Author Topic: Why would I invest in bonds right now?  (Read 2859 times)

MTBmustachian

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Why would I invest in bonds right now?
« on: January 10, 2019, 08:41:39 PM »
FTBFX Bond Fund currently yields 3.19% with an expense ratio of 0.45%, for a real return of approx. 2.74%. VBMFX is 2.67% with an expense ratio of 0.15% for a real return of approx. 2.5%.

However, I can now get 2.45% APY (and climbing) from a Money Market account that has no contribution limits (as compared to limits that I can invest in tax-deferred retirement accounts), and I can easily withdraw my money from that account at any time if I want to invest in some other way--say, a rental property.

So, at this point, why would I want to buy bonds? Why wouldn't I just save the percentage of my portfolio that I would have put into a bond fund and instead stash it in a money market account, until such time as bonds begin to climb again? Or does that qualify as "market timing"?

Or am I missing some really important part of the equation that makes bonds such a seemingly vital part of everyone's asset allocation, when compared to other things like money market funds and CDs?

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Re: Why would I invest in bonds right now?
« Reply #1 on: January 10, 2019, 09:05:25 PM »
Simple. You invest in bonds to reduce overall portfolio volatility.

William Bernstein has written extensively on the subject.

MustacheAndaHalf

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Re: Why would I invest in bonds right now?
« Reply #2 on: January 10, 2019, 09:08:15 PM »
California investors might also look at VCITX, California long-term tax-exempt bond fund.  I don't like bond funds with 7 year duration, but it does provide a 2.67% yield after CA and Federal tax.  Someone with higher income may find that beats out a money market yield of 2.5% pre-tax.

Do you invest in stock index funds?  You only mentioned bonds, money market accounts, and real estate.

MTBmustachian

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Re: Why would I invest in bonds right now?
« Reply #3 on: January 10, 2019, 09:16:48 PM »
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Simple. You invest in bonds to reduce overall portfolio volatility.

William Bernstein has written extensively on the subject.

Yeah I get that. Did you read my entire post above? The question is, why not use some other method to reduce portfolio volatility? Why use bonds?

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Do you invest in stock index funds?  You only mentioned bonds, money market accounts, and real estate.

Yes, I'm currently about 94% in stocks, which is why I'm looking to "reduce my overall portfolio volatility" as the previous guy put it. I just am having a hard time understanding why exactly bonds are the go-to method of reducing volatility, when it appears that at this point in time, there are even safer and more secure methods of savings/investment that can provide almost just as much return on investment.

So the short question is: what, if anything, makes bonds more attractive than a money market savings account that yields almost just as much?

maizeman

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Re: Why would I invest in bonds right now?
« Reply #4 on: January 10, 2019, 09:35:03 PM »
However, I can now get 2.45% APY (and climbing) from a Money Market account that has no contribution limits (as compared to limits that I can invest in tax-deferred retirement accounts), and I can easily withdraw my money from that account at any time if I want to invest in some other way--say, a rental property.

I mean you can also buy bonds in a taxable account, and withdraw the money at any time to invest it in other ways such as rental properties. At most brokerages you can can get checks and debt cards that draw directly from the account, so money in a bond fund would be just as accessible as a money market account.

So the short question is: what, if anything, makes bonds more attractive than a money market savings account that yields almost just as much?

So I don't actually have a good and convincing answer. But here is one minor point that is difference between the two:

-If interest rates go down in the future, an investment in bonds will provide better return than an equal investment in a money market account with an equal initial interest rate. (But of course if interest rates go up, the opposite it true).

That said, I've always preferred cash over bonds when it comes to "reducing overall portfolio volatility" so in your shoes I'd go with the money market account.

degrom7

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Why would I invest in bonds right now?
« Reply #5 on: January 10, 2019, 09:36:04 PM »

So the short question is: what, if anything, makes bonds more attractive than a money market savings account that yields almost just as much?

The historical returns for bonds are 5-6%. This is much higher than money market accounts and CDs. Replacing your bond allocation with that will reduce risk, but also decrease your returns. Money market accounts, HYSA, and/or CDS are used for emergency funds and to save up for a large purchase in the next couple of years.

