest rates plunge back to near zero, then I can just move the money from VMFXX to VWIUX.

There are tax-free money market funds. Why are income taxes a concern for your bond fund but not for your money market fund?

Bond funds are collections of bonds. If the bond fund holds a bond yielding 4% for 7 years, it will yield 4% for 7 years, regardless of what happens to market interest rates.

Consider the difference between a T-bills maturing in 4 weeks and a note maturing in 7 years. After 4 weeks passes, you are at the mercy of the market for what yield you might earn on your T-bills principal, but your 7 year bond still earns the same yield.

But the bond fund is continuosly buying new bonds, right? So it is adding LOWER rate bonds to the fund, which means you do not get the "4%" (which you would with an individual bond) but a diluted amount (accounting for the lower yield of the newer bonds). . . . right?

I've got some BND but am giving up on buying any more until I understand it better. As is said, don't buy it if you don't understand it . . .

Here's my grossly over-simplified explanation:

Imagine interest rates were constant across all maturities at 5%. Now imagine a bond fund that holds one bond maturing each year from 2024 through 2038. This is an intermediate bond fund with a yield to maturity of 5% and an average maturity of 8 years. We are going to compare this fund with your money market fund that largely invests in treasuries and repurchase agreements that mature in 1-2 months.

Okay, now over the course of the next year, interest rates fall across the board from 5% to 3%. The intermediate bond fund replaces the maturing bond with a new 15 year bond paying 3%. But it still holds the other 14 bonds. So now the bond fund is yielding an average of ~4.9%, while your money market fund is yielding 3%, since everything has matured and been replaced with lower yielding instruments.

Thanks for example. Not sure anyone cares to continue this thread, but just in case - another question about a bond fund (using BND as an example):

So the holdings go through continuous cycle of being replaced with current yield bonds. This affects the overall yield of the fund (whether TTM or SEC 30 day, etc). An owner of the fund gets the "interest" generated each month, based on the funds holdings. (am I correct so far?)

But how do I deal with the drop (or rise) of the value of a share of the fund? I see this being reported (on Yahoo, etc) as two such values - the market value and the NAV.

I assume the NAV is a calculated *market value* of the holdings of the fund, ie, if each bond held in the fund was (theoretically) sold that day on the open market, and all proceeds were added together, then divided by the number of shares. Right?

Then does the day's market price for a share of the fund simply indicate the "demand" (ie, intererest in buying) into the fund? And is that # a reflection of current trading action (people wanting to buy, people wanting to sell their shares), lagging by a day?

Sorry to keep asking stuff . . . I'm still trying to understand the loss of value I have experienced with BND I bought a while back.

[toddthebod]

Can you elaborate on this? VWIUX is a bond fund, not a money market fund. I invested it it because I wanted one bond fund for my portfolio and given that VWIUX is free from federal income tax, it generally gives me a higher after-tax return than VBLTX (total bond market index). VMFXX is a money market fund that is apparently offering slightly higher yields than VWIUX right now (and at no risk to principal).



How are you "locking in" an interest rate by buying BND or VWIUX? Don't all investors of a bond fund like BND or VWIUX receive the current SEC yield regardless of when they bought their shares? It seems the price they bought in at only becomes relevant if they sell the shares.

If interest rates plunge back to near zero, then I can just move the money from VMFXX to VWIUX.

There are tax-free money market funds. Why are income taxes a concern for your bond fund but not for your money market fund?

Bond funds are collections of bonds. If the bond fund holds a bond yielding 4% for 7 years, it will yield 4% for 7 years, regardless of what happens to market interest rates.

Consider the difference between a T-bills maturing in 4 weeks and a note maturing in 7 years. After 4 weeks passes, you are at the mercy of the market for what yield you might earn on your T-bills principal, but your 7 year bond still earns the same yield.

But the bond fund is continuosly buying new bonds, right? So it is adding LOWER rate bonds to the fund, which means you do not get the "4%" (which you would with an individual bond) but a diluted amount (accounting for the lower yield of the newer bonds). . . . right?

I've got some BND but am giving up on buying any more until I understand it better. As is said, don't buy it if you don't understand it . . .

Here's my grossly over-simplified explanation:

Imagine interest rates were constant across all maturities at 5%. Now imagine a bond fund that holds one bond maturing each year from 2024 through 2038. This is an intermediate bond fund with a yield to maturity of 5% and an average maturity of 8 years. We are going to compare this fund with your money market fund that largely invests in treasuries and repurchase agreements that mature in 1-2 months.

Okay, now over the course of the next year, interest rates fall across the board from 5% to 3%. The intermediate bond fund replaces the maturing bond with a new 15 year bond paying 3%. But it still holds the other 14 bonds. So now the bond fund is yielding an average of ~4.9%, while your money market fund is yielding 3%, since everything has matured and been replaced with lower yielding instruments.

Thanks for example. Not sure anyone cares to continue this thread, but just in case - another question about a bond fund (using BND as an example):

So the holdings go through continuous cycle of being replaced with current yield bonds. This affects the overall yield of the fund (whether TTM or SEC 30 day, etc). An owner of the fund gets the "interest" generated each month, based on the funds holdings. (am I correct so far?)

But how do I deal with the drop (or rise) of the value of a share of the fund? I see this being reported (on Yahoo, etc) as two such values - the market value and the NAV.

I assume the NAV is a calculated *market value* of the holdings of the fund, ie, if each bond held in the fund was (theoretically) sold that day on the open market, and all proceeds were added together, then divided by the number of shares. Right?

Then does the day's market price for a share of the fund simply indicate the "demand" (ie, intererest in buying) into the fund? And is that # a reflection of current trading action (people wanting to buy, people wanting to sell their shares), lagging by a day?

Sorry to keep asking stuff . . . I'm still trying to understand the loss of value I have experienced with BND I bought a while back.

NAV is calculated at the end of the day as the sum total value of the holdings of the fund (mutual fund or ETF) divided by the number of shares. The market price of an ETF, as you stated, goes up and down based on the trading activity during the day.

The yield of a bond fund includes distributions, but the two numbers will be slightly different depending on the changing values of the underlying holdings. The yield includes price appreciation/depreciation, so just because the SEC yield is 3.0%, you will not necessarily receive 3.0% in dividends. The total return of the fund should be similar to the SEC yield over the timeframe of the duration of the fund, barring significant changes in interest rates towards the end of that time period.

For BND and other intermediate bond funds, when we bought shares of them 18 months ago, we were expecting a tiny yield. Then interest rates shot up, so the price plummeted. In exchange, the yield is now much higher. These two factors will pretty much cancel each other out such that 7-8 years from now, you will have earned something close to that original tiny yield.

[grabiner]

Bond funds are collections of bonds. If the bond fund holds a bond yielding 4% for 7 years, it will yield 4% for 7 years, regardless of what happens to market interest rates.

Consider the difference between a T-bills maturing in 4 weeks and a note maturing in 7 years. After 4 weeks passes, you are at the mercy of the market for what yield you might earn on your T-bills principal, but your 7 year bond still earns the same yield.

But the bond fund is continuosly buying new bonds, right? So it is adding LOWER rate bonds to the fund, which means you do not get the "4%" (which you would with an individual bond) but a diluted amount (accounting for the lower yield of the newer bonds). . . . right? . . .

If rates fall, bond prices will rise, so you will get a higher immediate return and a lower future return, on either an individual bond or a bond fund. The return over the duration of a bond or bond fund will be the same.

Suppose that you buy a 7-year bond yielding 4%, and next year 6-year bonds yield 3%. Your one-year return on the 7-year bond will be about 10% because of the 4% income and 6% price increase, but you will then earn 3% over the following six years to get an overall 4% return. (These numbers are approximate because of compounding issues and coupon payments.)

