Author Topic: Is The Total Bond Market Index Fund Stupid?  (Read 4252 times)

steevven1

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Is The Total Bond Market Index Fund Stupid?
« on: February 26, 2018, 12:15:37 PM »
Hi everyone! I'm a hardcore, long-term indexer. I have no interest in market timing or individual security selection, at all. Buying the total world stock market via VTI and VXUS was a no-brainer for me. With that said, I am having trouble justifying buying the total world bond market via BND and BNDX, even though that's what my gut tells me to do.

BND and BNDX hold some bonds that pay less than 1% interest (particularly short-term, government bonds). Isn't this portion of the portfolio a complete waste for a retail investor like myself who can get 1.5% in a completely liquid, risk-free savings account? To be clear, I'm not suggesting that the savings account will outperform the total market fund. I'm suggesting that the portion of the total bond market fund allocated to short-term government debt would be outperformed by a savings account, so shouldn't I be bothered by owning it? It feels like some portion of my money would be misallocated and utterly wasted in a total bond market index fund due to this.

Am I making some mistake in logic? Is there a reasonable alternative for someone like myself?

Thanks!
« Last Edit: February 26, 2018, 12:18:22 PM by steevven1 »

Will

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #1 on: February 26, 2018, 12:28:58 PM »

chadat23

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #2 on: February 26, 2018, 02:33:13 PM »
So you're saying you want an actively managed bond fund that tries to strategically pick what does and doesn't make sense to include? ;)

While it's not what I'm looking for, I get what you're saying. Maybe some combination of funds could get you want you want?

DreamFIRE

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #3 on: February 26, 2018, 04:27:09 PM »
jlcollins discusses these things here:  http://jlcollinsnh.com/2017/12/20/the-bond-experiment-return-to-vbtlx/

And from the comments of that article, there is a reference to CD's and money markets.  Relevant posts:

Mr Wheat says   :

February 6, 2018 at 11:18 pm

The risk to benefit ratio of VTBLX concerned me in early 2017 due to low interest rates, so after reading great articles on CDs from Harry Sit and Allan Roth I moved 2/3 of my VTBLX into 3% CDs with a low early withdrawal penalty and the other 1/3 into shorter duration VBIRX (kept for rebalancing). Time will tell if it was a good move, but after a year no regrets. If anything I keep wondering why I don’t move my VBIRX into a money market fund.

jlcollinsnh says:

February 7, 2018 at 11:43 am

Sounds like a good approach, if a bit more complicated; especially if you have laddered your CDs.

Here's another recent bond related thread on this forum:
https://forum.mrmoneymustache.com/investor-alley/basic-bond-question/

Mighty-Dollar

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #4 on: February 26, 2018, 04:28:58 PM »
What's wrong with a total bond market index fund to represent your entire bond asset class? You're completely diversified so there's no worry about a single bond like a General Motors bond defaulting. Really it's all about deciding how much risk you want to take with bonds. Middle ground is the way to go. The average duration of a total bond market index fund is about 5.6% or so. That means it's not going to be overly sensitive to interest rate hikes.

jim555

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #5 on: February 26, 2018, 04:32:03 PM »
I don't like bond funds in a rising rate environment.  Lack of a set maturity date and you can't hold your way out of it.  Considering bond yields are breaking a 30 year down trend could bring a lot of pain to bondholders.
CDs or shorter maturity issues with a set date only for me.

DreamFIRE

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #6 on: February 26, 2018, 07:10:22 PM »
See that bond thread I linked to earlier.  There are some bond funds with defined maturity dates that work differently than regular bond funds.

aperture

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #7 on: February 26, 2018, 07:29:07 PM »
Right now bonds have low returns and high relative risk due to rising interest rates.  They make no sense as an investment vehicle, but if equities dip 20%+ in a week or a month, a bond position - even with low returns and rising interest rates may make sense.  Greater minds than mine have investigated this and come up with the idea that someone at my stage of life (approaching retirement) should not be 100% in equities.  I argued this with Jim Collins and we agreed to disagree.

I am not finding any US CDs that deliver 3.0% on my very brief search of the internet.  Best rate I found was 2.65% with a 5-year CD and minimum $25K deposit. 

Radagast

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #8 on: February 26, 2018, 07:32:22 PM »
I doubt any bond in BND is yielding less than 2% right now, because the 1-year treasury bond is yielding 2.03% and BND only targets 1 year and longer bonds.

I can understand avoiding BNDX. It's fine in balanced funds, but I don't see much reason to add it on your own.

BND is fine. You might get a dozen or two basis points chasing other options like CD's or something. Or not, it's not always a slam dunk and BND is more likely to give additional impetus to rebalancing than CD's are. Actually I don't think the end results between BND and most other options will be big enough to justify the recent surge of threads on the topic.

