Author Topic: Question about bond funds  (Read 3828 times)

HopetoFIRE

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Question about bond funds
« on: May 06, 2014, 01:36:05 PM »
So, I have opened up a Vanguard account and now hold VTSAX, VWITX and VGTSX.  I am trying to read up on bond funds, but I am still confused.  When you hold a bond fund, there is no maturity date, right?  Can I just hold it and add to it like I would VTSAX?  I thought I read somewhere about holding it until it matures, but I thought new funds are periodically added to bond funds.  Also do bond funds pay dividends?  Sorry if the questions seem simple, but still trying to wrap my head around everything. 

hodedofome

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Re: Question about bond funds
« Reply #1 on: May 06, 2014, 01:42:55 PM »
Yes a bond fund does not have a maturity date like an individual bond does. Bond funds typically do pay 'dividends' but it's really the interest that the individual bonds pay the bond fund. They pass along those interest payments to the fund investors like us. The bond fund worries about maturity dates and reinvesting that money once each bond matures.

Mr Mark

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Re: Question about bond funds
« Reply #2 on: May 06, 2014, 02:11:50 PM »
Different bond funds can contain very different mixes of bonds, typically sorted by quality and duration.

A fund will tell you what the average duration and type of bonds they hold. Each bond is a promise to
1. Repay the original amount ( nominal)
2. Meanwhile it pays a sum on a regular basis, the coupon

thus, very very long dated bonds move wrt interest rates, as interest rates rise, the bond price will fall

very very short dated bonds are not effected very much by long term rates, as soon you get your money back anyhow ( hopefully).

Mr Mark

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Re: Question about bond funds
« Reply #3 on: May 06, 2014, 02:53:13 PM »
There are lots of resources online (eg vanguard)

At the moment there are a few themes around the bond market

1. Interest rates paid by the safest most liquid bond instrument in the world, US Treasuries, set the market rates in US$. Over the past decades, long term interest rates have been on a long steady decline. They are near all time lows now, thanks to the crisis.  As a result, long dated treasury bonds have had a long term bull market in their price.  Some people think this mega-cycle has peaked, and long term bonds will slowly but surely lose value over the next decades too, especially the next one. But yields will corresponding rise, so the effect on shorter term bonds, if the trend is slow, isnt catastrophic.

2. Short term bond rates in the us are super duper low. Zero, basically. So you can borrow money easily if you are a bank. For free. All this cash is being pumped out by the Fed.  to try to get everyone to spend it, and stimulate the economy.   Quite artificial.  So if that artificial assistance stops, rates will rise and bonds will fall in the short term. Some think the Fed would actually like more inflation, which again moves rates up.


So, what to do?

1 dont panic. Bond prices are not as predictable as you'd think. As some have mentioned elsewhere,  bond funds are nicely up this year. And rates could still fall, a lot further and for some years. And if there is a big market correction in equities, they should hardly drop. So keep a % in bonds, no matter what the bond psychics portend. Minimum is usually 15% or so

2. Offset long term rate rises and inflation by getting a 4% fixed rate 30 year mortgage, and invest the capital.

3. Use laddered money market or cd certificate s for short term cash


timmoney

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Re: Question about bond funds
« Reply #4 on: May 06, 2014, 11:23:37 PM »
if you go into a bond fund make them of the shortest duration you can find. interest rates are low and look like they are about to go up. now when you hold a bond there are 2 things you need to know  1- the price of the bond 2- the yield on the bond.
  what you also must know is the two are inversely related. so as one goes up the other goes down. so if price of a bond goes up the yield goes down. just like if the yield goes up the price goes down.  so being that interest rates are being kept low due to government intervention and the government has stated that they are going to stop intervening the most likely scenario is yields will go up. so if yield goes up price comes down so the bond you or the manager of the fund just bought for say $100 in coming months may only be worth $90 due to the rise in rates.
  the duration of the bond matters. for every 1% rise in interest rates your bond fund will decrease in value equal to the duration of the bond. for example- lets say youre looking at 2 funds. choice A has an avg duration of 3 years choice B an average duration of 6 years. if rates rise to 1% choice A can be expected to fall 3% in value. choice B will fall 6% in value.   so be careful. warren buffet some months recommended buying the shortest term government bonds one could find.  personally i'd avoid bonds altogether at least for the time being.  rates look like theyre going to begin to rise right now. the dollar is weakening. check todays news.

Mr Mark

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Re: Question about bond funds
« Reply #5 on: May 07, 2014, 12:50:53 AM »
Tim,

Please stop making me want to buy 30 yr treasuries.