Suppose that you buy a bond fund which holds the 7-year bond, and sells it next year for a capital gain of 6%. The replacement bonds will earn only 3%, but those bonds will be starting with a higher value, so if interest rates don't change over the next six years, your return on the bond fund will still be 4% over seven years.

[CenTexan]

There are tax-free money market funds. Why are income taxes a concern for your bond fund but not for your money market fund?

Bond funds are collections of bonds. If the bond fund holds a bond yielding 4% for 7 years, it will yield 4% for 7 years, regardless of what happens to market interest rates.

Consider the difference between a T-bills maturing in 4 weeks and a note maturing in 7 years. After 4 weeks passes, you are at the mercy of the market for what yield you might earn on your T-bills principal, but your 7 year bond still earns the same yield.

But the bond fund is continuosly buying new bonds, right? So it is adding LOWER rate bonds to the fund, which means you do not get the "4%" (which you would with an individual bond) but a diluted amount (accounting for the lower yield of the newer bonds). . . . right?

I've got some BND but am giving up on buying any more until I understand it better. As is said, don't buy it if you don't understand it . . .

Here's my grossly over-simplified explanation:

Imagine interest rates were constant across all maturities at 5%. Now imagine a bond fund that holds one bond maturing each year from 2024 through 2038. This is an intermediate bond fund with a yield to maturity of 5% and an average maturity of 8 years. We are going to compare this fund with your money market fund that largely invests in treasuries and repurchase agreements that mature in 1-2 months.

Okay, now over the course of the next year, interest rates fall across the board from 5% to 3%. The intermediate bond fund replaces the maturing bond with a new 15 year bond paying 3%. But it still holds the other 14 bonds. So now the bond fund is yielding an average of ~4.9%, while your money market fund is yielding 3%, since everything has matured and been replaced with lower yielding instruments.

Thanks for example. Not sure anyone cares to continue this thread, but just in case - another question about a bond fund (using BND as an example):

So the holdings go through continuous cycle of being replaced with current yield bonds. This affects the overall yield of the fund (whether TTM or SEC 30 day, etc). An owner of the fund gets the "interest" generated each month, based on the funds holdings. (am I correct so far?)

But how do I deal with the drop (or rise) of the value of a share of the fund? I see this being reported (on Yahoo, etc) as two such values - the market value and the NAV.

I assume the NAV is a calculated *market value* of the holdings of the fund, ie, if each bond held in the fund was (theoretically) sold that day on the open market, and all proceeds were added together, then divided by the number of shares. Right?

Then does the day's market price for a share of the fund simply indicate the "demand" (ie, intererest in buying) into the fund? And is that # a reflection of current trading action (people wanting to buy, people wanting to sell their shares), lagging by a day?

Sorry to keep asking stuff . . . I'm still trying to understand the loss of value I have experienced with BND I bought a while back.

NAV is calculated at the end of the day as the sum total value of the holdings of the fund (mutual fund or ETF) divided by the number of shares. The market price of an ETF, as you stated, goes up and down based on the trading activity during the day.

The yield of a bond fund includes distributions, but the two numbers will be slightly different depending on the changing values of the underlying holdings. The yield includes price appreciation/depreciation, so just because the SEC yield is 3.0%, you will not necessarily receive 3.0% in dividends. The total return of the fund should be similar to the SEC yield over the timeframe of the duration of the fund, barring significant changes in interest rates towards the end of that time period.

For BND and other intermediate bond funds, when we bought shares of them 18 months ago, we were expecting a tiny yield. Then interest rates shot up, so the price plummeted. In exchange, the yield is now much higher. These two factors will pretty much cancel each other out such that 7-8 years from now, you will have earned something close to that original tiny yield.

Thank you (toddthebod and grabiner) for continuing to explain it to me. I think I am beginning to understand the vagaries of BND. For my learning styule (which is slow), I must be able to internally conceptualize and then reiterate.

From your reply, I appear to (kind of) understand NAV: NAV is an attempt/method to specify a current market value of a bond (or a group of bonds, for a bond fund) at the end of the trading day.

Point 1: For a person who has no intention of selling an individual bond before maturity, NAV is not important. The fact that the NAV might drop below what was paid (or conversely, rise above) is just "noise" along the pathway to maturity. When the bond reaches maturity, you get what you expected when you bought it. This explains to me why the Treasuries and CDs I hold move up and down in the "Gain/Loss" column on my broker's site. In the end (at maturity), I get the x% I thought I would when I bought it. (omitting any caveats of calls, bankruptcies, etc.). IS MY UNDERSTANDING OF THIS CORRECT?

Point 2: But for a bond fund, things are a little more complicated (for simple minds like mine). This is because a bond fund is a "soup" of different bonds, bought at different times, for different maturities, and at different yields. Since BND is an intermediate bond fund (meaning it buys bonds that mature at longest in 7 or 8 years), how should I view fluctuations in NAV? . . . as an actionable value? Or just more "noise?" If NAV drops and I sell prior to holding BND for 7 years, am I losing money?

[dbr]

From your reply, I appear to (kind of) understand NAV: NAV is an attempt/method to specify a current market value of a bond (or a group of bonds, for a bond fund) at the end of the trading day.

I would say that NAV is the exact DEFINITION of current market value, and it is taken at the end of the trading day. Do you have a different definition of end of day current market value?

Point 1: For a person who has no intention of selling an individual bond before maturity, NAV is not important. The fact that the NAV might drop below what was paid (or conversely, rise above) is just "noise" along the pathway to maturity. When the bond reaches maturity, you get what you expected when you bought it. This explains to me why the Treasuries and CDs I hold move up and down in the "Gain/Loss" column on my broker's site. In the end (at maturity), I get the x% I thought I would when I bought it. (omitting any caveats of calls, bankruptcies, etc.). IS MY UNDERSTANDING OF THIS CORRECT?

This is correct. What should not be overlooked is that holding the investment exactly to maturity is a severe limitation. And it is not just the holding to maturity but also that one cannot now predict what investment terms one can get to reinvest the asset. There are almost no instances in which an investor buys a bond and has a use for recovering the money in total exactly on one given day.* That does not mean owning bonds has no point. It might mean that holding to maturity has no point other than psychological comfort.

*The one important instance that does exist is setting up a spend down ladder of bonds as a way to manage withdrawals from a portfolio. This can make sense but it is not simple to show that this is a better or worse way to manage drawdowns than other ways.

Point 2: But for a bond fund, things are a little more complicated (for simple minds like mine). This is because a bond fund is a "soup" of different bonds, bought at different times, for different maturities, and at different yields. Since BND is an intermediate bond fund (meaning it buys bonds that mature at longest in 7 or 8 years), how should I view fluctuations in NAV? . . . as an actionable value? Or just more "noise?" If NAV drops and I sell prior to holding BND for 7 years, am I losing money?

I personally think that for a bond fund a more rational way to characterize the behavior of the investment is to assess return, including the variability of the return, over time just as one assesses other assets and collections of assets in modern portfolio theory. A good tool in which that approach is tabulated is something like Portfolio Visualizer. Planning tools like FireCalc and the many variations on that method base the analysis on return and variability of return for different assets. It does seem that buying a bond fund and then trying to focus on when one will or will not recover one's money is not the most helpful approach. But fluctuations in NAV are actionable because that is part of the volatility of returns and is part of the basic formulation of portfolio theory. The basic ingredients of portfolio theory are the statistical moments of the return distribution, meaning mean return and standard deviation if return, and then also the correlations among the returns of the different assets in the portfolio. In application of those concepts you have to see the bond fund as a component of a portfolio and not as an isolated asset. That is in fact what most investment planning involves. Probably if one is highly anxious about the bond holding in isolation one might best not own bond funds.

