Explain why long-term bonds aren't awesome

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Tamalak
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Explain why long-term bonds aren't awesome

Post by Tamalak » Mon Feb 12, 2018 5:11 pm

Stupid question as I'm an equity guy and don't understand bonds well. Forgive me.

I'm specifically looking at the BLV ETF product from Vanguard. Why is the return so high compared to other bond types? Is 7.5% a realistic forward-looking return?

The return seems more wobbly than most bond types but I don't see any drop worse than 10-12% or so. It didn't even twitch during the disaster of 2008, which says to me that this asset is uncorrelated with the stock market, which would make it really good paired with equities. Is this just a particularly good decade?

Chuck
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Re: Explain why long-term bonds aren't awesome

Post by Chuck » Mon Feb 12, 2018 5:18 pm

The yield you should expect is the SEC yield, which is currently 3.73%.

The average duration is 15 years, so it should be extremely volatile.

alex_686
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Re: Explain why long-term bonds aren't awesome

Post by alex_686 » Mon Feb 12, 2018 5:26 pm

Look up duration, which is a measurement of risk in bonds. Very simply, you multiple the change in rates by duration to get the change in NAV.

For example, assume that rates went up by 1%. A short term bond fund where bonds mature in 1 year would have a duration of 1 and would fall by 1%. A long term bond fund where bonds matured in 15 years would have a duration of 15 and fall by 15%.

Much more complex than that but that should give you a taste. Risk and return are linked. If you are seeing a high return try to figure out where the risk lies.

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Re: Explain why long-term bonds aren't awesome

Post by JBTX » Mon Feb 12, 2018 5:28 pm

The return was high because of its long term duration and historically falling interest rates.

With a duration of 14 if interest rates go up 1% your portfolio goes down 14%. If interest rate goes up 2% it goes down 28%, etc.

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Re: Explain why long-term bonds aren't awesome

Post by nisiprius » Mon Feb 12, 2018 5:29 pm

The average effective maturity in that fund is 24 years. That means you are locking yourself into a specific interest payment rate for about that long. To anyone who lived through the inflation of the late 1970s, that is an awfully long commitment. Between 1971 and 1986, the value of the dollar was cut to 1/3rd of what it had been. 24 years earlier, neither you nor the market would have been likely to see that coming.

And while you say that you are not bothered by the fluctuations, the duration is 15 years (compared to 6 for the VanguardTotal Bond Market Index Fund) so you are talking about 2.5X the interest rate risk of Total Bond. And even Total Bond has enough interest risk to be spooking at least some posters in this forum.

I wouldn't do it.
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Tamalak
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Re: Explain why long-term bonds aren't awesome

Post by Tamalak » Mon Feb 12, 2018 5:31 pm

So if I understand right.. rising interest rates are BAD for those already holding bonds, because you've already locked yourself in to a lower rate of return. And falling interest rates are GOOD for those holding bonds because you've locked yourself into a better return than is in the present?

So will the price of bond funds "try" to remain constant in the long run, and the average long-term return just be the SEC yield?

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Re: Explain why long-term bonds aren't awesome

Post by Catfish Plumber » Mon Feb 12, 2018 5:42 pm

My current total AA is 80/20 stocks/bonds. The bulk of my bonds is in BLV and VBLTX (etf and mutual fund versions of the same thing).

I think posting this will generate some advice on how total bond market would be better. But as things stand so far I am happy with my set up and plan to continue with it for the near future.

Until this post it’s felt like my own dirty little secret that goes against general boglehead philosophy. Pretty sure it’s a carryover from yield chasing days. I have a mental bond yield “floor” of 3.53%, the guaranteed rate of EE savings bonds if held 20 years, and I can’t bring myself to accept anything lower.

I have also recently found myself trying to recreate BLV with a combo of long term corporate and treasuries in some accounts that would otherwise charge for directly buying BLV. I believe BLV is split 40% treasuries vs 60% corporate. As time goes on I find myself wanting to buy more long term government as opposed to corporate, the idea being a recession could greatly harm stocks and corporate bonds but long term treasuries would do well. As bad as locking in 3% nominal for 30 years seems, it could be the best option if interest rates move down and stay low for an extended period of time due to poor economic conditions.

But to steal a closing line I saw someone else use: “I know nothing.”

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Re: Explain why long-term bonds aren't awesome

Post by alex_686 » Mon Feb 12, 2018 5:45 pm

Tamalak wrote:
Mon Feb 12, 2018 5:31 pm
So if I understand right.. rising interest rates are BAD for those already holding bonds, because you've already locked yourself in to a lower rate of return. And falling interest rates are GOOD for those holding bonds because you've locked yourself into a better return than is in the present?

So will the price of bond funds "try" to remain constant in the long run, and the average long-term return just be the SEC yield?
The math behind bond investing is fun and complex. Much more interesting than individual stocks in my opinion.

Bond prices already have all of the expected changes in the interest rates baked in. Duration is for unexpected changes. Then there is the yield curve, because short term and long term rates can move differently. Lots of fun.

Bond funds try to maximize their "Total Return", by maximize yield and price appreciation while managing risk. There are trade offs between these. Bond returns are not stable. We have been in a falling interest rate environment since 2008. This has caused huge price returns for those who held long term bonds while crushing those wanted yield. We are about as low as we can go and everybody is expecting rates to go up. However we have been expecting this for quite some time so I can't reassure you here.

It might help if you started with a new thread with your investment goals and your risk tolerance. We could then attack the issue top down. Now we are just scratching the technical details There is a standardized format out there.

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Re: Explain why long-term bonds aren't awesome

Post by nisiprius » Mon Feb 12, 2018 5:50 pm

Tamalak wrote:
Mon Feb 12, 2018 5:31 pm
So if I understand right.. rising interest rates are BAD for those already holding bonds, because you've already locked yourself in to a lower rate of return. And falling interest rates are GOOD for those holding bonds because you've locked yourself into a better return than is in the present?
No, it is more complicated than that. For a sudden interest rate rise, the duration tells you your "point of indifference." If the duration is 15 years, then the value of your bond fund holding, including reinvested interest, will fall, but over 15 years it will gradually rise because of a) interest being paid out, and b) the value of a bond rising to its face value when it matures. Up to 15 years you are worse off than if interest rates had remained stable. At 15 years, you are neither better nor worse off. After 15 years, you are better off because the bonds you are holding are paying higher interest.

