Author Topic: Short term bond vs Intermediate/total bond fund?  (Read 4945 times)

CoffeeR

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Short term bond vs Intermediate/total bond fund?
« on: February 25, 2018, 02:14:48 PM »
So, Warren Buffet recommends your bond allocation be in short term bonds, you want to take risk on the equity side. I've seen other writers recommend similar action. Still, the prevailing advise in these quarters appears to be intermediate or total bond funds.

So how do people invest here (bond wise)? Anyone here have a significant portion (maybe all) of their bond allocation in short term bonds? What was your thinking in doing this?






« Last Edit: February 25, 2018, 03:28:44 PM by CoffeeR »

Exflyboy

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #1 on: February 25, 2018, 05:30:23 PM »
Personally I regard bonds as that portion of my portfolio that I need to keep pace with inflation.

I.e if the economy does another 2008, how long do I need to survive on bonds.. So I set that value at about 10 years worth of spending.. This allows some price depreciation and ignores the rent income we currently get.

For us this represents about 20% allocation to Bonds... Although if the economy really does tank I will reduce to about 15% if the market makes a 20% pullback.. going as low as 10% if we really melt down.. Remember though we have both rent and pensions we could draw on and survive on just those comfortably.

I keep about 1 years worth of cash in addition to the bonds.

I tend to pick funds with about a 6 year average maturity (less affected by rising rates).

anisotropy

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #2 on: February 25, 2018, 11:15:53 PM »
A typical "aggregate" bond fund has plenty < 5 year bonds (~45%). A short term bond fund is almost 100% < 5 year and has 50% < 3 years.

With the yield currently being 2.6% vs 2.2%, short term bonds aint too bad.

Mighty-Dollar

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #3 on: February 26, 2018, 04:56:23 PM »
The total bond market index (BND, AGG) has an average duration of only 5.6 years.
iShares 3-7 Year Treasury Bond ETF (IEI) is slightly less volatile.
iShares 1-3 Year Treasury Bond ETF (SHY) is almost like owning a CD.

Radagast

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #4 on: February 26, 2018, 07:55:57 PM »
Ideally I'd like my bonds to have duration similar to the market duration. The easy way to do this is with a total bond market fund.

My ideal but not maybe not meaningfully better way is a "barbell" of long term government bonds and I-bonds/high yield checking accounts/things-like-that which averages out to something like the market duration.
« Last Edit: February 26, 2018, 09:33:17 PM by Radagast »

Radagast

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #5 on: February 26, 2018, 09:24:17 PM »
The total bond market index (BND, AGG) has an average duration of only 5.6 years.
iShares 3-7 Year Treasury Bond ETF (IEI) is slightly less volatile.
iShares 1-3 Year Treasury Bond ETF (SHY) is almost like owning a CD.
Amazingly BND is less volatile than IEI. It is remarkable stable for its duration.
https://www.portfoliovisualizer.com/asset-correlations?s=y&symbols=VBMFX+IEI+SHY+VFSTX&endDate=02%2F26%2F2018&timePeriod=1&numTradingDays=60
« Last Edit: February 26, 2018, 09:48:31 PM by Radagast »

heybro

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #6 on: April 24, 2018, 05:33:45 PM »
So, Warren Buffet recommends your bond allocation be in short term bonds, you want to take risk on the equity side. I've seen other writers recommend similar action. Still, the prevailing advise in these quarters appears to be intermediate or total bond funds.

So how do people invest here (bond wise)? Anyone here have a significant portion (maybe all) of their bond allocation in short term bonds? What was your thinking in doing this?

I've got the same question!

Interest Compound

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #7 on: April 24, 2018, 06:34:11 PM »
So, Warren Buffet recommends your bond allocation be in short term bonds, you want to take risk on the equity side. I've seen other writers recommend similar action. Still, the prevailing advise in these quarters appears to be intermediate or total bond funds.

So how do people invest here (bond wise)? Anyone here have a significant portion (maybe all) of their bond allocation in short term bonds? What was your thinking in doing this?

When he says to keep risk on the equity side, he isn't comparing Short Term bond index funds to Intermediate/Total bond index funds. He's comparing these funds to those High Yield/Junk bond funds with 5-8% yield.

Look at this chart. 2 of the lines are Total Bond and Short Term Bond, the third is a High Yield fund. Can you guess which is which?