[toddthebod]

From your reply, I appear to (kind of) understand NAV: NAV is an attempt/method to specify a current market value of a bond (or a group of bonds, for a bond fund) at the end of the trading day.

Point 1: For a person who has no intention of selling an individual bond before maturity, NAV is not important. The fact that the NAV might drop below what was paid (or conversely, rise above) is just "noise" along the pathway to maturity. When the bond reaches maturity, you get what you expected when you bought it. This explains to me why the Treasuries and CDs I hold move up and down in the "Gain/Loss" column on my broker's site. In the end (at maturity), I get the x% I thought I would when I bought it. (omitting any caveats of calls, bankruptcies, etc.). IS MY UNDERSTANDING OF THIS CORRECT?

Point 2: But for a bond fund, things are a little more complicated (for simple minds like mine). This is because a bond fund is a "soup" of different bonds, bought at different times, for different maturities, and at different yields. Since BND is an intermediate bond fund (meaning it buys bonds that mature at longest in 7 or 8 years), how should I view fluctuations in NAV? . . . as an actionable value? Or just more "noise?" If NAV drops and I sell prior to holding BND for 7 years, am I losing money?

In addition to what dbr said, I have one correction to "Since BND is an intermediate bond fund (meaning it buys bonds that mature at longest in 7 or 8 years)", BND holds funds with an average maturity of 8.9 years, not a maximum.

The question I have for you is what are you going to do with the principal when your individual bond reaches maturity?

[hudson4351]

There are tax-free money market funds. Why are income taxes a concern for your bond fund but not for your money market fund?

Bond funds are collections of bonds. If the bond fund holds a bond yielding 4% for 7 years, it will yield 4% for 7 years, regardless of what happens to market interest rates.

Consider the difference between a T-bills maturing in 4 weeks and a note maturing in 7 years. After 4 weeks passes, you are at the mercy of the market for what yield you might earn on your T-bills principal, but your 7 year bond still earns the same yield.

But the bond fund is continuosly buying new bonds, right? So it is adding LOWER rate bonds to the fund, which means you do not get the "4%" (which you would with an individual bond) but a diluted amount (accounting for the lower yield of the newer bonds). . . . right?

I've got some BND but am giving up on buying any more until I understand it better. As is said, don't buy it if you don't understand it . . .

Here's my grossly over-simplified explanation:

Imagine interest rates were constant across all maturities at 5%. Now imagine a bond fund that holds one bond maturing each year from 2024 through 2038. This is an intermediate bond fund with a yield to maturity of 5% and an average maturity of 8 years. We are going to compare this fund with your money market fund that largely invests in treasuries and repurchase agreements that mature in 1-2 months.

Okay, now over the course of the next year, interest rates fall across the board from 5% to 3%. The intermediate bond fund replaces the maturing bond with a new 15 year bond paying 3%. But it still holds the other 14 bonds. So now the bond fund is yielding an average of ~4.9%, while your money market fund is yielding 3%, since everything has matured and been replaced with lower yielding instruments.

Thanks for example. Not sure anyone cares to continue this thread, but just in case - another question about a bond fund (using BND as an example):

So the holdings go through continuous cycle of being replaced with current yield bonds. This affects the overall yield of the fund (whether TTM or SEC 30 day, etc). An owner of the fund gets the "interest" generated each month, based on the funds holdings. (am I correct so far?)

But how do I deal with the drop (or rise) of the value of a share of the fund? I see this being reported (on Yahoo, etc) as two such values - the market value and the NAV.

I assume the NAV is a calculated *market value* of the holdings of the fund, ie, if each bond held in the fund was (theoretically) sold that day on the open market, and all proceeds were added together, then divided by the number of shares. Right?

Then does the day's market price for a share of the fund simply indicate the "demand" (ie, intererest in buying) into the fund? And is that # a reflection of current trading action (people wanting to buy, people wanting to sell their shares), lagging by a day?

Sorry to keep asking stuff . . . I'm still trying to understand the loss of value I have experienced with BND I bought a while back.

NAV is calculated at the end of the day as the sum total value of the holdings of the fund (mutual fund or ETF) divided by the number of shares. The market price of an ETF, as you stated, goes up and down based on the trading activity during the day.

The yield of a bond fund includes distributions, but the two numbers will be slightly different depending on the changing values of the underlying holdings. The yield includes price appreciation/depreciation, so just because the SEC yield is 3.0%, you will not necessarily receive 3.0% in dividends. The total return of the fund should be similar to the SEC yield over the timeframe of the duration of the fund, barring significant changes in interest rates towards the end of that time period.

I thought SEC yield was only measuring dividends paid out per share and was not factoring in the price appreciation/depreciation of the shares themselves. Is that not correct?

Don't I receive the same in dividends each month regardless of what price I bought my bond fund's shares at?

For BND and other intermediate bond funds, when we bought shares of them 18 months ago, we were expecting a tiny yield. Then interest rates shot up, so the price plummeted. In exchange, the yield is now much higher. These two factors will pretty much cancel each other out such that 7-8 years from now, you will have earned something close to that original tiny yield.

Does the bond fund share price drop (due to the interest rate of the bonds currently held by the fund no longer being competitive with the market) and yield increase (due to lower-yielding bonds in the fund being replaced with newer, higher-yielding bonds) happen at the same rate?

[dbr]

I thought SEC yield was only measuring dividends paid out per share and was not factoring in the price appreciation/depreciation of the shares themselves. Is that not correct?

Here is the definition: https://www.investopedia.com/terms/s/se ... the%20year.

Calculation of the SEC Yield
Most funds calculate a 30-day SEC yield on the last day of each month, though U.S. money market funds calculate and report a seven-day SEC yield. The standardized formula for the 30-day SEC yield consists of four variables:

a = interest and dividends received over the last 30-day period

b = accrued expenses over the last 30-day period, excluding reimbursements

c = the average number of shares outstanding, on a daily basis, which were entitled to receive distributions

d = the maximum price per share on the day of the calculation, the last day of the period

The formula of the annualized 30-day SEC yield is:

2 x (((a - b) / (c x d) + 1) ^ 6 - 1)

There is only mention of earnings inside the fund less expenses relative to the price of the shares.

Don't I receive the same in dividends each month regardless of what price I bought my bond fund's shares at?

No. Here is a list of the dividends paid out per share of VBMFX, for example, for 2022:

Date Dividends
Dec 30, 2022 0.022 Dividend
Nov 30, 2022 0.021 Dividend
Oct 31, 2022 0.021 Dividend
Sep 30, 2022 0.02 Dividend
Aug 31, 2022 0.02 Dividend
Jul 29, 2022 0.019 Dividend
Jun 30, 2022 0.019 Dividend
May 31, 2022 0.018 Dividend
Apr 29, 2022 0.018 Dividend
Mar 31, 2022 0.018 Dividend
Feb 28, 2022 0.016 Dividend
Jan 31, 2022 0.017 Dividend
Dec 31, 2021 0.017 Dividend

[grabiner]

The yield of a bond fund includes distributions, but the two numbers will be slightly different depending on the changing values of the underlying holdings. The yield includes price appreciation/depreciation, so just because the SEC yield is 3.0%, you will not necessarily receive 3.0% in dividends. The total return of the fund should be similar to the SEC yield over the timeframe of the duration of the fund, barring significant changes in interest rates towards the end of that time period.

