What are your thoughts re long term bonds for bond portion of portfolio?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
eschen42
Posts: 14
Joined: Thu Oct 05, 2023 5:24 am

What are your thoughts re long term bonds for bond portion of portfolio?

Post by eschen42 »

Perhaps this may be labeled "market timing", yet I am thinking of this in terms of seizing a good rate of return on an investment when it's available.

Right now VMFXX has an SEC 30-day yield of about 5.25%. Whenever the Fed cuts the overnight rate, that will decrease; it seems reasonable to expect a cut in less than 12.8 years, i.e., the average duration of VLCTX, the long term bond index, which has an SEC 30-day yield of about 5.5%. I am assuming that the Fed will continue their policy of targeting a 2% inflation rate.

VUSFX (average duration 1 year) has an SEC 30-day yield of 5.04% (which is a bit puzzling to me, and I wonder whether that may be because the market expects the Fed to cut the overnight rate in less than a year). VBTLX, with an average duration of 6.1 years, has an SEC 30-day yield of about 4.5% (suggesting to me that issuers will pay about 100 bp more to borrow the money for twice as long).

In broad terms, it appears to me that, over the next 12.8 years, buying and holding VLCTX might both experience twice the bump in principal value as VBTLX and have a yield advantage (relative to VUSFX) for roughly twice as long as VBTLX.

What arguments suggest favoring VBTLX as an investment over VLTCX, and vice versa:
  • right now?
  • when the yield curve has reverted to an upward slope?
P.S. I am not posting this to the "personal investments" forum because I am interested in peoples' thoughts regarding general theory rather than seeking mentoring specific to anyone's particular investment situation.
User avatar
Beensabu
Posts: 5728
Joined: Sun Aug 14, 2016 3:22 pm

Re: What are your thoughts re long term bonds for bond portion of portfolio?

Post by Beensabu »

eschen42 wrote: Mon Mar 25, 2024 1:49 pm Right now VMFXX has an SEC 30-day yield of about 5.25%. Whenever the Fed cuts the overnight rate, that will decrease; it seems reasonable to expect a cut in less than 12.8 years, i.e., the average duration of VLCTX, the long term bond index, which has an SEC 30-day yield of about 5.5%. I am assuming that the Fed will continue their policy of targeting a 2% inflation rate.
You can get a higher yield for longer with VLCTX, yeah? It comes with more credit and interest rate risk, though.
VUSFX (average duration 1 year) has an SEC 30-day yield of 5.04% (which is a bit puzzling to me, and I wonder whether that may be because the market expects the Fed to cut the overnight rate in less than a year).
Why is it puzzling? The 1-month still has a higher yield than the 1-, 2- and 3-year (and those longer durations were being issued with yields less than 5% for a significant portion of the last 1-3 years.
VBTLX, with an average duration of 6.1 years, has an SEC 30-day yield of about 4.5% (suggesting to me that issuers will pay about 100 bp more to borrow the money for twice as long).
I don't know about that assumption. Corporate bond yields aren't just determined by duration. Besides, you're comparing a total bond fund to a long-term corporate bond fund - the sector composition of issuers is completely different. Plus a long-term bond fund still has lots of older bonds issued at whatever yields were demanded back then - 2/3 of VLCTX has a maturity of 20+ years.
In broad terms, it appears to me that, over the next 12.8 years, buying and holding VLCTX might both experience twice the bump in principal value as VBTLX and have a yield advantage (relative to VUSFX) for roughly twice as long as VBTLX.
It might.
What arguments suggest favoring VBTLX as an investment over VLTCX, and vice versa:
  • right now?
  • when the yield curve has reverted to an upward slope?
For VBTLX: Less potential for loss in value from now (if future yields rise).
For VLTCX: Greater potential for gain in value from now (if future yields drop).

If the yield curve "normalizes" by long yields going higher, then VLTCX will look more attractive than it does now (less potential for loss in value from rate changes the higher the yield). However, I can't imagine this happening without credit risk increasing, and that's not something most people are into when it comes to long bonds.