If the interest rate rise is gradual, then the loss is not as bad, but the time to be "back on track" is even longer.

Thus, Vanguard says that Total Bond, with a duration of 6 years, "may be" suitable for an investor with a 4-10 year time horizon. There are no absolutes because there's no limit to what you can imagine interest rates doing, but for reasonable scenarios there isn't much danger if you are prepared to hold for 4-10 years. But for the long-term bond fund, you would need to be prepared to hold for 15 years or more.
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Re: Explain why long-term bonds aren't awesome

Post by nisiprius » Mon Feb 12, 2018 5:51 pm

The Vanguard Total Bond Market Index Fund is a reasonable starting point. You may decide that is not your preferred bond fund, but do not be too quick to assume that any other bond fund is far better, "awesome." If you think you see something that is far better, you missed something, you are overlooking something.

Don't forget that in the fundamental meaning of the two words, "awesome" and "awful" basically mean the same thing!
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.

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Tamalak
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Re: Explain why long-term bonds aren't awesome

Post by Tamalak » Mon Feb 12, 2018 5:58 pm

Thank you all. That illuminated a lot of my questions, including some unasked ones (like why long-term bonds holds any drawbacks at all over short-term ones if the ETFs for both are totally liquid).

I see now that a lot of the risks involved with long-term bonds did not materialize in the last 10 years so that 10 year chart makes them look a lot safer than they are.
It might help if you started with a new thread with your investment goals and your risk tolerance. We could then attack the issue top down. Now we are just scratching the technical details There is a standardized format out there.
I'm 100% equities (VTI/VXUS at world cap) for years and comfortable with them. As Warren Buffett says "Never invest in a business you cannot understand," and I understand exactly what they are, which makes sudden drops like the most recent one much less scary.

I don't anticipate ever adding bonds to my portfolio but I think it was time for me to stop being completely ignorant about them.

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Re: Explain why long-term bonds aren't awesome

Post by pascalwager » Mon Feb 12, 2018 8:30 pm

nisiprius wrote:
Mon Feb 12, 2018 5:50 pm
Tamalak wrote:
Mon Feb 12, 2018 5:31 pm
So if I understand right.. rising interest rates are BAD for those already holding bonds, because you've already locked yourself in to a lower rate of return. And falling interest rates are GOOD for those holding bonds because you've locked yourself into a better return than is in the present?
No, it is more complicated than that. For a sudden interest rate rise, the duration tells you your "point of indifference." If the duration is 15 years, then the value of your bond fund holding, including reinvested interest, will fall, but over 15 years it will gradually rise because of a) interest being paid out, and b) the value of a bond rising to its face value when it matures. Up to 15 years you are worse off than if interest rates had remained stable. At 15 years, you are neither better nor worse off. After 15 years, you are better off because the bonds you are holding are paying higher interest.

If the interest rate rise is gradual, then the loss is not as bad, but the time to be "back on track" is even longer.

Thus, Vanguard says that Total Bond, with a duration of 6 years, "may be" suitable for an investor with a 4-10 year time horizon. There are no absolutes because there's no limit to what you can imagine interest rates doing, but for reasonable scenarios there isn't much danger if you are prepared to hold for 4-10 years. But for the long-term bond fund, you would need to be prepared to hold for 15 years or more.
The VG Target Retirement Income Fund includes 37.3% Total Bond Market Index Fund. How do you leave TBM alone for 4-10 years if you're regularly withdrawing living expenses from the TR Fund?

In reality, you may take an interest rate loss on all of the TR fund bond components if rates are rising during retirement.

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Re: Explain why long-term bonds aren't awesome

Post by RRAAYY3 » Mon Feb 12, 2018 8:36 pm

feels like bonds are pretty much as risky as equity without the return potential ...

[100/0 guy that knows nothing about bonds, accumulation phase]

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Re: Explain why long-term bonds aren't awesome

Post by venkman » Mon Feb 12, 2018 8:58 pm

RRAAYY3 wrote:
Mon Feb 12, 2018 8:36 pm
feels like bonds are pretty much as risky as equity without the return potential ...
Since 1993, the worst calendar year return for Vanguard's Total Stock Market Index was -37%.

The worst calendar year return for VG's Total Bond Index was -2.66%.

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Re: Explain why long-term bonds aren't awesome

Post by chevca » Mon Feb 12, 2018 9:03 pm

Long term bonds can definitely be considered risky. The duration risk is high. Take risk on the equity side, IMO.

Long term bonds were awesome back in the day. Those that bought them back in the '80s made out nicely.

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Re: Explain why long-term bonds aren't awesome

Post by RRAAYY3 » Mon Feb 12, 2018 9:14 pm

venkman wrote:
Mon Feb 12, 2018 8:58 pm
RRAAYY3 wrote:
Mon Feb 12, 2018 8:36 pm
feels like bonds are pretty much as risky as equity without the return potential ...
Since 1993, the worst calendar year return for Vanguard's Total Stock Market Index was -37%.

The worst calendar year return for VG's Total Bond Index was -2.66%.
cool. how about best calendar year returns ... or returns in general since then ... or the current environment's impact on bond performance ...

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Re: Explain why long-term bonds aren't awesome

Post by neurosphere » Mon Feb 12, 2018 9:20 pm

pascalwager wrote:
Mon Feb 12, 2018 8:30 pm

The VG Target Retirement Income Fund includes 37.3% Total Bond Market Index Fund. How do you leave TBM alone for 4-10 years if you're regularly withdrawing living expenses from the TR Fund?