I thought SEC yield was only measuring dividends paid out per share and was not factoring in the price appreciation/depreciation of the shares themselves. Is that not correct?

SEC yield is based on yield to maturity (or yield to call for bonds likely to be called), so it does include price appreciation. See SEC yield[/quote]

Don't I receive the same in dividends each month regardless of what price I bought my bond fund's shares at?

The dividend each month does not depend on the purchase price of your shares, but it will change as the bonds in the fund change. If a bond paid $1000 to buy a bond with a 2.4% yield, that bond pays $2 per month in dividends. Since rates have rise, the future return on the bond will be more than $2 per month, as the price will return to $1000 when the bond matures.

If the fund now sells the bond for $900 to buy a bond with a 4% yield, that new bond pays $3 per month in dividends. but the price will no longer appreciate; the new bond worth $900 will be worth $900 when it matures.

[toddthebod]

I thought SEC yield was only measuring dividends paid out per share and was not factoring in the price appreciation/depreciation of the shares themselves. Is that not correct?

Don't I receive the same in dividends each month regardless of what price I bought my bond fund's shares at?

Here's an another way to think about it: How can Treasury bills have a yield if there are no coupon payments? And how would you calculate the NAV of a bond fund that held only Treasury bills?

Does the bond fund share price drop (due to the interest rate of the bonds currently held by the fund no longer being competitive with the market) and yield increase (due to lower-yielding bonds in the fund being replaced with newer, higher-yielding bonds) happen at the same rate?

When it comes to bonds, price and yield are two numbers that express the same measurement. There's no such thing as "lower-yielding bonds being replaced with newer, higher-yielding bonds." In fact, given the current inverse yield curve, an intermediate fund will generally be replacing higher-yielding bonds with lower-yielding bonds.

[dbr]

SEC yield is based on yield to maturity (or yield to call for bonds likely to be called), so it does include price appreciation. See SEC yield

Thank you for this reference. I will add an extract from the SEC document that makes very clear exactly what is involved here. The fact that SEC yield is a form of yield to maturity summed over all the holdings is a fact that should be made clear as these references describe:

The formula of the annualized 30-day SEC yield is:

2 x (((a - b) / (c x d) + 1) ^ 6 - 1)

To calculate interest earned on debt obligations for purposes of “a” above:
(a)
Calculate the yield to maturity of each obligation held by the Fund based on the market value of the obligation (including actual accrued interest) at the close of business on the last business day of each month or, with respect to obligations purchased during the month, the purchase price (plus actual accrued interest). The maturity of an obligation with a call provision(s) is the next call date on which the obligation reasonably may be expected to be called, or if none, the maturity date.
(b)
Divide the yield to maturity by 360 and multiply the quotient by the market value of the obligation (including actual accrued interest) to determine the interest income on the obligation for each day of the subsequent month that the obligation is in the portfolio. Assume that each month has 30 days.

[hudson4351]

I thought SEC yield was only measuring dividends paid out per share and was not factoring in the price appreciation/depreciation of the shares themselves. Is that not correct?

Don't I receive the same in dividends each month regardless of what price I bought my bond fund's shares at?

Here's an another way to think about it: How can Treasury bills have a yield if there are no coupon payments? And how would you calculate the NAV of a bond fund that held only Treasury bills?

Maybe I have a fundamental misunderstanding in how bonds and/or bond funds work. My understanding is the following:

1. I buy shares of a bond fund at a particular NAV price
2. I get paid a monthly dividend which is simply my share of the coupon payments of the bonds held by the fund; the amount paid per share is independent of the price at which each share was purchased
3. The NAV price will fluctuate from day to day based on interest rates and other factors
4. When/if I decide to sell the shares of my bond fund, I can realize a gain or a loss on the price of the shares themselves based on whether the NAV price at the time of sale is higher or lower than the purchase price; this is separate from the return that can be calculated from the dividends paid out by those shares; Vanguard therefore reports two separate returns for bond funds: "Capital return by NAV" and "Income return by NAV" (plus the sum of the 2, "Total return by NAV").

Is all of that correct so far?

Does the bond fund share price drop (due to the interest rate of the bonds currently held by the fund no longer being competitive with the market) and yield increase (due to lower-yielding bonds in the fund being replaced with newer, higher-yielding bonds) happen at the same rate?

When it comes to bonds, price and yield are two numbers that express the same measurement. There's no such thing as "lower-yielding bonds being replaced with newer, higher-yielding bonds." In fact, given the current inverse yield curve, an intermediate fund will generally be replacing higher-yielding bonds with lower-yielding bonds.

If the bonds currently held by the fund are paying 4% but new bonds are paying 5% (hypothetical scenario), then when the 4% bonds held by the fund mature and are replaced by bonds paying 5%, then isn't that an example of "lower-yielding bonds being replaced with newer, higher-yielding bonds."?

[toddthebod]

Maybe I have a fundamental misunderstanding in how bonds and/or bond funds work. My understanding is the following:

1. I buy shares of a bond fund at a particular NAV price
2. I get paid a monthly dividend which is simply my share of the coupon payments of the bonds held by the fund; the amount paid per share is independent of the price at which each share was purchased
3. The NAV price will fluctuate from day to day based on interest rates and other factors
4. When/if I decide to sell the shares of my bond fund, I can realize a gain or a loss on the price of the shares themselves based on whether the NAV price at the time of sale is higher or lower than the purchase price; this is separate from the return that can be calculated from the dividends paid out by those shares; Vanguard therefore reports two separate returns for bond funds: "Capital return by NAV" and "Income return by NAV" (plus the sum of the 2, "Total return by NAV").

Is all of that correct so far?

Don't ultra-short bond funds (and Treasury Money Market Funds) pay dividends? They don't have coupon payments. TIPS funds also pay out the inflation-adjustment. The distributions from a bond fund are not "simply my share of the coupon payments". Furthermore, shouldn't the fund be indifferent between buying a 10-year bond maturing in 5 years with a low coupon payment and a significant discount versus a newly-issued 5-year bond with a higher coupon payment and no discount? If they were only paying out coupon payments, there would be bond funds that specialized in buying discount bonds with low coupons in order to defer taxes and reduce reinvestment risk. That doesn't exist.

If the bonds currently held by the fund are paying 4% but new bonds are paying 5% (hypothetical scenario), then when the 4% bonds held by the fund mature and are replaced by bonds paying 5%, then isn't that an example of "lower-yielding bonds being replaced with newer, higher-yielding bonds."?

The instant a new bond exists with a yield of 5%, the existing bond in your scenario also has a yield of 5%.

It seems that ultimately the issue here is you continually conflate yield, distributions, and coupon payments.

[dbr]

It could be that trying to hold a bond fund and figure out how it is like holding a single bond is an exercise in futility, let alone trying to line up a bond fund with a money market fund, a savings account, or a CD.

In fact the fundamental difference that a bond fund does not mature and can be managed to constant duration is just exactly the financial reason one would own a bond fund. Other reasons such as diversification and convenience in many aspects might also motivate owning a bond fund.

[CenTexan]

Maybe I have a fundamental misunderstanding in how bonds and/or bond funds work. My understanding is the following:

1. I buy shares of a bond fund at a particular NAV price
2. I get paid a monthly dividend which is simply my share of the coupon payments of the bonds held by the fund; the amount paid per share is independent of the price at which each share was purchased
3. The NAV price will fluctuate from day to day based on interest rates and other factors
4. When/if I decide to sell the shares of my bond fund, I can realize a gain or a loss on the price of the shares themselves based on whether the NAV price at the time of sale is higher or lower than the purchase price; this is separate from the return that can be calculated from the dividends paid out by those shares; Vanguard therefore reports two separate returns for bond funds: "Capital return by NAV" and "Income return by NAV" (plus the sum of the 2, "Total return by NAV").

