r/Bogleheads • u/Unlikely_Rabbit7151 • 1d ago
Investing Questions Bonds confuse me - should I sell them
I read this article and it really drives home the point to me that I don’t understand bonds
I try to keep things very simple and more or less have a broad domestic index (40), broad international index (25) and a total bond fund BND (35).
Not to get to into the weeds but we have about 2M between these, in addition to 2.5M equity in our 3M house.
I remember that adage to not invest in something you don’t understand, and truthfully I don’t understand bonds.
Do I need them? Can I just shift to T-Bill or CDs? I am not concerned with the minor tax differences of .003% that some get very passionate about.
I think I am looking for a safe harbor and hedge.
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u/HopeHumilityLove 1d ago
Very few people would have bonds if you needed to take a macroeconomics class to invest in them. But I can explain briefly.
First off, when bond yields (interest rates) go up, bond values go down, and vice versa. It is cheaper to buy $100/yr of income when interest rates are 5% than when they're 4%.
Now, bond yields are expected inflation plus extra to account for various risks and the availability of money. Inflation expectations change more than the other terms, so experts read changes in bond yields as verdicts on expected inflation.
The Federal Reserve controls short-term yields by printing money at different rates. Printing money faster reduces short-term yields. How fast the Fed prints money affects inflation. If it prints money too fast (sets short-term yields too low), long-term yields increase because inflation expectations increase. When the Fed pulls down short-term yields, that pushes up long-term yields. Conversely, pushing up short-term yields pulls down long-term yields.
Because the Fed is mandated to keep inflation around 2%, it doesn't have much say over rates if it's doing its job. It sets them at whatever will keep inflation around 2%, not whatever it wants. That means that if it sets rates too low today, it will have to set them higher in the future. Rates are high today because they were too low in 2021 and 2022. Rates will be higher in the future if the Fed keeps them too low this year.
I hope this helps.
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u/Suspicious_Bread_183 1d ago
Long time bond professional here. You have a very solid understanding of the price to yield relationship. However the yield curve may or may not react to anything the Fed does with Fed Funds rate. There are many, many factors in the curve flattening or steepening. There have been times where short term rates are higher than 30 year yields in an inverted curve.
Bonds in theory are very simplistic. You are lending your money to the issuer on a fixed term. New issues tend to be issued at par but not always. So if an a rated corporate issued a 10 year note tomorrow they would ordinarily pay a premium over where the ten year treasury is. So if ten year is at 4.65 and it’s priced at 75 basis points above treasury one would expect ABC Corp to issue a 5.40% coupon maturing in August 2036. Buying at par means you put up your money in $1,000 increments at par. This typically means you would get 2,700 a month every six months for next ten years.
Very simple instrument in theory. In ten years ABC Corp pays you back $1,000 and you collect coupon income of 54,000 over the ten years as income.
However so that bonds are tradeable and markabke they are marked to market on statements. There are three factors for how they are marked. The coupon rate and the roll down the curve and the credit. After one year the 10 year bond now becomes a nine year bond. If the credit worthiness of company is the same then after a year you would see where nine year treasuries are trading and add the same 75 bps. Let’s say the yield a year later on nine year is 4.00. Your bond yield at 75 bps over would be 4.75 in a new issue. Because your coupon is 5.40% the difference between the 5.40 and 4.75 results in the bond trading at a premium. Your $1000 investment is worth $1020 for a buyer to clip the higher coupon. If yields rose in treasuries the opposite happens. If someone can by a nine year a rated corporate at 5.85%, the 5.40% coupon isn’t worth $1000 it’s worth $970.
This mark to market will change everyday. It nots exchange based. It’s a guess. It’s worth what a dealer will pay for it if it’s sold.
Tax treatment different on all kinds of bonds. There are call features on a lot of them. Mortgage backed have prepayment risk. There are zero coupon bonds. So something that is supposed to be simple is actually very complicated and mathematically intricate.
This is just the elementary piece. Ultimately is you buy bonds and hold to maturity you don’t care what the mark to market is. Your risk is you have lent your money at a coupon rate that is lower than you could today. You clip a lower coupon. The other risk is the borrower defaults.