DreamFIRE

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #9 on: February 26, 2018, 08:09:15 PM »
I am not finding any US CDs that deliver 3.0% on my very brief search of the internet.  Best rate I found was 2.65% with a 5-year CD and minimum $25K deposit.
There's a few listed here listed at 5 year 3%, but only one appears to be an actual FDIC CD while the other two are a term deposit / savings certificate.
https://www.depositaccounts.com/cd/5-year-cd-rates.html

steevven1

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #10 on: February 26, 2018, 08:16:11 PM »
Thanks for the replies. Given me a lot to think about.

aperture

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #11 on: February 26, 2018, 08:42:57 PM »
I am not finding any US CDs that deliver 3.0% on my very brief search of the internet.  Best rate I found was 2.65% with a 5-year CD and minimum $25K deposit.
There's a few listed here listed at 5 year 3%, but only one appears to be an actual FDIC CD while the other two are a term deposit / savings certificate.
https://www.depositaccounts.com/cd/5-year-cd-rates.html

Thanks for your response and the link.

Indexer

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #12 on: February 26, 2018, 09:00:59 PM »
I'm always surprised when investors are concerned about the bond side of their portfolio. The bonds are the safety net. They are boring, even when they have a bad year, they are really really boring. You know what a bad year for Total Bond looks like?  -2.15%  That's the worst year it's had in the past 15 years, and it's the only time it's had a negative return in the past 15 years.*

A few items to consider.
1. We don't really know what interest rates will do. In 2013 investors were so sure interest rates were going to rise that they sold out of bonds, that's the year Total bond was down 2.15%, but they were wrong. Interest rates went down in 2014, not up, and 2014 was a great year for bonds.

2. Total bond is diversified across maturities, short, intermediate, and long. That's why it was down 2.15% in 2013 when many long term bond funds were down over 10%. Total Bond also managed to maintain positive returns from 2003-2006, which was the last time we experienced sustained rising interest rates. Even if rates rise it could still have positive returns. A slow rise in rates isn't a serious threat, it's priced in. It's the big unforeseen jumps in rates that pose a threat, and those are normally due to inflation which is nasty for even more reasons.

3. This is the important part. This is the primary reason you add bonds to a portfolio that already contains stocks. When stocks go down bonds tend to remain stable, OR even rise in value. When stocks go through a serious crash we experience a flight to quality, a.k.a a flight to government bonds. Total bond was UP 5.15% in 2008. That gives you two very powerful tools for portfolio management. It allows you to control how much risk you are taking, and it makes rebalancing stronger. Cash, CDs, money markets, and savings bonds don't act as the same hedge against stocks.

The consequence of 3 is that a stock/bond portfolio is more efficient than a stock/cash portfolio. In most years bonds earn more than cash, and bonds act as a better hedge against stocks. Therefor, a stock/bond portfolio will normally have higher returns and less risk than a stock/cash portfolio.


* I picked the past 15 years because that is what I could find on the website. Going back further, the worst year for a balanced bond portfolio(pre-Total bond) was about -8%. That's still very little risk relative to stocks, and that drop was due to hyperinflation.

jim555

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #13 on: February 27, 2018, 04:10:47 AM »
Bond rates have been so low, and in Europe almost zero, that it makes absolutely no sense to own a bond.  The German Bund 5 year is 0.04%, anyone who owns this should have their head examined.  IT IS NOT A SAFE INVESTMENT!  Massive rate risk. with no upside potential.

CorpRaider

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #14 on: February 27, 2018, 08:21:17 AM »
I think there have been some pretty bad returns historically for bonds on occasion, if you look at the real (net of inflation) returns.

GreyMatterCatalyst

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #15 on: February 27, 2018, 09:49:23 AM »
Except from Buffett's 2011 shareholder letter:

"Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.
Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as the holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control."

http://www.berkshirehathaway.com/letters/2011ltr.pdf

ChpBstrd

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #16 on: February 27, 2018, 12:38:53 PM »
You could sell cash-secured puts against LQD (iShares investment grade bond fund) until you are assigned shares. 

Current price is $116.82. Puts at the $116 strike expiring in 52 days are selling for $1/share (That's 6% annualized.). When you are eventually assigned (i.e. when LQD is under $116 on expiration day) you keep the money made from selling however many puts it took to get there and acquire a bond allocation yielding about 3.2% at the $116 price - which is less than you'd pay if you bought LQD today.

The interesting thing about this trade is that it yields almost twice as much as LQD but has less risk because you can only be assigned shares at $0.82 less than the current price. Downside is paying seven to nine commissions per year (or until assigned), so your portfolio's scale would need to be big enough so that commissions are a negligible percentage.

Indexer

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #17 on: February 27, 2018, 05:58:00 PM »
Bond rates have been so low, and in Europe almost zero, that it makes absolutely no sense to own a bond.  The German Bund 5 year is 0.04%, anyone who owns this should have their head examined.  IT IS NOT A SAFE INVESTMENT!  Massive rate risk. with no upside potential.

No one is talking about the German bund. The post is about Total Bond, which is paying almost 3%.

Massive rate risk?  Please clarify. What qualifies as massive risk? How much downside potential do you see for Total Bond?

