Bond ETFs vs Individual Bonds

Discussion of the Bond portion of the Permanent Portfolio

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jalanlong
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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!
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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%
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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/
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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?
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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
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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.
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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.
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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
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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)
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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
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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
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Re: Bond ETFs vs Individual Bonds

Post by jalanlong » Thu Sep 01, 2022 4:49 pm

Kbg wrote:
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)
The problem with the example in this article is that interest rates jump one time and that's it. In a scenario such as that, I understand completely how a Bond Fund can "catch up" and your losses be erased quickly. But in a scenario which we may be facing now where interest rates make a slow creep up, how would that work? If interest rates go up in the spring, then again in the summer, then again in the fall, then again next year and the year after that....wouldn't your fund just keep losing ground? It could conceivably take quite a while to make those losses back correct?
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Re: Bond ETFs vs Individual Bonds

Post by barrett » Fri Sep 02, 2022 9:12 am

jalanlong wrote:
Thu Sep 01, 2022 4:49 pm
Kbg wrote:
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)
The problem with the example in this article is that interest rates jump one time and that's it. In a scenario such as that, I understand completely how a Bond Fund can "catch up" and your losses be erased quickly. But in a scenario which we may be facing now where interest rates make a slow creep up, how would that work? If interest rates go up in the spring, then again in the summer, then again in the fall, then again next year and the year after that....wouldn't your fund just keep losing ground? It could conceivably take quite a while to make those losses back correct?
I struggle with this as well. Here is a link for Vanguard Total Bond Market Index Fund Admiral Shares (with an average duration of 6.7 years):

https://investor.vanguard.com/investmen ... mance-fees

So, down 11.41% YTD with a 30-day SEC Yield of 3.41%. Assuming no further rise in interest rates, one isn't made whole in nominal dollars until more than three years have passed. Obviously it's worse than that if rates continue to rise.

Of course, now that I write this out, there's nothing that is contradictory to the article that kbg posted. It's just been a painful year to be invested in bonds with durations longer than a year or so. I guess we just haven't seen interest rate risk in sustained action for quite a while. It's telling when one sees all the "What happened to the value of my bond fund?" posts on Bogleheads.
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Re: Bond ETFs vs Individual Bonds

Post by mathjak107 » Fri Sep 02, 2022 1:11 pm

This is not how you figure break even . The above is not 3years .

The 30 day sec yield is based on an average share price over the 30 days. , not your personal share price you own at .

It’s easy to see if you take a hypothetical fund with a duration of 5 years that sells for 10 bucks and pays 5% .

If rates jump to 6% the fund will fall 5% to 9.50 .

The sec yield may be 6% but it will take you way more than a year to make back the 5% you fell .

In this case it will take 5 years as the extra 1% a year offsets the 5% drop.
.

The duration figure is how long you need to hold approx.

You will have your original purchase deal back as you get 5% total return after 5 years in my example
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Re: Bond ETFs vs Individual Bonds

Post by dockinGA » Fri Sep 02, 2022 5:57 pm

mathjak107 wrote:
Fri Sep 02, 2022 1:11 pm
This is not how you figure break even . The above is not 3years .

The 30 day sec yield is based on an average share price over the 30 days. , not your personal share price you own at .

It’s easy to see if you take a hypothetical fund with a duration of 5 years that sells for 10 bucks and pays 5% .

If rates jump to 6% the fund will fall 5% to 9.50 .

The sec yield may be 6% but it will take you way more than a year to make back the 5% you fell .

In this case it will take 5 years as the extra 1% a year offsets the 5% drop.
.

The duration figure is how long you need to hold approx.

You will have your original purchase deal back as you get 5% total return after 5 years in my example
Yet again, you've misread what someone wrote, and answered a question that's completely irrelevant.

