03-15-2021, 07:04 PM
Let me rephrase the title.... Don't ever invest in bonds if you do not understand the basic fundamentals. I am no bond guru for sure, but I have warned a few here to be careful and I think it deserves a thread now.
Here are a few bond proverbs I've heard oft repeated my entire investing career that spans over 35 years....
-Bonds are part of every diversified portfolio.
-Subtract your age from 100, invest the resulting in equities, the rest should be in bonds for diversification.
-Bonds are safer than equities.
-When you retire you should have at least 40% of your assets in bonds. Even more as you age.
Well that was then and this is now. I never followed any of that advice. I held a small amount of diversified term bonds (fund) through the decades. It was my belief equities would outperform. Bonds weren't so horrible. Long-term bonds tended to rise when equities corrected. Your bonds might be up 20% when the stock market corrected 20%. I could flip your bonds to stocks and buy some stocks on sale every few years.
It was all good as interest rates on average slowly dropped for four decades. 2019-2020 were more than pretty good years for bonds. So what is the problem? If you aren't aware, the value of your bond capital moves inversely to interest rates. If you are in bonds and interest rates drop 2% then your portfolio (individual bonds, mutual funds or you ETF is worth more money as it is invested at an above market rate). The inverse is just as true. It's no small matter if you are on the wrong end of the rate move. Here is an example and I will round the numbers.
Vanguard Extended Duration ETF EDU. It's a respected fund. Vanguard does nothing unnecessarily reckless and their bond funds have above average ratings. EDU yields 2.2% currently. It's invested in US Treasury bonds mostly over 20yrs in duration. US Treasuries are about as safe as anything in this world. Your capital is down 17% YTD. That is only 10 weeks! It will theoretically take you 8 years to be even if interest rates were level from here. What caused this? A 3/4% rise in interest rates. That's not much, but on a percentage basis it is at near zero short term interest.
This is much of the reason investors are paying too much for equities with a modest dividend. It's no more dangerous than this long bond example. I hold a considerable amount in ultra short term bonds as a cash alternative. The yield is only .6% currently. That isn't attractive but my capital loss is not 17% YTD. I am about even. (I gave up my meager interest as of today). My capital is still there. I can sleep well with that risk/reward.
Are bonds bad forever? No they are not, but you better know what you are getting into. If rates raise another 3/4% long bonds are going to get much uglier. Bonds and interest rates may be boring to you, but they have an extraordinary effect on the capital markets and some understanding is highly recommended.
Comments from others wiser than I are certainly welcome. I tried to keep this very basic because basic can make or break your bond investment. There is nothing particularly complicated about what just occurred to long bond funds.
Here are a few bond proverbs I've heard oft repeated my entire investing career that spans over 35 years....
-Bonds are part of every diversified portfolio.
-Subtract your age from 100, invest the resulting in equities, the rest should be in bonds for diversification.
-Bonds are safer than equities.
-When you retire you should have at least 40% of your assets in bonds. Even more as you age.
Well that was then and this is now. I never followed any of that advice. I held a small amount of diversified term bonds (fund) through the decades. It was my belief equities would outperform. Bonds weren't so horrible. Long-term bonds tended to rise when equities corrected. Your bonds might be up 20% when the stock market corrected 20%. I could flip your bonds to stocks and buy some stocks on sale every few years.
It was all good as interest rates on average slowly dropped for four decades. 2019-2020 were more than pretty good years for bonds. So what is the problem? If you aren't aware, the value of your bond capital moves inversely to interest rates. If you are in bonds and interest rates drop 2% then your portfolio (individual bonds, mutual funds or you ETF is worth more money as it is invested at an above market rate). The inverse is just as true. It's no small matter if you are on the wrong end of the rate move. Here is an example and I will round the numbers.
Vanguard Extended Duration ETF EDU. It's a respected fund. Vanguard does nothing unnecessarily reckless and their bond funds have above average ratings. EDU yields 2.2% currently. It's invested in US Treasury bonds mostly over 20yrs in duration. US Treasuries are about as safe as anything in this world. Your capital is down 17% YTD. That is only 10 weeks! It will theoretically take you 8 years to be even if interest rates were level from here. What caused this? A 3/4% rise in interest rates. That's not much, but on a percentage basis it is at near zero short term interest.
This is much of the reason investors are paying too much for equities with a modest dividend. It's no more dangerous than this long bond example. I hold a considerable amount in ultra short term bonds as a cash alternative. The yield is only .6% currently. That isn't attractive but my capital loss is not 17% YTD. I am about even. (I gave up my meager interest as of today). My capital is still there. I can sleep well with that risk/reward.
Are bonds bad forever? No they are not, but you better know what you are getting into. If rates raise another 3/4% long bonds are going to get much uglier. Bonds and interest rates may be boring to you, but they have an extraordinary effect on the capital markets and some understanding is highly recommended.
Comments from others wiser than I are certainly welcome. I tried to keep this very basic because basic can make or break your bond investment. There is nothing particularly complicated about what just occurred to long bond funds.