Well. Here we are in Part XII of our series on Stocks. And the subject is Bonds. What’s up with that??
When I first began this series the plan was for maybe four or five segments. Sure enough, those focused on stocks. But then we looked at some portfolio ideas and some other stuff, like bonds, got added to the mix. Next thing you know we looking at different kinds of investment buckets, the prospect of Vanguard getting nuked and asking if everyone can retire a millionaire. (Clearly, I should have called this my series on Investing. Note to self: make the change for the book.)
So now adding Bonds to the mix seems not such a stretch. They are, in a sense, the more steady and reliable cousins to stocks. Or so it seems. But as we’ll see, bonds are not as risk free as many believe.
In any event, since we have included Vanguard’s Total Bond Market Fund, VBTLX, to the Wealth Preservation and Building Portfolio we should take a little closer look at the things.
The challenge is the subject of bonds is a BIG topic. Most of the details are unlikely to be of interest to the readers of this blog on simple investing. Heck, they’re not all that interesting to me. Yet, unless you are comfortable just taking my word for it, you might want to know just what these things are and why they’ve found their way into our portfolio.
But how much info is enough? Beats me. So here’s what we’ll do. In this post I’ll talk about bonds in Stages. Once you’ve read enough to be comfortable owning the things (or not) you can just stop reading. If you get to the end, the point where I’m too bored to write more, still hungry — google is your friend.
Info Stage I
Bonds are in our portfolio to provide a deflation hedge. Deflation is one of the two big macro risks to your money. Inflation is the other and we hedge against that with REITS (real estate). Ying and yang.
Bonds also tend to be less volatile than stocks and they serve to make our investment road a bit smoother.
Info Stage II
So what are bonds anyway, and how do they differ from stocks?
In the simplest terms: When you buy stock you are buying a part ownership in a company. When you buy bonds you are loaning money to a company, or to the government.
Since deflation is when the price of stuff falls, when you get paid back the money you’ve lent has more purchasing power. Your money buys more stuff than when you lent it. This increase in value helps to offset the losses deflation will bring to your other assets.
In times of inflation prices rise, so money owed to you loses value. When you get paid back your cash buys less stuff. Better then to own assets that rise with inflation. Real estate fits that bill and REIT funds allow us to own a broadly diversified portfolio of properties without the hassles of hands on management. Our REITs should rise in value even as inflation erodes the value of the money tied up in our bonds.
We’ll only see this sharp rise in the one and fall in the other in times of rapid inflation or deflation. Both of which are bad times. In the more normal times of modest inflation our bonds and REITS will still serve us well. Bonds will pay their interest and REITs their dividends.
Info Stage III
Since we own our bonds in VBTLX, a broad-based bond index fund, most of the risks in owning individual bonds go away. The fund holds 5248 bonds, all investment grade and none rated lower than Bbb (see Stage IV). This reduces default risk. The fund holds bonds of wildly differing maturity dates, mitigating the interest rate risk. The fund holds bonds across a broad range of terms, reducing inflation risk.
In the next Stages we’ll talk more about these risks, but what’s important to understand at this point is: If you are going to hold bonds, holding them in a fund is the way to go. Very, very few individual investors opt to buy individual bonds. US treasuries and bank CDs being the exceptions.
Info Stage IV
The two key elements of bonds are the interest rate and the term. The interest rate is simply what the bond issuer (the borrower) has agreed to pay the bond buyer (the lender — you). The term is simply for how long the money is being lent. So, if you were to buy a $10,000 bond at a 10% interest rate with a 10 year term from XYZ company, each year XYZ would pay you $1000 interest (10% of 10k) and at the end of 10 years they would repay the full $10,000. If you hold the bond until the end of the 10 years, or to the Maturity Date, the only thing you have to worry about is the possibility of XYZ defaulting.
