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herein lies the problem... with the fund I just referred to, the NAV has fallen but the distribution yield over a year and a half has not changed, in fact it is hardly any different from Jan 2018 and now it is actually falling. Your math would only work if the distribution yield gradually crept up to offset the drop in NAV, which is what I thought would happen, but it isn't happening - not quite sure why... perhaps redemptions or the management is prematurely selling bonds at a loss, who knows...
The intermediate bond fund needs to be held 7 years to see the return you got when you bought the change do not happen each year but over time migrate over the funds duration value. It is no different then selling a bond before maturity if rates rise
Last edited by mathjak107; 03-02-2019 at 01:49 PM..
bond funds do not increase their distributions logarithmic fashion yearly all the time . it depends on the mix of bonds , but high quality bond funds have a duration value . that is the point where drops in nav are cancelled out by increases in interest over time ..
in my example above you would get your 5% but remember that is in a 6% world eventually .. so when rates rise you get what is the rate the day you bought or better but you are always behind current rates
so you can never look at a bond fund prior to it's duration ( maturity in a way ) to do a comparison .
so lets look at fidelity total bond .. it has a duration of 5.38 years
the closest cash equal would have been a 5 year cd ..
total bond returned 5.38% over the last 5 years .. had you bought a 5 year cd you got much less
vanguard total bond has a 6 year duration .. payouts barely increased for 2015 ,2016,2017 then took a big jump in 2018...
2015 was 2.00 , 2016- 2.00 ,2017- 2.04 , 2018-2.21
so the payouts are not in a gradual order as you may think .
lets go out longer .
TLT has a duration of 17 years
cd's back then were 4..09% , rolling over a 5 year cd produced even a lower return .. TLT RETURNED 5.63%
you can go through most of history and you will find if you compare the bond fund duration to what you would have gotten on cash the bond funds usually start out at a higher rate then cash instruments do ..
but some bond funds like TLT can be very powerful and move as much as stocks not based on just rates , but on fear , greed and perception ... that makes them quite powerful in recessions or just the scent of recessions and when rebalanced they can buy a lot more equities then had one been in cash instruments .
if you bought fidelity total bond today with a 5 year duration you are at 3.32% , the highest paying 5 year cd is about 3.10 ... so hanging in 5 years should give you about 3.32% , but if rates fall the bond fund can see additional appreciation if you want to sell earlier and take a profit. if rates rise you should see at least the 3.32 range
Last edited by mathjak107; 03-03-2019 at 04:25 AM..
the analysis would work if interest rates are static from this point. In a rising rate environment the bonds will keep falling and losing money until such a point is reached where interest rates level off. From THAT point it will still take the duration of the bond to return the original yield. Now, if interest rates keep increasing over the next 3-4 years and on top of that add a 6 year duration that's a 9-10 year period.
If one has a 10+ year horizon you can invest that same money in equities and generate a far superior return.
My point was that term risk is high at this point and what is the point of taking on that term risk? If rates rise to 4% from here on a 6 year duration bond fund it will fall 8% in value. How long has one to wait to recoup all those losses and get the original compounded value?
One probably has to wait 9-10 years perhaps more to recoup all that, so what is the point? If one has 10+ years just invest it in equities and keep an inflated Emergency fund for exigencies.
For bonds to rally in the next crisis rates have to go back down below 2%, what is the likelihood of that? I am not very optimistic that will happen simply due to the current fiscal situation, it was possible in '08 because the balance sheet and debt wasn't as high.
the relationship still holds true .. if rates go up 2% instead of 1% , the increase in additional interest because now it is 2% higher over the duration still makes you whole eventually.. the duration does not get longer .. it stays about the same but the additional interest increases are just greater because they went up more . over that duration period the fund is retiring older bonds and adding higher paying ones . the duration value is the cross over point .
long treasury bonds rates have gone up almost 44% and the duration is still 17 years for TLT
i would bet the long treasury bond sees the 1.80- 2.25 % range in the next recession
Last edited by mathjak107; 03-03-2019 at 03:39 PM..
Infact, I am just rethinking my entire philosophy on bonds. I have a staggering 17.5% of my portfolio in bonds , infact I am now thinking a good strategy would be to have an inflated emergency fund in a money market, say 18 months of expenses and then go 100% equities.
You're hitting on a common mistake: conflating two separate decisions:
1) How much risk are you willing to take?
2) How do you construct a Pareto efficient portfolio for that level of risk?
Quote:
Originally Posted by k374
If one has a 10+ year horizon you can invest that same money in equities and generate a far superior return.
That you can hypothetically generate a far superior return isn't the issue; the issue is the return-per-unit-of-risk-that-you-incur.
Even if one has a multi-hundred year horizon such as, say, a major university endowment, a 100% equity portfolio is unlikely to be Pareto efficient. There are other ways to construct the portfolio with lower risk and higher expected returns.
10YT is back to 10.59 and bonds are going up again. It looks like the bond market thinks there is some turbulence ahead. If one would want to reduce their bond holdings by around 10% would this be a good time or would one want to wait until there is more turbulence and bonds possibly rally even more?
Going to liquidate my bond position on Monday, pay the short term cap gain (@ 33.3% ouch, but it's a small amount of gain anyway!). My strategy is going to be 100% equities + 1 year expenses in an oversized emergency fund, possibly a 2 yr CD, rates are approaching 3% now so I can lock that in.
I dislike putting my bonds in tax advantaged as I don't want to lose the superior compounding effect of equities and I don't like to hold bonds in my taxable due to the onerous taxes in California. And I don't want to hold Munis since they pay little.
My strategy is going to be 100% equities + 1 year expenses in an oversized emergency fund, possibly a 2 yr CD, rates are approaching 3% now so I can lock that in.
Hey, if you can stomach seeing those values cut in half, go for it.
The underappreciated function of bonds is not only that they rally in equity bear markets, but also that they represent a store of cash to buy equities when they are cheap(er).
Hey, if you can stomach seeing those values cut in half, go for it.
I have a 12-20 year time horizon, I would've kept the bonds but the taxes are absolutely killing me relative to the paltry return.
If I wasn't living in the Extortionate Republic of California I would've just let my bonds be there...but paying 10% tax on top of 24% Federal already and starting with a miniscule 2.5% return to begin with, too much.
I don't want to pay taxes on something that does not return anything to begin with. Worse, I don't want to pay taxes on something that is losing value.
The core problem with bonds is the low yield. If you go and see history most of the returns are coming from yield, in the past the yield was 3.5-6+ %, now it's 2.5%. The NAV cannot be counted on, if you look at the historical NAV it's the same from 15 years ago so the return from bonds is essentially the yield which is currently not there, and after taxes and inflation it's negative.
So to avoid taxes i've been advised to put the bonds in my 401k. Well, that makes no sense. A 401k cannot be accessed until 59.5 years which is 15+ years for me. Why put bonds in there if you can't withdraw it for 15 years anyway? Why is this considered sensible?
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, infact I am now thinking a good strategy would be to have an inflated emergency fund in a money market, say 18 months of expenses and then go 100% equities.