Is all of that correct so far?

I'm back again . . . and not trying to hijack huson4351's thread, but trying to build on it for our* understanding of bond funds (* those of us unlike toddthebod, dbr, grabiner, etc = the folks who are light-years ahead of me)

Is it possible for someone to answer the above bolded question: Is all of that correct so far? with a yes or no?

- - - AND - - -

Would it help me understand bond funds if we began with a purely theoretical bond fund example that ONLY purchased bonds at an identical rate? Say 4%? This would eliminate the variable of rate changes, which gets confusing to simple minds. In this type example, wouldn't all of hudson4351's points be correct about how bond funds work (ignore calls, bankruptcies, etc)? Could someone spell out how this "4% only" fund would work?

(Please ignore this request/post if it is truly stupid - and I'll just stick to Ts and CDs . . .)

[toddthebod]

Maybe I have a fundamental misunderstanding in how bonds and/or bond funds work. My understanding is the following:

1. I buy shares of a bond fund at a particular NAV price
2. I get paid a monthly dividend which is simply my share of the coupon payments of the bonds held by the fund; the amount paid per share is independent of the price at which each share was purchased
3. The NAV price will fluctuate from day to day based on interest rates and other factors
4. When/if I decide to sell the shares of my bond fund, I can realize a gain or a loss on the price of the shares themselves based on whether the NAV price at the time of sale is higher or lower than the purchase price; this is separate from the return that can be calculated from the dividends paid out by those shares; Vanguard therefore reports two separate returns for bond funds: "Capital return by NAV" and "Income return by NAV" (plus the sum of the 2, "Total return by NAV").

Is all of that correct so far?

I'm back again . . . and not trying to hijack huson4351's thread, but trying to build on it for our* understanding of bond funds (* those of us unlike toddthebod, dbr, grabiner, etc = the folks who are light-years ahead of me)

Is it possible for someone to answer the above bolded question: Is all of that correct so far? with a yes or no?

- - - AND - - -

Would it help me understand bond funds if we began with a purely theoretical bond fund example that ONLY purchased bonds at an identical rate? Say 4%? This would eliminate the variable of rate changes, which gets confusing to simple minds. In this type example, wouldn't all of hudson4351's points be correct about how bond funds work (ignore calls, bankruptcies, etc)? Could someone spell out how this "4% only" fund would work?

(Please ignore this request/post if it is truly stupid - and I'll just stick to Ts and CDs . . .)

No, it is not correct. The monthly distribution is not based on the coupon payments.

[Geologist]

Bond funds accrue interest every day from every bond. This is not related to when they receive coupon payment, if the bond even pays coupons. (So, for example, the fund is accruing interest every day from zero-coupon bonds if it holds those.) At the end of the month, it pays a dividend based on the total accrued interest (again, how much it actually received in “cash” is not relevant). This is all part of accrual accounting, which is what funds use (you may work on a cash basis, but they don’t).

[dbr]

No, it is not correct. The monthly distribution is not based on the coupon payments.

This is the one where SGOV is a good example that you have mooted. No coupons but a monthly dividend.

I don't think I could do it but it might be interesting to show what the cash flow process in that fund actually looks like leading to finding the cash to pay dividends to the share holders accounting for how the fund arrived at the actual dividends paid and what the fund NAV was at each month. Of course we understand that the interest that is earned is because the bonds are bought at discount, being zero coupon bonds. The link to what the fund holds is here: https://www.ishares.com/us/products/314 ... aType=fund

I don't mean you should do this, but until one walks through that exercise it remains mysterious how the dividend amount is arrived at each month, how the fund NAV ends up where it does, and what the fund return is. One could also walk through the YTM and the 30 day SEC yield to know exactly how those numbers become what they are. All of this would be done tracking the actual holdings in the fund.

These are all detailed accounting steps that don't apply when one is laying out what one has with a single bond, a CD, or whatever. It is also what explains the appetite for bond ladders where the investor can see each and every individual bond rather than a complicated collection of bonds in a fund.

[grabiner]

Don't ultra-short bond funds (and Treasury Money Market Funds) pay dividends? They don't have coupon payments.

Zero-coupon bonds are taxed as if they earned interest at a fixed rate to match their value at maturity, so funds such as Vanguard's EDV which hold them distribute dividends at that rate. This "interest" also increases the basis of the bond, so there is no capital gain if a zero is held to maturity.

Also, bond funds accrue dividends continuously; if the fund pays dividends monthly on a bond which pays a coupon every six months, the dividend is 1/6 of the monthly coupon, rather than no dividend for five months and then the full coupon for the sixth month.

Furthermore, shouldn't the fund be indifferent between buying a 10-year bond maturing in 5 years with a low coupon payment and a significant discount versus a newly-issued 5-year bond with a higher coupon payment and no discount? If they were only paying out coupon payments, there would be bond funds that specialized in buying discount bonds with low coupons in order to defer taxes and reduce reinvestment risk.

The bond market will be indifferent between these bonds. And the IRS rules require that buying these bonds creates the same tax situation; if you or a fund buys a bond with a market discount, the price increase between purchase and maturity is taxed as ordinary income, not as a capital gain.

However, holding these bonds is not tax-equivalent. If you or a fund bought the 10-year bond at par 5 years ago, and the bond is now trading at a discount, the tax will only be due on the lower coupon for the next five years. If you or a fund sells this bond to buy a new bond with a higher coupon, there will be an immediate capital loss (which can offset other capital gains in the fund) but the taxable dividend over the next five years will be higher. This creates a slight tax advantage for a taxable-bond fund to hold on to lower-coupon bonds, and for a muni fund to switch to higher-coupon bonds (to distribute more tax-exempt income and reduce the capital gain when the fund is sold).

[trybogle]

@CenTexan

The below book has been very useful to understand bonds, its well organized and lays out foundational concepts well, your local library may have it.
The Bond Book by Annette Thau (Author)

[hudson4351]

Bond funds accrue interest every day from every bond. This is not related to when they receive coupon payment, if the bond even pays coupons. (So, for example, the fund is accruing interest every day from zero-coupon bonds if it holds those.) At the end of the month, it pays a dividend based on the total accrued interest (again, how much it actually received in “cash” is not relevant). This is all part of accrual accounting, which is what funds use (you may work on a cash basis, but they don’t).

So this accrual of interest and distribution of monthly dividends is just bookkeeping within the brokerage and is unrelated to when the brokerage receives cash from the bond issuers?

[hudson4351]

The yield of a bond fund includes distributions, but the two numbers will be slightly different depending on the changing values of the underlying holdings. The yield includes price appreciation/depreciation, so just because the SEC yield is 3.0%, you will not necessarily receive 3.0% in dividends. The total return of the fund should be similar to the SEC yield over the timeframe of the duration of the fund, barring significant changes in interest rates towards the end of that time period.

I thought SEC yield was only measuring dividends paid out per share and was not factoring in the price appreciation/depreciation of the shares themselves. Is that not correct?

SEC yield is based on yield to maturity (or yield to call for bonds likely to be called), so it does include price appreciation. See SEC yield

Don't I receive the same in dividends each month regardless of what price I bought my bond fund's shares at?

The dividend each month does not depend on the purchase price of your shares, but it will change as the bonds in the fund change. If a bond paid $1000 to buy a bond with a 2.4% yield, that bond pays $2 per month in dividends. Since rates have rise, the future return on the bond will be more than $2 per month, as the price will return to $1000 when the bond matures.