I'm currently 100% stocks.

Sent from my iPhone using Tapatalk

Radagast

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Re: Why would I invest in bonds right now?
« Reply #6 on: January 10, 2019, 10:40:34 PM »
1) lock in the higher interest rate, in case rates are lower 1 through 10 years from now (as a bond fund investor you would just get a capital gain, as your higher yield bonds suddenly became more valuable to other people whom you could sell too)(as Maizeman points out the converse is also true)
2) hope the extra bond volatility compared to money markets happens at different times than stock volatility, to get a rebalancing bonus
3) the yield is higher, so if this is a long term holding eventually you are guaranteed to end up with more money

SEC Yield from respective fund websites:
VBTLX: 3.20% (note: VBMFX is dead, where did you even get that)
FTBFX: 3.68%
VMMXX: 2.47%

Over the next year I might tolerate 0.7% difference for safety sake, but compounded over a decade+plus I start to care about the extra.

gpyros85

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Re: Why would I invest in bonds right now?
« Reply #7 on: January 10, 2019, 11:59:13 PM »
You are investing in a bond fund NOT an invidiual bond, so other risks apply.

A bond fun is a basket of bonds usually grouped in short, medium or long term. The risk in this is it is traded similiar to a stock and thus will go down in value as interest rates rise.

I would highly recommend AGAINST this in this market climate as we are in record low interest rate period and there is much chance longer term bond will go HIGHER not lower.

Also, as you already discovered, the savings account(Capital One 360 has one over 10k paying 2.0% and FDIC) is very competitive to these bonds with only inflation risk.


Good Luck Investing.

gpyros85

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Re: Why would I invest in bonds right now?
« Reply #8 on: January 11, 2019, 12:01:51 AM »
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Yes, I'm currently about 94% in stocks, which is why I'm looking to "reduce my overall portfolio volatility" as the previous guy put it. I just am having a hard time understanding why exactly bonds are the go-to method of reducing volatility, when it appears that at this point in time, there are even safer and more secure methods of savings/investment that can provide almost just as much return on investment.

So the short question is: what, if anything, makes bonds more attractive than a money market savings account that yields almost just as much?

History shows that when stocks go down bonds go up as in the "flight to safety" However, what planners won't tell you is there has been several times in history when bonds AND stocks have decreased in value

Also, notice you mentioned an expense ratio on the bond fund, there isn't an expense ratio on cash sitting in a savings account is there? This is the typical financial planner pushing for a 70/30 or 60/40 jargon.

Mississippi Mudstache

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Re: Why would I invest in bonds right now?
« Reply #9 on: January 11, 2019, 10:48:38 AM »
I've been at 90% stocks/10% bonds for about 5 years now. It's been driving me nuts to hold onto $20,000 worth of bonds while rates are so low, but I was hesitant to make any changes in a misguided attempt to "stay the course". However, as others have noted, the reason to own bonds is to reduce portfolio volatility - not to increase returns. I genuinely don't give a sh!# about volatility right now. I'm still 10+ years from FIRE. So I finally decided to make the change, and I took the recent ~15% drop in the markets as an opportunity to sell off half of my bond allocation. I'm currently at 95% stock, which feels much better. If the market drops 30% from its peak any time in the next few years - and if bond yields are still historically low when/after that happens - I'll get rid of them all and go 100% stock.

My plan is to begin ratcheting back up the bond allocation as I approach retirement, but volatility reduction and capital preservation are simply not primary investment goals at the moment.

COEE

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Re: Why would I invest in bonds right now?
« Reply #10 on: January 11, 2019, 11:03:49 AM »
By definition bonds perform better than money market accounts.  The FTBFX fund you referenced actually had a 30-day yield of 3.50%*.  That's 105 basis points more than your MMA!  That's quite a lot.  1.05% compounded over many years turns into a lot of money.  Even the other intermediate term bond you referenced (VBMFX) is reporting a 3.19%*.  That's still 74 basis points more than your MMA - which can turn into decent additional returns when considering compounding.