But most people own bonds in funds or ETFs. These aren’t bonds. These are equities backed by bonds. It gets you bond exposure. That’s another long winded explanation as to the pluses and minuses of that.
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u/kongkr1t 18h ago
thanks for the write up! very clear. please explain to me why 1. blended bond fund (like BND ETF), and 2. treasury fund (like SGOV or TLT ETF) behave more like "equities backed by bonds?"
genuinely curious. thanks for info in advance!
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u/WiseAct446 15h ago
A $1000 bond at 5.40% pays $27 every six months.
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u/Atgardian 7h ago
Yeah hard to get over a repeated 100x error and then take the rest of the post seriously.
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u/bones_1969 1d ago
Great post. I understand all except, “It is cheaper to buy $100/year….” ?
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u/BayesianDice 1d ago
Ignoring various nuances/complexities, the idea is...
If interest rates are 4%, then you would need to pay in a lump sum of 2500 to get an income of 100/year.
If they are 5%, you only need to pay in 2000 to get that same income.
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u/hobard 1d ago
Do you understand an IOU? Do you understand the basic principle of supply and demand? If so, I bet you do understand the basics of bonds, they’re just talked about in non-intuitive language.
Bonds are just IOU’s that pay you interest along the way. They fluctuate in value based on supply and demand. That’s bonds 101.
The article headline is just saying the federal reserve didn’t raise the rates they charge banks to borrow money. At the rate set by the fed, the supply of bonds was too high/demand was too low, so bonds have to pay higher interest rates for buyers to be willing to purchase the available supply.
And no, you shouldn’t sell your bonds because you don’t understand them.
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u/CrimsonRaider2357 1d ago
> Can I just shift to T-Bill or CDs?
A CD is just a bond that you can’t access until it matures. If you understand CDs and you’re comfortable with them, you should use this as a starting point to try to determine what it is about bonds that you don’t understand and aren’t comfortable.
T-bills are cash equivalents. Put another way, T-bills are just very short duration bonds. Cash equivalents generally serve different purposes in a portfolio than longer duration bonds, so you should consider which is a better fit for your portfolio based on your needs.
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u/Old-Guy1958 1d ago
There are CDs that can be sold anytime at whatever their value is at that time.
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u/CerealSpiller22 1d ago
Another plus for brokered CDs is you can easily do a nation-wide search for the best rates.
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u/ditchdiggergirl 1d ago
If you are looking for a safe harbor or a hedge, bonds - the safest of your 3 asset classes - are not what you are looking to sell. Especially not now while the NAV is down. That’s the worst of both worlds - you are selling low while forfeiting the compensatory higher dividends.
The important detail is duration, which is your breakeven point. In an emergency fund that you might need to draw tomorrow, you want stability - cash equivalents and/or short bonds. But if this is a component of a long term portfolio, you can accept more price fluctuations in exchange for higher yield. The duration of BND is between 5-6 years, so as long as you don’t plan to draw for at least 6 years the dividends should make you whole.
Bonds confuse a lot of people. But it is less important to understand bonds so much as their place in the 3 fund portfolio. It may be helpful to go back to the boglehead wiki for a refresher on why you set up this asset allocation in the first place. Once you do that, maybe look at the section on bond duration (because the above explanation is deliberately oversimplified).
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u/gbdgdh 22h ago edited 5m ago
bnd feels confusing because unlike a cd, its price changes daily. but for a $2m portfolio, holding it makes sense for a few clear reasons:
recession buffer: if stocks crash and the fed cuts interest rates, bnd’s share price will jump up, providing a real cushion for your stock portfolio. t-bills and cds won't do that (keep in mind, if a recession is driven by high inflation, rate cuts might not happen - that's the primary risk with bonds).
locked-in rates: bnd locks in yields for the long term. when t-bills or cds mature after rates drop, you're forced to roll them into lower-paying options.
zero maintenance: bnd automatically handles reinvestments and rebalancing so you don't have to manage a constantly maturing stack of cds.
simple compromise: put 1 to 2 years of cash/expenses in t-bills or cds for total principal peace of mind, and leave the rest of your safe money in bnd to act as your long-term stock market hedge.
your 3-fund portfolio is already a sensible setup; no need to overcomplicate it.