If the options you're picking from are Short Term Bond vs Total Bond, it likely won't matter which one you pick. I'd pick Total just to have full exposure. Just steer clear of High Yield.
« Last Edit: April 24, 2018, 07:55:52 PM by Interest Compound »

Radagast

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #8 on: April 24, 2018, 11:14:11 PM »
So, Warren Buffet recommends your bond allocation be in short term bonds, you want to take risk on the equity side. I've seen other writers recommend similar action. Still, the prevailing advise in these quarters appears to be intermediate or total bond funds.

So how do people invest here (bond wise)? Anyone here have a significant portion (maybe all) of their bond allocation in short term bonds? What was your thinking in doing this?

I've got the same question!
If the answer to your question seems vague and possibly meaningless, that's because it is ;). Obvious answers are obvious.

MustacheAndaHalf

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #9 on: April 25, 2018, 08:58:33 AM »
Bonds have two interesting aspects: quality and term.  Quality ranges from U.S. government to "high yield" (junk) bonds from corporations who may not be able to pay.  Term ranges from money-market funds (essentially) to 30-year or even 40-year bonds.  When you pick a 30-year bond, and interest rates go against you, the bond value drops since nobody wants the lower interest rates.

So... since the crazy inflation of the early 1980s, bond yields have declined to their current historic lows.  So when you look at prior bond performance - even 30 years worth - you're actually biasing your data with a time where bonds had gains from the way yields changed.  And looking ahead, we can't fall to -5% bond yields, so that isn't going to repeat.

I favor bonds with shorter term.  Within retirement accounts, consider iShares Core 1-5 year bond ETF (ISTB).  Compare that to Vanguard Total Bond (BND):

ISTB has SEC yield 2.82% with duration 2.76 years
BND has SEC yield 3.01% with duration 6.15 years

If bond yields go up 0.25%, what happens?
2.76 duration x -1 x .25 = -0.69% performance hit to ISTB
6.15 duration x -1 x .25 = -1.54% performance hit to BND

So after 0.25% yield increase (maybe after a Fed interest rate hike):
BND: 3.01% - 1.54% = 1.47% total return (capital loss + interest)
ISTB: 2.82% - 0.69% = 2.13% total return (capital loss + interest)

If you think any interest rate hikes will happen, and will translate to higher bond yields, then a shorter duration protects against that scenario.  Plus, it means your risk is being taken with stocks instead of bonds.  As an added benefit, shorter-term (high quality) bonds tend to be the least correlated with stock moves.

CoffeeR

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #10 on: April 25, 2018, 12:55:39 PM »
If you think any interest rate hikes will happen, and will translate to higher bond yields, then a shorter duration protects against that scenario.  Plus, it means your risk is being taken with stocks instead of bonds.  As an added benefit, shorter-term (high quality) bonds tend to be the least correlated with stock moves.
I decided, after I posted the question here, to move my bond allocation in my retirement accounts to short term treasuries (index). The reason is the (possible) end of 30 year bond bull market and the rising interest rate environment. I understand the market timing police will pounce on me in regards to that statement, but that is fine by me.

I am still not sure what to do with by "bond" allocation in my taxable account. Right now it is in a money market account. I am thinking about building a 12 month treasury bond ladder. That is, I use 1/12th of the money to purchase one year treasury bills every month. The commission is very low (for me), the yield on a 12 month treasury right now is 2.25%+ and I expect it to go up for the next year or so. This should yield more than a money market without the (nominal) risk of loosing money *if* I hold to duration. If I need the money sooner, treasuries are quite liquid.

« Last Edit: April 25, 2018, 01:00:57 PM by CoffeeR »

Interest Compound

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #11 on: April 25, 2018, 02:11:52 PM »
If you think any interest rate hikes will happen, and will translate to higher bond yields, then a shorter duration protects against that scenario.  Plus, it means your risk is being taken with stocks instead of bonds.  As an added benefit, shorter-term (high quality) bonds tend to be the least correlated with stock moves.
I decided, after I posted the question here, to move my bond allocation in my retirement accounts to short term treasuries (index). The reason is the (possible) end of 30 year bond bull market and the rising interest rate environment. I understand the market timing police will pounce on me in regards to that statement, but that is fine by me.

I am still not sure what to do with by "bond" allocation in my taxable account. Right now it is in a money market account. I am thinking about building a 12 month treasury bond ladder. That is, I use 1/12th of the money to purchase one year treasury bills every month. The commission is very low (for me), the yield on a 12 month treasury right now is 2.25%+ and I expect it to go up for the next year or so. This should yield more than a money market without the (nominal) risk of loosing money *if* I hold to duration. If I need the money sooner, treasuries are quite liquid.