When you loan the bank money, they turn around and loan that money out.  They are making that additional 74+ basis points that you're losing out on.  By definition you will not see as high of returns in you MMA over time as you will in the bond market.  The bond market cuts out the middle man.

Another factor in all of this is what you intend to use the money for and your risk tolerance.  EF?  First-tier or second-tier?  Perhaps you're saving for a home remodel, a rental house, or a college education.  Should you hold this savings in cash, or are you happy with changing the time you achieve your goal by holding more bonds or maybe even stocks.  Should these savings be part of your investment AA or not?

I do suggest having a plan for the money you hold in cash equivalents (MMA, MMF's, Savings, Cash, etc) otherwise invest that money in bonds.

* - SEC yield on 1/9/19 which were reported on the bond fund's website on the morning of 1/11/19.  Also note that these yields are net of fees, including expense ratios.  They do assume however, that distributions are reinvested.

Rob_bob

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Re: Why would I invest in bonds right now?
« Reply #11 on: January 11, 2019, 01:14:08 PM »
FTBFX may have a nice yield over 3% but over the last year the price have declined by 3% so how does that return compare to a CD?

MTBmustachian

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Re: Why would I invest in bonds right now?
« Reply #12 on: January 11, 2019, 01:18:43 PM »
Quote
-If interest rates go down in the future, an investment in bonds will provide better return than an equal investment in a money market account with an equal initial interest rate. (But of course if interest rates go up, the opposite it true).

Quote
The historical returns for bonds are 5-6%. This is much higher than money market accounts and CDs. Replacing your bond allocation with that will reduce risk, but also decrease your returns. Money market accounts, HYSA, and/or CDS are used for emergency funds and to save up for a large purchase in the next couple of years.

Ah now we're getting somewhere. So to paraphrase, bonds are currently at or near a low point in their yields, and money market accounts are at or near a high point in their yields? So based on this info, it's just a random occurrence that money markets appear so favorable when compared to bonds at this point in time?

Quote
By definition bonds perform better than money market accounts.  The FTBFX fund you referenced actually had a 30-day yield of 3.50%*.  That's 105 basis points more than your MMA!  That's quite a lot.  1.05% compounded over many years turns into a lot of money.  Even the other intermediate term bond you referenced (VBMFX) is reporting a 3.19%*.  That's still 74 basis points more than your MMA - which can turn into decent additional returns when considering compounding.

* - SEC yield on 1/9/19 which were reported on the bond fund's website on the morning of 1/11/19.  Also note that these yields are net of fees, including expense ratios.  They do assume however, that distributions are reinvested.

Ahh so the yield number already has the fees subtracted out? This is a bit of info I did not know. Thanks! Also, thanks for the SEC analysis. So the best way to find these numbers is to visit the fund's website directly?

maizeman

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Re: Why would I invest in bonds right now?
« Reply #13 on: January 11, 2019, 02:07:56 PM »
So to paraphrase, bonds are currently at or near a low point in their yields, and money market accounts are at or near a high point in their yields? So based on this info, it's just a random occurrence that money markets appear so favorable when compared to bonds at this point in time?

Not random. I suspect it is the same forces that have been producing a flat or somewhat inverted yield curve recently. People are willing to accept lower interest rates for a guarantee that the same interest rate will be paid for many years (normally the opposite is the case). you can think of a money market account as sort of an instantaneous bond. In normal circumstances it’d pay less than a one week note which pays less than one month less than one year less than ten year less than 30 year and so on.

COEE

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Re: Why would I invest in bonds right now?
« Reply #14 on: January 11, 2019, 03:21:07 PM »
...it's just a random occurrence that money markets appear so favorable when compared to bonds at this point in time?

So the best way to find these numbers is to visit the fund's website directly?