Barrett stated a (rough) time frame to be made whole in nominal dollars. He didn't say that 3 years was the time required for him to 'catch up' to someone who waited and purchased at the higher yield, thereby saving the drop in bond price. But you went ahead and answered a question he didn't ask (in fact he never even asked a question but you decided to correct him anyway), one garbled and barely interconnected sentence at a time.
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Re: Bond ETFs vs Individual Bonds

Post by mathjak107 » Fri Sep 02, 2022 6:06 pm

The replay was to this post from jalalong and As Barrett said … So, down 11.41% YTD with a 30-day SEC Yield of 3.41%. Assuming no further rise in interest rates, one isn't made whole in nominal dollars until more than three years have passed. Obviously it's worse than that if rates continue to rise.
—————————++++++++++

Jalanong “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? “
—————————
The sec yield is not reflecting a personal breakeven ..breakeven is about 5-6 years

Stay out of my posts….
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Re: Bond ETFs vs Individual Bonds

Post by dockinGA » Fri Sep 02, 2022 6:17 pm

mathjak107 wrote:
Fri Sep 02, 2022 6:06 pm
The replay was to this post from jalalong , it is agreeing with this
—————————++++++++++

“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? “
—————————
It has nothing to do with the party you referenced ….

Stay out of my posts….
OK, you're confusing everybody again and making no sense.

Nowhere did jalanlong say ANYTHING about 3 years. He gave no calculations, no rough numbers, nothing referencing 3 years. Barrett did make reference to calculating time to get back to nominal (specifically 3 years), referenced SEC yield, both of which you immediately repeated in your subsequent post, and yet I'm now supposed to think that you were replying to jalanlong?

Then, you come back with a quote from jalalong, from the very first post on this page, from July 14th, and claim you were replying to him.

Moderators, I implore you, let's rid this page of these trolls who bring nothing useful to the discussion. One could argue there's not much being discussed without the trolls, but having nothing being discussed is of more value to everyone as opposed to having to counterbalance factually incorrect information, and then being denigrated incessantly for pointing out factually incorrect or misleading information.
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Re: Bond ETFs vs Individual Bonds

Post by mathjak107 » Fri Sep 02, 2022 6:20 pm

I think dicknga should be banned for all his personal attacks on posters ..

I think it is disgusting behavior being accepted by mods here as okay.

I posted the reasons you can’t go by sec yield to breakeven in case anyone here got the impression from what was illustrated that you can.

I still say in any self respecting forum you would have been cut off for your personal attacks whenever you disagree with something..why it is accepted here as ok is a mystery
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Re: Bond ETFs vs Individual Bonds

Post by dockinGA » Fri Sep 02, 2022 7:11 pm

mathjak107 wrote:
Fri Sep 02, 2022 6:20 pm
I think dicknga should be banned for all his personal attacks on posters ..

I think it is disgusting behavior being accepted by mods here as okay.

I posted the reasons you can’t go by sec yield to breakeven in case anyone here got the impression from what was illustrated that you can.

I still say in any self respecting forum you would have been cut off for your personal attacks whenever you disagree with something..why it is accepted here as ok is a mystery
There aren't too many instances (if any) of me making anything that could be construed as a personal attack. If there is, it was brought about by trying to point out where you're wrong and providing misleading or incorrect information, and then having you try to change the subject or being completely oblivious to why I'm pointing out what I'm pointing out because you're not even replying to anything anyone else is saying. As myself and others have said, you derail every discussion, and whether that is due to ignorance, trolling, or some other reason, I don't know, but none of the reasons are likely very flattering for you.

Just in this one forum post, going back to several months ago, I had to correct you when you said that bond funds can do something that individual bond holders can't do. When I pointed out the error in your statement, you immediately contradicted your previous post. When I asked for clarification, you refused to answer and went silent in this particular forum for nearly 2 months. In the meantime, several articles were posted from other posters that went a long way towards clearing up the initial questions that jalanlong had. Several other questions and meaningful posts followed, and then you chime in again, out of the blue, answering a question nobody asked. Perhaps what you're trying to communicate makes sense in your head, but oftentimes it doesn't make sense when you write it on the page in such a scattershot fashion, firing off responses every 30 seconds.

Now, please let fly your next name-calling riposte that any self-respecting 3rd grader could come up with on the school playground.
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