Author Topic: BOND TIMING. School me.  (Read 9262 times)

Merdox

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BOND TIMING. School me.
« on: June 30, 2017, 06:24:13 AM »
Upfront question: is now a good time to buy bonds?

I know that timing the market/interest rates is unwise, so let's get that out of the way. I'm seeing some conflicting opinions out there on the state of bonds right now and the actual vs. perceived effect of the Fed's manipulation of interest rates, etc. What does everyone think? Assuming I'm stupid enough to try to time it out, is now a good or bad time for bonds?

Btw I'm looking at VBTLX and VTABX, so please feel free to advise on those specifically.
« Last Edit: June 30, 2017, 06:31:20 AM by Merdox »

Heroes821

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Re: BOND TIMING. School me.
« Reply #1 on: June 30, 2017, 06:39:56 AM »
So many posts lately about market timing... I know MMM just posted a recession post, but lets all remember

Be a Stoic

What does your IPS say? https://www.bogleheads.org/wiki/Investment_policy_statement

Are you planning to retire in 20 years and need to be aggressive? Are you retiring in 3 years and need a better balance?

Radagast

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Re: BOND TIMING. School me.
« Reply #2 on: June 30, 2017, 07:08:17 AM »
I'd say timing bonds is almost impossible, and even if you succeed the amount of money you would make is small. The only real question is, are bonds useful for your current situation?

Merdox

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Re: BOND TIMING. School me.
« Reply #3 on: June 30, 2017, 08:55:49 AM »
So I'm kinda near FIRE and have some additional cash laying around, which is why I'm starting to think about bonds -- I *could* keep working and probably will, but I'd like to restructure my portfolio so that I *could* stop working in a year or so if I really want to, assuming it makes sense. Even after that I'd look to generate enough income here and there to live off so that I can hopefully leave my stash alone a while longer, but we'll see.

I'll get more specific. Right now I'm 100% equities (like 80% VTSAX and 20% VTIAX). I have some new cash (not yet invested) which might amount to say 12% or so of my overall net worth. I'm looking at VBTLX and VTABX. Considering where interest rates are now, the upcoming recession, and my (potentially) very short retirement target date, what do you smarter finance folks think?

Merdox

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Re: BOND TIMING. School me.
« Reply #4 on: June 30, 2017, 09:27:11 AM »
Straight up: should I buy 10k of VBTLX today to start?

JackieTreehorn

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Re: BOND TIMING. School me.
« Reply #5 on: June 30, 2017, 09:35:58 AM »
Check the technicals.  Use a candlestick chart and check for a Doji.  Also look at the 200 day moving average and make sure it's not in a death cross.  Also see when the next full moon is.  Assuming all looks good, go short on iron condors.

Merdox

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Re: BOND TIMING. School me.
« Reply #6 on: June 30, 2017, 10:12:34 AM »
Straight up: should I buy 10k of VBTLX today to start?

Seriously, though.  How should we know what is the right thing for you to do?

I gave background. Don't worry, I'm not asking you to make my decisions, just gauging opinions. News today after some signals from central banks indicate falling bond prices/rising yields and expectations that that will continue. I'm thinking I'll probably pick some up today.

Any reason I shouldn't go with VBTLX? Seems like bond allocations are more complex than stocks around here.

YoungInvestor

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Re: BOND TIMING. School me.
« Reply #7 on: June 30, 2017, 10:17:53 AM »
I have the same dilemma these days. I think I'm going to go with shorter term bonds or even rate-reset preferred shares. Probably the latter, the more I think about it.

dreadmoose

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Re: BOND TIMING. School me.
« Reply #8 on: June 30, 2017, 10:26:27 AM »

Quote
In the short-term bond market, never leverage unsecured capital adequacy requirements.

If you'd like to grab a ton of opinions and then make a decision off the general knowledge inherent within I can't recommend this site enough:

https://phrasegenerator.com/finance

I get all of my financial advice from it.

#takewithgrainofsalt #asgoodasallotheradviceontiming

spokey doke

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Re: BOND TIMING. School me.
« Reply #9 on: June 30, 2017, 10:32:58 AM »
Head over to bogleheads forum...tons of recent threads on if/when/why to hold bonds/bond funds

https://www.bogleheads.org/forum/viewforum.php?f=10


Merdox

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Re: BOND TIMING. School me.
« Reply #10 on: June 30, 2017, 10:37:34 AM »
Now I'm thinking more about VSBSX to start but to keep my allocation stock-heavy for the time being. Thanks for the replies and the links, which I'll check out now and then probably rework my whole strategy. Much love and appreciation for all the wisdom and guidance.

Merdox

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Re: BOND TIMING. School me.
« Reply #11 on: June 30, 2017, 10:40:17 AM »

Quote
In the short-term bond market, never leverage unsecured capital adequacy requirements.

If you'd like to grab a ton of opinions and then make a decision off the general knowledge inherent within I can't recommend this site enough:

https://phrasegenerator.com/finance

I get all of my financial advice from it.

#takewithgrainofsalt #asgoodasallotheradviceontiming

I'm liquidating all my investments today and reinvesting according to my next 10 clicks on this site. If my kids are homeless next month it's on you.

dreadmoose

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Re: BOND TIMING. School me.
« Reply #12 on: June 30, 2017, 10:42:54 AM »

Quote
In the short-term bond market, never leverage unsecured capital adequacy requirements.

If you'd like to grab a ton of opinions and then make a decision off the general knowledge inherent within I can't recommend this site enough:

https://phrasegenerator.com/finance

I get all of my financial advice from it.

#takewithgrainofsalt #asgoodasallotheradviceontiming

I'm liquidating all my investments today and reinvesting according to my next 10 clicks on this site. If my kids are homeless next month it's on you.

Either way I charge a 2% MER for advice from that site so make the check out to dreadmoose now before you're brok... i mean super rich..