I wouldn't say MMA's are more favorable than bonds.  They are priced correctly for the current market.  I showed you already that intermediate bonds are returning something between 74-104 bps better return.  That's quite a lot.  I'd encourage you to calculate the difference in earnings of 2.45%, 3.19%, and 3.50% earnings over 30 years.  It's not insignificant.  Most MMA's don't return 2.45% either.  The rate you're getting is quite high for a MMA.  With an MMA you probably also getting check-writing ability.

The best way I know to find a fund's SEC yield is to look at the prospectus.  A prospectus is filed with the SEC and is held to a much higher standard than the website.  Second is their website.  SEC yields change daily.  It can be difficult to compare yields between funds because many funds file at different times, or report yields on different dates, or different types of funds report different lengths of SEC yields, etc.  It's not simple.  One fund may have a better yield than another on one day and a few months down the road the other fund my have a better yield.

I'm also curious where you're getting an MMA with 2.45% yield.

COEE

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Re: Why would I invest in bonds right now?
« Reply #15 on: January 11, 2019, 03:40:15 PM »
FTBFX may have a nice yield over 3% but over the last year the price have declined by 3% so how does that return compare to a CD?

The price of the fund has lost 3%.  That does not include dividends.  With dividends reinvested, last years performance was -0.67%.

Most intermediate bond funds lost value last year due to rising interest rates.  This is called interest rate risk.

Example:
Say I buy a $1000 1-year bond at 3%.  Purchase price is $970
A month later that same bond can be bought with a 4% rate.
Now my bond is only worth about $960* to compensate for the 1% change.
At maturity I will still get $1000

* it will actually be worth slightly more because the term is now only 11 months.

Andy R

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Re: Why would I invest in bonds right now?
« Reply #16 on: January 11, 2019, 08:09:01 PM »
FTBFX may have a nice yield over 3% but over the last year the price have declined by 3% so how does that return compare to a CD?

The price of the fund has lost 3%.  That does not include dividends.  With dividends reinvested, last years performance was -0.67%.

Most intermediate bond funds lost value last year due to rising interest rates.  This is called interest rate risk.

Yes and the question is based on this understanding - why invest in bonds when cash currently yields about the same minus the risk.

Indexer

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Re: Why would I invest in bonds right now?
« Reply #17 on: January 11, 2019, 08:26:21 PM »

Yeah I get that. Did you read my entire post above? The question is, why not use some other method to reduce portfolio volatility? Why use bonds?

...

So the short question is: what, if anything, makes bonds more attractive than a money market savings account that yields almost just as much?

Flight to quality. Bonds aren't just more stable than stocks. They tend to move the opposite direction as stocks in crisis events. This is due to 2 reasons. 1. When investors are dumping stocks in a crash they tend to buy bonds so bond prices rise as stocks fall. 2. The Fed lowers rates during recessions, which is also good for bond prices.

You can compare bonds and cash in a vacuum, but where bonds really shine is when you add them to an existing stock portfolio. Bonds tend to rise when stocks fall. This means that a stock/bond portfolio is more efficient than a stock/cash portfolio. The stock/bond portfolio has historically averaged higher returns and experienced less of a drop during down markets than a stock/cash portfolio.

COEE

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Re: Why would I invest in bonds right now?
« Reply #18 on: January 12, 2019, 10:11:15 AM »
why invest in bonds when cash currently yields about the same minus the risk.

Looking at the current environment and deciding to hold more cash or jump from cash to intermediate, or intermediate to short, or any other combination thereof is market timing and is ill advised.  Why?  Because looking at the current environment is really looking at the very recent past to predict future returns - which is ultimately a losers game.

I suggest evaluating your goals, creating an IPS, and sticking to the plan.

The MMA and Intermediate Bond Funds discussed here are two very different investment vehicles that should be used to achieve very different goals.  A loss of 0.67% in an intermediate bond fund with an average duration of 5.63 years is transient and does not represent the bigger picture of buying FTBFX.  Buying FTBFX and holding will most likely outperform any MMA over the long term.  If the goal is to buy a new car in a year, then FTBFX is probably not a good investment to meet the goal.  If the goal is to buy an investment property in 10 years, then FTBFX is a great investment choice.

