Fed Interest Raise Increases and Bond Risk

[Richie]

Greetings,

I keep hearing people say (not here, elsewhere) that the bond market may not be so good in the foreseeable future, due to the fact that the fed is raising interest rates.  I am still a newbie when it comes to these things.  Does this mean that bonds may not be as safe as conventional wisdom states to drop an emergency fund into?

[SwordGuy]

I've been learning about bonds the last few months.  I make no pretense to be an expert.

But I think if I end up using bonds, I think it will be as a bond ladder.  I wouldn't intend to sell a bond early to raise money, I would just wait until the next one matured and returned my funds.  That way, I would never be at the risk of the bonds selling at a big discount because the interest rate went up.

One thing I have yet to figure out is how much work and how much time that would take to set up and maintain.

[VoteCthulu]

For short term money, medium to long term bond funds are not the safest invesment, since rate changes are likely to reduce the immediate value.

Short term Bond funds are ok, but you can currently get more return from a high interest savings account.

For long term money, bond funds are still fine, because the short term hit when rates go up will eventually turn into higher annual bond yields. Rebalancing according to your asset allocation will help capture this future growth as current prices decline.

Individual bonds are a whole different ball of wax, that you really need to educate yourself thoroughly on before buying.

[Heckler]

http://canadiancouchpotato.com/2015/05/18/how-changing-interest-rates-affect-fixed-income/

I trust this guy.

I've seen the evidence.  My bond funds (short and mid/long) both say they've lost 3-4% since owning them.  I bought $21k VSB three years ago.  Its hovered +\- $200 from $21k. However, when I also add in the cash dividends it pays, that Ive been reinvesting elsewhere, my short bonds are naking a bit of dough.  The key is to hold them well past thier duration.  Thats when the interest starts overtaking the capital losses. 

Yes, I can see why accumulators may not see bonds as great, but wait till the next three year bear.

[MustacheAndaHalf]

You might take a look in Google Finance at "EDV" (extended duration bonds) and "BND" (total bond market).  You can see how in the past month longer-term bonds bounced around more, and wound up further in the negative.

While interest rates are rising, it's better to be in shorter term bonds.  Each increase in yields / rates translates to a drop in the value of bond funds.  If yesterday you held bonds paying 2%, and today new bonds pay 2.25%... those old bonds don't look so good, and they lose value.  You can look up "duration" to see how dramatic it can be - bond funds like "Vanguard extended duration" may have a 24 year duration (increases multiplied by -24!) compared to "Vanguard Total Bond" with a much lower 6 year duration (increases multiplied by -6).

Note that individual bonds don't really protect you - you're just losing opportunity cost instead of seeing real dollars disappear.  When rates rise, the bond you hold goes down in market value.  Bond funds will pickup higher yielding bonds over time, while an individual bond holder will keep their lower yielding bond.

I disagree with the analysis that says take more credit risk with bonds.  The problem is that stocks should be driving portfolio growth, not bonds.  Bonds should be for stability.  Increasing credit risk makes bonds move more like stocks - just take a look at junk bonds during the 2008 crisis versus government bonds.  If bonds drop sharply at the same time stocks drop sharply, those bonds aren't very useful for diversifying a portfolio.  That's why higher quality bonds are a good idea - they show less correlation with stocks, and can balance your portfolio better when stock corrections occur.

[Radagast]

Greetings,

I keep hearing people say (not here, elsewhere) that the bond market may not be so good in the foreseeable future, due to the fact that the fed is raising interest rates.  I am still a newbie when it comes to these things.  Does this mean that bonds may not be as safe as conventional wisdom states to drop an emergency fund into?

-Nope. 3% is a big annual price movement for most bond funds, but a big day for stocks. Bonds are still many times safer than stocks in the short run.
-It shows that bond returns are not correlated with stocks, which is a good sign
-If bond prices fall it means they now have a higher expected return than they did before, shouldn't that be a buying sign?
-The best guess of every bond investor on the planet is the current price, otherwise the price would be different. Are you smarter than every bond investor on the planet?
-When the Fed raised rates this week, rates dropped sharply. The exact opposite of what everyone said. This is because of the point above that the best guess of everyone for every bond is the current price, and the Fed did not indicate rates rising as fast as people had expected. This is convenient, it means that the current market price is a free consultation with all the bond experts on the planet. If you polled all the governments, institutions, hedge funds, and everyone with skin in the game about what they thought the correct price for bonds should be, the average answer would be exactly the current price. So the only thing you need to decide is what amount of bonds you want relative to everything else.

One thing I have yet to figure out is how much work and how much time that would take to set up and maintain.

I began the process once though I didn't hit buy at the end. I think it would take one minute per year per length of ladder. Pretty easy.