So, default is the first risk associated with bonds. To help investors evaluate the risk in any company or government bond, various rating agencies evaluate their credit worthiness. They use a scale ranging from AAA on down to D, kinda like high school. The lower the rating the higher the risk. The higher the risk the harder it is to find people to buy your bonds. The harder it is to find people to buy your bonds the more interest you have to pay to attract them. Investors expect to be paid more interest when they shoulder more risk.
So, default risk is also the first factor determining how much your bond will pay you. As a buyer of bonds, the more risk you are willing to accept the higher the interest you’ll receive.
Info Stage V
Interest Rate Risk is the second risk factor associated with bonds and it is tied to the term of the bond. This risk only comes into play if you decide to sell your bond before the maturity date at the end of the term. Here’s why:
When you decide to sell your bond you offer it to buyers on what is called the “secondary market.” Using our example above these buyers might offer more than the 10k you paid, or less. It depends on how interest rates have changed since your purchase. If rates have gone up, the value of your bond will have gone down. If rates have gone down, the value of your bond will have risen. Confusing, no? Look at it this way:
You decide to sell your bond from our example above. You paid $10,000 and are earning 10%/$1000 per year. Now, let’s say interest rates have risen to 15% and I have $10,000 to invest. Since I can buy a bond that will pay me $1500 per year, clearly I’m not going to be willing to pay you $10,000 for your bond that only pays $1000. Nobody would, and you’d be stuck. Fortunately, however, the secondary bond market will calculate exactly what lower price your bond is worth based on the current 15% interest rate. You might not like the price, but at least you’ll be able to sell.
But if interest rates drop, the roles reverse. If instead of 10% they fall to 5%, my $10,000 will only buy me a bond paying $500 per year. Since yours pays $1000, clearly it is worth more than the $10,000 you paid. Again, should you wish to sell, the bond market will calculate exactly what your higher price will be.
When interest rates rise, bond prices fall. When interest rates fall, bond prices rise. In either case, if you hold a bond to the end of its term you will, barring default, get exactly what you paid for it.
Info Stage VI
As you’ve likely guessed, the length of the term of a bond is our third risk factor and it also helps determine the interest rate paid. The longer the term of a bond the more likely interest rates will change significantly before it matures and that means greater risk. While each bond is priced individually, there are three bond term groupings: Short, medium and long. Looking at US Treasury Securities for example we have:
Bills — Short-term bonds of 1-5 year terms.
Notes — Mid-term bonds of 6-12 year terms.
Bonds — Long-term bonds of 12+ year terms.
Generally speaking, short-term bonds pay less interest as they are seen as having less risk since your money is tied up for a shorter period of time. Accordingly long-term bonds are seen as having higher risk and pay more. If you are a bond analyst type, you’ll graph this on a chart and create what is called a Yield Curve. The greater the difference between short, mid and long-term rates, the steeper the curve. This difference varies and sometimes things get so wacky short-term rates become higher than long-term rates. The chart for this event produces the wonderfully named Inverted Yield Curve and it sets the hearts of bond analysts all a flutter.
Info Stage VII
Inflation is the biggest risk to your bonds. Inflation is when the cost of goods is rising. When you lend your money by buying bonds, during periods of inflation when you get it back it will buy less stuff. Your money is worth less. A big factor in determining the interest rate paid on a bond is the anticipated inflation rate. Since some inflation is almost always present in a healthy economy, long-term bonds are sure to be affected. That’s a key reason they typically pay more interest. So, when we get an Inverted Yield Curve and short rates are higher than long rates, investors are anticipating low inflation or even deflation.
Info Stage VIII
If you’ve read this far, I have a secret to share and a confession to make. I no longer hold my personal bond allocation in VBTLX. For now, I’m using VFIDX. This is Vanguard’s Intermediate-Term Investment Grade Index Bond fund.
This change is buried here because it doesn’t fit with the basic concept of the Simple Path; namely an investment strategy that can be set and left to run with minimal attention. Meeting that parameter is best served with VBTLX and its coverage of the entire bond market. That’s still the recommendation I stand by for the Simple Path portfolios, and I’ll personally be returning to it in the future.