Can you substantiate, with data, what exactly you're trying to protect against?

Let's look at the time period between 1977 and 1980, where interest rates almost quadrupled:



Here's how Short-Term and Intermediate-Term performed:



And here's how it performs overall:



So in the scenario where rate almost quadruple, you save a tiny bit of drawdown. In all other scenarios, you greatly underperform.

When you look at these graphs, is this what you expected? Is this exactly the type of dip you're intending to protect yourself against? If not, you might want to re-think your position.

Radagast

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #12 on: April 25, 2018, 09:28:20 PM »
Example of why short term bonds are not always best: From 2009-2013 short term treasury bonds gave a small positive return, while very long term ones gave a negative return. Yet, if you made monthly contributions and rebalanced, you made quite a bit more money with long term bonds. https://www.portfoliovisualizer.com/backtest-portfolio?s=y&timePeriod=2&startYear=2009&firstMonth=1&endYear=2013&lastMonth=12&endDate=04%2F25%2F2018&initialAmount=1000&annualOperation=1&annualAdjustment=1000&inflationAdjusted=true&annualPercentage=0.0&frequency=2&rebalanceType=5&showYield=false&reinvestDividends=true&benchmark=-1&benchmarkSymbol=SHY&symbol1=EDV&allocation1_1=100&allocation1_3=20&symbol2=SHY&allocation2_2=20&symbol3=VTSAX&allocation3_2=80&allocation3_3=80

In all there seems to be about a 4-5% advantage to very long term bonds vs. very short term bonds. It breaks out vaguely like:
1. Right now long term yields are higher about 0.5%.
2. There is another 0.5% rebalancing bonus
3. Dollar cost averaging gives another 2% bonus

This is a cherry picked interval, but the principle holds up. Even for a total bond vs short term bond fund, the total bond fund probably has an inherent 1% advantage in this situation. The short term actually has to outperform by around 1% to be the better investment.

Now obviously EDV is a risky investment, and in a long term downward trending market it will lose bigly. But more likely than not short term bonds will underperform intermediate almost always. And that is why I only see value to short term bonds in retirement or when you absolutely can't afford to lose 100% of the money invested in them. But not as part of a static asset allocation. Only as spending money.

CoffeeR

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #13 on: April 26, 2018, 08:24:38 AM »
Interest Compound and Radagast. You may both be right (you probably are!) and have valid points and data. Still, the issue is one of personal risk tolerance as I approach retirement. As I have stated elsewhere, I intent to go far more conservative before retirement then most people here would recommend. I then expect to increase my equity holdings over time. I may switch to intermediate term or total bond funds in the future as I enter in the next phase of my life.

I would be surprised if intermediate term bonds do not out perform short term bonds over the next couple of years. Still, I look at how short vs intermediate bonds performed during the 2008-2009 melt down and intermediate bonds make me nervous. "but look at how they recovered" some say. Yeah, they did. Every down turn in the last 30 years or so has been followed by a swift recovery  so the general consensus based on extensive data mining concludes it must happen again. Hmm, yes, I do expect it will happen again. Until, of-course, it does not. Would any kind of data mining have predicted the Japaneses stock market  failure to recover for 20+ years after the 1992 collapse? That may be an extreme example, but even with bonds, I do not see any historical data (complete cycle) that corresponds to the possible end of a 30 year bull market with rates increases starting from a floor of near zero.

I may let myself be persuaded by the data. We shall see.

Interest Compound

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #14 on: April 26, 2018, 10:37:08 AM »
I look at how short vs intermediate bonds performed during the 2008-2009 melt down and intermediate bonds make me nervous.

If you can look at this chart showing how Short Term Bond and Total Bond performed during 2008-2009, and genuinely see something that Short Term Bond protected you against, to the point where you'd feel "nervous" holding Total Bond...then I agree, stick with Short Term Bond.



However, if that's truly the case, I'm surprised you're holding any stocks at all :-P

Radagast

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #15 on: April 26, 2018, 08:20:13 PM »
Interest Compound and Radagast. You may both be right (you probably are!) and have valid points and data. Still, the issue is one of personal risk tolerance as I approach retirement. As I have stated elsewhere, I intent to go far more conservative before retirement then most people here would recommend. I then expect to increase my equity holdings over time. I may switch to intermediate term or total bond funds in the future as I enter in the next phase of my life.
If I had a specific date where I needed money I would make my bonds match that (in fact my post was more directed at recent posters than you). If I needed to protect sequence of return risk at a sudden end of income I would certainly have shorter bond duration, probably a single ladder of CD's and STRIPS built up starting five years before and completing five years after the date. In additon to a small allocation to longer term bonds that would carry through.

