Bond ETFs vs Individual Bonds

Discussion of the Bond portion of the Permanent Portfolio

Moderator: Global Moderator

Post Reply
User avatar
jalanlong
Executive Member
Executive Member
Posts: 712
Joined: Mon Jul 01, 2019 7:30 am

Bond ETFs vs Individual Bonds

Post by jalanlong » Thu Jul 14, 2022 4:15 pm

I have been trying to wrap my head around constant maturity bond ETFs for ages and for some reason I just dont get it. The article from Cullen Roche below says that bond etfs are not any riskier than holding individual bonds as long as you hold the fund for its duration. He claims the problem is that people buy a bond fund with a 6 year duration and then hold it for 2 years and complain they lost money.

https://www.pragcap.com/the-biggest-myt ... ates-rise/

The article claims if you buy an bond eft and hold it for its duration then you would make what you would have made if you just bought individual bonds of the same maturity.

For the life of me I cannot wrap my head around how that is possible. For example, see the vanguard intermediate bond etf here:

https://investor.vanguard.com/investmen ... v#overview

This etf has a duration of 6 years. Its current yield to maturity is 3.4. It has lost -10% YTD. So let's say I bought this fund on Jan 1st of this year. And lets also say that rates continue to rise. Maybe 1% a year for the next couple of years. How on earth am I earning my money back on this fund by the year 2027? At best I would be lucky to break even right? If rates decline then I can see gains then of course. Even if rates stay exactly the same as they are today, I don't see how I earn very much given that I have already lost 10% right off the starting block. It would take me 3 years of 3.4 yield just to get back to even. And if this were an individual bond then I would understand that the price would rise to par as we got closer to maturity. But in this case the fund is selling bonds when they reach like 3 years to maturity and replacing them with something around 7 year bonds.

I will admit that I do not understand bond etfs very well and I feel like there is something obvious I am missing. So if anyone can explain it to me better I would greatly appreciate it!
User avatar
mathjak107
Executive Member
Executive Member
Posts: 4203
Joined: Fri Jun 19, 2015 2:54 am
Location: bayside queens ny
Contact:

Re: Bond ETFs vs Individual Bonds

Post by mathjak107 » Fri Jul 15, 2022 2:40 am

Imagine you buy a treasury fund for 10 dollars a share and a duration of 5 years .

…to keep the illustration simple let’s suppose the day you bought it paid 5% .

Well if rates rise 1% , nav falls to 9.50 however you get an extra 1% a year in interest at 6% instead of 5% .

Unlike individual bonds ,bond funds have variable rates .

That extra 5% in interest over the 5 years offsets the 5% drop in nav and so you get your original deal back after 5 years which is 5% .

Sure that is 5% in a 6% world so you are behind the curve , but it is just like you bought a 5 year bond paying the same 5%
User avatar
mathjak107
Executive Member
Executive Member
Posts: 4203
Joined: Fri Jun 19, 2015 2:54 am
Location: bayside queens ny
Contact:

Re: Bond ETFs vs Individual Bonds

Post by mathjak107 » Fri Jul 15, 2022 7:11 am

Funds also can do something you can’t do with individual bonds and that is called ride the yield curve

https://www.kitces.com/blog/how-bond-fu ... est-rates/
dockinGA
Executive Member
Executive Member
Posts: 167
Joined: Tue May 04, 2021 9:29 am

Re: Bond ETFs vs Individual Bonds

Post by dockinGA » Fri Jul 15, 2022 11:22 am

mathjak107 wrote:
Fri Jul 15, 2022 7:11 am
Funds also can do something you can’t do with individual bonds and that is called ride the yield curve

https://www.kitces.com/blog/how-bond-fu ... est-rates/
Do you care to offer an explanation of why this can't be done with individual treasury bonds?
User avatar
mathjak107
Executive Member
Executive Member
Posts: 4203
Joined: Fri Jun 19, 2015 2:54 am
Location: bayside queens ny
Contact:

Re: Bond ETFs vs Individual Bonds

Post by mathjak107 » Fri Jul 15, 2022 1:14 pm

You can do it the same as funds do .