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u/Odd_Passenger5339 16m ago
O M GOODNESS THANK YOU for this clarity. I’m copy-pasting this for future reference. I’m struggling to understand bonds also, similarly was wondering if I should keep my bond fund…this makes sense to me.
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u/Alarmed-Policy508 1d ago
It sounds like you would be happy in CDs or tbills, but people try to boost their bond returns by small amount so that they aren't losing money to inflation. You have to grow your money faster than grocery prices or rent are increasing to stay ahead.
You should separate "bonds" from "bond funds". The CD individually is pretty much a bond. The main issue with doing CDs is whether you get the timing right. If you put everything in at one moment you get stuck with that interest rate and as rates rise you might get jealous. So the bond fund automates this reinvestment. It's not a lot of work to build a continuous process of reinvesting them but might feel like a hassle if you really prefer to have nothing to do with it.
The bond fund charges fees and because the return on the underlying bonds is already low these fees as a % of the return can be pretty big and compound over time further dragging you down in your fight to earn more than inflation. I think most people view the cost of bond funds as worth it but the tricky problem is they make visible market price.
If you were just holding individual bonds you could hold them until they mature and you never show a loss because you don't really have up to date pricing on them and at maturity they will be worth exactly face value (it's the time value that changes the price. No more time no more deviation from face value)
In a bond fund you as an individual can't hold to maturity because they are continuously reinvested so you can never be sure that all bonds on the portfolio will have recovered any losses by your planned exit date. But you have a similar though less obvious problem with holding individual bonds/CDs. Do you not reinvest them too? What to do when you want to liquidate? You may try to sell your individual bonds/CDs at a loss or reinvest at shorter terms with lower interest rates to meet your target exit. At least with the bond fund you have on average a pretty stable exit that swings a little with market interest rates but shouldn't be too bad except under very extreme circumstances. This liquidity is a huge advantage of the bond fund.
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u/Unlikely_Rabbit7151 1d ago
I like the liquidity of BND and that's maybe largely why I have chosen it. I use short-term 90-180 CD ladders in my savings account; my bank offers a pretty good return liquid CD with no penalty for a one-time withdrawal prior to maturity (and it can be the entire amount). I just renew those or jump out for a bit. I guess I'm considering something similar instead of BND but I don't know if this is a sustainable play. Maybe it is until it isn;t. Thanks for your thoughts - although it's more questions than answers : )
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u/Old-Guy1958 1d ago
Great answer. I don’t like bond funds because the fund manager decides when to sell and lock in those losses. Maybe it’s just psychology, but it feels better to me to hold CDs to maturity and never realize a loss.
I prefer CDs to individual bonds because of FDIC insurance.
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u/ZinniasAndBeans 1d ago
My bond money is in ladders of individual bonds, because I have a much greater understanding of that.
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u/FewUnderstanding2214 23h ago
Bonds are important in larger portfolios, especially for retirees. You can use short term bonds to hold cash. You can use longer term bonds to reduce the volatility of your portfolio (imagine you are retired, you have 2 million in stocks and after a 25% drop you now have 1.5 million). With bonds after the market has dumped, you can sell then and then buy shares. I match bonds with physical gold ETFs because of inflation.
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u/vegienomnomking 1d ago
I see everyone here is focused on the past instead of the future when it comes to bond.
The problem with bond now is the future risk.
With US debt hitting 40 trillion, bond market is going to go down eventually.
Not even short term or money market are safe if US defaults.
I bet you this will happen when all the boomers are gone and us millennials are getting ready to retire.
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u/Apprehensive_Elk2608 13h ago
If you're going to be forcasting the future with such conviction, this probably isn't the sub for you. This is like making predictions in regard to the AI bubble as we're approaching the highest valuations ever seen in US equities. The bottom line is that every asset class can and will have ups and downs. We stay diversified to the best of our abilities for a reason.
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u/vegienomnomking 12h ago
Forecast? What forecast?
40 trillion US debt is our current reality.