If it normalizes by long yields staying put while shorter duration yields drop, VBTLX will have gotten an appreciation bump and be looking less attractive at lower short- and intermediate-term yields.

If it normalizes by long yields dropping while shorter duration yields drop more, then VLTCX will have gotten a greater appreciation bump than VBTLX and at that point be subject to greater potential downside should rates rise again from there.

It's objectively better to get into a long-term bond fund when yields are higher than when they are lower, but you still always run the risk that they might go higher from there.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
User avatar
martincmartin
Posts: 904
Joined: Wed Jul 02, 2014 3:04 pm
Location: Boston, MA USA

Re: What are your thoughts re long term bonds for bond portion of portfolio?

Post by martincmartin »

Historically, 5% interest rates are actually low. Through the entire 1990s they were higher. From 2004 to 2006, rates rose from 1.25% to 5.25%.

https://www.bankrate.com/banking/federa ... unds-rate/

It's only since 2007 that low rates have been the norm. Why do you think rates over the next decades will follow the most recent 15 years, rather than any time before?

Stocks almost always outperform bonds over 20 years. So why do you hold bonds?

- If it's because your emotions will get the better of you during a downturn and you might get anxious or panic sell, then hold short term treasuries. This is Bill Bernstein's point.
- If you have a more objective & rational goal, e.g. minimizing the chance of running out of money in retirement, then hold total bond market or intermediate bonds.

It seems you're holding bonds because you heard you should hold bonds, and are then trying to maximize returns in your bond portion, without understanding why you should hold bonds instead of stocks in the first place. If the goal is to maximize returns, then don't hold long term bonds, instead hold stocks. If you choose to hold some bonds rather than all stocks, then knowing why you hold bonds affects which bonds you hold. The goal of the bonds portion isn't to maximize returns.
Topic Author
eschen42
Posts: 14
Joined: Thu Oct 05, 2023 5:24 am

Re: What are your thoughts re long term bonds for bond portion of portfolio?

Post by eschen42 »

martincmartin wrote: Sun Mar 31, 2024 7:59 pm If the goal is to maximize returns, then don't hold long term bonds, instead hold stocks. If you choose to hold some bonds rather than all stocks, then knowing why you hold bonds affects which bonds you hold. The goal of the bonds portion isn't to maximize returns.
Thank you for your reply, martincmartin.

My intention here was to elicit discussion of allocation within the bond portion of the portfolio, not between bonds and stocks. I think that your final sentences focus on this question, i.e., that bonds are "bilge water" that may slosh about to stabilize the roll of the ship riding the winds of stock returns. The term "bilge water" is not pejorative here; rather, I think that you may favor a diverse array of bonds with sufficient ability to absorb whatever "gusts" that inflation or the business cycle may throw at them, so that the principal overall may be preserved until it's needed either to fund expenses or to rebalance the stock:bond allocation.

Have I understood you with regard to allocation among bonds?
User avatar
nisiprius
Advisory Board
Posts: 52348
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: What are your thoughts re long term bonds for bond portion of portfolio?

Post by nisiprius »

Having lived through the inflation of the 1970s and 1980s, there is no way I would be willing to lock up any important percentage of my money into a twenty-to-thirty year nominal (fixed number of dollars) instrument.

5% only looks good because it's been so much lower for so long. Fifteen years from now it may look like a once-in-a-lifetime opportunity, or it may look like death warmed over.

Frankly, I'm feeling unhappy and impatient because I bought a 17-month CD paying 3.44% when that looked like a great rate, and it won't mature until May.

And I once had a CD paying over 13% and at the time that did not look like anything more than sorta OK.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
exodusing
Posts: 2237
Joined: Thu Oct 13, 2022 7:32 am

Re: What are your thoughts re long term bonds for bond portion of portfolio?

Post by exodusing »

FWIW, the academic economist consensus is that the conservative (or risk-free) asset for the long-term investor is long-term inflation indexed bonds.