[Back on topic, I am currently not purchasing any bonds but my IPS has me doing it in 3 years no matter what so we'll see if I crack at that point and time some stuff]

MrSpendy

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Re: BOND TIMING. School me.
« Reply #13 on: June 30, 2017, 10:48:47 AM »
My opinion is that the bond market should be "timed" much more so than the equity market. one should weigh the potential risks versus potential rewards from investing in the bond market more so than the equity market. this is because the upward bound of return from an individual bonds (and to a lesser extent the bond market) is much more knowable and that bond market has competitors for your investment dollars (CD's and savings bonds) that are very legitimate alternatives to the Vanguard Total Bond market index.

For example, I don't think it is hopeless market timing or a bad thing to say "the bond index yields 2.3% with duration of 6, I can buy a CD or saving bond with a similar yield and liquidity without credit or duration risk / reward, I'll do that instead". it is market timing in that you will miss out if rates go down and the bond market experiences capital appreciation. your return will vary from the "passive alternative".

if the role of bonds in the portfolio is stability and you can get more stability with the same hold to maturity type of return, why not?

there is a sophisticated retort to this line of reasoning involving bonds' correlation with stocks and the diversification benefits, but I'd counter that CD's / savings bonds correlation of 0 to everything but a collapse of the FDIC / government also works and that historical correlation of bonds / equities (particularly during the last crisis where bonds shot up when equities went down) may not repeat.

in short, I think it's okay to decide when to not take duration or credit risk for the safe part of the portfolio and to weight the risks versus the reward.

 it's not the same as saying "I think this company will outperform the stock market", it's saying making 2% isn't worth it if I can lose 7% if rates increase by 1% or 2.7% isn't worth it to me if I can lose 18% if rates go up by 1% (in the case of the 30 year treasury).

to answer the question about the long term bond fund. I would say that you should buy it if you want to make 3.5% yield + - the return from duration+a little credit risk. if that has a role in your portfolio, then buy it. if not, then don't buy it. I personally think you should have a very good reason for buying bonds with the most risk and reward in terms of duration. You don't appear to have one so I'd advise against it.

Merdox

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Re: BOND TIMING. School me.
« Reply #14 on: June 30, 2017, 10:55:53 AM »
My opinion is that the bond market should be "timed" much more so than the equity market. one should weigh the potential risks versus potential rewards from investing in the bond market more so than the equity market. this is because the upward bound of return from an individual bonds (and to a lesser extent the bond market) is much more knowable and that bond market has competitors for your investment dollars (CD's and savings bonds) that are very legitimate alternatives to the Vanguard Total Bond market index.

For example, I don't think it is hopeless market timing or a bad thing to say "the bond index yields 2.3% with duration of 6, I can buy a CD or saving bond with a similar yield and liquidity without credit or duration risk / reward, I'll do that instead". it is market timing in that you will miss out if rates go down and the bond market experiences capital appreciation. your return will vary from the "passive alternative".

if the role of bonds in the portfolio is stability and you can get more stability with the same hold to maturity type of return, why not?

there is a sophisticated retort to this line of reasoning involving bonds' correlation with stocks and the diversification benefits, but I'd counter that CD's / savings bonds correlation of 0 to everything but a collapse of the FDIC / government also works and that historical correlation of bonds / equities (particularly during the last crisis where bonds shot up when equities went down) may not repeat.

in short, I think it's okay to decide when to not take duration or credit risk for the safe part of the portfolio and to weight the risks versus the reward.

 it's not the same as saying "I think this company will outperform the stock market", it's saying making 2% isn't worth it if I can lose 7% if rates increase by 1% or 2.7% isn't worth it to me if I can lose 18% if rates go up by 1% (in the case of the 30 year treasury).

to answer the question about the long term bond fund. I would say that you should buy it if you want to make 3.5% yield + - the return from duration+a little credit risk. if that has a role in your portfolio, then buy it. if not, then don't buy it. I personally think you should have a very good reason for buying bonds with the most risk and reward in terms of duration. You don't appear to have one so I'd advise against it.

Very, very helpful. Exactly the kind of guidance I'm looking for. Thank you.

FrugalFisherman10

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Re: BOND TIMING. School me.
« Reply #15 on: June 30, 2017, 11:20:33 AM »
Yeah, mrspendy that was good. Thanks for laying that out

MrSpendy

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Re: BOND TIMING. School me.
« Reply #16 on: June 30, 2017, 12:18:04 PM »
just to clarify re "liquidity"
https://www.gsbank.com/savings-products/high-yield-cds.html

the goldman sachs 5 yr CD yields 2.25% and is FDIC insured. if you withdraw early you pay 270 days interest which is equivalent to 1.6875%. So the most you can lose on this CD (barring collapse of Goldman Sachs AND FDIC), is 1.6875%.

Goldman CD
Risk: 1.7%
Reward: 2.25%

Bond Market (vanguard total bond market)
Risk: 6% for every 1% change in rates
Reward: 2.3% + potential for gain if rates drop

Choosing the vanguard fund is basically saying "I want to make more money if rates drop AND/OR I need the absolute flexibility of being able to re-balance / withdraw without penalty / fees and that is worth the additional risk incurred". You may also choose the bond fund if you have millions of dollars to allocate to bonds and finding a few FDIC institutions is too cumbersome".

the CD basically has a huge put option on the bond market. if rates did something crazy like in 1994 when they went up 300 bps, the bond market would lose a good bit 12-14% (not the full 18% because duration decreases as rates increase and you earn the coupon). but the CD's would hold steady. choosing the CD decreases risk and return (from rate changes) but I think that's fine for the bond portion of the portfolio.

there are some issues with going CD's (or I-bonds) versus bond market so it's not an absolute no brainer, but it is a form of "market timing" that I don't think is wrong.




Cwadda

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Re: BOND TIMING. School me.
« Reply #17 on: June 30, 2017, 12:21:48 PM »

Merdox

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Re: BOND TIMING. School me.
« Reply #18 on: June 30, 2017, 12:35:01 PM »
just to clarify re "liquidity"
https://www.gsbank.com/savings-products/high-yield-cds.html

the goldman sachs 5 yr CD yields 2.25% and is FDIC insured. if you withdraw early you pay 270 days interest which is equivalent to 1.6875%. So the most you can lose on this CD (barring collapse of Goldman Sachs AND FDIC), is 1.6875%.

