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With passage of the most recent Federal legislation the Congressional Budget Office projects another 3.5 trillion dollars added to the US debt over the next 10 years. The inevitable result of this will be the Federal Reserve having to increase interest rates.
In 2022 this scenario resulted in a bloodbath in my intermediate bond fund. I don’t remember in my copious reading any advanced warnings of prices dropping precipitously as interest rates increased (in fairness I had read about the inverse relationship between prices and yields, just no warning as to just how bad it could be). Since then I have converted all the money that was in my intermediate bond fund to short term ETFs to shorten my bond funds’ duration and thus limit any future damage from rising rates.
My question is do any Humble Dollar readers have any other suggestions as to how to get a decent return on these monies other than depositing these monies into a Federal money market fund?
I’ve decided Federal Money Market Fund and Short Term Treasury Bond Fund will serve my purpose for bonds. Try as I have, I just don’t understand TIPS funds enough and do not want to manage ladders.
Where is the best place to keep your money if you are a follower of William Bernstein: “If You’ve Won the Game, Stop Playing” and you are 80 years old?
OK, I am not completely sold on these products, but I also have not read any coverage in Humble Dollar about them. They are unfortunately named iShares iBonds (I think there’s another version called BulletShares by Invesco). They are built for laddering bonds. For example, IBDV targets Dec. 2030 maturity with Investment Grade Corporate bonds. You can also use US Treasuries, US TIPS, Municipals and High Yield baskets. IBDV has a 0.10% net expense ratio with 668 bond holdings. Current NAV is about 21.82 and the target NAV is approximately 25 in Dec. 2030. This target NAV is the same for all iShares iBonds. The large basket of bonds protects against any one bond defaulting. Interest payments occur throughout the life of the bond (monthly?).
In principle, one could readily build a ladder knowing what the expected maturity payout is and when it is. ETFs and Mutual Funds have this constantly moving payout date as bonds fall into and out of their target windows. This has been my greatest source of heart burn (e.g. 2022 capital loss) with bond baskets. Choosing bonds, other than US government issued, is a tricky business – not one I wish to learn. The net expense ratio is quite reasonable.
Does anyone have any first hand experience with these instruments?
Thanks for reminding me about the iShares iBonds. I have considered discussing them with our fee only financial advisor in the near future in an amount to cover what I expect will be a small shortfall in covering our basic expenses not covered by our delayed Social Security and pension income
Don’t forget I-Bonds for set and forget longer term bond purchases. There are purchase limits imposed annually on individuals. These are easy to purchase via US government Treasury Direct website. One advantage is no tax on interest until the bond is cashed. Current rate is 3.98%.
These are longer term investments and there are early redemption interest penalties. In general, best to hold at least 5 years.
“The interest rate on a Series I savings bond changes every 6 months, based on inflation. The rate can go up. The rate can go down.
The overall rate is calculated from a fixed rate and an inflation rate. The fixed rate never changes. The inflation rate is reset every 6 months and, therefore, so is the overall rate.”
I believe the movement of future interest rates is unknowable. I do however have some concern that some flavor of the 2022 bond market could show up though. I currently allocate to individual t-bills with durations out to 3 years, individual TIPs with durations to 5 years, I bonds (I’ve owned these for 25 years), and high yield corporates. Our bond holdings did well during 2022, though much of it was held in a stable value fund in my former 401k plan in the years leading up to 2022, and for the following year. Some may find this too much complexity though, and I may simplify these allocations to a simple 3 year t-bill laddie in my early 70s as I begin SS, and also see the majority of my I bond positions mature.
I have SGOV ETF, TIP bonds, and T bills.
Short term ETF – for example SGOV, ultra short-term US Treasuries – provides ease of transaction, automatic reinvesting even with fractional share and maintenance, on top of exemption from State taxes. The cons are fluctuating NAV, lower yield than T bills and some money market accounts to cover the expense ratio.
With individual T bills, timing of maturity and tax deferral flexibility are the pros on top of no fee and state tax exemption. Tradeoffs are lower liquidity, maintenance complexity, and larger minimums needed for diversification.
TIP bonds: already said in my previous reply below.
I’m with Norman, and have only bought bonds outright to eliminate the “bond conundrum” or potential “damage from rising rates.”
The whole purpose of the fixed income portion of the portfolio is to protect principal to provide comfort and stability, while letting the equity portion deliver growth. As you indicate with bond funds, we just don’t know what the principal will be in the outer years when some of the money might be needed – so bond funds indeed provide a fundamental “conundrum.” I’d rather accept the variability conundrum on the equity side of the equation.
Even with individual bonds, when you do a balance sheet, the value of your bonds will have gone down when interest rates rise just like the value of the bond fund. Holding them until maturity only means that you will regain at least what you paid when they mature. Furthermore, if you ever do need to sell an individual bond before maturity, you will likely find that the amount you receive will be less than what your broker says is the current market price. I own TIPS that I purchased in 2002. Their value rises and falls with interest rates. When you own bonds whether in funds or the actual bonds, your net worth will rise and fall with changes to interest rates.
If I own a bond I should receive the face value when I surrender it at maturity. I will also receive the coupon rate during the life of the bond, e.g. 3.8%.
TIPS are different because they are tied to inflation. The interest rate, or coupon, can rise or fall (TIPS rate is determined every 6 months). The interest rate will be applied to the principal value of the bond and the value of that principal will change during the life of the bond. Interest payments rise or fall as inflation changes. However, the government guarantees that the principal amount will be paid, no matter what the inflation rate.
Selling a bond before maturity incurs a cost as the “value” of the bond is determined at the time of sale. If interest rates have risen since the bond was purchased it may be necessary to sell at a discount, and there may be brokerage fees, too.