But if you have a more active investing inclination, as I do, you might want to consider VFIDX for the time being. Here’s my thinking:
- A few short years ago we were teetering on the brink of a deflationary depression like that of the 1930s. Very scary stuff.
- The antidote is a nice solid bit of inflation.
- This is exactly what the Fed is trying hard to spark.
- The Fed has been aggressively pumping money into the system and has taken short term rates to zero. Historic lows.
- Surprisingly inflation has remained low, but that is sure to change.
- Likely fast and hard.
In this environment short-term bonds are paying next to nothing. Long-term bonds will get hit hard when inflation reignites. Intermediate bonds pay a decent interest rate and their term makes them less vulnerable than long bonds to inflation. It’s like Goldilocks and the Three Bears. Papa’s bed is too big. Baby’s bed too small. But Mama’s medium term bond bed is just right. For now, I’m hangin’ with Mama.
Info Stage IX
Here are a few other risks:
Credit downgrades. Remember those rating agencies we discussed above? Maybe you bought a bond from a company rated AAA. This is the risk that sometime after you buy the company gets in trouble and its rating is downgraded. The value of your bond goes down with it.
Callable bonds. Some bonds are “callable,” meaning that the bond issuer can pay them off before the maturity date. They give you your money back and stop paying interest. Of course they would only do this when interest rates are falling and they can borrow money more cheaply. As you now know, when rates fall the value of your bond goes up. But if it gets called, poof! There goes your nice gain.
Liquidity risk. Some companies are just not all that popular and that goes for their bonds. Liquidity risk refers to the possibility that when you want to sell few buyers will be interested. Few buyers = lower prices.
All of these risks are nicely mitigated simply by owning a broad-based bond index fund.
Info Stage X
There are precisely a gazillion different types of bonds. Basically they come from national governments, state and local governments, government agencies and companies. Term length, interest rates and payment terms are limited only by the imagination of the buyers, sellers and regulators. Further….
…and here’s where my interest in writing about these things drifts away. ~2200 words is enough. Nothing further matters for us index fund bond investors. But if you just have to know more, Google is your friend. Be sure to report your findings in the comments.
31 Comments
Don’t want to waste much of your time, but if it is raining and you cannot ride your motorcycle, and you are bored, can you please take a quick peek at the Vanguard Canada products?
https://www.vanguardcanada.ca/individual/etfs/etfs.htm
Mainly, I (and many of your Canadian readers I am sure) am interested in your opinion considering relatively low amount of assets and small number of holdings (with exception of US index one). For example, Canada Index ETF only has 100 or so stocks, and at times, certain stocks represented huge chunks of Index (for example, Nortel at one point represented 36% of the entire Toronto Stock Exchange, and most recently, RIM of course – and both had incredible drops).
Also, I am still trying to figure effect currency exchange is going to play when buying Vanguard US Index funds (what do they mean by CAD$ hedged?)??? For example, I could buy Vanguard ETF’s in US dollars and through US stock exchange (via Questrade), and I could also buy them in Canada from my tax-free savings accounts or my RRSP account. I am just not sure what is better option, assuming that Canadian dollar is at historical heights and only has one way to go (down). I am assuming that it is better to buy in US funds but I am not certain (I am VERY green when it comes to investing).
I second this post by Mr. RS. I am another green Canadian trying to figure out my investing plans outside of Canada. I’m excited for Vanguard Canada’s new ETF’s to launch in December and having a mind like yours take a peak at them and translate into your writing style would be greatly appreciated eh.
Hi Mr. RB and Mr. HB…
Well, it is a rainy day today….
Just took a quick look. VUS – https://www.vanguardcanada.ca/individual/etfs/etfs-detail-overview.htm?portId=9551- is (as a total US stock market index fund) a match for VTSAX, with an interesting twist and a bit higher expense ratio.