Goldman CD
Risk: 1.7%
Reward: 2.25%

Bond Market (vanguard total bond market)
Risk: 6% for every 1% change in rates
Reward: 2.3% + potential for gain if rates drop

Choosing the vanguard fund is basically saying "I want to make more money if rates drop AND/OR I need the absolute flexibility of being able to re-balance / withdraw without penalty / fees and that is worth the additional risk incurred". You may also choose the bond fund if you have millions of dollars to allocate to bonds and finding a few FDIC institutions is too cumbersome".

the CD basically has a huge put option on the bond market. if rates did something crazy like in 1994 when they went up 300 bps, the bond market would lose a good bit 12-14% (not the full 18% because duration decreases as rates increase and you earn the coupon). but the CD's would hold steady. choosing the CD decreases risk and return (from rate changes) but I think that's fine for the bond portion of the portfolio.

there are some issues with going CD's (or I-bonds) versus bond market so it's not an absolute no brainer, but it is a form of "market timing" that I don't think is wrong.

Opened up a whole new area for me to explore. Thank you again and please keep it coming if you want, MrSpendy.

mxt0133

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Re: BOND TIMING. School me.
« Reply #19 on: June 30, 2017, 02:02:36 PM »
Upfront question: is now a good time to buy bonds?

For a single bond if you buy them at face value. In an environment with raising interest rates your bond market price will go down, by how much depends on the duration of those bonds, however if you hold them to maturity you will get back your initial investment plus any interest it paid.  The only thing you would be loosing out on is the opportunity cost of being able to invest in a bond with a higher yield or coupon payments.

Bond funds are a bit different at they don't mature because any bonds that do mature are replaced by new issue bonds so the price of a share will fluctuate if interest rates go up or down. 

If we however everyone thinks that stocks are going to go down or a recession is coming then government and investment grade bonds do well as there is a flight to quality, out of stocks into 'safe' bonds.  So if you think we will be in a recession in the next quarter or two getting into bonds now would be the right move.


Now if your real question is do bonds have a place in your portfolio that is a whole different question.  You are near FIRE and are in 100% equities.  How would you feel if at the point you do RE the market drops 10-20%?  If you can handle that kind of volatility then you don't need bonds.  Putting bonds in your portfolio will help reduce volatility so if you can only stomach 5-15% swings then adding bonds can help you stay within that range.

I am about 75% of my barista FI number and do not intended to ever stop working for money, even if I have to sweep floor or lift boxes.  So technically I don't need bonds if I want to maximize my returns.  But I don't like the volatility of 100% equities and like to use bonds as a ballast which I can use to re-balance if my equities tank.  It makes me feel good to buy low, however small the amount might be and I get my market-timing fix.

My VBTLX holdings are down year-to-date.  Since my equities have been doing well my asset allocation has drifted almost 5% so I need to re-balance and get my bond allocation back up to my target, so I get to buy bonds low and sell equities high which scratches my market timing itch.

Radagast

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Re: BOND TIMING. School me.
« Reply #20 on: June 30, 2017, 02:04:15 PM »
Yes, at your stage you should have bonds. When you are halfway/within 5 years of FIRE start gliding towards 10-25% bonds to minimize sequence of returns risk (up to 40% if you are scared of stocks or planning a reverse glide path). Move your cash to bonds ASAP, because cash is even less useful, unless you need it tomorrow.

VBTLX is fine. If you want to go yield chasing for CD's that is fine too. Don't over think it, because the rewards for successfully timing the bond market are very tiny.

VSBSX has a yield of 1.28%. Say inflation is 2%. You lost money. Good job. What where you trying to do again?

Rates rise, VSBSX loses 2% and pays back 2%, VBTLX loses 7% and pays back 3%. In 2.5 years VBLTX will come out ahead. In fact it will come out ahead after 3 years about 95% of the time (I made that up, not looked it up).

Say VBLTX lost 5% more than VSBSX did because of a 1% increase in yield, and bonds were 20% of your portfolio. Well, you suffered a huge 1% loss over the course of a year because of your choice of bond funds. Big whoop, your stock funds lost more than that several times this week. That is why timing the bond market is virtually pointless, and differences between bond funds are mostly not important. I see no reason to use VSBSX when the most likely result is having less money.

It is easy to get into the weeds thinking about bonds with virtually no meaningful difference in outcome.
"I use intermediate term bond index because I don't like the convexity of MBS" OK
"I only use 3-7 year treasury bonds because academic research shows term and credit risk don't pay" Fine (what is inflation?)
"I listen to Jack Bogle and add corporate bonds, because total bond doesn't have enough" whatever
"I use a barbell of short and long term treasury bonds" carry on
"I have 12 CD's from 7 online credit unions because that has given me an extra .5% return (we're talking about 10 bps per year on my portfolio people!!!) without the interest rate risk compared to bonds, plus the early withdrawal penalty is less than interest rate risk 12% of the time!" Ummm alright
"I divide my bond allocation among total bond, long duration zero coupon treasury bonds, high yield tax exempt bonds, series I savings bonds, hedged international bonds, TIPS, plus some CD's at various banks" Ok, wow

None of the above really matter on 10-20% of the total. If you start getting into long term bonds it can matter a little.

Radagast

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Re: BOND TIMING. School me.
« Reply #21 on: June 30, 2017, 02:16:34 PM »
if rates did something crazy like in 1994 when they went up 300 bps, the bond market would lose a good bit 12-14% (not the full 18% because duration decreases as rates increase and you earn the coupon). but the CD's would hold steady.
Technically speaking, the CD's would lose almost the same amount. You just wouldn't notice because you wouldn't do the math, unlike the bond fund which does the math for you every single day. You are correct that CD's often have higher rates which would add up (by a very tiny amount) over time, if you are OK with going out and looking for them.

MrSpendy

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Re: BOND TIMING. School me.
« Reply #22 on: June 30, 2017, 02:25:13 PM »
i'm confused by this. Why would your CD's go down? their redemption value is the same regardless of rates. I you withdraw early you pay the penalty (1.7%) but your downside is floored.