Mighty-Dollar

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #16 on: April 27, 2018, 12:41:42 AM »
Amazingly BND is less volatile than IEI. It is remarkable stable for its duration.
That's because of all of the really short term bonds in the portfolio. 1 month, 3 months, etc.

MustacheAndaHalf

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #17 on: April 27, 2018, 08:58:56 AM »
Example of why short term bonds are not always best: From 2009-2013 ...
This is a cherry picked interval, but the principle holds up.
Picking an arbitrary 4 year interval does not sound principled to me.

Interest Compound - I read in one of Larry Swedroe's books that short-term bonds are less correlated with stock price changes, which suggests an additional boost to the combination of short-term bonds and stocks.  Taking bonds in isolation ignores that.

CoffeeR - If you pick 12 month treasuries, those are only exempt from state tax - not Federal tax.  If you want to squeeze a little more out of your bonds in taxable, calculate the after tax yield of a few choices.  (Vanguard Short-Term bond has a 1.1 year duration, very close to the 12 month treasury, but only 1.69% yield after Federal tax).  If you live in CA or NY, Vanguard has state-specific tax-exempt bond funds that are exempt from Federal and State income tax (but you won't get to pick a shorter term).

Radagast

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Re: Short term bond vs Intermediate/total bond fund?
« Reply #18 on: April 29, 2018, 04:54:54 PM »
Amazingly BND is less volatile than IEI. It is remarkable stable for its duration.
That's because of all of the really short term bonds in the portfolio. 1 month, 3 months, etc.
First, BND does not hold bonds with less than 1 year to maturity (at least not longer than it takes to sell them), so it contains no bonds with 1 month or 3 month maturities.

Second, compare BND with GOVT, the iShares "total treasury" ETF.
           BND   GOVT
StdDev   3.1   3.25
Duration   6.15   6.08
%1-3Year   22.1 31.4

Total Bond Index BND is less volatile than a total treasury fund GOVT, even though BND has lower credit quality, more duration, and a lower percentage of short term bonds. I expect the corporate bonds and government backed mortgages are somewhat uncorrelated from treasury bonds, which is why it is more stable.

Example of why short term bonds are not always best: From 2009-2013 ...
This is a cherry picked interval, but the principle holds up.
Picking an arbitrary 4 year interval does not sound principled to me.
Cherry picked to find a rare recent period where short term bonds outperformed, to demonstrate a principle which is correct. I cherry pick periods where short term bonds did better :). All else being equal, a person making regular contributions will almost always end up wealthier or FI faster using market duration or longer, but a person making withdrawals should consider market duration or possibly shorter. Here is another example. Even when short term bonds outperformed BND, a regular contributor ended with more money using BND.
https://www.portfoliovisualizer.com/backtest-portfolio?s=y&timePeriod=2&startYear=2009&firstMonth=1&endYear=2018&lastMonth=12&endDate=04%2F29%2F2018&initialAmount=1000&annualOperation=1&annualAdjustment=1000&inflationAdjusted=true&annualPercentage=0.0&frequency=2&rebalanceType=1&showYield=false&reinvestDividends=true&benchmark=-1&benchmarkSymbol=VBTLX&symbol1=VFSUX&allocation1_1=100&allocation1_2=20&symbol2=VBTLX&allocation2_3=20&symbol3=VTSAX&allocation3_2=80&allocation3_3=80

Quote
Interest Compound - I read in one of Larry Swedroe's books that short-term bonds are less correlated with stock price changes, which suggests an additional boost to the combination of short-term bonds and stocks.  Taking bonds in isolation ignores that.
They are so stable that this is more or less insignificant, and may only apply to Treasury bonds.

At the end the difference between short and intermediate term is probably tiny, but in the long run intermediate should come out consistently ahead by a small amount. People making regular contributions might favor longer term bonds, and people making regular withdrawals might consider shorter term bonds if they want to. Intermediate or total market funds are always acceptable.

Edit: forgot to add PV link
« Last Edit: April 30, 2018, 10:10:48 AM by Radagast »