Bond Market Index vs Money Market with a high rate

[ClimateMind]

Hey everyone,

I have what might be a really simple question - I could make it complex with background, but I'll try to keep it simple. The simple question is, why would I keep any funds in a bond market index and not a money market account that gets better returns?

Way back when I got introduced to index fund investing and asset allocation, I split my investments mostly between a total stock market index (VTSAX) and a total bond index (VBTLX). (I have a REIT fund, but that's not too relevant - this question is basically about the bonds.) Like a good index investor, I chose a bond allocation, and gradually have increased it over the last 12 years or so - started at 10% bonds; currently abut 20%. meanwhile, frankly, I have not paid much attention to the rate of return, I just trusted the asset allocation system (stocks and bond, reallocation, etc.) and went about my life.

Recently I started wondering if I should increase the bond allocation even more, considering that I might be FIREing in 3 years or so (or sooner, but that's another topic). I started looking into VBTLX and saw that it's been getting pretty poor returns for some time - 5 year return of a bit less than 3%. Then I realized that I can get a 5.24%.

Am I missing something? (and I would not be surprised if I were) Why shouldn't I transfer all my VBTLX funds into VMFXX (the vanguard money market account)? We're talking about $300k in bonds, so the difference in return is meaningful. Thank you!

[EvenSteven]

Recently I started wondering if I should increase the bond allocation even more, considering that I might be FIREing in 3 years or so (or sooner, but that's another topic). I started looking into VBTLX and saw that it's been getting pretty poor returns for some time - 5 year return of a bit less than 3%. Then I realized that I can get a 5.24%.

This is a bit of an apples to oranges comparison. Looking at what the last 5 years has been of VBTLX versus what the current rate is for VMFXX.

You can think of them both being bond funds but with different durations (with VMFXX having an extremely short duration), so the main difference that I think you are missing is interest rate sensitivity. If interest rates fall, the longer duration funds will have price appreciation. Conversely, if interest rates rise, those longer duration funds will see a price decrease. Over the long term, assuming you can't reliably predict interest rate changes, the bond fund usually has a greater total return than money market funds.

[ClimateMind]

Thank you! That makes sense and I realize that i didn't quite understand what a money market fund was. Or rather, I'm so used to money market funds having negligible interest that I saw the rates, got greedy, and suddenly thought it was a good long term investment.

This has practical application because I recently inherited about $90k and it's sitting in a Schwab money market account. It feels really strange to sell when it's earning 5%, and buy into bonds. If I am following good long-term investment strategy, should I still favor the bond fund? Is it an opportunity to buy low?

[EvenSteven]

Thank you! That makes sense and I realize that i didn't quite understand what a money market fund was. Or rather, I'm so used to money market funds having negligible interest that I saw the rates, got greedy, and suddenly thought it was a good long term investment.

This has practical application because I recently inherited about $90k and it's sitting in a Schwab money market account. It feels really strange to sell when it's earning 5%, and buy into bonds. If I am following good long-term investment strategy, should I still favor the bond fund? Is it an opportunity to buy low?

Ha, that depends on what interest rates do! If we get continued rate hikes, then It would be best to keep it in VMFXX, then buy into VBTLX at the price bottom (yield top). But the trick is being able to predict interest rates. At this point in time, I don't think it will matter too much which you pick.

Poster nisiprius at bogleheads has a lot of good posts about bonds, and there was a recent thread that touches on your concerns here. I think it is relevant and has a good take home message:
https://www.bogleheads.org/forum/viewtopic.php?p=7397002#p7397002

[ClimateMind]

Thanks I will check out that thread!

I suppose for diversification I could make a case for keeping a portion in the money market, with the added benefit that it's liquid.