Even if you think bonds are close to peak, the yield/ price curve is almost exponential,  not linear. A 4% coupon 30 yr treasury will look very nice if rates are forced down to 2%. Or imagine 0.5%

Quality bonds always have value in a portfolio,  IMHO. The diversity works for a reason.  So I think a 100%equity ratio is far too aggressive. 

hodedofome

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Re: Question about bond funds
« Reply #6 on: May 07, 2014, 07:53:44 AM »
if you go into a bond fund make them of the shortest duration you can find. interest rates are low and look like they are about to go up. now when you hold a bond there are 2 things you need to know  1- the price of the bond 2- the yield on the bond.
  what you also must know is the two are inversely related. so as one goes up the other goes down. so if price of a bond goes up the yield goes down. just like if the yield goes up the price goes down.  so being that interest rates are being kept low due to government intervention and the government has stated that they are going to stop intervening the most likely scenario is yields will go up. so if yield goes up price comes down so the bond you or the manager of the fund just bought for say $100 in coming months may only be worth $90 due to the rise in rates.
  the duration of the bond matters. for every 1% rise in interest rates your bond fund will decrease in value equal to the duration of the bond. for example- lets say youre looking at 2 funds. choice A has an avg duration of 3 years choice B an average duration of 6 years. if rates rise to 1% choice A can be expected to fall 3% in value. choice B will fall 6% in value.   so be careful. warren buffet some months recommended buying the shortest term government bonds one could find.  personally i'd avoid bonds altogether at least for the time being.  rates look like theyre going to begin to rise right now. the dollar is weakening. check todays news.

Don't look now but the trade in 2014 has been long 30 year treasuries and REITs, while selling US stocks. Having a bias about what's going to happen in the future = BAD.

aclarridge

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Re: Question about bond funds
« Reply #7 on: May 07, 2014, 12:55:09 PM »
Check the holdings of the bond fund, make sure you understand what you're buying. Government or corporate or a mix, average maturity, credit rating profile? Usually the point of holding bonds is that they're the safe part of your portfolio, so don't buy a junk bond or long-term corporates for the high yield - in fact don't think about yield.

If you need the money to be available at short notice, keep it in short-term stuff only. If it's just the long-term safe side of your portfolio, get a mix of short and long term bonds.

EDIT: To answer your question, yes you can just hold it and buy/sell it as needed like any other fund.
« Last Edit: May 07, 2014, 12:57:25 PM by FI40 »

timmoney

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Re: Question about bond funds
« Reply #8 on: May 07, 2014, 06:39:19 PM »
what you could also do is look for closed end funds. they report their net asset value. find one that sells at a discount to its net asset value. its not a guarantee that it wont go down in price but at least you can get a bit of a feel for what the assets they hold are worth

timmoney

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Re: Question about bond funds
« Reply #9 on: May 07, 2014, 09:27:38 PM »
Also have you considered municipal bonds? Many are tax efficient and offer good yields

Guy Incognito

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Re: Question about bond funds
« Reply #10 on: May 08, 2014, 08:20:13 AM »
I bought in to a couple of closed-end Muni Bond funds myself in December.  6.5% tax free yield at 10+% discounts to NAV sounded good to me.

There's certainly the possibility that these funds lose value if/when there's a spike in interest rates, but the discounts to NAV eased my fears a bit.  Plus, other alternative investment options (i.e. stocks) also get hurt when rates rise.

In fact, I'm using these Muni Funds as my middle-ground answer to the "pay down mortgage or invest" question.  Specifically, this means investing ~$130k to generate $715/mth in tax-free income, which covers my P+I.  So rather than pay off the $138k remaining on my mortgage to avoid my $715 monthly payment...I pay my mortgage with tax-free muni bond fund interest while keeping the tax break on my mortgage interest.

I do dumb things sometimes so perhaps this is stupid...and welcome anyone's thoughts on this "strategy"... but I needed to diversify away from 100% stocks anyway and this at least helps me accomplish that.  We'll see how it goes!

timmoney

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Re: Question about bond funds
« Reply #11 on: May 08, 2014, 05:35:10 PM »
I don't think you're dumb at all. I believe there is such a thing as good debt and i think you're using your money wisely. You're essentially paying off your house with what I call "cheap" money.

As for the closed end funds NAV can go down but it can also go up. I use them and like them too. 
Another thing I like are floating rate bonds. They're tied to LIBOR rates so if rates go up your shielded somewhat.  Every investment comes with risk.
  Another thing I do is I like to piggy back what some of these big time investors do. I've followed bill gross into funds before and always did well.
 I also put some money into TIPS too.