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  • Dex February 2015
  • msf February 2015
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Bonds, Bond funds, historic low interest rates

randynevinrandynevin
in Fund Discussions
I'd like to hear other's thoughts on these ideas:

Like many investors, I've been concerned about the portion of my portfolio that is intended to generate reasonable dividend yield without undue price risk. Especially since interest rates are at all-time lows, and are bound to come back up (eventually). A rise in interest rates will cause the value of bonds and bond funds to fall.

What I'd like to do is buy the bonds directly and hold them to maturity. In that case I'd be collecting the dividend payments and ignoring the paper loss of value, since I'd always get my principal back at maturity. But with individual corporate bonds there would be a risk of default which would be hard for me to mitigate by buying lots of bonds. No risk of default if I buy treasuries, but I can't stand the anemic yields. And I don't have much knowledge on how to buy bonds and know I'm getting good prices.

And so bond funds with low durations are my current vehicle of choice. They can have a zero or negative return year when interest rates rise. But lately I've come to the conclusion this risk can be ignored, as long as you're willing to hold the fund at least 2-3 years, and it's this that I'd like comments on.

Take a look at this graph of the federal funds rate, especially from 1990 on:
image

Periods of rising interest rates were: 1994, mid-1999/mid-2000, mid-2004/mid-2006. In all these cases, the rising rates resulted in a flattening or slight reduction in total return, as reflected in this graph of the Vanguard short-term corporate fund:
image

And if you continued to hold through the year following the completion of the rising rate period, you would have recovered most or all of your paper loss. Hence my thinking it's probably best if you just ride it out. (But sticking with low-duration bonds, of course)

Thoughts? Thx!

Comments

  • Dex
    edited February 2015
    "generate reasonable dividend yield without undue price risk" = 1.86%
    VFSTX - Average effective maturity 3.0 years

    http://finance.yahoo.com/echarts?s=VFSTX+Interactive#{"range":"max","scale":"linear"}

    If you buy now at 10.70, be aware that there have been several years where it has been below that number.

    The other factor is inflation. With inflation and taxes and VFSTX at 1.86% you are not making money.
  • msf
    edited February 2015
    2% APY CD, 32 month maturity - shorter than VFSTX, NCUA-insured, zero price risk, higher yield. if you think rates will be going up, you can take the interest payments monthly, but unlike a bond (except a zero coupon) or bond fund you have the option to avoid reinvestment risk by having the interest compound.

    http://www.elements.org/Shamrock_Certificate_Rate

    I find that banks and credit unions continue to offer better yielding, safer investments than short term bonds.
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