Concerns with the future of bonds

[ghaynes]

I opened a Betterment account this month since I wanted a service where I could set and forget it. This account is not long term and will be strictly used for a car replacement which I plan to use in the next 3-4 years.

Since this is short term I want to be conservative so my allocation is 70% bonds / 30% stocks. I opened the account with an initial investment of $10000 (to get there lower fee) and will deposit $500 per month to it.

My concern is the future of bonds and the possibility of the "bond bubble" since rates are at an all time low and will likely rise making bonds lose value. So now I'm thinking my conservative allocation doesn't appear conservative.

Should I be concerned?

My account looks like this as of today:

$3500 - iShares TIPS Bond ETF
$3500 - iShares 1-3 Year Treasury Bond ETF
$3000 - Mix of VTI: Vanguard Total US Stock Market, IVE: iShares S&P 500 Value Stocks, VEA: Vanguard MSCI EAFE Stocks

[Honest Abe]

Short term bonds and TIPS are very low-yield by nature and due to their short maturities are somewhat immune to big shifts in the bond markets.  I wouldn't worry too much about it. Not saying you're immune to any loss but a huge loss in the value of a short term bond would most likely be made up for by a surge in risk assets. (Stocks)

[chucklesmcgee]

the possibility of the "bond bubble" since rates are at an all time low and will likely rise making bonds lose value.

I'm inexperienced with bonds and don't quite follow. Rates could rise, though probably not for at least 12 months or so, if the Federal Reserve's projections are any indication. How does a rising interest rate make your bonds lose value, especially TIPS?

[Honest Abe]

@Chuck.. If I sell a piece of my debt that pays 1%, then next year I'm paying 2% for someone to buy my debt, the "face value" of the first note will go down. Why? Because why would anyone want to buy my debt for 1% when I'm currently paying 2%?

People are concerned about a bond bubble because of how rates are bring held down by the fed. You're right that any meaningful change in fed policy is a year or so away, which was why I was telling OP that the short term nature of those bond funds protect the holders somewhat from a future movement in the interest rates. (which is why short terms bonds pay less interest than long term bonds -- less risk to the holder of the bonds)

[sheepstache]

the possibility of the "bond bubble" since rates are at an all time low and will likely rise making bonds lose value.

I'm inexperienced with bonds and don't quite follow. Rates could rise, though probably not for at least 12 months or so, if the Federal Reserve's projections are any indication. How does a rising interest rate make your bonds lose value, especially TIPS?

As Abe says, it has the to do with the price of the bonds if you try to sell them on the secondary market (which is also what matters with a bond fund).   A bond that you just hold until maturity wouldn't change.

http://badmoneyadvice.com/2010/01/bond-prices-go-down-when-interest-rates-go-up.html

I swear, Abe, I do not have it in for Betterment :)  but this is another of my issues with them.  Hoping that the "risky" part of the portfolio makes up for a huge loss in the "conservative" part of the portfolio is not how most people would think of it.  Better to know why bonds are so risky right now and understand that's why Betterment has you in such low-paying funds.  At least ghaynes checked what the specific allocation was and has heard of a bond bubble and has come here to ask questions.  I feel like actual conservative investors are at this point simply not in bonds at all or barely.

[Honest Abe]

Haha.. well at risk of sounding like a fanboy I'll offer an opposing view. Those two bond funds are really the only thing to fit the "conservative" bill right now, as they don't offer much other than income (and a very small bit of income at that, but to betterment's point, even these paltry returns are better than most savings accounts.) Seeing as bonds with such short maturities don't offer much risk as far as their market value goes, that's as much reward as you can expect.

Also it should be noted that the allocation was set by the OP because of his relatively near-term goal with the account.. It's not the allocation I would choose but that's a whole other topic. :)

[ghaynes]

Thanks for the feedback. Abe, what allocation would you use for this short term goal?

[Honest Abe]

I would say 50/50 at this point.... Given the state of the stock market I wouldn't be too concerned about losing principal in the next couple years.. If you feel like you want to reallocate a more conservative mix in the last year before your purchase to protect gains I would say that going more heavily into bonds would be warranted. However I'm not a financial professional, nor do I play one on TV, so do as you see fit. :)