If the fund now sells the bond for $900 to buy a bond with a 4% yield, that new bond pays $3 per month in dividends. but the price will no longer appreciate; the new bond worth $900 will be worth $900 when it matures.

I see now that the SEC yield formula does take price appreciation into account. Given that, is it not fair to compare a bond fund's SEC yield with that of a money market fund (as I was trying to do in my original post) as a way of estimating which will pay greater dividends each month given that the shares in a money market fund don't appreciate?

It seems one would have to sell shares of a bond fund to actually realize the SEC yield, whereas the SEC yield of a money market fund is simply what one would receive in interest each month.

[dbr]

The yield of a bond fund includes distributions, but the two numbers will be slightly different depending on the changing values of the underlying holdings. The yield includes price appreciation/depreciation, so just because the SEC yield is 3.0%, you will not necessarily receive 3.0% in dividends. The total return of the fund should be similar to the SEC yield over the timeframe of the duration of the fund, barring significant changes in interest rates towards the end of that time period.

I thought SEC yield was only measuring dividends paid out per share and was not factoring in the price appreciation/depreciation of the shares themselves. Is that not correct?

SEC yield is based on yield to maturity (or yield to call for bonds likely to be called), so it does include price appreciation. See SEC yield

Don't I receive the same in dividends each month regardless of what price I bought my bond fund's shares at?

The dividend each month does not depend on the purchase price of your shares, but it will change as the bonds in the fund change. If a bond paid $1000 to buy a bond with a 2.4% yield, that bond pays $2 per month in dividends. Since rates have rise, the future return on the bond will be more than $2 per month, as the price will return to $1000 when the bond matures.

If the fund now sells the bond for $900 to buy a bond with a 4% yield, that new bond pays $3 per month in dividends. but the price will no longer appreciate; the new bond worth $900 will be worth $900 when it matures.

I see now that the SEC yield formula does take price appreciation into account. Given that, is it not fair to compare a bond fund's SEC yield with that of a money market fund (as I was trying to do in my original post) as a way of estimating which will pay greater dividends each month given that the shares in a money market fund don't appreciate?

It seems one would have to sell shares of a bond fund to actually realize the SEC yield, whereas the SEC yield of a money market fund is simply what one would receive in interest each month.

It is certainly true that bond funds have way more moving parts than savings accounts or generally cash, meaning fixed principal, assets. A single bond by itself already crosses a line into marketable assets that are more complicated than savings accounts. As a consequence equating indices that are calculated for a bond or a bond fund, such at YTM or SEC yield, with analogous numbers for a simpler investment might lead to confusion and disappointment.

Regarding your specific point, possibly the most devious aspect of a bond fund is how to determine the significance of yield to maturity when there is no maturity. Part of the answer to that is that SEC yield is not used as a planning tool for how to use the investment but rather exists due to a necessity to enforce a common definition to compare investments without engaging in shenanigans. My approach to how to use a bond fund as an investment is that for me the bond fund is an asset among others in a portfolio and the relevant descriptor is the the expected return and the variability of return. Both of those are statistical parameters that might be assumed or estimated but aren't terms and conditions attached to the individual bond fund. Choosing a bond fund is based on characteristics such as term (duration) and credit risk, inflation indexing, cost and diversification and so on. I would not attempt to buy or sell a bond fund based on looking at some current measure for yield nor on trying to estimate what the dividends might be. A person who finds those parameters compelling would probably be best off not selecting bond funds.

[hudson4351]

The yield of a bond fund includes distributions, but the two numbers will be slightly different depending on the changing values of the underlying holdings. The yield includes price appreciation/depreciation, so just because the SEC yield is 3.0%, you will not necessarily receive 3.0% in dividends. The total return of the fund should be similar to the SEC yield over the timeframe of the duration of the fund, barring significant changes in interest rates towards the end of that time period.

I thought SEC yield was only measuring dividends paid out per share and was not factoring in the price appreciation/depreciation of the shares themselves. Is that not correct?

SEC yield is based on yield to maturity (or yield to call for bonds likely to be called), so it does include price appreciation. See SEC yield

Don't I receive the same in dividends each month regardless of what price I bought my bond fund's shares at?

The dividend each month does not depend on the purchase price of your shares, but it will change as the bonds in the fund change. If a bond paid $1000 to buy a bond with a 2.4% yield, that bond pays $2 per month in dividends. Since rates have rise, the future return on the bond will be more than $2 per month, as the price will return to $1000 when the bond matures.

If the fund now sells the bond for $900 to buy a bond with a 4% yield, that new bond pays $3 per month in dividends. but the price will no longer appreciate; the new bond worth $900 will be worth $900 when it matures.

I see now that the SEC yield formula does take price appreciation into account. Given that, is it not fair to compare a bond fund's SEC yield with that of a money market fund (as I was trying to do in my original post) as a way of estimating which will pay greater dividends each month given that the shares in a money market fund don't appreciate?

It seems one would have to sell shares of a bond fund to actually realize the SEC yield, whereas the SEC yield of a money market fund is simply what one would receive in interest each month.

It is certainly true that bond funds have way more moving parts than savings accounts or generally cash, meaning fixed principal, assets. A single bond by itself already crosses a line into marketable assets that are more complicated than savings accounts. As a consequence equating indices that are calculated for a bond or a bond fund, such at YTM or SEC yield, with analogous numbers for a simpler investment might lead to confusion and disappointment.

Regarding your specific point, possibly the most devious aspect of a bond fund is how to determine the significance of yield to maturity when there is no maturity. Part of the answer to that is that SEC yield is not used as a planning tool for how to use the investment but rather exists due to a necessity to enforce a common definition to compare investments without engaging in shenanigans. My approach to how to use a bond fund as an investment is that for me the bond fund is an asset among others in a portfolio and the relevant descriptor is the the expected return and the variability of return. Both of those are statistical parameters that might be assumed or estimated but aren't terms and conditions attached to the individual bond fund. Choosing a bond fund is based on characteristics such as term (duration) and credit risk, inflation indexing, cost and diversification and so on. I would not attempt to buy or sell a bond fund based on looking at some current measure for yield nor on trying to estimate what the dividends might be. A person who finds those parameters compelling would probably be best off not selecting bond funds.

This makes sense. It seems my attempt to compare the SEC yield of a bond fund to that of a money market fund will not give me the information I thought it would give me.

Regarding the bolded portion of your quote - are the expected and variability of return figures that are explicitly published for individual bond funds, or can you only look at the historical returns?

[dbr]

Regarding the bolded portion of your quote - are the expected and variability of return figures that are explicitly published for individual bond funds, or can you only look at the historical returns?

This gets into portfolio design and trying to lay some expectation on future performance based on history, on estimates people believe in for some reason, and so on. The first commandment in that area is "Don't expect the expected return." which means that the possible average value of a statistical distribution is not a reliable promise of actual performance. In using history to estimate expected return one must be conscious of putting a margin of statistical error around that estimate and be highly conscious of how unpredictable actual results are going to be. And so on. But that is the best you can do. Investing is risky. Stocks are risky. Bonds are risky. Money is risky.

I often come back to how sobering it is to contemplate the historical record in displays like this one: https://engaging-data.com/visualizing-4-rule/

Investing is not rocket science. In rocket science you can actually place a lander on Mars within 10 feet of where it is supposed to be, at least sometimes anyway. In investing you are lucky if you guess expected return within a factor of 2.

So, the way you cope with things being this way is that you adjust over time and keep on truckin':

[hudson4351]

Regarding the bolded portion of your quote - are the expected and variability of return figures that are explicitly published for individual bond funds, or can you only look at the historical returns?