They are operating this fund using, to quote from the description “derivative instruments to seek to hedge the U.S. dollar exposure of the securities included in the MSCI U.S. Broad Market Index back to the Canadian dollar.” All that means is operating the fund with the goal of mitigating the currency risk inherent as the Canadian and US dollars fluctuate in value relative to each other. This is probably why the expense ratio is a bit higher.
If you were to buy VTI – https://personal.vanguard.com/us/funds/snapshot?FundId=0970&FundIntExt=INT – (the US ETF) your investment would be in US dollars. When it comes time to sell and convert back to Canadian dollars your return will be effected by any change in the exchange rate between the two currencies.
Basically, you have then made two investments: One in stocks and one in the US dollar. If that is your intent, no problem. Just be sure to understand that’s what’s happening when you buy VTI, whereas VUS is attempting to remove it from the mix.
Finally, you give me pause when you say “assuming that Canadian dollar is at historical heights and only has one way to go (down).” You may have excellent reasons for coming to this conclusion. But predicting the direction of currency values is a very tricky prospect. Be careful.
I certainly have no idea what the future for the CA dollar holds, although since I like visiting Canada, down works for me.
Hope this helps!
Again, wish I had understood this long ago!
So, generally, if I hold a bond until it matures, I don’t care about the yield.
And holding a bond fund, I don’t even care about the individual funds. and if I think inflation is coming, then houses are better than stocks and stocks are better than bonds. Thank you!
Glad to help, but let me clarify a couple of points.
“if I hold a bond until it matures, I don’t care about the yield.”
Actually, we always care about the yield. It is the main reason to buy bonds. ‘Yield’ is a bit of a tricky word in the bond world, having a couple of different definitions. Which is why I avoided it in the post. But, for our purposes, think of it as the interest rate a bond pays.
“And holding a bond fund, I don’t even care about the individual funds.”
I think you meant to say: And holding a bond fund, I don’t even care about the individual bonds in the fund.
“if I think inflation is coming, then houses are better than stocks and stocks are better than bonds.”
Generally, yes. But, and as the seasoned RE investment pro I know you to be you know this, it depends on the specific houses and their location.
Okay, then maybe I’m not as clear as I thought. I thought interest is one thing, but yield is the difference in the attractiveness of the bond in the secondary market as interest rates change. So I’ll go back and reread things – slowly.
And about those houses, yes, they’re not bad. I still have a few, maybe 6.
But if I had known what I’ve learned from your blog long ago, I would reconsider buying anything!
or maybe I’ve not been as clear as I should be. It can be confusing stuff, so if you still have quetions please don’t hesitate.
6 houses. wow!
Good introduction piece, but I disagree on your last point there, Jim. The type of bond does have an important feature- tax exemption! Interest income exemption from federal and/or state taxes can have a sizable impact on returns, and is worth discussing.
Hi Gestalt….
Nice to see you here.
Point well taken, and this is the problem with writing about bonds: Where to draw the finish line.
Tax exempt munis (municipal bonds) are certainly a worthy topic and could easily be a post all their own. I’ve always been impressed with your knowledge on the MMM forums, so please feel free to add to my comments if you care to.
In short, these are bonds issued by local governments and government agencies, typically to fund public works projects like schools, airports and the like.
While offering lower interest rates than other bonds they have the advantage of being exempt from the Federal income tax and, for the state in which they are issued, state income tax.This makes them appealing to folks in high income tax brackets, especially if they live in a high income tax state.
Since they are not held in our simple path bond funds, VBTLX and VFIDX, I merrily skipped ‘em for this post.
Vanguard has several funds devoted to munis, including several focused on specific states. Anyone interested can check them out here:
https://personal.vanguard.com/us/funds/vanguard/all?sort=name&sortorder=asc
BTW, thanks for occasionally linking my posts on Reddit. I always see a flow of new readers when you do.