I think you are saying that the present value of the future payments of the CD is lower because of the discount rate going up. But that doesn't matter because you just redeem early and you get par minus the early redemption penalty. you hold the put option.
« Last Edit: June 30, 2017, 02:27:58 PM by mrspendy »

Radagast

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Re: BOND TIMING. School me.
« Reply #23 on: June 30, 2017, 02:32:04 PM »
i'm confused by this. Why would your CD's go down? their redemption value is the same regardless of rates. I you withdraw early you pay the penalty (1.7%) but your downside is floored.
The CD would lose value because you could now get a higher return somewhere else. The loss would be exactly the same as it would be on a bond with the same rate, you just wouldn't notice unless you did the math.

The question would then be, "To take advantage of the now-higher rates, which is worse, the early withdrawal penalty of the CD or the loss of value on the bond?"

MrSpendy

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Re: BOND TIMING. School me.
« Reply #24 on: June 30, 2017, 02:40:04 PM »
to use an example, let's compare a 5 yr Goldman Sachs CD (2.25%) to a 5 yr zero coupon treasury (1.78%)

the 5 yr CD pays 2.25%, you give GS $100, they pay you 2.25% and par at the end of the term. with the zero coupon treasury, you pay $91.5 and get $100 in 5 years.

Let's say rates go up 300 bps tomorrow (not likely). Your 5 year zero coupon treasury is worth $79.1 (using an internet PV calculator). Your CD can be redeemed for $100 - $1.7 = $98.3. the treasury loses 14% the CD loses 2% which illustrates the value of the early redemption ability.

If you wanted to cash out and invest at the new high rate, you could. the CD holder "exercises the put option" by redeeming early and then invests in the zero coupon bond (or a new CD at a higher rate).

Conversely if rates decline by 100 bps immediately the 5 yr treasury is now worth $96.1 and appreciates, whereas your CD doesn't (though I have seen CD's at premiums on fidelity so theoretically maybe you can sell them to capture that a little, but i think that's for brokered CD's without the early redemption ability).

you can also see this in the case of EE savings bonds versus a 20 yr zero coupon treasury. With savings bonds and CD's with redemption value, you can get back your principal (less any penalties) whereas with bonds your market value is subject to duration risk. you do not lose the ability to then reinvest at higher rates, but you didn't lose (much) money on the way to those higher rates.
« Last Edit: June 30, 2017, 03:05:20 PM by mrspendy »

Radagast

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Re: BOND TIMING. School me.
« Reply #25 on: June 30, 2017, 02:49:53 PM »
Yup that would be a win for the CD which would lose about 12% of its value (I didn't do the math) but could be redeemed for a loss of less than 2%.

MrSpendy

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Re: BOND TIMING. School me.
« Reply #26 on: June 30, 2017, 02:51:04 PM »

The question would then be, "To take advantage of the now-higher rates, which is worse, the early withdrawal penalty of the CD or the loss of value on the bond?"

at the bond market's duration of 6, 33 bps will cause your bonds to go down by 2% (note: everything here is rough math because duration is dynamic), which is more than your early redemption penalty.

so after 33 bps is when the put option embedded in non mark to market CD's i-bonds/ee bonds high yield savings accounts etc. has value.

MrSpendy

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Re: BOND TIMING. School me.
« Reply #27 on: June 30, 2017, 02:51:34 PM »
Yup that would be a win for the CD which would lose about 12% of its value (I didn't do the math) but could be redeemed for a loss of less than 2%.

posted too quickly. looks like we are on the same page.

Merdox

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Re: BOND TIMING. School me.
« Reply #28 on: June 30, 2017, 03:13:45 PM »
Yes, at your stage you should have bonds. When you are halfway/within 5 years of FIRE start gliding towards 10-25% bonds to minimize sequence of returns risk (up to 40% if you are scared of stocks or planning a reverse glide path). Move your cash to bonds ASAP, because cash is even less useful, unless you need it tomorrow.

VBTLX is fine. If you want to go yield chasing for CD's that is fine too. Don't over think it, because the rewards for successfully timing the bond market are very tiny.

VSBSX has a yield of 1.28%. Say inflation is 2%. You lost money. Good job. What where you trying to do again?

Rates rise, VSBSX loses 2% and pays back 2%, VBTLX loses 7% and pays back 3%. In 2.5 years VBLTX will come out ahead. In fact it will come out ahead after 3 years about 95% of the time (I made that up, not looked it up).

Say VBLTX lost 5% more than VSBSX did because of a 1% increase in yield, and bonds were 20% of your portfolio. Well, you suffered a huge 1% loss over the course of a year because of your choice of bond funds. Big whoop, your stock funds lost more than that several times this week. That is why timing the bond market is virtually pointless, and differences between bond funds are mostly not important. I see no reason to use VSBSX when the most likely result is having less money.

It is easy to get into the weeds thinking about bonds with virtually no meaningful difference in outcome.
"I use intermediate term bond index because I don't like the convexity of MBS" OK
"I only use 3-7 year treasury bonds because academic research shows term and credit risk don't pay" Fine (what is inflation?)
"I listen to Jack Bogle and add corporate bonds, because total bond doesn't have enough" whatever
"I use a barbell of short and long term treasury bonds" carry on
"I have 12 CD's from 7 online credit unions because that has given me an extra .5% return (we're talking about 10 bps per year on my portfolio people!!!) without the interest rate risk compared to bonds, plus the early withdrawal penalty is less than interest rate risk 12% of the time!" Ummm alright
"I divide my bond allocation among total bond, long duration zero coupon treasury bonds, high yield tax exempt bonds, series I savings bonds, hedged international bonds, TIPS, plus some CD's at various banks" Ok, wow

None of the above really matter on 10-20% of the total. If you start getting into long term bonds it can matter a little.

So helpful. Really. Thank you.

MrSpendy

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Re: BOND TIMING. School me.
« Reply #29 on: June 30, 2017, 03:21:05 PM »
Yes, at your stage you should have bonds. When you are halfway/within 5 years of FIRE start gliding towards 10-25% bonds to minimize sequence of returns risk (up to 40% if you are scared of stocks or planning a reverse glide path). Move your cash to bonds ASAP, because cash is even less useful, unless you need it tomorrow.