A seminal paper is https://www.aeaweb.org/articles?id=10.1257/aer.91.1.99 Here's a paper noting that https://www.johnhcochrane.com/research- ... portfolios

Income from long-term inflation indexed bonds is known and is more stable than from shorter term bonds. Prices may fluctuate more, but why should a long-term investor care about short-term price fluctuations?
User avatar
Hacksawdave
Posts: 844
Joined: Tue Feb 14, 2023 4:44 pm

Re: What are your thoughts re long term bonds for bond portion of portfolio?

Post by Hacksawdave »

eschen42 wrote: Mon Mar 25, 2024 1:49 pm Perhaps this may be labeled "market timing", yet I am thinking of this in terms of seizing a good rate of return on an investment when it's available.

Right now VMFXX has an SEC 30-day yield of about 5.25%. Whenever the Fed cuts the overnight rate, that will decrease; it seems reasonable to expect a cut in less than 12.8 years, i.e., the average duration of VLCTX, the long term bond index, which has an SEC 30-day yield of about 5.5%. I am assuming that the Fed will continue their policy of targeting a 2% inflation rate.

P.S. I am not posting this to the "personal investments" forum because I am interested in peoples' thoughts regarding general theory rather than seeking mentoring specific to anyone's particular investment situation.
Okay, what would you be holding these for in your portfolio? What purpose do they serve? In my case the sole purpose of holding long maturity bond funds is for monthly income to cashflow in retirement. SEC yield and NAV movements are meaningless to me.

I look at three metrics:

• The distribution amount per share
• The distribution yields.
• The distribution NAV price

With these three metrics I determine the cost per basis point of income. If I feel comfortable with the price paid for income, I buy it. If I do not like the price paid, I pass. I exchanged $56K of Vanguard CA MMF VCTXX to add to my existing Vanguard VCLAX CA long-term tax-exempt fund last December. I did not foresee the cost getting any cheaper for the longs and pulled the trigger.

Both distribution amount per share and NAV values have moved higher. The distribution per share amount on longer term funds has finally started moving in a more consistent upward trend each month without as much ‘choppiness’ as they saw in the first half of 2022.
Topic Author
eschen42
Posts: 14
Joined: Thu Oct 05, 2023 5:24 am

Re: What are your thoughts re long term bonds for bond portion of portfolio?

Post by eschen42 »

Dear all (this was originally intended for beensabu, but it fits you all):

I recognize that my question was incomplete. Hacksawdave and exodusing both discerned my intent. What I forgot to say was that I am trying to understand the theory that should drive decisions about bond funds that would not require distribution for 20 years or more.

Thank you, Hacksawdave, for outlining your procedure and reasoning.
User avatar
Beensabu
Posts: 5728
Joined: Sun Aug 14, 2016 3:22 pm

Re: What are your thoughts re long term bonds for bond portion of portfolio?

Post by Beensabu »

eschen42 wrote: Mon Apr 01, 2024 5:05 pm I am trying to understand the theory that should drive decisions about bond funds that would not require distribution for 20 years or more.
In theory, you match duration to when you need to access the money, shortening the duration as you get closer to that point.

In practice, long duration comes with interest rate / price risk and short duration comes with reinvestment risk, so intermediate duration (or a mix of long/short or long/intermediate/short for an overall intermediate duration) is a middle ground.

In theory, you demand a premium (as far as yield) for taking credit risk (corporates vs. treasuries).

In practice, credit spreads are narrow during good times and wider during bad times, so an investment-grade mix of corporates and treasuries at all times is a middle ground.

Combine both middle grounds, and you get VBTLX.

If you're not afeared of the interest rate or credit risk that comes with long-term corporate bonds and the duration is appropriate for your timeline, then VLTCX is an option. If you're somewhat afeared of credit risk, then VBLAX is a middle ground for long-term bonds.

It's just figuring out which risks you personally are and are not willing to take, out of the ones you are able to take.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
User avatar
steve r
Posts: 1310
Joined: Mon Feb 13, 2012 7:34 pm
Location: Connecticut

Re: What are your thoughts re long term bonds for bond portion of portfolio?

Post by steve r »

OP

I backtested bonds in the context of a portfolio of global and U.S. stocks from 1962.