In reality, you may take an interest rate loss on all of the TR fund bond components if rates are rising during retirement.
Imagine you have a 30 year retirement, and you withdraw 1/30 (for the sake of argument) of your balance each year. You'd be invested in bonds for an "average" of 15 years. Much longer than the duration of the Total Bond Market Index. If rates are steadily rising throughout your retirement period of 30 years, the money which "stayed" in bonds early in retirement benefited from the early rise in rates, in the sense that they started to pay out increased interest as rates went up.

But yes, if you imagine a 30 year period of interest rate increases which starts on your retirement date, well, that could be painful. TIPS anyone? Oh wait, the TR income fund has about 17% in TIPS. In addition to a 35% equity exposure. So if there is inflation or unexpected inflation which drives bond rates, there are other components in the TR fund which will benefit. :D
If you have to ask "Is a Target Date fund right for me?", the answer is "Yes".

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Re: Explain why long-term bonds aren't awesome

Post by nisiprius » Mon Feb 12, 2018 9:30 pm

RRAAYY3 wrote:
Mon Feb 12, 2018 8:36 pm
feels like bonds are pretty much as risky as equity without the return potential ...

[100/0 guy that knows nothing about bonds, accumulation phase]
1) You are a movie actor. You have reason to believe that the studio is solvent and able to pay the costs of producing a film. Which is riskier? A contract to pay you a specific dollar amount? That's like a bond. Or, a share of the net profit? That's like a stock.

2) See if you can guess which four growth charts are bond funds and which four are stock funds.

Source

Image
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Re: Explain why long-term bonds aren't awesome

Post by Dottie57 » Mon Feb 12, 2018 9:34 pm

venkman wrote:
Mon Feb 12, 2018 8:58 pm
RRAAYY3 wrote:
Mon Feb 12, 2018 8:36 pm
feels like bonds are pretty much as risky as equity without the return potential ...
Since 1993, the worst calendar year return for Vanguard's Total Stock Market Index was -37%.

The worst calendar year return for VG's Total Bond Index was -2.66%.
Numbers say it all.

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Re: Explain why long-term bonds aren't awesome

Post by onourway » Mon Feb 12, 2018 9:36 pm

RRAAYY3 wrote:
Mon Feb 12, 2018 9:14 pm

cool. how about best calendar year returns ... or returns in general since then ... or the current environment's impact on bond performance ...
Many investors have fabulously short memories.

1998-2012 was a fifteen year period in which bonds outperformed stocks. And without the wrenching volatility.

Image

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Re: Explain why long-term bonds aren't awesome

Post by pascalwager » Mon Feb 12, 2018 10:31 pm

neurosphere wrote:
Mon Feb 12, 2018 9:20 pm
pascalwager wrote:
Mon Feb 12, 2018 8:30 pm

The VG Target Retirement Income Fund includes 37.3% Total Bond Market Index Fund. How do you leave TBM alone for 4-10 years if you're regularly withdrawing living expenses from the TR Fund?

In reality, you may take an interest rate loss on all of the TR fund bond components if rates are rising during retirement.
Imagine you have a 30 year retirement, and you withdraw 1/30 (for the sake of argument) of your balance each year. You'd be invested in bonds for an "average" of 15 years. Much longer than the duration of the Total Bond Market Index. If rates are steadily rising throughout your retirement period of 30 years, the money which "stayed" in bonds early in retirement benefited from the early rise in rates, in the sense that they started to pay out increased interest as rates went up.

But yes, if you imagine a 30 year period of interest rate increases which starts on your retirement date, well, that could be painful. TIPS anyone? Oh wait, the TR income fund has about 17% in TIPS. In addition to a 35% equity exposure. So if there is inflation or unexpected inflation which drives bond rates, there are other components in the TR fund which will benefit. :D
Okay, thanks--seems reasonable. I'm setting up my own TR income fund using the same five VG funds except I'll be about 60/40, stocks/bonds. I won't be withdrawing regular income–-I have a pension.

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Re: Explain why long-term bonds aren't awesome

Post by zonto » Wed Jul 24, 2019 12:54 pm

Found this thread recently and thought I'd see how investors holding balanced portfolios since 2015 (when the Federal Reserve started raising rates from 0.25%) would have faired through the end of June 2019: Portfolio Visualizer backtest.

Even during this period of rising rates, investors with long term Treasuries came out ahead of those investing in Vanguard Total Bond Market Index Fund.
“Diversification is about accepting good enough while missing out on great but avoiding terrible.” - Ben Carlson

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Re: Explain why long-term bonds aren't awesome

Post by pdavi21 » Wed Jul 24, 2019 1:07 pm

The reason it didn't twitch in 2008 was that it's duration exposure counteracted its credit exposure. In a stock market crash where interest rates rise, it will perform very poorly and show a (relative to shorter duration bond funds) high correlation to stocks.

I still think BLV is a great bond fund for those who:
1. Have a long horizon and a desire for risk
2. Do not want INTL bond exposure
3. Want corporate bond exposure
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Re: Explain why long-term bonds aren't awesome

Post by bigtex » Wed Jul 24, 2019 1:20 pm

So if I don't want that downside bond fund risk when interest rates rise, is the best counter to that to hold long term CD's and individual bonds? Or how can I hold a non equity product that won't plummet when interest rates rise?

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Re: Explain why long-term bonds aren't awesome

Post by longinvest » Wed Jul 24, 2019 1:23 pm

zonto wrote:
Wed Jul 24, 2019 12:54 pm
Found this thread recently and thought I'd see how investors holding balanced portfolios since 2015 (when the Federal Reserve started raising rates from 0.25%) would have faired through the end of June 2019: Portfolio Visualizer backtest.