VBTLX is fine. If you want to go yield chasing for CD's that is fine too. Don't over think it, because the rewards for successfully timing the bond market are very tiny.

VSBSX has a yield of 1.28%. Say inflation is 2%. You lost money. Good job. What where you trying to do again?

Rates rise, VSBSX loses 2% and pays back 2%, VBTLX loses 7% and pays back 3%. In 2.5 years VBLTX will come out ahead. In fact it will come out ahead after 3 years about 95% of the time (I made that up, not looked it up).

Say VBLTX lost 5% more than VSBSX did because of a 1% increase in yield, and bonds were 20% of your portfolio. Well, you suffered a huge 1% loss over the course of a year because of your choice of bond funds. Big whoop, your stock funds lost more than that several times this week. That is why timing the bond market is virtually pointless, and differences between bond funds are mostly not important. I see no reason to use VSBSX when the most likely result is having less money.

It is easy to get into the weeds thinking about bonds with virtually no meaningful difference in outcome.
"I use intermediate term bond index because I don't like the convexity of MBS" OK
"I only use 3-7 year treasury bonds because academic research shows term and credit risk don't pay" Fine (what is inflation?)
"I listen to Jack Bogle and add corporate bonds, because total bond doesn't have enough" whatever
"I use a barbell of short and long term treasury bonds" carry on
"I have 12 CD's from 7 online credit unions because that has given me an extra .5% return (we're talking about 10 bps per year on my portfolio people!!!) without the interest rate risk compared to bonds, plus the early withdrawal penalty is less than interest rate risk 12% of the time!" Ummm alright
"I divide my bond allocation among total bond, long duration zero coupon treasury bonds, high yield tax exempt bonds, series I savings bonds, hedged international bonds, TIPS, plus some CD's at various banks" Ok, wow

None of the above really matter on 10-20% of the total. If you start getting into long term bonds it can matter a little.

Not to completely go down a rabbit hole here, but I respectfully disagree. The duration and credit spread gods should be respected and there are real differences in risk reward between different types of bonds. If you went into the crisis long a bunch of 30 yr zero's you killed it; if you went in with anything with some credit risk, not so much.

I'd agree that nothing matter in small rate moves and in 95% of environments though.

To be one of those people, I personally barbell i-savings bonds and long term treasuries :). The i-bonds are my emergency fund (they are liquid after 1 year, penalty in years 1-5) and low volatility store of value with no market risk. The long term treasuries are for depression/deflation/japan scenario (just 2% of net worth but will rise over time).

to me the biggest risk in traditional stock/bond portfolio is if rates rise while stocks go down  and inflation picks up (basically 1970's).

That risk is mitigated if you can find things that don't have market risk (CD's, i-bonds, savings accounts), that keep up with inflation (i-bonds), and yield as much (or almost as much) as the bond market to mitigate opportunity cost.





« Last Edit: June 30, 2017, 03:28:40 PM by mrspendy »

Merdox

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Re: BOND TIMING. School me.
« Reply #30 on: June 30, 2017, 03:34:46 PM »
I'm a broken record with the gratitude but all of this is really helpful. Keep it coming.

Radagast

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Re: BOND TIMING. School me.
« Reply #31 on: June 30, 2017, 03:52:13 PM »
To be one of those people, I personally barbell i-savings bonds and long term treasuries :). The i-bonds are my emergency fund (they are liquid after 1 year, penalty in years 1-5) and low volatility store of value with no market risk. The long term treasuries are for depression/deflation/japan scenario (just 2% of net worth but will rise over time).
We may actually be on exactly the same page.

Indexer

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Re: BOND TIMING. School me.
« Reply #32 on: July 02, 2017, 08:28:17 AM »
Who cares what bonds are paying, whether interest rates will rise, and what CD rates are?

If you care about any of those things then you are ignoring the reason to buy bonds.

Do you own stocks and can you and your goals handle a 55% drop in value?

If the answer is no, then you need bonds. You don't buy bonds because you want that 2% yield. You buy them because they go up when stocks go down, and on average they grow faster than cash.

A 75% stock 25% bond portfolio has higher average annual returns AND less historic downside than a 75% stock 25% cash portfolio.

MrSpendy

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Re: BOND TIMING. School me.
« Reply #33 on: July 02, 2017, 10:50:14 AM »
Quote
Who cares what bonds are paying, whether interest rates will rise, and what CD rates are?

in the absence of a major shift in inflation, sharp interest rate rises etc. no one will have to care. If those do happen, you'd be better off owning I-bonds, CD's, stable value, etc. If deflation, sharp rate decreases occur, you'd be better off going long term govvies

Quote
If you care about any of those things then you are ignoring the reason to buy bonds.

disagree. you clearly care about rate moves. see below.

Quote
You don't buy bonds because you want that 2% yield. You buy them because they go up when stocks go down, and on average they grow faster than cash.

"go up when stocks go down" means "yields decrease when stocks go down"; therefore you are making a bet that rates will decline when stocks fall. you are assuming negative correlation of stocks and bonds.

Quote
A 75% stock 25% bond portfolio has higher average annual returns AND less historic downside than a 75% stock 25% cash portfolio.

Agreed, because generally cash (3 month T-bills) return less than the bond market and because historically the negative correlation between stocks and bonds that you assume will happen has happened.

But it may not happen in the future. That's my point. The returns of bonds in the vast majority of scenarios will be pretty damn close to their initial yield. there are extreme scenarios where bonds way way way outperform cash/the alternatives I'm talking about ( significant deflation being the most severe) and there are scenarios where the alternative will outperform (inflation, sharp rate rises, etc.). in the middle, it's all likely debating over a few basis points. Unless you are deploying many millions, then it's not the choice between 75% stocks / 25% bonds and 75% stocks / 25% cash, it's a choice between 75% stocks / 25% bonds and 75% stocks / 25% reasonable bond alternatives.

For me guaranteed zero correlation > assumed negative correlation. But only time will tell.