That’s a good explanation of Muni bonds. It should also be noted that interest from U.S. Treasury Bonds (which are widely held in our favorite bond index funds) is exempt from state and local taxes, which if you live in a high-tax state like me (NY), can boost your returns somewhat (in my case, over 6% in tax exemption). I’m sure your Nevadan readers will care less. It should also be noted that there is a school of thought that believes that the tax point is moot, as the returns on muni bonds are low enough (compared to corporate bonds) to offset the tax advantages they provide.
I make sure that our readers in the subreddit are exposed to the most kickass FI articles from around the web. Keep on writing kickass articles, and I’ll make sure they get posted.
great points, especially the balance on return between munis and corp. no free lunch.
Mmm….
I should have hit you up for a guest post on this. Bonds are my least favorite investment topic.
Thanks for spreading the word!
The Canadian Couch Potato recently reviewed the new Vanguard ETFs, I suggest our Canadian readers check out this really useful blog:
http://canadiancouchpotato.com/2012/09/06/vanguard-announces-five-new-etfs/
thanks Tara….
…that should help.
So, I’ve been worried about the inflation thing myself, and currently not being in bonds at all I’m wondering if I should just continue to stay out of them. But I’m wondering also in your case why VIPSX isn’t what you’d go for. Or how you would feel about I bonds (besides their very small purchase limit) or straight up TIPS. Is it that your timeframe is such that VFIDX will slowly go up as the current bonds in it expire and are replaced with higher-value ones and you just plan to ride it? Or is it that VFIDX hedges against multiple outcomes while VIPSX only hedges against inflation? Sorry if that doesn’t make too much sense.
Hi Sheep….
Mostly because I see a negative yield and too much risk in VIPSX and the TIPS (Treasury Inflation Protected Securities) it invests in.
10 year TIPS sold at a -0.75% yield at the last auction. That’s right, a negative return. This gets a bit tricky as you need to subtract inflation from the bond’s coupon rate to get the real picture. The inflation protection the government provides on the yield comes at a very high cost.
But even more importantly remember what we learned in Stage V above. When rates fall, bond prices rise. The last few years TIPS (and other bonds) have done spectacularly well as the Fed has relentlessly lowered interest rates.
But now rates are at zero. No place else to go but up. TIPS with their negative yield actually cost you money to own.
If the Fed succeeds in reigniting inflation, their next step will be to raise interest rates to keep it from raging out of control. When that happens, TIPS will get killed. As will the long-bonds we discussed above.
Intermediate bonds, like those in VFIDX, will get hurt too. But at least we are earning a positive yield on them and their shorter maturities will help.
Either way, this is another reason you definitely want to own your bonds in a fund.
Since funds hold so many bonds, all bought at different times with different maturity dates, some will be getting paid off freeing up money to reinvest in new bonds paying higher rates. That should soften the blow.
In theory anyway.
But if the Fed loses control of inflation, bonds will be a very bad place to be. But our REITS should improve at the same time. We own both, ’cause you can’t predict the future. At least I can’t.
Arg, browser crashed and ate my reply but I basically wanted to say thank you for the reply. I think the TIPS thing does make sense to me because I guess the interest rate is set by the market when they’re sold. Also you inspired me to look more into I bonds and I read something that made me realize you always lose against inflation if you buy with a fixed rate lower than your tax rate.
Nicely done. I was wondering when the post on bonds was coming. Even though we can’t predict the future, I’m finding it difficult to pull the trigger on bond buying with rates this low.
I’m with you on that one. My saving’s account yields more. But it’s great to hear someone actually discussing the dangers of DEflation. A topic that doesn’t get enough attention.
Hi FF….
It does surprise me that deflation has gotten so little attention. Especially since a couple of years back we were teetering right on the brink.
I chalk it up to the fact that only the very eldest of us around have any experience with it.
If it happens, cash and bonds are where you want your money. Of course, if we get inflation instead the game changes completely. That’s why I hedge for both.
Thanks Prob8…
…easy to understand your reluctance. The only reason to own them is for deflation protection and income. The first is looking less likely and there’s not much of the second to be had at the moment.