Even during this period of rising rates, investors with long term Treasuries came out ahead of those investing in Vanguard Total Bond Market Index Fund.
It's easy to play the backtesting game. If I split the total-bond allocation 50/50 US/international I get that using the broader bond allocation beats using long-term bonds on a risk-adjusted basis (higher sharpe and sortino ratios) over the exact same selected time period. (PV backtest). :wink:

I don't know about others, but I'd much prefer to have my bond allocation diversified across over the (8,566 + 5,897) = 14,463 bonds of the Total Bond Market Index Fund (VBTLX) and the Total International Bond Index Fund (VTABX) than concentrated into the 58 bonds of the Long-Term Treasury Fund (VUSUX) or the 81 strips of the Extended Duration Treasury Index Fund (VEDTX).

I prefer to diversify as broadly as possible instead of gambling my money on the outperformance of a tiny part of the market in an attempt to maximize returns. Others think differently.

“Don't look for the needle in the haystack. Just buy the haystack!” -- Jack Bogle
Last edited by longinvest on Wed Jul 24, 2019 1:34 pm, edited 3 times in total.
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Re: Explain why long-term bonds aren't awesome

Post by pdavi21 » Wed Jul 24, 2019 1:25 pm

zonto wrote:
Wed Jul 24, 2019 12:54 pm
Found this thread recently and thought I'd see how investors holding balanced portfolios since 2015 (when the Federal Reserve started raising rates from 0.25%) would have faired through the end of June 2019: Portfolio Visualizer backtest.

Even during this period of rising rates, investors with long term Treasuries came out ahead of those investing in Vanguard Total Bond Market Index Fund.
Your point can still be made, but a small complaint with your method is that the last rate increase (perhaps for awhile) was in December 2018. The performance between December 2018 and June 2019 should be excluded from your backtest.

EDIT: Also, the first rate hike was December 2015, so same for January to November 2015.
"We spend a great deal of time studying history, which, let's face it, is mostly the history of stupidity." -Stephen Hawking

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Re: Explain why long-term bonds aren't awesome

Post by zonto » Wed Jul 24, 2019 1:44 pm

longinvest wrote:
Wed Jul 24, 2019 1:23 pm
zonto wrote:
Wed Jul 24, 2019 12:54 pm
Found this thread recently and thought I'd see how investors holding balanced portfolios since 2015 (when the Federal Reserve started raising rates from 0.25%) would have faired through the end of June 2019: Portfolio Visualizer backtest.

Even during this period of rising rates, investors with long term Treasuries came out ahead of those investing in Vanguard Total Bond Market Index Fund.
It's easy to play the backtesting game. If I split the total-bond allocation 50/50 US/international I get that using the broader bond allocation beats using long-term bonds on a risk-adjusted basis (higher sharpe and sortino ratios) over the exact same selected time period. (PV backtest). :wink:

I don't know about others, but I'd much prefer to have my bond allocation diversified across over the (8,566 + 5,897) = 14,463 bonds of the Total Bond Market Index Fund (VBTLX) and the Total International Bond Index Fund (VTABX) than concentrated into the 58 bonds of the Long-Term Treasury Fund (VUSUX) or the 81 strips of the Extended Duration Treasury Index Fund (VEDTX).

I prefer to diversify as broadly as possible instead of gambling my money on the outperformance of a tiny part of the market in an attempt to maximize returns. Others think differently.

“Don't look for the needle in the haystack. Just buy the haystack!” -- Jack Bogle
This is what I do currently (70% total U.S. bond market index / 30% total international bond index (USD-hedged), per Vanguard recommendation), but lately I've been wondering why. At the very least, moving to intermediate U.S. treasuries provide better risk adjusted returns because they are more volatile and less correlated with equities due to the lack of corporate bonds. Threads like these have really caught my eye as a young accumulator with a long investing horizon, using bonds only to diversify equity risk and to use for rebalancing in a future crisis:

viewtopic.php?f=10&t=285269
viewtopic.php?f=10&t=251043
pdavi21 wrote:
Wed Jul 24, 2019 1:25 pm
Your point can still be made, but a small complaint with your method is that the last rate increase (perhaps for awhile) was in December 2018. The performance between December 2018 and June 2019 should be excluded from your backtest.

EDIT: Also, the first rate hike was December 2015, so same for January to November 2015.
Thank you for the clarification!
“Diversification is about accepting good enough while missing out on great but avoiding terrible.” - Ben Carlson

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Re: Explain why long-term bonds aren't awesome

Post by MotoTrojan » Wed Jul 24, 2019 1:47 pm

Comparing longterm bond performance to fed rate is quite flawed. The fed (or short in general) rate can go up while long rates come down, as the yield curve compresses.

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Re: Explain why long-term bonds aren't awesome

Post by aristotelian » Wed Jul 24, 2019 2:00 pm

Based on backtesting, long bonds have the best track record of maximizing returns and lowering portfolio volatility when combined with stocks. However, they are risky and there is the chance of a Black Swan in which both stocks and long bonds go down at the same time.

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Re: Explain why long-term bonds aren't awesome

Post by longinvest » Wed Jul 24, 2019 2:09 pm

zonto wrote:
Wed Jul 24, 2019 1:44 pm
longinvest wrote:
Wed Jul 24, 2019 1:23 pm
zonto wrote:
Wed Jul 24, 2019 12:54 pm
Found this thread recently and thought I'd see how investors holding balanced portfolios since 2015 (when the Federal Reserve started raising rates from 0.25%) would have faired through the end of June 2019: Portfolio Visualizer backtest.

Even during this period of rising rates, investors with long term Treasuries came out ahead of those investing in Vanguard Total Bond Market Index Fund.
It's easy to play the backtesting game. If I split the total-bond allocation 50/50 US/international I get that using the broader bond allocation beats using long-term bonds on a risk-adjusted basis (higher sharpe and sortino ratios) over the exact same selected time period. (PV backtest). :wink:

I don't know about others, but I'd much prefer to have my bond allocation diversified across over the (8,566 + 5,897) = 14,463 bonds of the Total Bond Market Index Fund (VBTLX) and the Total International Bond Index Fund (VTABX) than concentrated into the 58 bonds of the Long-Term Treasury Fund (VUSUX) or the 81 strips of the Extended Duration Treasury Index Fund (VEDTX).

