Author Topic: Why VBTLX with rising rates?  (Read 1516 times)

Exflyboy

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Why VBTLX with rising rates?
« on: November 16, 2018, 12:36:08 PM »
OK investing 101 question.

Like a lot of folks I have about 20% of the stash in total bond fund which I believe has about an 8 year duration from memory.

Of course as rates rise which is a 95% certainty the value of these funds decreases.

Bond funds are meant to smooth the volatility of the stock funds but they WILL continue to lose value as rates rise.. sooo.. why invest in them in this environment?

I feel like I should out my flame suit on..:)

jacoavluha

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Re: Why VBTLX with rising rates?
« Reply #1 on: November 16, 2018, 05:10:39 PM »
Rates been rising for a while. Have a look at total bonds return over that time.

Andy R

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Re: Why VBTLX with rising rates?
« Reply #2 on: November 16, 2018, 08:22:19 PM »
Rates been rising for a while. Have a look at total bonds return over that time.

I thought this was indicating that bonds have not been adversely affected by the rate rises, but I was curious to take a look at this and this is what I found (see attached). It seems that over the last 2 years the value of the fund has dropped around 10% which is an enormous amount for something that should be considered a "safe" asset.
If I'm looking at the wrong thing can you point out where I went wrong please.




RWD

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Re: Why VBTLX with rising rates?
« Reply #3 on: November 16, 2018, 08:53:57 PM »
Rates been rising for a while. Have a look at total bonds return over that time.

I thought this was indicating that bonds have not been adversely affected by the rate rises, but I was curious to take a look at this and this is what I found (see attached). It seems that over the last 2 years the value of the fund has dropped around 10% which is an enormous amount for something that should be considered a "safe" asset.
If I'm looking at the wrong thing can you point out where I went wrong please.

I see some simplification and omissions in your assessment.
- You picked the absolute peak value for VBTLX as your starting point
- The drop from that point is actually 8.2%, not 10%
- You omitted dividends (which ranged from 2.31%-2.88% over that period)

So the actual return for that 2.3 year period is around -1% annually. Hardly something to go crazy over. Especially considering the cherry picked starting point.

Yahoo lists the following returns over the last few years:
2013: -2.15%
2014: 5.89%
2015: 0.40%
2016: 2.60%
2017: 3.56%
YTD: -2.32%

jacoavluha

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Re: Why VBTLX with rising rates?
« Reply #4 on: November 16, 2018, 09:28:36 PM »
Exactly. Rates rise. Fund NAV will decrease. But yields will rise. Hence total return rather flat, even in a rising rate environment. And now equities are very choppy. So total bond is right there doing what itís supposed to do.

Andy R

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Re: Why VBTLX with rising rates?
« Reply #5 on: November 16, 2018, 11:31:50 PM »
I see some simplification and omissions in your assessment.
- You picked the absolute peak value for VBTLX as your starting point
- The drop from that point is actually 8.2%, not 10%
- You omitted dividends (which ranged from 2.31%-2.88% over that period)

So the actual return for that 2.3 year period is around -1% annually. Hardly something to go crazy over. Especially considering the cherry picked starting point.

Thank you for your reply.

Regarding the starting point.
The start date was the start date from the second rate rise (which I did post a graph of), which was the start of many and frequent rate rises (there was a long pause after the first so I left that one out), so it was not specifically to start at the peak, but to start based on the multiple rate rises, which happened to be the peak, and seems indicative of what will happen if there are many more rate rises, which looks to be decent chance of, and what the OP is specifically asking about.

Regarding omitting dividends.
If one invests in short term bonds or CDs, do they not get the same dividends, without the loss of capital value that longer term bonds are exposed to in an environment of very low rates that are expected to normalise by going up?

Exactly. Rates rise. Fund NAV will decrease. But yields will rise. Hence total return rather flat, even in a rising rate environment. And now equities are very choppy. So total bond is right there doing what itís supposed to do.

Hmm didn't occur to me that yields will rise as value drops.
Do they really rise enough to make up for it though?
Say you had a $100 worth of bonds with 10 years left and with interest paid at 3% yield.
Then rates rise by 1%.
Would it be roughly accurate that the bonds value would drop 8% (1% x 8 years) down to $92, but then the return would be 3/92 = 3.26% ?
I'm probably missing something here, because it doesn't seem like this would make up for the loss in value to make it even?