Mighty-Dollar

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Re: BOND TIMING. School me.
« Reply #34 on: July 02, 2017, 03:08:02 PM »
I know that timing the market/interest rates is unwise
You said it.
"Nobody but nobody, has consistently guessed the direction of the bond or stock market over any meaningful length of time." - John Markese, President, American Association of Individual Investors Journal
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves" -- Peter Lynch, former manager of best performing mutual fund in the world, Fidelity Magellan Fund
"By trying to time the market, you are essentially gambling with your financial future at very poor odds" -- Baltimore Sun
"You've gotta be right at least twice. The odds are just terrible." -- John Bogle, founder and retired CEO of The Vanguard Group
"If you want to suppress volatility itís likely youíll suppress your returns as well, itís just that simple" -- The Irrelevant Investor

Indexer

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Re: BOND TIMING. School me.
« Reply #35 on: July 02, 2017, 09:09:30 PM »
Quote
You don't buy bonds because you want that 2% yield. You buy them because they go up when stocks go down, and on average they grow faster than cash.

"go up when stocks go down" means "yields decrease when stocks go down"; therefore you are making a bet that rates will decline when stocks fall. you are assuming negative correlation of stocks and bonds.

Quote
A 75% stock 25% bond portfolio has higher average annual returns AND less historic downside than a 75% stock 25% cash portfolio.

Agreed, because generally cash (3 month T-bills) return less than the bond market and because historically the negative correlation between stocks and bonds that you assume will happen has happened.

Yes, historically bonds prices go up when stocks crash. There is a negative correlation and I assume it will continue to exist. Let's go back a step and ask "why" that negative correlation exists in the first place.

Stock and bond prices aren't negatively correlated during periods of high volatility because of chance, or magic, or because someone says so. They are negatively correlated because they compete for attention.

Go back to 2008. Hundreds of billions of dollars are being pulled from the stock market. Where does that money go? People aren't withdrawing the money to put under their mattress. In a big crash we experience a 'flight to quality' which could just as easily be named a 'flight to the safest bonds.' When people pull their money out of the stock market out of fear that money tends to go to one of three places.
1. money markets(backed by short term high quality commercial paper & t-bills[gov bonds]).
2. treasuries(gov bonds)
3. bank accounts. Well in a recession, especially like an '08 credit crisis, banks aren't going to lend to just anyone. They have hundreds of billions of dollars in new deposits, at the same time they aren't lending out more money. Are they going to pay you interest and then earn nothing themselves? Of course not. They are going to keep that money with the Fed(who buys gov bonds) or parked in safe quality investments... gov bonds.

YES, I believe that when stocks crash (safe)bonds go up. This is true whether bonds are yielding 10%, 5%, 2%, 0.01%, or even negative -1%. When the UK voted to leave the EU European stocks went down, and German bonds which already had negative yields saw their values increase(yields went down even more). Even with negative bond yields the negative correlation to stocks remained. When people are scared they will GLADLY pay for safety.

There are many paths the money can take, but in a crash money moves from risky investments(stocks) to the safest
 investments (gov bonds). As long as that is true and as long as bonds earn more than cash then a stock & bond portfolio is more efficient than a stock & cash portfolio.

@mrspendy, as long as flight to quality exists I believe that bonds will rise in value when stocks crash. Do you see any reason flight to quality would cease to exist?



*Now, one scenario where both stocks and bonds do poorly, unexpected high inflation. If yields have to rise quickly to combat inflation that is bad for bonds, and if bonds start yielding 6% that is going to make them pretty attractive compared to stocks at high valuations which could put a damper on stock returns. I recognize this. However, it isn't a crash. Neither investment class is losing 50% of it's value because inflation came in higher than expected. Yes, holding money in cash to then deploy into bonds/stocks would yield better returns than holding stocks/bonds in the short term, but that's market timing which is very unreliable. Long term, even with higher inflation, the stock/bond portfolio would be better since the bonds will adjust to the higher yields giving you higher long term returns and stocks tend to be the best long term hedge against inflation. On that note, inflation has been historically low the past few years, and central banks are having a harder time fighting off deflation than inflation.
« Last Edit: July 03, 2017, 04:46:50 AM by Indexer »

MrSpendy

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Re: BOND TIMING. School me.
« Reply #36 on: July 03, 2017, 06:34:35 AM »
I do not have any reason to believe that the correlation that has existed will not continue to exist. As you point out there are macro scenarios where the correlation won't exist and there are scenarios where it will.

 There is simply a level of interest rates where I'm not willing to participate in the bond market's risk and I think that i-bonds, CD's etc. (and a small slug of long term treasuries, where you do get more juice from rate decreases, deflation etc.) are better risk/reward and better for my (and my parents') portfolio. Better reward in that those generally yield more than duration matched govvies, and better risk in that those can't lose market value.

Recognizing that bonds have indeed gone to negative yields around the globe, ultimately, I believe rates are zero bound and therefore the upside for participating in duration risk is relatively limited. Credit spreads are generally tight as well and I have no real interest in picking up yield that way (generally CD's yield more than tsy's so if the index yields more than CD's, assuming constant duration, it's because of credit risk)

As noted above, if a five year zero coupon treasury is at $91.5, I'm more than willing to forego the upside of it going to $100 if five year rates go to 0%; a CD with a higher yield and limited mark to market risk, or a i-bond that yields inflation and can not lose any value (even in deflation, which is better than a TIP), is simply preferable to me. If institutions could invest in those, they would.

It's a way to take advantage of only having a few hundred K or a few million to invest. It's our way of saying "hey i'm not a french bank or japanese insurance company and no one is forcing me to buy this shitty piece of paper".

As a thought experiment, if the bond market went to 0% yield or slightly negative tomorrow (like it is in Japan or Switzerland), would you stay invested in the bond market? I wouldn't. I'm willing to risk underperforming the bond market in the event of rate decreases in exchange for a  more certain return and for sidestepping duration and credit risk. 

I think I've belabored that and we've properly discussed for the OP the reasons for holding bonds and for not holding bonds (and instead holding i-bonds, CD's, stable value, etc.