With rates falling these last few years the cap gains have been nice, but it’s hard to see how that continues.
Still, I’ll hold mine as part of a balanced diet.
This is a great post! A small typo: I think that Stage XI should be Stage IX.
If you’re ever looking for a new post topic, I’d love to see more on deflation. I’ve always been confused about it and about it’s consequences. It seems like it would be a good thing, and yet….
This explains a lot about bond funds. Now I just have to figure out what to do with the EE savings bonds I got as a kid. I looked them up online and apparently they’re earning interest, but of course I’m not collecting anything, since right now they’re just pieces of paper sitting in a drawer. So confusing!
Thanks for providing some clarity to the topic of bonds!
Thank you CR…
…and thanks for the proofreading catch. Correction made.
I’ve been pondering your question on deflation and there seems no short answer, so a future post it is!
Not surprising that you find it a bit confusing. In some cases and in small doses it is a good thing. In other cases it is the ugly dance partner leading depression across the floor. We’ll look at both.
Hello fellow Canadians and Mr. Collins (thank you for your great work, I am learning a lot from you). I just compared VTI and VUS myself and made the decision to go with VTI. I have been monitoring the Canadian dollar and it’s relative strength to the USD and went with the economists who convinced me that the CDN is 10% above it’s historical value. While in the short-term the loonie may stay high due to all the quantitative easing, I think Canada is about to suffer some weakness in housing which will gradually reduce our dollar. Certainly this is just one person’s opinion, but I’d rather bet on the USD over the long-term and hopefully enjoy the potential triple benefit of a rising US stock market, lower MER, and a little currency arbitrage for good measure. The .60 to .70 loonie is still very fresh in my memory!
Hey Alram…
thanks for sharing your plan and, more importantly, your thinking behind it.
Just wanted to say thanks for this whole series. It’s entries like this that make me grateful for the blogging community. I never got into economics or finance at university partly because an article like this would have taken two weeks to cover in class, with all of the associated hand-holding. This was so much more comprehensible and useful to real-world me than any of the classes I took in econ back then. Please keep up the great work, it’s really helpful!
Also, quick clarification question to make sure I’ve got this down — the reason you shy away from long-term bonds right now is because the rates are currently low across the board (short, intermediate, and long-term), and once inflation increases those rates will be insufficient to make up for the lost future value. Or is it because in a low-inflation or deflationary economy the short-term and intermediate rates are proportionately higher relative to long-term rates, compared to an inflationary economy? Or both? So right now you’re in intermediate, which has slightly lower rates than the long-term but also lower risk, and once inflation picks back up the rates for long-term will increase as well to make up for lost future value and at that point it makes more sense to shift back to long-term? It seems like if you buy long-term in a period of high inflation, when inflation drops that gives you the double benefit of less value lost through inflation than expected, as well as the leftover higher rate. I’m not even considering purchasing right now, just want to understand the interplay between inflation, rates, and yields.
Thanks again!
Thanks LCC! (Intriguing handle you have there, BTW.)
Let me break down your questions and try to clarify:
“….shy away from long-term bonds right now is because the rates are currently low across the board (short, intermediate, and long-term), and once inflation increases those rates will be insufficient to make up for the lost future value.”
Correct!
“Or is it because in a low-inflation or deflationary economy the short-term and intermediate rates are proportionately higher relative to long-term rates, compared to an inflationary economy?”
No. If we were to go into a long deflationary economy, US government long bonds would be your friend. US Government bonds to reduce default risk. Long term because your money will steadily gain value over the life of the bond as the price of goods and services declines. (I have a post on deflation coming soon.) Bond prices go up when rates go down.
“So right now you’re in intermediate, which has slightly lower rates than the long-term but also lower risk….”
Yes. The Fed is working hard to ignite inflation and I think they’ll succeed. ‘Don’t fight the Fed.’ as the Wall Street saying goes. With inflation will come higher interest rates and long bonds will drop in value. Short bonds have the lowest inflation risk, but currently pay nothing. Intermediate bonds pay a decent rate but don’t lock me in like the long bonds would. They are the happy middle choice.