Frugancial Advisor

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Re: Why VBTLX with rising rates?
« Reply #6 on: November 17, 2018, 01:58:08 AM »
For volatility reduction and (historically) negative correlation to equities.

In a rising rate environment, tilting fixed income asset allocations to shorter duration bonds (floating rate) and including laddered CDs with increasing yields could be a superior option for those with longer term time horizons and are only holding fixed income for aforementioned reasons.

I have shifted 100% of the fixed income component of my portfolio to a mixture of floating rate securities, preferred resets, and laddered CDs which when matured can either continue the ladder or be used to buy into a decreasing equity market.

Hope that helps!

jacoavluha

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Re: Why VBTLX with rising rates?
« Reply #7 on: November 17, 2018, 08:45:32 AM »
the thing is, people know rates are rising. So is that already baked into the price? Nothing is straightforward. If not total bond, then you have to decide what else. Are you timing the bond market? Shorter duration? T bills? CDs? And then what, later on? Is your investment horizon long term? If it is, Iíd just stick with total bond. Will be interesting to see what happens to the fund price when we inevitably get to a bear market in equities.

Boofinator

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Re: Why VBTLX with rising rates?
« Reply #8 on: November 17, 2018, 10:33:54 AM »
This is probably obvious to most if not all, but I didn't see it mentioned: Over the duration, a fixed-term bond fund is essentially guaranteed to return the yield (plus or minus a trivial amount depending on the timing of interest rate changes). So if the effective duration is 8 years, and the yield is 3.4%, you will receive close to that level of return over the duration. Obviously with Total Bond it is a bit messier due to the mix of durations, but the same general principle applies: Each bond will return the yield over the duration.

So long term, bonds are not risky, but short term, long-term bonds carry some risk due to interest rate changes. If you are worried about capital preservation over a short time period, you should probably invest in shorter term bonds.

By the way, I'm not so certain of a "95% certain" rate rise. People have been using similar statements of certitude for years, but it is only fairly recently that the rates actually began to rise. Also, if the market was actually 95% certain of a rate rise, bond funds would be priced accordingly, and the corresponding interest rate rise would result in a small blip on returns. So if this were to be the case, there would actually be minimal interest rate risk.

MustacheAndaHalf

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Re: Why VBTLX with rising rates?
« Reply #9 on: November 17, 2018, 12:33:53 PM »
So if the effective duration is 8 years, and the yield is 3.4%, you will receive close to that level of return over the duration. Obviously with Total Bond it is a bit messier due to the mix of durations, but the same general principle applies: Each bond will return the yield over the duration.
You can roughly think of a bond fund as being a 3.4% bond for "duration" number of years, but there's a more significant detail: the duration tells you the impact of changes in yield.

Total Bond actually has a duration of 5.9 years.  If interest rates go up in December (the market consensus), then Total bond would be impacted by: 5.9 x -1 x 0.25 = -1.5%.  That's the theory of how duration gets used.

In practice it's more complicated because the market has assigned different chances of different events: the chance the Fed does nothing versus raises rates +0.25%.  Some of the hit has already been priced in, but since the Fed might not raise rates, there's also some +0% priced in.

There's actually a non-market timing reason to use shorter-term bonds: correlation.  Bonds are useful when stocks drop - you can rebalance to buy more stocks.  Shorter-term bonds are less correlated with stocks, and so offer slightly better diversification.

Radagast

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Re: Why VBTLX with rising rates?
« Reply #10 on: November 17, 2018, 11:26:21 PM »
My understanding of the rule of thumb is that in a linearly rising rate environment ( eg .25% every quarter) you will break even in nominal terms at the funds duration and match the starting yield at twice the duration. The best advice is to keep your duration below your need for money and if you donít know and donít care then match the market duration.

In my research I decided I like the following choices:
VBTLX or VTEB if keeping things simple
I bonds for safety and not losing money ever in any way
Bank products like CDs, high yield checking and saving, and deposit bonuses that are safe and have decent returns ( or treasury bonds if competitive)
EDV to take interest rate risk
VWALX to take credit risk in not the exact same entities that you take stock risk in

Look around there are lots of threads here and on bogleheads. Personally I donít see any reason to try market timing cash vs bonds which seems pretty unprofitable and instead just keep it to Bonds: yes/no, what percentage, does the duration/ risk match my time/need. Right now they are all very long term but I may have short term needs coming up that will need safer investments.