I prefer to diversify as broadly as possible instead of gambling my money on the outperformance of a tiny part of the market in an attempt to maximize returns. Others think differently.

“Don't look for the needle in the haystack. Just buy the haystack!” -- Jack Bogle
This is what I do currently (70% total U.S. bond market index / 30% total international bond index (USD-hedged), per Vanguard recommendation), but lately I've been wondering why. At the very least, moving to intermediate U.S. treasuries provide better risk adjusted returns because they are more volatile and less correlated with equities due to the lack of corporate bonds. Threads like these have really caught my eye as a young accumulator with a long investing horizon, using bonds only to diversify equity risk and to use for rebalancing in a future crisis:

viewtopic.php?f=10&t=285269
viewtopic.php?f=10&t=251043
Zonto, it's particularly difficult to "ignore the noise". It's easy to get mislead by attractive backtests and promises of higher risk-adjusted returns through concentration into specific sub-markets.

To help, I suggest to use a good enough all-in-one fund like Vanguard's LifeStrategy Moderate Growth Fund (VSMGX) which isn't concentrated into any of the two major asset classes and to stop attempting to maximize returns. It's sufficient to simply spend just a little less than with a higher stock allocation to retire with dignity. Using an all-in-one globally-diversified balanced index fund greatly simplifies investing and can sidestep a long list of behavioral mistakes.

If you're interested in the idea of the linked thread, it's implemented in the Accumulation sheet (specially designed for people in the accumulation phase) of the VPW Accumulation And Retirement Worksheet.
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Re: Explain why long-term bonds aren't awesome

Post by MotoTrojan » Wed Jul 24, 2019 2:11 pm

aristotelian wrote:
Wed Jul 24, 2019 2:00 pm
Based on backtesting, long bonds have the best track record of maximizing returns and lowering portfolio volatility when combined with stocks. However, they are risky and there is the chance of a Black Swan in which both stocks and long bonds go down at the same time.
50’s-70’s weren’t a black swan but certainly were an ugly time for long bonds.

HEDGEFUNDIE
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Re: Explain why long-term bonds aren't awesome

Post by HEDGEFUNDIE » Wed Jul 24, 2019 2:14 pm

longinvest wrote:
Wed Jul 24, 2019 1:23 pm
I don't know about others, but I'd much prefer to have my bond allocation diversified across over the (8,566 + 5,897) = 14,463 bonds of the Total Bond Market Index Fund (VBTLX) and the Total International Bond Index Fund (VTABX) than concentrated into the 58 bonds of the Long-Term Treasury Fund (VUSUX) or the 81 strips of the Extended Duration Treasury Index Fund (VEDTX).

I prefer to diversify as broadly as possible instead of gambling my money on the outperformance of a tiny part of the market in an attempt to maximize returns. Others think differently.
This is one of the most misleading things I've seen on Bogleheads recently.

What kinds of bonds are the majority of those thousands of bonds in the Total Bond Market and Total International Bond funds? Corporate bonds, that contain corporate credit risk! Which most investors are already exposed to in their equities!

An investor who has an equity allocation is much more diversified by holding one single Intermediate or Long Term Treasury bond than by holding a thousand corporate bonds; that is not an opinion, that is a fact.

longinvest
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Re: Explain why long-term bonds aren't awesome

Post by longinvest » Wed Jul 24, 2019 3:05 pm

HEDGEFUNDIE wrote:
Wed Jul 24, 2019 2:14 pm
longinvest wrote:
Wed Jul 24, 2019 1:23 pm
I don't know about others, but I'd much prefer to have my bond allocation diversified across over the (8,566 + 5,897) = 14,463 bonds of the Total Bond Market Index Fund (VBTLX) and the Total International Bond Index Fund (VTABX) than concentrated into the 58 bonds of the Long-Term Treasury Fund (VUSUX) or the 81 strips of the Extended Duration Treasury Index Fund (VEDTX).

I prefer to diversify as broadly as possible instead of gambling my money on the outperformance of a tiny part of the market in an attempt to maximize returns. Others think differently.
This is one of the most misleading things I've seen on Bogleheads recently.

What kinds of bonds are the majority of those thousands of bonds in the Total Bond Market and Total International Bond funds? Corporate bonds, that contain corporate credit risk! Which most investors are already exposed to in their equities!

An investor who has an equity allocation is much more diversified by holding one single Intermediate or Long Term Treasury bond than by holding a thousand corporate bonds; that is not an opinion, that is a fact.
Dear HEDGEFUNDIE,

What I wrote was factual. I have my own preferences and there exist others who think differently.

Here's supporting material for my statements.

I - The number of holdings are provided on the following sites:
  • Vanguard Total Bond Market Index Fund (VBTLX): number of bonds 8,566 (link).
  • Vanguard Total International Bond Index Fund (VTABX): number of bonds 5,897 (link).
  • Vanguard Long-Term Treasury Fund (VUSUX): number of bonds 58 (link).
  • Vanguard Extended Duration Treasury Index Fund (VEDTX): number of bonds 81 (link). Note that the portfolio holdings page reveals that the 81 bonds are effectively all strips.
II - Here are the risk ratings that Vanguard attributes to the funds on a scale of 1 (less risk, less reward) to 5 (more risk, more reward):
  • Vanguard Total Bond Market Index Fund (VBTLX): Risk Potential 2 (link).
  • Vanguard Total International Bond Index Fund (VTABX): Risk Potential 2 (link).
  • Vanguard Long-Term Treasury Fund (VUSUX): Risk Potential 3 (link).
  • Vanguard Extended Duration Treasury Index Fund (VEDTX): Risk Potential 5 (link).
III - In the particular case of the Vanguard Extended Duration Treasury Index Fund (VEDTX), the Portfolio & Management page says:

"The fund is primarily intended for institutional investors with extremely long-term liabilities—20 years or more. Prospective individual investors are urged to consult with their own advisors to determine if the fund is suitable for their overall investment programs and financial positions."