“…and once inflation picks back up the rates for long-term will increase as well to make up for lost future value and at that point it makes more sense to shift back to long-term?”
Yes, but it won’t make up for future lost value. It will just mean long-bonds, in fact all bonds, will pay better rates with less risk. Unless, of course, the Fed over shoots and we get excessive inflation. If that happens the game changes again.
This is why I still recommend https://personal.vanguard.com/us/funds/snapshot?FundId=0584&FundIntExt=INT, the Total Bond Market Fund for my recommended portfolios. It won’t give the top performance that all this dancing might, but it can absorb both scenarios and investors don’t have to worry about it.
“It seems like if you buy long-term in a period of high inflation, when inflation drops that gives you the double benefit of less value lost through inflation than expected, as well as the leftover higher rate.”
True, but a little like saying if you buy stocks when the market goes up you’ll make more money. The trick is to know when that is. In the early 1980s here in the US we had very high inflation. You could buy 30-year US Treasuries, probably the safest investment in the world, that paid 16, 17, 18%. Locked in for 30 years. Looking back it is hard to imagine a much better investment.
Problem was at the time people thought inflation was going to continue to rise and that would have destroyed these bonds.
Turns out, inflation fell and they were golden.
Right around the same time Business Week ran a story with this headline emblazoned on the cover: The Death of Equities.
The theme was that stocks had taken such an inflation beating that no one would ever be silly enough to own them again. Turns out that marked the beginning of the greatest bull market in history.
Hope this helps!
That’s fantastic, clears things right up. Thanks again!
I enjoy your blog. After reading your post on bonds I got to looking at the yield on my Vanguard short term bond index fund VBIRX and it was only 0.54%. Your VFIDX was >2% and the duration was not too much longer. I switched some funds to VFIDX for potentially better returns for the increased bond term. I then read an article by Larry Swedroe on why you should keep government bond (like VBIRX) instead of corprate bonds (like VFIDX).
http://www.cbsnews.com/8301-505123_162-57524713/better-returns-more-stocks-or-riskier-bonds/?tag=cbsnewsMainColumnArea
This reminded me why you want to hold uncorrelated investments. I am tired of low bond yields like everyone else, but I don’t need to have bonds crash with stocks.
I am curious what you think about Swedroe’s article.
I agree with Swedroe’s article. Basically what he is saying is that bonds become riskier with lower credit ratings and that much below “a” they take on risk profiles similar to stocks. But 80% of what VFIDX holds is rated ‘a’ or higher and nothing is below ‘b’
A ‘junk’ bond fund like this one is closer to what he is discussing:
https://personal.vanguard.com/us/funds/snapshot?FundId=0529&FundIntExt=INT#hist=tab%3A2
High yield and high, stock like, risk.
You have identified the low rate VBIRX pays you and in return you are getting a low risk profile. It’s perfect if that is your goal.
For me, the higher yield of VFIDX is worth the somewhat higher risk. But I’ve also got my finger on the trigger and am watching closely for signs of inflation.
For the simple wealth portfolios I have created and recommend here VBTLX is the way to go, as I said in the post.
I would still conclude that bond investments as well as stock investments are somewhat dangerous right now. In fact at any given time, there is some level of risk associated with any investment. It’s the nature of investing. Risk is a funny thing. When the stock market is rip roaring, most everyone is willing to take a little more risk than they really should, and when the market is depressed, most are so fearful that little to no level of risk can be tolerated. Neither of these extremes makes for good investing. Thanks for the post.
Yep. Risk is a constant companion with each and every investment. Even cash in the bank, or mattress, carries a healthy dose of inflation risk.
As you point out, we tend to be bold when we should be cautious and cautious just when it’s time to be bold.
This is why, all the way back in Part I, I said:
“Recognize the counterproductive psychology that causes bad investment decisions and correct it in yourself.”
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