For short term investors, Treasury Bills or money market “high interest” savings might be better choices so as to avoid early sale.
I have held a variety including TIPS, I-Bonds, Treasuries and T-Bills as well as municipal bonds and CDs. It is determined by interest rates and availability. The choice has been easier in recent years because of better yields.
FYI, from TreasuryDirect (bold added for emphasis)
We sell TIPS for a term of 5, 10, or 30 years.
As the name implies, TIPS are set up to protect you against inflation.
Unlike other Treasury securities, where the principal is fixed, the principal of a TIPS can go up or down over its term.
When the TIPS matures, if the principal is higher than the original amount, you get the increased amount. If the principal is equal to or lower than the original amount, you get the original amount.
TIPS pay a fixed rate of interest every six months until they mature. Because we pay interest on the adjusted principal, the amount of interest payment also varies.
You can hold a TIPS until it matures or sell it before it matures.
I prefer to own bonds outright. I’ve found the Tip Watch website to be helpful. With Money Market, high yield savings and CDs paying about 4% I don’t have to be as picky these days.
I’ve avoided bond funds, particularly when returns were very low. I felt I wasn’t being adequately compensated for risk and shifted toward individual bonds. At the time there was some concern about “breaking the buck” of MMFs. I considered that to be misguided. I recall the elephant in the room was the low fund returns. Today there are continued risks.
2022 proved my point. While anything is possible, some possibilities are more likely than others. The losers in my portfolio are the few bond funds/ETFs I did not sell. The dollar value of the losses are 0.4% of “my” portfolio. Very little but then I do think many investors were shocked in 2021-22.
How do you know interest rates will go up? What about this scenario:
Increased deficits and debt make the markets jittery and in response the Federal Reserve (as they have done many times in the recent past) lower interest rates to calm markets.
Further, the Federal Reserve is incentivized to lower rates to help the (very) indebted federal government pay its debts.
The most indebted nation on Earth (Japan) has very low rates, much lower than USA or EU.
David, this article from Jonathan’s Money Guide might offer some insights into bond funds:
https://humbledollar.com/money-guide/risk-and-bond-returns/
And Jonathan has posted a number of articles about his view of where to look for portfolio growth.
Good read. Thanks Ed.
Caveat Emptor!
VBIL, Vanguard 0-3 Month Treasury Bill ETF
I don’t base my financial decisions on 2022 (Yes my bond ETFs did poorly but they still did better than my stocks..) We still have a few bond ETFs including BND and also own individual TIPs to maturity in a rolling ladder liability matched against future needs. In any case, I don’t really own bond funds for returns, I own them for some diversification and risk-management.
If it helps, I recently did some research on short duration ETFs with an eye towards 2022 performance and settled on JPST. It was launched in 2018 and has never lost money, even in 2022 (+1.14%). It also has a solid yield that matches the best MM funds I could find.
You may want to take a closer look at JPST. 30% of its holdings are in BBB-rated debt. The recent yield of 3m T-Bills, which have much less risk, is slightly lower at ~4.4% vs. 4.76% for JPST’s average yield-to-maturity. I’d expect a higher yield from JPST to take on that slice of BBB risk.
Ok thanks. I appreciate your response and will have a closer look.
I agree, assuming you want short duration – on the Treasury side you have to go out to 10 year Bonds to get the same yield as 1 – 3 month T-bills. So T-bills and MM funds which focus on T-bills like Vanguards VUSXX are good yields with pretty low risk. Vanguard has a number of short term/duration bond ETF’s but you’re adding some risk.
I followed the recommendations from Morningstar and TIPS Watch: go for individual TIP bonds to keep up with expected future inflation and still earn a respected 2% on top of inflation (buying from the secondary market). You can buy the TIP bond based on maturity date to match personal need or expectation, avoid TIP funds which are affected by interest rate changes hence volatile.
2022 was especially bad for bonds because the term premium — extra yield paid for holding a bond for longer — was nearly zero when inflation hit and intermediate bond prices fell fast (bond yield moves up as prices go down).
When I stretched my bond portfolio duration in October and November of 2023, I did it because 7y and 10y Treasury Notes were then priced for a yield close to modern averages and I was willing to hold those bonds to maturity.
Today, after the passage of a tax and spending bill likely to continue deficit growth indefinitely, I’m reminded of 1994 when yields jumped by about 2.5-3.5 pp, but off a base of about 4.5% for 10y. So, pretty bad for bond prices but not as brutal as 2022.
Going forward, I’m planning to trim our duration, which is already lower after two years have passed. But I’ll do it carefully while trying to avoid the extremes of income risk and duration risk. Once our larger Social Security benefit starts we will dial down bond duration further. The focus then will be preserving the purchasing power of about seven years of living expenses in our bonds (and more in cash/MM).
A key concept with bond funds is duration. Bond duration is a measure of a bond’s price sensitivity to changes in interest rates. Duration quantifies the percentage change in a bond’s price for a 1% change in interest rates. If a bond fund has a duration of 6 years, typical for an intermediate term bond fund, and interest rates rise by 1%, the fund’s price is expected to decrease by approximately 6%. A bond fund with a high duration is a warning that the price drop with increasing interest rates will be large. If you can’t tolerate these drops, don’t hold high duration bond funds. Instead stay with short-term funds with durations typically close to 2 years. If that is still too much, then there are some ultra-short-term funds with durations of less than 1 year. After that, money markets, CD’s or if you have the skills and time build your own short-term ladder of Treasury bills and/or bonds.
*Edited 7/8 to fix typo’s