Eric

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #18 on: February 27, 2018, 06:20:05 PM »
BND and BNDX hold some bonds that pay less than 1% interest (particularly short-term, government bonds). Isn't this portion of the portfolio a complete waste for a retail investor like myself who can get 1.5% in a completely liquid, risk-free savings account?

Sure, but then your bond holdings become all mid- to long-term.  What happens when interest rates rise?  You don't want to be holding all longer term bonds when that happens.

While those yields are poor, they play an important role in the fund, because they have a short expiration date, allowing the fund to replace them with higher yields as they come available.

As Indexer has pointed out, the point of the bond fund, and bonds in general, is not to make you a shitload of money.  It's their stabilization properties that reduce volatility that make them a valuable part of any portfolio.

triangle

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #19 on: February 27, 2018, 11:06:23 PM »
If you are investing today in order to start using the money 30 years from now then I think it would be stupid to buy a bond index instead of a stock index.  If you need the money in less than 10 years then things become more interesting, where some bond allocation makes sense. 

If you had conviction that the stock market is over valued then holding more bonds or cash would be part of your strategy. But since you are not trying to second guess the market I think the main concern is your time horizon, since stocks should outpace bonds over time. 

Radagast

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #20 on: February 27, 2018, 11:47:31 PM »
Bond rates have been so low, and in Europe almost zero, that it makes absolutely no sense to own a bond.  The German Bund 5 year is 0.04%, anyone who owns this should have their head examined.  IT IS NOT A SAFE INVESTMENT!  Massive rate risk. with no upside potential.
Oo. It could lose 6% over the course of a year if everything goes wrong. That is way more dangerous than stocks, which lost 6% in a few hours a month ago because everything went right. You do not know if BND yields will be up or down in three years, or even next year. If they go down, there is upside potential.
Except from Buffett's 2011 shareholder letter:

"Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.
Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as the holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control."

http://www.berkshirehathaway.com/letters/2011ltr.pdf
So you are recommending keeping 10%-40% in these, depending on circumstance, proximity to/from FIRE, and risk tolerance? Because that is what I am recommending.
If you are investing today in order to start using the money 30 years from now then I think it would be stupid to buy a bond index instead of a stock index.  If you need the money in less than 10 years then things become more interesting, where some bond allocation makes sense. 

If you had conviction that the stock market is over valued then holding more bonds or cash would be part of your strategy. But since you are not trying to second guess the market I think the main concern is your time horizon, since stocks should outpace bonds over time. 
I assume everybody here hopes to need some of this money in 20 years or less, otherwise, they wouldn't be here.

Bonds are really boring. And you can back test them. They have clearly defined math. It's pretty easy to invest in them in a way that will likely be useful to you personally, or at least increase your odds judging by history. I don't see how there can be heated opinions.

Mr. Green

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #21 on: February 28, 2018, 08:08:52 AM »
I feel like this thread is a little misleading. The whole reason people call bonds "safe" is that they don't tend to have big gains or big losses. Not having bonds in your portfolio because it could lose some money in a given year isn't thinking through why we put bonds in our portfolios in the first place. We don't do it for the returns, we do it because it's lessens the wild gyrations of the best and worst years of equity returns, hopefully preventing us from making emotional decisions to buy or sell. Yet bond funds have still outperformed other vehicles like CDs or savings accounts, as they should. If you could earn more sitting in CDs then bonds would be broken and no one would invest in them. If all you wanted was returns, be 100% in VTSAX and just know you're going to white knuckle some of those rollercoaster rides.

triangle

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Re: Is The Total Bond Market Index Fund Stupid?
« Reply #22 on: March 01, 2018, 06:28:31 AM »
I think there can be heated opinions on bonds, but hopefully we can all discuss politely. As I do not dismiss others opinions even if I disagree with them. :)

First issue is the yield curve and current low rates. The average annual return for Bonds over the next 10-30 years cannot be as good as the past 30 years. Because of the current low rates. If bonds can slightly out-pace inflation that will be an accomplishment. They can provide ballast to the portfolio but not much wealth generation IMO.

Second issue is that someone who is FIRE or looking for early retirement should by definition be expecting to live a long time and need to live off their investments for a longer time period than someone who retires in their 60's. So they need their investments to work harder over a long time period, perhaps 30 years or more. Sure there will be a lot more volatility in a mostly stock portfolio but that is where a bucket approach of having some number of months of expenses held in cash/CD along with other shorter term instruments (including bonds) for a few years worth of expenses is a good risk mitigation strategy so one does not need to sell stocks when there is market crash along the way.

Or stated in a different way I think it would be financially unwise for a 50 year old just reaching FIRE to invest in the traditional 50% stocks and 50% bonds. Since they should be planning to live for 30 years or more assuming their is no known health issues. In which case a stock portfolio (indexing or not) should easily outperform bonds.
« Last Edit: March 01, 2018, 06:30:40 AM by triangle »