The point: Market timing is bad; Investing to meet your goals is good.

COEE

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Re: Why would I invest in bonds right now?
« Reply #19 on: January 12, 2019, 10:23:26 AM »
This is also a fun exercise to drive home my point (hopefully).

This website is a fun website to play around with.  I have preloaded FTBFX and FSHBX into the link.  Intermediate and short bond funds, respectively.  Both actively managed with durations of about 6 and 1.5 years, respectively. 

If you take the bar at the bottom of the graph and expand it to be about 1.5 years and slide the bar back and fourth, you will find that the short-term fund almost always had a positive yield for that 1.5 year period (with the exception of 2008).  Also note that the intermediate fund (FTBFX) had several occurrences of not yielding as much as the short-term fund (FSHBX).  It also had had a couple periods of losing value over 1.5 years.

Now expand the bar at the bottom of the graph to be about 6 years and slide the bar back and fourth - what do you see?  You should see that longer term bonds almost always outperform shorter bonds.

Unfortunately I couldn't find a prime MMF in this particular tool which would be a closer representation to a MMA than a short term bond, but a short term bond fund is close enough to make the point.

ETA: Here is another link comparing the following vanguard funds:
VBLTX long bond index - 14.7 year duration
VBILX intermediate bond index - 6.3 year duration
VBIRX short bond index - 2.7 year duration
VBTLX total bond index - 6.0 year duration
It's interesting to do a comparison of these as well.

It's also interesting to compare FTBFX and FSHBX - actively managed funds - as well.
« Last Edit: January 12, 2019, 11:49:23 AM by COEE »

Indexer

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Re: Why would I invest in bonds right now?
« Reply #20 on: January 12, 2019, 11:03:06 AM »
An extra detail I believe is important in 2019, the Fed isn't expected to raise rates nearly as much(if at all) in 2019 compared to the 4 increases in 2018.

While you can make an argument for a mmkt or ultra-shorts instead of a Total bond index during a period of rising rates that logic falls apart if rates are steady.

I'm also curious where you're getting an MMA with 2.45% yield.

Vanguard's Prime money market: https://investor.vanguard.com/mutual-funds/profile/VMMXX


Ah now we're getting somewhere. So to paraphrase, bonds are currently at or near a low point in their yields, and money market accounts are at or near a high point in their yields? So based on this info, it's just a random occurrence that money markets appear so favorable when compared to bonds at this point in time?


Not really. MMKTs normally pay slightly less than bonds, but rates were so low most of the past 10 years that mmkts were paying almost nothing. With rates normalizing mmkts are getting back to normal. In 2007 mmkts and bonds were very close, but when the recession came bonds were a much better bet.


Recession:
2007
VMMXX income 5.14%  (I know it seems impossible now, but mmkts were paying over 5% in 2007.)
VBTLX income 5.32%  + 1.7% appreciation = 7.02%

2008
VMMXX income 2.77%
VBTLX income 4.95% + 0.2% = 5.15%

2009
VMMXX income 0.53%
VBTLX income 4.37% + 1.67% = 6.04%

... fast forward to rising rates...

2015
VMMXX income 0.05%
VBTLX income  2.42% - 2.02%  = 0.4% 

Even with rising rates VBTLX was still better in 2015. It was also better in 2016 and 2017.

2018
VMMXX income 1.95%
VBTLX income 2.74% - 2.77% = -0.03%

Everyone is focused on the very recent past, 2018, but most of the time bonds are better than mmkts.

COEE

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Re: Why would I invest in bonds right now?
« Reply #21 on: January 12, 2019, 11:19:06 AM »
I'm also curious where you're getting an MMA with 2.45% yield.

Vanguard's Prime money market: https://investor.vanguard.com/mutual-funds/profile/VMMXX

That's a money market fund... No check writing ability and not FDIC insured.  A different investment than we're talking about upthread.