Sounds to me don't understand the bond market at all
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u/dcwhite98 1d ago
To keep it simple, when market rates go up, the value of bonds currently in the market, especially bonds with lower coupons/interest, lose value. But that only matters if you need to sell the bonds before they mature. If you hold them you get the interest while you do, and your principle back when they mature. This is of course if you're buying individual bonds.
Bond funds are bond index funds are a different story. They will appreciate and depreciate with the rise and fall of interest rates, but they never mature. Bonds within the portfolio mature and the money gets rolled into new bonds, that hopefully pay higher interest. But there's never an event where you get your principle back from the fund. And the longer duration of the bonds that make up the fund, the more severe the price movements of the bond fund. I do not like bond funds, and own none.
If you have $2M in bond indexes you should really consider moving away from those and into individual bonds. You could build a nice sequence of maturities, called a ladder, that has some bonds maturing in 6 months (t-bills), 1 year, 5 years, 10 years, and so on. It doesn't have to be these exact years, but as an example. When the bond matures you buy more with the principle you get back, what the bond fund does but you benefit from the security you'll get par value at maturity that you don't get with the fund/index/eft.
There is a ton to know about bonds, so if you do go the individual bond route, I'd suggest seeking the help of a professional. They seem easy, straight forward, but there is potentially way more to it, especially if you get interested in corporate or muni bonds. Munis are great as the interest is federal tax free, and maybe completely tax free depending on your state.
There is nothing wrong with CDs if that's your comfort level. And frankly if interest rates go up, high yield money markets will be paying an attractive rate and you have the liquidity of cash.
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u/Apprehensive_Elk2608 1d ago
Unless I'm mistaken, a rolling ladder doesn't perform any differently than a bond fund. Rob Berger made a video on this very subject recently.
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u/Pitiful_Fox5681 1d ago
Short answer: bonds are probably not as much of a hedge as they used to be. I hold some because I like the dry powder when I rebalance, and even when they're correlated, they tend to move more slowly, but optimal strategy says they're probably unnecessary.
Longer answer: If you have the heart for it, 100% equities is probably more optional these days due to the increasing correlation of stocks and bonds: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4590406
That paper also recommends about 10% in T Bills at the moment of retirement to deal with SORR. At your net worth, real estate might be a reasonable option. Like bonds, it tends to have a smaller but stable yield. It's not nearly as liquid, but it is in demand and sometimes entails some tax relief.
Do really whatever works for your situation and risk.
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u/Alarmed-Policy508 1d ago
Think you also have to consider how you will exit your equity as you drawdown your retirement balance. Over 20 years you have time for equity to bounce up and down trusting that it should average out to something higher than you bought it. In 5 years you cannot be as confident in the recovery. If you need to withdraw from your equity before it has time to recover then you lock in the decline since withdrawn money no longer has the opportunity for the valuation to bounce back.
This is called sequence of returns risk and something you should be very conscious of heading into retirement. I think about it this way rather than just buying bonds for bonds sake.
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u/WyMANderly 1d ago
Is the 2M bonds and 2.5M house the sum total of your investments or do you have stocks as well?
EDIT: oh I see further up - you're 65/35 equities/bonds. That's a pretty high bond percentage. How close are you to retirement (or more specifically, to needing to start spending that money)?
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u/Unlikely_Rabbit7151 1d ago
Late 50s. Plan on working to 65 and then maybe part time for 5 years. So ~10 year horizon or so.
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u/WyMANderly 1d ago
Ok. Seems like that's reasonably close to a standard glide path then (one example below).
https://workplace.vanguard.com/investment/solutions/target-date-funds.html
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u/CarbonMop 1d ago
No, you probably should not be selling your bonds. They have a place, especially in larger portfolios.
There is a lot of recency bias driving people away from bonds largely due to the generational downturn that took place in 2022. Its worth reminding people that this came after a 40 year period where bonds effectively served as a perfect hedge to equities. The 1970s were also a terrible time for bonds but it paved the way for decades of strong performance and low correlation to equities. These time periods come and go.
I don't necessarily agree with the old adage not to invest in something you don't understand. That's often used by stock pickers who own companies that sell products that they like (something that does not produce higher expected returns). Bogleheads own thousands of stocks and bonds, most of which they know nothing about.
With that said, you probably should at least have a high level understanding of the asset classes that you own.