Also since the things i'm talking about are limited capacity (i-bonds = $10K / year / SS#, CD's = $250K / person / institution), many will end up holding both.

MrSpendy

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Re: BOND TIMING. School me.
« Reply #37 on: July 03, 2017, 06:52:30 AM »
 
Quote
Yes, holding money in cash to then deploy into bonds/stocks would yield better returns than holding stocks/bonds in the short term, but that's market timing which is very unreliable.

Just to be clear, I'm not advocating for cash. Cash doesn't yield 2.25% (like 5 yr Goldman Sachs CD's do) or 0% real / inflation (like i-bonds do) or 1.8% like my fully liquid TIAA stable value in my 403(b) does.

In my opinion, investing in things that yield almost as much if not more than bonds while taking less risk is not a form of "market timing" that is hazardous to wealth.

Just as an example  my $10K of i-bonds purchased in may 2012 are worth $10,764. They've returned 1.48% annualized, tax deferred, since inflation has been muted. The bond index has returned 2.03% in the past 5 years. If I'd invested in the vanguard bond index, I'd have $11,030.00 (before tax).

About 2.5% cumulative underperformance over the five years for the i-bonds. If this persisted for 50 years (2% vs 1.5%), it'd be about 22% cumulative underperformance for the i-bonds, so that's a risk of my preferred bond strategy. But underperforming on my 7% position in I-bonds certainly won't kill me. Being 28 and ~80% equities influences my thoughts on the matter so that should be known for context.

the i-bonds are guaranteed by full faith and credit, have no duration (you can redeem either in year 1.01 or at year 30), etc. They are by all measures a far lower risk instrument and they have underperformed the bond index. the lower risk makes the i-bonds a bit more flexible, you can use i-bonds as an emergency fund, whereas i wouldn't do that with the bond index, for example.

that's the underperformance i'm willing to have but others may not

http://performance.morningstar.com/fund/performance-return.action?t=VBMFX
« Last Edit: July 03, 2017, 08:08:28 AM by mrspendy »

Radagast

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Re: BOND TIMING. School me.
« Reply #38 on: July 03, 2017, 08:48:27 AM »
This is what I was saying. We are arguing over 0.1%, and the most likely result is that after 10 years it won't matter very much. CD's are probably the best choice if you don't mind looking around for rates and dealing with several institutions, because they have higher rates and essentially no risk. An i-bond / long term treasury bar bell sounds nice and is what I plan to use as well, but that will most likely not matter much except maybe in extreme circumstances. Total bond market is easy and you will have lots of cheerleaders keeping you on course.

The end result is that the difference between these three will probably be 0.5% at most after a few years, which is 0.1% on 20% of the portfolio. Sure we would all like to have 0.1%. But we can't predict which of the three will give it to us, and what stocks do will have a much bigger impact. You could make more money by taking a part time job at Home Depot than the differences here.

ChpBstrd

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Re: BOND TIMING. School me.
« Reply #39 on: July 03, 2017, 02:40:41 PM »
Here's how to time the bond market:

TLT's current price is 124.50 and if instead of clicking "buy" today you sell a put option with a strike price of 124.00 that expires August 18 (46 days from now). You are paid a premium of $1.90 (current quote) or 1.5% of your set-aside cash in exchange for waiting 46d before you get the shares. Plus, if assigned, you'll pay $0.50 less per share than if you bought today, which should more than cover commissions.

But hey, if you can make over 1% every 46 days, why not just do that instead of sitting in bonds! Sell any shares that get assigned, then rinse and repeat.

Merdox

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Re: BOND TIMING. School me.
« Reply #40 on: July 04, 2017, 08:31:39 AM »
OK, bear with me and forgive my ignorance because I'm going to get very basic. I'm unclear as to how a bond index (let's say VBMFX) performs in relation to a recession timeline. Interest rates rise leading up to a recession and are lowered during, so the best time to buy bonds (assuming you have a crystal ball) is in the lead up to a recession, correct? Does that apply to bond indices as well?

I have a new pile of cash sitting in my checking, which ideally I'd like to use to buy either stocks or maybe a property during the recession. Am I definitely, unambiguously better off dumping it into VBMFX until then? Couldn't it lose value there leading up to the recession?

Guide me, o wise ones.

MrSpendy

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Re: BOND TIMING. School me.
« Reply #41 on: July 04, 2017, 09:11:47 AM »
No one knows the answers to those questions.

To summarize the above.

1. traditional bogleheads would say stick to an asset allocation that involves bonds. bonds have a diversification benefit (by historically zigging when stocks zag) and hence damper portfolio volatility, and  can even increase overall return

2. some (like me) think bonds don't pay you much for the risk so choose to use CD's / i-bonds / HY savings / stable value etc. these return almost as much but won't lose value. BUT they won't go up in value either. historically bonds have increased in value when stocks fall (see indexer's post)

3. in most cases the choice between total bond and those other things won't make a HUGE difference (see radagast's post).

no one here can tell you where the bond market or rates are going. if I could, I would've been a better bond trader when I worked as one (and found it more interesting)!


Quote
Am I definitely, unambiguously better off dumping it into VBMFX until then? Couldn't it lose value there leading up to the recession?

EDIT: I guess the answer to this question is "no" because you are not "definitively, unambiguously" better off. the return from bonds will most likely be higher than cash. but there is risk to the "most likely" you are being paid for taking duration risk (mostly) and a smidge of credit risk (vanguard bond index is 70% govvies, 30% high grade corps, so the credit risk is minimal but non-zero).
« Last Edit: July 04, 2017, 09:16:02 AM by mrspendy »

Radagast

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Padonak

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Re: BOND TIMING. School me.
« Reply #43 on: July 05, 2017, 08:42:43 PM »
Excellent thread!

I am trying to understand the difference between buying bonds vs VBTLX (total bond fund).

How is the value of VBTLX affected by increasing interest rates compared to the value of a single bond let's say. My understanding is if you buy a specific bond at a specific price and interest rates go up, the market price of this bond will decline, so if you sell it before it's paid off, you lose money. If you wait for it to be paid off, there is an opportunity cost of buying the same bond cheaper, but you get paid the same amount given that the issuer doesn't default. How is VBTLX different? How often does the fund actually buy new bonds and sell existing bonds? How does this affect the price?