Long Term Treasuries (LTT)) outperformed in terms of overall return and fractionally on a risk adjusted basis over intermediate term treasuries. BND type funds faired worse. Corporate bonds may have higher yields, but corporations refinance at lower rates if rates fall. Treasuries do not do this. Moreover, government bonds have lower correlation with stocks. In a sense if you own stocks of a company that borrows and own bonds, you are both the borrower and the lender -- which benefits the middleman. Only fractionally though.

With this knowledge, I tried to own them (LTT). Some people can put into context that the bonds are able to lose money, I could not. An I come at this as one whom is comfortable with owning stocks index funds that underperform. I mean bond yields would rise fractionally, and LTT would lose like one percent.

So I switched to ITT index fund. Most of the benefits of LTT, but more manageable volatility.
"Owning the stock market over the long term is a winner's game. Attempting to beat the market is a loser's game. ..Don't look for the needle in the haystack. Just buy the haystack." Jack Bogle
User avatar
martincmartin
Posts: 904
Joined: Wed Jul 02, 2014 3:04 pm
Location: Boston, MA USA

Re: What are your thoughts re long term bonds for bond portion of portfolio?

Post by martincmartin »

eschen42 wrote: Mon Apr 01, 2024 10:13 am
martincmartin wrote: Sun Mar 31, 2024 7:59 pm If the goal is to maximize returns, then don't hold long term bonds, instead hold stocks. If you choose to hold some bonds rather than all stocks, then knowing why you hold bonds affects which bonds you hold. The goal of the bonds portion isn't to maximize returns.
Thank you for your reply, martincmartin.

My intention here was to elicit discussion of allocation within the bond portion of the portfolio, not between bonds and stocks. I think that your final sentences focus on this question, i.e., that bonds are "bilge water" that may slosh about to stabilize the roll of the ship riding the winds of stock returns. The term "bilge water" is not pejorative here; rather, I think that you may favor a diverse array of bonds with sufficient ability to absorb whatever "gusts" that inflation or the business cycle may throw at them, so that the principal overall may be preserved until it's needed either to fund expenses or to rebalance the stock:bond allocation.

Have I understood you with regard to allocation among bonds?
If your goal is to "absorb whatever "gusts" that inflation or the business cycle may throw at them," this sounds like you want to reduce volatility. In that case, you should have the bonds that vary the least, which are short term Treasuries. This is Bill Bernstein's advice. This is to overcome the Shakespeare, emotions and panic.

If your goal is "that the principal overall may be preserved until it's needed either to fund expenses or to rebalance the stock:bond allocation," this sounds more like the rational side, trying to minimize the chance of running out of money in retirement. In this case, historical investigations along the line of the Trinity/Bengen study show a slight advantage for a Total Bond Market fund. The reasons why this works best, or the underlying mechanism, aren't explained by the study. Although one thing that's clear: during the Great Depression, where there was significant DE-flation, long term bonds were best, as their real value increased dramatically, whereas short term bonds were the worst sort to hold. During the 1970s, with significant IN-flation, short term bonds were best and long term bonds were hammered. So why try to pick winners? Intermediate bonds were never the worst option to hold, so are kind of a "least bad averaged over all situations" option. Holding TBM does slightly better, at least in historical investigations.
steadyosmosis
Posts: 1044
Joined: Mon Dec 26, 2022 11:45 am

Re: What are your thoughts re long term bonds for bond portion of portfolio?

Post by steadyosmosis »

One could build a TIPS ladder, for up to 30 years.
Age<59.5. Early-retired. AA ~55/45. Taxable account, Roth IRA, HSA...all are 100% equities. 100% of fixed income is in tIRA. I spend from taxable and rebalance in tIRA.
Florida Orange
Posts: 1189
Joined: Thu Jun 16, 2022 2:22 pm

Re: What are your thoughts re long term bonds for bond portion of portfolio?

Post by Florida Orange »

I have a much better idea of what my long term bonds will be worth in 10 years than what my short term bonds will be worth in 10 years.
Post Reply