This gets into portfolio design and trying to lay some expectation on future performance based on history, on estimates people believe in for some reason, and so on. The first commandment in that area is "Don't expect the expected return." which means that the possible average value of a statistical distribution is not a reliable promise of actual performance. In using history to estimate expected return one must be conscious of putting a margin of statistical error around that estimate and be highly conscious of how unpredictable actual results are going to be. And so on. But that is the best you can do. Investing is risky. Stocks are risky. Bonds are risky. Money is risky.

I often come back to how sobering it is to contemplate the historical record in displays like this one: https://engaging-data.com/visualizing-4-rule/

Investing is not rocket science. In rocket science you can actually place a lander on Mars within 10 feet of where it is supposed to be, at least sometimes anyway. In investing you are lucky if you guess expected return within a factor of 2.

So, the way you cope with things being this way is that you adjust over time and keep on truckin':

Another thing I noticed is that the historical price of VWIUX (and probably other bond funds; VWIUX was the only one I checked) varies within a relatively tight range: $12-$15/share from 2001-present. The price doesn't increase over long periods of time, as do the share prices of stock index funds, although Vanguard does break down the total return into its capital and income components. My question is: is this behavior fundamental to bond funds, or is it just a consequence of the interest rate environment and/or other factors during that time? Should one expect to have much of the gains from a bond fund be due to appreciation in share price?

[grabiner]

Another thing I noticed is that the historical price of VWIUX (and probably other bond funds; VWIUX was the only one I checked) varies within a relatively tight range: $12-$15/share from 2001-present. The price doesn't increase over long periods of time, as do the share prices of stock index funds, although Vanguard does break down the total return into its capital and income components. My question is: is this behavior fundamental to bond funds, or is it just a consequence of the interest rate environment and/or other factors during that time? Should one expect to have much of the gains from a bond fund be due to appreciation in share price?

This is normal behavior for a high-quality bond fund. If a bond doesn't default, its price at issue and maturity will be the same, and the net effect on the fund share price will be zero. Since funds sell bonds before maturity, the share price may increase or decrease as rates fall or rise, but it should stay relatively stable on average.

There are two minor factors working in opposite directions. Long-term bonds usually have higher yields than short-term bonds, so a fund which buys a long-term bond and sells it when it becomes short-term will have a slight capital gain if rates don't move. Working the other way is that the fund may have to distribute capital gains when rates fall, so that the gain does not turn in to price appreciation.

Note the "high-quality". The share price of junk bond funds tends to fall over time, as some junk bonds default (or are sold for a loss when they become likely to default, if the fund doesn't want to wait for the potential default).

[hudson4351]

Another thing I noticed is that the historical price of VWIUX (and probably other bond funds; VWIUX was the only one I checked) varies within a relatively tight range: $12-$15/share from 2001-present. The price doesn't increase over long periods of time, as do the share prices of stock index funds, although Vanguard does break down the total return into its capital and income components. My question is: is this behavior fundamental to bond funds, or is it just a consequence of the interest rate environment and/or other factors during that time? Should one expect to have much of the gains from a bond fund be due to appreciation in share price?

This is normal behavior for a high-quality bond fund. If a bond doesn't default, its price at issue and maturity will be the same, and the net effect on the fund share price will be zero. Since funds sell bonds before maturity, the share price may increase or decrease as rates fall or rise, but it should stay relatively stable on average.

There are two minor factors working in opposite directions. Long-term bonds usually have higher yields than short-term bonds, so a fund which buys a long-term bond and sells it when it becomes short-term will have a slight capital gain if rates don't move. Working the other way is that the fund may have to distribute capital gains when rates fall, so that the gain does not turn in to price appreciation.

Note the "high-quality". The share price of junk bond funds tends to fall over time, as some junk bonds default (or are sold for a loss when they become likely to default, if the fund doesn't want to wait for the potential default).

Regarding the bolded portion above:

When you say "becomes short term", you're saying a bond fund that buys a long-term bond and sells it when it only has a relatively short time period to maturity, correct?

If the bond fund was focused on high quality, long-term bonds, what would be the reason for selling it early?

I must be missing something here - why would there be a capital gain when the bond is sold if interest rates didn't move?

[hudson4351]

Another calculation I looked at was the following:

monthly dividend from VWUIX as a percentage of total invested

VS

monthly dividend from VMFXX as a percentage of total invested

This comparison was done during a month in which no contributions were made to either fund balance.

In my case the numbers were 0.22% for VWIUX vs 0.43% for VMFXX. It seems to me that my money invested in VMFXX is currently paying almost double the percentage monthly dividend than that invested in VWIUX, which again makes me think that I'm better off putting money intended to my bond allocation into VMFXX instead until the monthly dividend from VWUIX as a percentage of total invested exceeds that of VMFXX.

Am I missing something here? I know that the income return of VWIUX will go up over time as maturing bonds are replaced with new, higher-yielding bonds and that the fund price (i.e. "capital return" in Vanguard's info pages) will appreciate as existing bonds mature, but is there any downside to not investing further into VWIUX until it's monthly dividend as a percentage of total invested equals that of VMFXX? I guess I would miss out on the share price appreciation but isn't most of the return of bond funds due to income?

In any case I started reading The Bond Book as was recommended earlier in this thread, so hopefully that will improve my understanding here.

[grabiner]

There are two minor factors working in opposite directions. Long-term bonds usually have higher yields than short-term bonds, so a fund which buys a long-term bond and sells it when it becomes short-term will have a slight capital gain if rates don't move. Working the other way is that the fund may have to distribute capital gains when rates fall, so that the gain does not turn in to price appreciation.

Regarding the bolded portion above:

When you say "becomes short term", you're saying a bond fund that buys a long-term bond and sells it when it only has a relatively short time period to maturity, correct?

If the bond fund was focused on high quality, long-term bonds, what would be the reason for selling it early?

"Early" just means "before maturity". A long-term bond eventually becomes an intermediate-term and then a short-term bond

For example, Vanguard Long-Term Treasury Index holds Treasuries maturing in 15-30 years. It can buy a 30-year Treasury, but must then sell it in 15 years when it becomes a 15-year bond.

I must be missing something here - why would there be a capital gain when the bond is sold if interest rates didn't move?

Long-term bonds usually have higher yields than short-term bonds, as compensation for the additional interest-rate risk. Thus, when a long-term bond becomes a short-term bond, its yield will fall even if long-term and short-term yields haven't changed. (Currently, the yield curve is inverted, with short-term bonds yielding more, but this only happens when investors expect long-term yields to fall; otherwise, nobody would buy a long-term bond with a lower expected return than a short-term bond.)

[grabiner]

Another calculation I looked at was the following:

monthly dividend from VWUIX as a percentage of total invested

VS

monthly dividend from VMFXX as a percentage of total invested

This comparison was done during a month in which no contributions were made to either fund balance.

In my case the numbers were 0.22% for VWIUX vs 0.43% for VMFXX. It seems to me that my money invested in VMFXX is currently paying almost double the percentage monthly dividend than that invested in VWIUX, which again makes me think that I'm better off putting money intended to my bond allocation into VMFXX instead until the monthly dividend from VWUIX as a percentage of total invested exceeds that of VMFXX.

Am I missing something here? I know that the income return of VWIUX will go up over time as maturing bonds are replaced with new, higher-yielding bonds and that the fund price (i.e. "capital return" in Vanguard's info pages) will appreciate as existing bonds mature, but is there any downside to not investing further into VWIUX until it's monthly dividend as a percentage of total invested equals that of VMFXX? I guess I would miss out on the share price appreciation but isn't most of the return of bond funds due to income?