But most people who buy individual bonds ladder them the way they want and hold them to maturity as the longer ones are there new shorter maturities
dockinGA
Executive Member
Executive Member
Posts: 167
Joined: Tue May 04, 2021 9:29 am

Re: Bond ETFs vs Individual Bonds

Post by dockinGA » Fri Jul 15, 2022 1:28 pm

mathjak107 wrote:
Fri Jul 15, 2022 1:14 pm
You can do it the same as funds do .
Correct, which is the method usually used for individual treasury purchasers using the PP approach. Buy at 30, sell at 20. Regardless, why did you make the comment, point blank, that 'Funds also can do something you can’t do with individual bonds and that is called ride the yield curve;, a direct quote from your post. It's just flat out wrong, and also in direct opposition to what is said in the article you linked to. That article points out that for lower liquidity bonds, a small investor would get eaten up with slippage, etc., but that's much less of an issue for treasuries.

My guess is you made the comment you did just so you could throw out there that you know the phrase 'ride the yield curve.' Impresses the folks over at city-data, but not so much here.
dockinGA
Executive Member
Executive Member
Posts: 167
Joined: Tue May 04, 2021 9:29 am

Re: Bond ETFs vs Individual Bonds

Post by dockinGA » Sat Jul 16, 2022 11:38 am

dockinGA wrote:
Fri Jul 15, 2022 1:28 pm
mathjak107 wrote:
Fri Jul 15, 2022 1:14 pm
You can do it the same as funds do .
Regardless, why did you make the comment, point blank, that 'Funds also can do something you can’t do with individual bonds and that is called ride the yield curve;, a direct quote from your post.
Still waiting on an answer here Mathjak. Please provide us with an answer so you can counterbalance some of my useless and argumentative posts.
User avatar
Smith1776
Executive Member
Executive Member
Posts: 2638
Joined: Fri Apr 21, 2017 6:01 pm

Re: Bond ETFs vs Individual Bonds

Post by Smith1776 » Sat Jul 16, 2022 1:33 pm

dockinGA wrote:
Sat Jul 16, 2022 11:38 am
dockinGA wrote:
Fri Jul 15, 2022 1:28 pm
mathjak107 wrote:
Fri Jul 15, 2022 1:14 pm
You can do it the same as funds do .
Regardless, why did you make the comment, point blank, that 'Funds also can do something you can’t do with individual bonds and that is called ride the yield curve;, a direct quote from your post.
Still waiting on an answer here Mathjak. Please provide us with an answer so you can counterbalance some of my useless and argumentative posts.
;D
The only dogma I follow is diversification.
Kbg
Executive Member
Executive Member
Posts: 2505
Joined: Fri May 23, 2014 4:18 pm

Re: Bond ETFs vs Individual Bonds

Post by Kbg » Mon Jul 18, 2022 4:53 pm

Here ya go...this is how it happens

https://pwco.com/how-bond-portfolios-lo ... unce-back/

Of course reality and interest rates moving around make it more complex but the end effect is the same...complete self-healing over time (largely tied to duration length)
Kbg
Executive Member
Executive Member
Posts: 2505
Joined: Fri May 23, 2014 4:18 pm

Re: Bond ETFs vs Individual Bonds

Post by Kbg » Mon Aug 01, 2022 4:22 pm

Not sure anyone cares anymore...but a link explaining how bond funds are essentially self-healing over time this a couple days old.

https://advisors.vanguard.com/insights/ ... andonbonds
seajay
Executive Member
Executive Member
Posts: 176
Joined: Mon Aug 09, 2021 11:11 am

Re: Bond ETFs vs Individual Bonds

Post by seajay » Thu Aug 04, 2022 10:23 am

Cross link that may be of interest viewtopic.php?p=242237#p242237
Post Reply