The best money market account I can find with check writing and FDIC insurance is through Sallie Mae Bank - 2.20% APY.
« Last Edit: January 12, 2019, 11:32:08 AM by COEE »

Radagast

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Re: Why would I invest in bonds right now?
« Reply #22 on: January 12, 2019, 01:21:43 PM »
A complete list of Vanguard Money Market Funds:
https://investor.vanguard.com/mutual-funds/profile/VMFXX
They all have check writing available (for checks larger than $250). But in general they don't seem easy to move around as a deposit account.

Outside of basic checking for money I need to pay for stuff every day, I would not invest in any FDIC account if it's yield was lower than Vanguard Federal Money Market Fund (VMFXX), which is at 2.3% right now. Also, about 50% of VMFXX income is free of state and local taxes, another advantage. For those with $50k sitting around there is a Treasury Money Market Fund that is 100% exempt from state and local taxes. And those are so safe I can only think of a handful of scenarios where I would personally use them, because safety is an expensive illusion.

COEE

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Re: Why would I invest in bonds right now?
« Reply #23 on: January 12, 2019, 06:26:35 PM »
A complete list of Vanguard Money Market Funds:
https://investor.vanguard.com/mutual-funds/profile/VMFXX
They all have check writing available (for checks larger than $250). But in general they don't seem easy to move around as a deposit account.

Outside of basic checking for money I need to pay for stuff every day, I would not invest in any FDIC account if it's yield was lower than Vanguard Federal Money Market Fund (VMFXX), which is at 2.3% right now. Also, about 50% of VMFXX income is free of state and local taxes, another advantage. For those with $50k sitting around there is a Treasury Money Market Fund that is 100% exempt from state and local taxes. And those are so safe I can only think of a handful of scenarios where I would personally use them, because safety is an expensive illusion.

I never realized Vanguard funds have check writing ability - I learned something new today - thanks for the info!  Still not sure I want to give up FDIC insurance.  Different strokes, I suppose.  I probably make up the very small difference by buying treasuries and I-bonds myself anyway.

MTBmustachian

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Re: Why would I invest in bonds right now?
« Reply #24 on: January 12, 2019, 06:49:39 PM »
Quote
I'm also curious where you're getting an MMA with 2.45% yield.

Thanks for all of this info! I really appreciate it.

The MMA is at CIT Bank… yeah, it’s pretty decent right now. No check writing but I can transfer money to my checking account online very quickly.

But I now better understand the argument you’re making for bonds—basically, over a longer period of time, they should outperform an MMA.

jacoavluha

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Re: Why would I invest in bonds right now?
« Reply #25 on: January 12, 2019, 06:53:03 PM »
money market is basically ultra short / short term bonds. so what you're really asking is why invest in intermediate term or long term bonds when you can get the same / almost the same yield in short term bonds. it's a common question, the scenario is the often discussed "inversion of the yield curve" so you can google that

me personally I try to match duration with my investing horizon. So most assets in total bond fund. First layer of emergency fund in MM. I don't try to be any smarter than that

Have a look at BND / VBTLX in Q4 2018 while equities were going down.

COEE

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Re: Why would I invest in bonds right now?
« Reply #26 on: January 13, 2019, 08:58:49 AM »
Quote
I'm also curious where you're getting an MMA with 2.45% yield.

Thanks for all of this info! I really appreciate it.

The MMA is at CIT Bank… yeah, it’s pretty decent right now. No check writing but I can transfer money to my checking account online very quickly.

But I now better understand the argument you’re making for bonds—basically, over a longer period of time, they should outperform an MMA.

I don't think the 2.45% CIT bank account is a MMA.  I believe it is a high yield savings account since it has no check writing ability.   The differences are minimal though.  Their MMA is yielding 1.85%.  It is not clear to me that it has check writing ability either, but I assume it does.

I personally only keep 2 months of emergency funds in my MMA.  It has check writing ability and can be used with a literal stroke of a pen when I get in an emergency situation.

I'm glad you understand the difference in wanting to buy a MMA/HYSA vs buying an intermediate bond.  I was able to learn a few new things while we discussed it as well!  Thanks to this discussion, I am considering adding long bonds to my investment portfolio for bonds that I don't think I will ever sell.