You are missing the known effect of bonds at a discount. If new 5-year bonds from a particular issuer are yielding 4%, and VWIUX holds a bond that is 5 years from maturity and is paying only 2% of its value as a dividend, that bond must be currently trading at a discount. If yields don't change, this bond will earn 4% next year, paying 2% as a dividend and having its price increase by 2%. And whether yields change or not, both the discount bond and the new bond will earn 4% over five years as a combination of price appreciation and dividends.

This is the reason to use the SEC yield for comparison.

The other effect is the expected change in interest rates. If the yield curve is inverted, then investors expect bond yields to fall. If that happens in the next month, then bonds will yield more than money-market funds in that month even if current SEC yields on money-market funds are higher. (This is only an expectation; bond yields might not drop in the next month, but they are just as likely to drop twice as much as investors' expectations, in which case bond funds will yield much more than money-market funds.)

[hudson4351]

Another calculation I looked at was the following:

monthly dividend from VWUIX as a percentage of total invested

VS

monthly dividend from VMFXX as a percentage of total invested

This comparison was done during a month in which no contributions were made to either fund balance.

In my case the numbers were 0.22% for VWIUX vs 0.43% for VMFXX. It seems to me that my money invested in VMFXX is currently paying almost double the percentage monthly dividend than that invested in VWIUX, which again makes me think that I'm better off putting money intended to my bond allocation into VMFXX instead until the monthly dividend from VWUIX as a percentage of total invested exceeds that of VMFXX.

Am I missing something here? I know that the income return of VWIUX will go up over time as maturing bonds are replaced with new, higher-yielding bonds and that the fund price (i.e. "capital return" in Vanguard's info pages) will appreciate as existing bonds mature, but is there any downside to not investing further into VWIUX until it's monthly dividend as a percentage of total invested equals that of VMFXX? I guess I would miss out on the share price appreciation but isn't most of the return of bond funds due to income?

You are missing the known effect of bonds at a discount. If new 5-year bonds from a particular issuer are yielding 4%, and VWIUX holds a bond that is 5 years from maturity and is paying only 2% of its value as a dividend, that bond must be currently trading at a discount. If yields don't change, this bond will earn 4% next year, paying 2% as a dividend and having its price increase by 2%. And whether yields change or not, both the discount bond and the new bond will earn 4% over five years as a combination of price appreciation and dividends.

This is the reason to use the SEC yield for comparison.

The other effect is the expected change in interest rates. If the yield curve is inverted, then investors expect bond yields to fall. If that happens in the next month, then bonds will yield more than money-market funds in that month even if current SEC yields on money-market funds are higher. (This is only an expectation; bond yields might not drop in the next month, but they are just as likely to drop twice as much as investors' expectations, in which case bond funds will yield much more than money-market funds.)

Regarding the bolded portion:

Doesn't this mean I shouldn't prefer investing in VWIUX over VMFXX until the SEC yield of VWIUX is greater than or equal to that of VMFXX?

From prior comments in this thread I thought it was incorrect to compare the SEC yield of a money market fund with that of a bond fund, yet as my calculation above shows the money I have in VMFXX is earning nearly double the percentage monthly dividends as the money I have in VWIUX.

[grabiner]

You are missing the known effect of bonds at a discount. If new 5-year bonds from a particular issuer are yielding 4%, and VWIUX holds a bond that is 5 years from maturity and is paying only 2% of its value as a dividend, that bond must be currently trading at a discount. If yields don't change, this bond will earn 4% next year, paying 2% as a dividend and having its price increase by 2%. And whether yields change or not, both the discount bond and the new bond will earn 4% over five years as a combination of price appreciation and dividends.

This is the reason to use the SEC yield for comparison.

The other effect is the expected change in interest rates. If the yield curve is inverted, then investors expect bond yields to fall. If that happens in the next month, then bonds will yield more than money-market funds in that month even if current SEC yields on money-market funds are higher. (This is only an expectation; bond yields might not drop in the next month, but they are just as likely to drop twice as much as investors' expectations, in which case bond funds will yield much more than money-market funds.)

Regarding the bolded portion:

Doesn't this mean I shouldn't prefer investing in VWIUX over VMFXX until the SEC yield of VWIUX is greater than or equal to that of VMFXX?

No, because of the following paragraph.

From prior comments in this thread I thought it was incorrect to compare the SEC yield of a money market fund with that of a bond fund, yet as my calculation above shows the money I have in VMFXX is earning nearly double the percentage monthly dividends as the money I have in VWIUX.

SEC yields on money-market muni funds fluctuate a lot, so the short-term values are not very reliable indications of returns. but the general shape of the yield curve, and the SEC yield, say that the total return (including price changes) on the bond fund is much more than the dividend.

[hudson4351]

You are missing the known effect of bonds at a discount. If new 5-year bonds from a particular issuer are yielding 4%, and VWIUX holds a bond that is 5 years from maturity and is paying only 2% of its value as a dividend, that bond must be currently trading at a discount. If yields don't change, this bond will earn 4% next year, paying 2% as a dividend and having its price increase by 2%. And whether yields change or not, both the discount bond and the new bond will earn 4% over five years as a combination of price appreciation and dividends.

This is the reason to use the SEC yield for comparison.

The other effect is the expected change in interest rates. If the yield curve is inverted, then investors expect bond yields to fall. If that happens in the next month, then bonds will yield more than money-market funds in that month even if current SEC yields on money-market funds are higher. (This is only an expectation; bond yields might not drop in the next month, but they are just as likely to drop twice as much as investors' expectations, in which case bond funds will yield much more than money-market funds.)

Regarding the bolded portion:

Doesn't this mean I shouldn't prefer investing in VWIUX over VMFXX until the SEC yield of VWIUX is greater than or equal to that of VMFXX?

No, because of the following paragraph.

Regarding the following paragraph (included in the quote above):

This is the first link I found when I searched for yield curve:

https://www.ustreasuryyieldcurve.com/

Is this the correct yield curve to be looking at even though I'm invested in VWIUX, a muni bond fund, rather than a treasury bond fund?


Regarding your quote "If the yield curve is inverted, then investors expect bond yields to fall.":

If the yield curve is inverted, then don't investors actually expect yields to rise given that as longer term bonds move closer toward maturity (i.e. toward shorter term bonds) the yield goes up?


Regarding your quote "If that happens in the next month, then bonds will yield more than money-market funds in that month even if current SEC yields on money-market funds are higher.":

I'm confused because saying "bonds will yield more than money-market funds in that month" seem to imply that bond yields/interest rates will rise, but the prior sentence said that "investors expect bond yields to fall".


Regarding your quote "bond yields might not drop in the next month, but they are just as likely to drop twice as much as investors' expectations, in which case bond funds will yield much more than money-market funds.":

In this hypothetical case bonds would outperform money market funds not because the bonds are paying a higher dividend but because of price appreciation, correct?


For some reason I find bonds far more confusing than stocks.

SEC yields on money-market muni funds fluctuate a lot, so the short-term values are not very reliable indications of returns. but the general shape of the yield curve, and the SEC yield, say that the total return (including price changes) on the bond fund is much more than the dividend.

I've been checking the SEC yields for both VMFXX (Federal Money Market) and VWIUX (Intermediate Term Muni Bond Fund) pretty regularly and they don't seem to vary too much. VMFXX has been in the 5.0-5.3% range and VWIUX in the 3.4-3.7% range for quite a while now, so they don't seem to fluctuate that much, unless those are considered large fluctuations?