This is an unusual warning that we don't find on Vanguard's broad-market index funds often recommended on this site: total US stocks, total international stocks, total US bonds, and total international bonds.

You are free to think differently, but I do not adhere to the view that concentrating my portfolio into specific tiny parts of various markets would diversify my portfolio.

The quote bears repeating:

Don't look for the needle in the haystack. Just buy the haystack!” -- Jack Bogle

longinvest
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Re: Explain why long-term bonds aren't awesome

Post by MotoTrojan » Wed Jul 24, 2019 3:17 pm

longinvest wrote:
Wed Jul 24, 2019 3:05 pm
HEDGEFUNDIE wrote:
Wed Jul 24, 2019 2:14 pm
longinvest wrote:
Wed Jul 24, 2019 1:23 pm
I don't know about others, but I'd much prefer to have my bond allocation diversified across over the (8,566 + 5,897) = 14,463 bonds of the Total Bond Market Index Fund (VBTLX) and the Total International Bond Index Fund (VTABX) than concentrated into the 58 bonds of the Long-Term Treasury Fund (VUSUX) or the 81 strips of the Extended Duration Treasury Index Fund (VEDTX).

I prefer to diversify as broadly as possible instead of gambling my money on the outperformance of a tiny part of the market in an attempt to maximize returns. Others think differently.
This is one of the most misleading things I've seen on Bogleheads recently.

What kinds of bonds are the majority of those thousands of bonds in the Total Bond Market and Total International Bond funds? Corporate bonds, that contain corporate credit risk! Which most investors are already exposed to in their equities!

An investor who has an equity allocation is much more diversified by holding one single Intermediate or Long Term Treasury bond than by holding a thousand corporate bonds; that is not an opinion, that is a fact.
Dear HEDGEFUNDIE,

What I wrote was factual. I have my own preferences and there exist others who think differently.

Here's supporting material for my statements.

I - The number of holdings are provided on the following sites:
  • Vanguard Total Bond Market Index Fund (VBTLX): number of bonds 8,566 (link).
  • Vanguard Total International Bond Index Fund (VTABX): number of bonds 5,897 (link).
  • Vanguard Long-Term Treasury Fund (VUSUX): number of bonds 58 (link).
  • Vanguard Extended Duration Treasury Index Fund (VEDTX): number of bonds 81 (link). Note that the portfolio holdings page reveals that the 81 bonds are effectively all strips.
II - Here are the risk ratings that Vanguard attributes to the funds on a scale of 1 (less risk, less reward) to 5 (more risk, more reward):
  • Vanguard Total Bond Market Index Fund (VBTLX): Risk Potential 2 (link).
  • Vanguard Total International Bond Index Fund (VTABX): Risk Potential 2 (link).
  • Vanguard Long-Term Treasury Fund (VUSUX): Risk Potential 3 (link).
  • Vanguard Extended Duration Treasury Index Fund (VEDTX): Risk Potential 5 (link).
III - In the particular case of the Vanguard Extended Duration Treasury Index Fund (VEDTX), the Portfolio & Management page says:

"The fund is primarily intended for institutional investors with extremely long-term liabilities—20 years or more. Prospective individual investors are urged to consult with their own advisors to determine if the fund is suitable for their overall investment programs and financial positions."

This is an unusual warning that we don't find on Vanguard's broad-market index funds often recommended on this site: total US stocks, total international stocks, total US bonds, and total international bonds.

You are free to think differently, but I do not adhere to the view that concentrating my portfolio into tiny parts of various markets would diversify my portfolio.

The quote bears repeating:

Don't look for the needle in the haystack. Just buy the haystack!” -- Jack Bogle

longinvest
You did not include an intermediate treasury fund such as VFITX, which Vanguard lists as a #2 in risk, just like your total bond funds. Also risk of a holding alone is quite different than the total risk of a portfolio of assets.

Number of holdings does not equal diversification of risk. I don't think anything you've stated proves that either total bond fund along with an equity fund is less risky than VFITX, which is the closest in duration-exposure to total bond.

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Re: Explain why long-term bonds aren't awesome

Post by Forester » Wed Jul 24, 2019 3:28 pm

Tamalak wrote:
Mon Feb 12, 2018 5:11 pm

The return seems more wobbly than most bond types but I don't see any drop worse than 10-12% or so. It didn't even twitch during the disaster of 2008, which says to me that this asset is uncorrelated with the stock market, which would make it really good paired with equities. Is this just a particularly good decade?
LT bonds may behave differently in the next crisis. The maximum real term drawdown in US long-term bonds is 68%.

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Re: Explain why long-term bonds aren't awesome

Post by MotoTrojan » Wed Jul 24, 2019 3:32 pm

Tamalak wrote:
Mon Feb 12, 2018 5:11 pm
Stupid question as I'm an equity guy and don't understand bonds well. Forgive me.

I'm specifically looking at the BLV ETF product from Vanguard. Why is the return so high compared to other bond types? Is 7.5% a realistic forward-looking return?

The return seems more wobbly than most bond types but I don't see any drop worse than 10-12% or so. It didn't even twitch during the disaster of 2008, which says to me that this asset is uncorrelated with the stock market, which would make it really good paired with equities. Is this just a particularly good decade?
If BLV's return during the 2008 disaster impresses you, then check-out TLT or VEDTX which had 35-65% pops.

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Re: Explain why long-term bonds aren't awesome

Post by vineviz » Wed Jul 24, 2019 3:42 pm

longinvest wrote:
Wed Jul 24, 2019 3:05 pm
What I wrote was factual. I have my own preferences and there exist others who think differently.
What you wrote included some facts, but it was also incredibly misleading.

For one thing, what you wrote implied that the number of holdings in a portfolio is an accurate measure of its diversification. It is not.