PizzaSteve

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Re: BOND TIMING. School me.
« Reply #44 on: July 06, 2017, 10:35:06 AM »
I'd say timing bonds is almost impossible, and even if you succeed the amount of money you would make is small. The only real question is, are bonds useful for your current situation?
This is not necessarily true.

Timing bonds is a lot of work, but possible.  Some small lots are inefficiently priced.  Not for beginners though.
« Last Edit: July 06, 2017, 03:23:06 PM by PizzaSteve »

talltexan

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Re: BOND TIMING. School me.
« Reply #45 on: July 06, 2017, 11:42:21 AM »
posting to follow. This thread is amazing!

Of course, Paul Merriman ( http://paulmerriman.com/turn-3000-50-million/ ) doesn't recommend people younger than 40 own any bonds. But he's not writing with FIRE in mind.

Radagast

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Re: BOND TIMING. School me.
« Reply #46 on: July 06, 2017, 10:16:58 PM »
I'd say timing bonds is almost impossible, and even if you succeed the amount of money you would make is small. The only real question is, are bonds useful for your current situation?
This is not necessarily true.

Timing bonds is a lot of work, but possible.  Some small lots are inefficiently priced.  Not for beginners though.
(I read your earlier post that these were muni bonds which you bought in 2009.) I have read on the internet that the secondary high yield municipal bond market can be less than efficient. I can imagine on top of that 2009 was a particularly inefficient time for that area of the market, so I am not surprised you did pretty well. (I'd still rather have used the money on stocks, but that's me.) That said I don't have experience with individual muni bonds and doubt I'll ever have enough money or interest to make it worth while.

However, within the context of the thread, good luck trying to use market timing to come out far ahead using total bond market funds, short term bonds, CD's, or even i-bonds and long term treasuries if you match the market duration. If you start to have 40% bonds or more the then what you choose is probably more important.

Excellent thread!

I am trying to understand the difference between buying bonds vs VBTLX (total bond fund).

How is the value of VBTLX affected by increasing interest rates compared to the value of a single bond let's say. My understanding is if you buy a specific bond at a specific price and interest rates go up, the market price of this bond will decline, so if you sell it before it's paid off, you lose money. If you wait for it to be paid off, there is an opportunity cost of buying the same bond cheaper, but you get paid the same amount given that the issuer doesn't default. How is VBTLX different? How often does the fund actually buy new bonds and sell existing bonds? How does this affect the price?
VBTLX sells and especially buys vast sums of bonds to/from other market participants every day to match the flows of money out and especially in to the fund. It is forced to realize any opprtunity cost immediately, otherwise they would not be able to sell/buy from the other players. Also they must estimate the value of the fund each day so that the fund's investors can place orders. By comparison, if you bought a bond individually you would not realize the opportunity cost unless you tried to sell it.

Indexer

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Re: BOND TIMING. School me.
« Reply #47 on: July 09, 2017, 09:17:38 AM »
Just to be clear, I'm not advocating for cash. Cash doesn't yield 2.25% (like 5 yr Goldman Sachs CD's do) or 0% real / inflation (like i-bonds do) or 1.8% like my fully liquid TIAA stable value in my 403(b) does.
Quote

Okay, we are having a discrepancy with definitions. In the investing world all of the things you mentioned fall under the definition of cash equivalents. When I referenced cash I meant ALL of those.

Just like corporate bonds and treasuries both fit under the broad definition of bonds, savings accounts, money markets, and CDs fall under the broad definition of cash.

Radagast

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Re: BOND TIMING. School me.
« Reply #48 on: July 09, 2017, 09:34:52 PM »
About a year ago I got curious about bonds too and spent a pretty long time reading about them before I realized it didn't matter than much. But, it can matter a little. It you are looking to do a little better than Total Bond Market for a little extra work and similar risk here are a couple ways I found. Probably not coincidentally they touch on points made by MrSpendy and Pizza Steve. All the numbers were current the day of the post.

Here are some benchmark bond funds.
Bond TypeDurationYield15% Tax Yield25% Tax Yield
Total Bond Index (BND)6.142.392.031.79
Treasury Bond Index (GOVT)6.041.721.461.29
Municipal Bond Index (VTEB)5.771.921.921.92

One way to get the same duration and yield as Total Bond is shown below. It's components have essentially no default risk and can be expected to do very well in pretty much any economic environment, so over the long term it should come out ahead of Total Bond by out performing in crises. I-bonds have the benefit of being both inflation adjusted and tax advantaged because you do not pay taxes on the interest, only the ending value of the bond when you redeem it or it matures. I said this was equivalent to a 10% tax, but the number will vary. The tax efficiency is another advantage over Total Bond, but ideally you would want the long term bonds at least to be tax sheltered.
Bond TypeDurationYield15% Tax Yield25% Tax Yield
Long Term Government (VGLT)17.52.732.322.05
5-yr CD Ladder2.52.352.001.76
Series I Saving Bonds01.961.761.76
Equal Weight (1/3's)6.672.352.031.86

Another option is below. Again it is a very close match to Total Bond in yield and duration. These two funds have been equal to or recently better than Total Bond in back testing, but when you account for the tax-freeness of the municipal bond fund it is definitely better, with a similar level of credit risk (the "high yield" tax exempt fund has similar credit risk to an investment grade corporate bond fund). If you put the treasury bonds in a tax sheltered account it will be even better.
Bond TypeDurationYield15% Tax Yield25% Tax Yield
Intermediate Government (VGLT)5.231.811.541.36
High(ish) Yield Municipal (VWAHX)7.42.882.882.88
Equal Weight (50/50)6.322.352.212.12

Neither of these is market timing because they have similar duration to the market, but they might help you get a bit better return. The one with muni bonds has better after tax return, while the one with CD's and treasury bonds is safer. Put all bonds except muni bonds and i-bonds in tax advantaged accounts to get the full benefit. Did I mention before that you probably won't get more than 0.2% out of this in the long run?