For another thing, what you wrote implied that a portfolio containing stocks, treasuries, and corporate bonds is more diversified than a portfolio containing only stocks and treasury bonds. It is not.

longinvest wrote:
Wed Jul 24, 2019 3:05 pm
You are free to think differently, but I do not adhere to the view that concentrating my portfolio into specific tiny parts of various markets would diversify my portfolio.
This is also misleading because it characterizes (perhaps inadvertently) a MORE diversified portfolio as being excessively concentrated, without regard for the ACTUAL degree of diversification that is present.

The reality, whether you adhere to it or not, is that a portfolio which is 60% stocks and 40% Vanguard Extended Duration Treasury Index Fund (VEDTX) is more diversified than a portfolio that is 60% stocks and 40% Vanguard Total Bond Market Index Fund (VBTLX) regardless of how many different bonds the latter fund holds.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Explain why long-term bonds aren't awesome

Post by longinvest » Wed Jul 24, 2019 3:51 pm

Dear Vineviz,
vineviz wrote:
Wed Jul 24, 2019 3:42 pm
What you wrote included some facts, but it was also incredibly misleading.
It wasn't.
vineviz wrote:
Wed Jul 24, 2019 3:42 pm
This is also misleading because it characterizes (perhaps inadvertently) a MORE diversified portfolio as being excessively concentrated, without regard for the ACTUAL degree of diversification that is present.
It's not.

Vineviz, you use your own definition of diversification to make false accusations.

I don't share your definition of diversification as being "more returny for the same volatility (in the past)".

I use the widely accepted definition of diversification as spreading my money broadly based on market capitalization.

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Re: Explain why long-term bonds aren't awesome

Post by stuper1 » Wed Jul 24, 2019 3:57 pm

Just because you bought the stock of company A and then bought a bond from company A doesn't mean that you have spread your money more broadly. A lot or maybe all of those corporate bonds are from the same companies that are represented in the stock index. For me, I like to hold all Treasury bonds on the bond side.

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Re: Explain why long-term bonds aren't awesome

Post by vineviz » Wed Jul 24, 2019 4:08 pm

longinvest wrote:
Wed Jul 24, 2019 3:51 pm
I don't share your definition of diversification as being "more return for the same volatility (in the past)".
What you've wrote is a caricature of the actual definition of "diversification" and, in any case, I certainly shouldn't be credited with inventing it.

It's not my intent to force you into having a diversified portfolio: I respect your right to invest any way you'd like. But in financial economics, "diversification" is are well-defined concept and its validity doesn't depend on how widely understood (or not) it is.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

longinvest
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Re: Explain why long-term bonds aren't awesome

Post by longinvest » Wed Jul 24, 2019 4:28 pm

vineviz wrote:
Wed Jul 24, 2019 4:08 pm
longinvest wrote:
Wed Jul 24, 2019 3:51 pm
I don't share your definition of diversification as being "more returny for the same volatility (in the past)".

I use the widely accepted definition of diversification as spreading my money broadly based on market capitalization.
What you've wrote is a caricature of the actual definition of "diversification" and, in any case, I certainly shouldn't be credited with inventing it.
Dear Vineviz,

There exist multiple definitions for the word "diversification".

Merriam-Webster provides two principal definitions with two sub-definitions for the second meaning:

https://www.merriam-webster.com/diction ... sification
Definition of diversification
  1. the act or process of diversifying something or of becoming diversified : an increase in the variety or diversity of something
    1. the act or practice of spreading investments among a variety of securities or classes of securities
    2. the act or policy of increasing the variety of a company's products
I used meaning 2.a in my posts. I consider broad diversification to mean spreading my money broadly according to market capitalization. It isn't equal-weighted across securities for obvious reasons having to do with basic arithmetic (see this post for details). It's a widely-used meaning of diversification in the context of investing.

Don't look for the needle in the haystack. Just buy the haystack!” -- Jack Bogle

longinvest
Bogleheads investment philosophy | One-ETF global balanced index portfolio | VPW

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Re: Explain why long-term bonds aren't awesome

Post by pdavi21 » Wed Jul 24, 2019 4:41 pm

vineviz's definition of "diversification" is the most widely accepted definition in personal finance.

Unfortunately, his definitions of "asset [class/type]" and "is" are controversial and incorrect, respectively.
Last edited by pdavi21 on Thu Jul 25, 2019 4:55 pm, edited 1 time in total.
"We spend a great deal of time studying history, which, let's face it, is mostly the history of stupidity." -Stephen Hawking

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Re: Explain why long-term bonds aren't awesome

Post by vineviz » Wed Jul 24, 2019 5:13 pm

pdavi21 wrote:
Wed Jul 24, 2019 4:41 pm
Unfortunately, his definitions of "asset [class/type]" and "is" are controversial and incorrect, respectively.
I'm not aware that I have either used the word "asset" in a controversial way or defined it in any way, but if recall me doing so and think it is relevant to this discussion please point us to an instance of one or both.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Explain why long-term bonds aren't awesome

Post by NPT » Wed Jul 24, 2019 5:31 pm

You need to look up historical data going back a very long time to get some sense of all the different ways bonds can behave. Considering only the past few decades is not very useful. As to "why long-term bonds aren't awesome", I recommend looking at the charts in this previous post of mine. It shows that between 1946 and 1982 long-term treasury bonds lost approximately 67% percent of their value, adjusted for inflation. Fixed income investments can lose money for an extraordinarily long time in after-inflation terms, and long-term bonds can lose a lot of money when that happens.

As for their correlation to the stock market, it varies a lot, and over the really long term very short-term fixed income instruments have actually been slightly less correlated to the stock market than long-term ones, although it is easy to believe otherwise if one only considers the mostly deflationary environment and crises of recent times. We have not experienced periods with significant inflation for decades in the developed world, so it makes sense to be careful with jumping to conclusions based only on recent data.

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Re: Explain why long-term bonds aren't awesome

Post by HEDGEFUNDIE » Wed Jul 24, 2019 5:39 pm

longinvest wrote:
Wed Jul 24, 2019 3:51 pm
Dear Vineviz,
vineviz wrote:
Wed Jul 24, 2019 3:42 pm
What you wrote included some facts, but it was also incredibly misleading.
It wasn't.
vineviz wrote:
Wed Jul 24, 2019 3:42 pm
This is also misleading because it characterizes (perhaps inadvertently) a MORE diversified portfolio as being excessively concentrated, without regard for the ACTUAL degree of diversification that is present.
It's not.

Vineviz, you use your own definition of diversification to make false accusations.

I don't share your definition of diversification as being "more returny for the same volatility (in the past)".

I use the widely accepted definition of diversification as spreading my money broadly based on market capitalization.

longinvest
Longinvest, which of these is more diversified?

1. A portfolio of 100 tech stocks
2. A portfolio of 10 stocks, one from each major industry sector

The “widely accepted definition” of diversification would lead anyone to pick #2.

Ask yourself why #2 is more diversified than #1, and you will also realize why a portfolio with stocks + long treasuries is more diversified than stocks + total bond. It is the same fundamental principle.

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Re: Explain why long-term bonds aren't awesome

Post by Hector » Wed Jul 24, 2019 6:07 pm

bigtex wrote:
Wed Jul 24, 2019 1:20 pm
So if I don't want that downside bond fund risk when interest rates rise, is the best counter to that to hold long term CD's and individual bonds? Or how can I hold a non equity product that won't plummet when interest rates rise?
I Bonds is another option.

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Re: Explain why long-term bonds aren't awesome

Post by zonto » Wed Jul 24, 2019 6:15 pm

NPT wrote:
Wed Jul 24, 2019 5:31 pm
You need to look up historical data going back a very long time to get some sense of all the different ways bonds can behave. Considering only the past few decades is not very useful. As to "why long-term bonds aren't awesome", I recommend looking at the charts in this previous post of mine. It shows that between 1946 and 1982 long-term treasury bonds lost approximately 67% percent of their value, adjusted for inflation. Fixed income investments can lose money for an extraordinarily long time in after-inflation terms, and long-term bonds can lose a lot of money when that happens.

As for their correlation to the stock market, it varies a lot, and over the really long term very short-term fixed income instruments have actually been slightly less correlated to the stock market than long-term ones, although it is easy to believe otherwise if one only considers the mostly deflationary environment and crises of recent times. We have not experienced periods with significant inflation for decades in the developed world, so it makes sense to be careful with jumping to conclusions based only on recent data.
I noticed this phenomenon of a short-term fund having a lower correlation than a longer duration fund yesterday when researching correlations of multiple Vanguard municipal bond funds of varying duration. See: PV backtest. However, as folks have been discussing in these recent threads, correlation isn't everything because one must also consider the volatility of the fund/asset being considered for diversification.

Once you do that, the same relationship we've been discussing above bears out. PV backtest. The longer duration funds were more effective diversifiers of equity risk. I will note here that the results when using Vanguard's intermediate and long-term tax exempt funds are much closer than if you run the same test using short-, intermediate-, and long-term Treasuries.
“Diversification is about accepting good enough while missing out on great but avoiding terrible.” - Ben Carlson

jdilla1107
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Re: Explain why long-term bonds aren't awesome

Post by jdilla1107 » Wed Jul 24, 2019 6:20 pm

EE Bonds are pretty awesome if held for exactly 20 years.

- They effectively yield 3.53%, which is 50% higher than a 20 year treasury right now.
- They have a free put option in case interest rates increase a lot. (You can sell them for a bit more than what you paid)
- They are tax deferred.

I have been maxing these out every year for the last 10 years. And for the last 10 years, various people on this forum have said rates can only go up.

Also, note that Vanguard Total Bond Market is about 15% long term bonds, so some of the people arguing against them here, own them in their funds.

I would say moderation is important though.

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vineviz
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Re: Explain why long-term bonds aren't awesome

Post by vineviz » Wed Jul 24, 2019 6:33 pm

NPT wrote:
Wed Jul 24, 2019 5:31 pm
You need to look up historical data going back a very long time to get some sense of all the different ways bonds can behave. Considering only the past few decades is not very useful.
Perhaps not, but in the case of long-term US Treasury bonds considering the decades before 1980 is potential even less useful.

For one thing, before the Volcker-Greenspan era the Federal Reserve was actively and directly suppressing long-term yields as part of their policy approach. As a result, the relationship between inflation and bond returns was seriously distorted. See here for a long-winded take.

Also, people forget but US Treasury bonds were frequently issued with call provisions in the 1950s, 1960s, and 1970s. As you know, bonds with call options have payouts that behave very differently from non-callable bonds when rates rise.
NPT wrote:
Wed Jul 24, 2019 5:31 pm
As for their correlation to the stock market, it varies a lot, and over the really long term very short-term fixed income instruments have actually been slightly less correlated to the stock market than long-term ones, although it is easy to believe otherwise if one only considers the mostly deflationary environment and crises of recent times. We have not experienced periods with significant inflation for decades in the developed world, so it makes sense to be careful with jumping to conclusions based only on recent data.
Correlation is only one of the two attributes that two attributes that impact the diversification benefits an asset brings to a portfolio. Variance is the other. Combining the correlation to US stocks of various US Treasury funds - Vanguard Total Bond Market included for reference - with the variance of those funds yields covariance, which is directly related to diversification benefit (lower covariance means more diversificaiton potential). This graph illustrates the fact that even though funds with maturities from 1 year (e.g. SHY) to 30 years (e.g EDV) have similar correlations, their diversification impact is far from similar.

Image
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Re: Explain why long-term bonds aren't awesome

Post by fennewaldaj » Wed Jul 24, 2019 9:21 pm

vineviz wrote:
Wed Jul 24, 2019 6:33 pm

For one thing, before the Volcker-Greenspan era the Federal Reserve was actively and directly suppressing long-term yields as part of their policy approach. As a result, the relationship between inflation and bond returns was seriously distorted. See here for a
Wasn't QE an attempt to actively suppress long and intermediate term rates?

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