Buying any bonds is timing the market... as long as bonds pay less than savings accounts

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VTI
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Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by VTI »

(This applies to individuals, not institutions. Many institutions have no choice but to park their money in bonds.)

When bonds pay less than savings accounts or other cash vehicles, I can think of only scenario in which bonds beat cash: Falling interest rates in the short term.

When interest rates fall, your principal increases. You can then either:
  • Sell while your higher-rate bonds still command a premium (the longer you wait, the smaller the premium)
  • Hold in hopes of interest rates falling again
If interest rates stay flat, you lose. If interest rates rise, you lose. If interest rates stay flat for a long time and then fall, you probably lose, because you've been long missing out on the higher yields of savings accounts.

You're betting that interest rates will fall (and fall soon). Isn't that market timing?
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000
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by 000 »

I think "negative arbitrage" is a more accurate term for what you describe but yes it is indeed strange to hold bonds or MMF when HYSA pays more.

Bond bulls are drunk on declining interest rates, but the trough is running empty. Probably still a little bit left though....
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by VTI »

000 wrote: Wed Apr 21, 2021 8:04 pm Bond bulls are drunk on declining interest rates, but the trough is running empty. Probably still a little bit left though....
They might be right, but why do they believe they know better than the market? Why do Bogleheads endorse market-timing bonds but not market-timing stocks?
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by finite_difference »

VTI wrote: Wed Apr 21, 2021 8:07 pm
000 wrote: Wed Apr 21, 2021 8:04 pm Bond bulls are drunk on declining interest rates, but the trough is running empty. Probably still a little bit left though....
They might be right, but why do they believe they know better than the market? Why do Bogleheads endorse market-timing bonds but not market-timing stocks?
If interest rates fall, the NAV of bonds goes up.

If interest rates increase, bonds will pay more.

Either way it’s fine, and bonds will beat cash. It’s market timing to assume we know what will happen. It’s foolishness to expect that bonds will pay out more than 0% real.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by 000 »

VTI wrote: Wed Apr 21, 2021 8:07 pm
000 wrote: Wed Apr 21, 2021 8:04 pm Bond bulls are drunk on declining interest rates, but the trough is running empty. Probably still a little bit left though....
They might be right, but why do they believe they know better than the market? Why do Bogleheads endorse market-timing bonds but not market-timing stocks?
I'm not sure they really endorse market-timing. Most Bogleheads will probably hold their bonds to duration. It's more like they have taken "nobody knows nothing" and "stay the course" to unintended extremes.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by Kenkat »

What bonds are paying less than savings accounts?
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by VTI »

finite_difference wrote: Wed Apr 21, 2021 8:13 pm If interest rates increase, bonds will pay more.
Bonds will pay more, but not the bonds that you bought back when they paid less than savings accounts.

Your bonds might now pay a higher yield, but they'll pay that higher yield on a lower NAV. You'll still make less money than if you had deposited money in a savings account.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by nisiprius »

Let's just look at the first premise:

Bonds aren't paying less than savings accounts.

Vanguard Total Bond Market Index Fund:
30 day SEC yield as of 4/19/2021, 1.32%.

Image

DepositAccounts.com
Savings account national average 0.14%.
"Top 1% average" 0.76%.
Highest they are showing for nationwide-available accounts: 0.70% at "Nationwide at Axos Bank"

Image
Last edited by nisiprius on Wed Apr 21, 2021 8:33 pm, edited 2 times in total.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by JoMoney »

Kenkat wrote: Wed Apr 21, 2021 8:25 pm What bonds are paying less than savings accounts?
3 Year Treasuries yielding 0.312%

vs.
say, a Capital One 360 Performance Savings yielding 0.40%
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by jeffyscott »

Kenkat wrote: Wed Apr 21, 2021 8:25 pmWhat bonds are paying less than savings accounts?
Yep, they are mostly not any longer. The 5 year treasury is at 0.81%, that's better than any savings account that I see on deposit accounts. HYS may yield more than T-bills or money market, but not bonds.

There are still CDs paying more than the treasury of the same term, but the differential is much less than it had been.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by runninginvestor »

A 2year duration fund, VSGBX yields 0.71% and the admiral class has 0.81%. You do have principal risk from interest increases if held less than 2 years, but HYSA and these kinds of funds are fairly similar yields at the moment if rates remain unchanged.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by watchnerd »

VTI wrote: Wed Apr 21, 2021 7:58 pm (This applies to individuals, not institutions. Many institutions have no choice but to park their money in bonds.)

When bonds pay less than savings accounts or other cash vehicles
Que?

Last month I bought a Treasury STRIP yielding 1.89%.

What cash equivalent is paying that?
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by jeffyscott »

This statement would've made more sense a year ago, at which time the previously mentioned CapOne savings account was paying 1.5% and even the 30 year treasury was paying only about 1.2%.

The results over the past year would be something like maybe 1% for the savings account, due to the declining yield vs. -2.13% for Vanguard Intermediate Treasury Index Fund.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by watchnerd »

Oh and then there is this:

Savings I Bonds May 2021 Interest Rate: 3.54% Inflation Rate

https://www.mymoneyblog.com/savings-i-b ... -2021.html
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by dboeger1 »

Note that the bond market is massive and huge amounts of bonds are bought and held by not just very large institutions but governments as a means of storing value and/or satisfying currency exchange requirements. Such "investors" don't have an online Ally account as an option. That helps explain why Treasury yields don't always make sense for individuals like us in the context of a low rate environment. As we've seen in recent years, high-yield savings accounts aren't actually the best stores of value in a falling-rate environment because rates can drop at any time. A bond may yield less, but it provides a guaranteed yield, which is important for some use cases.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by nisiprius »

OK, I have to address the question of terminology.
VTI wrote: Wed Apr 21, 2021 7:58 pm...You're betting that interest rates will fall (and fall soon). Isn't that market timing?...
No, it isn't. Staying the course is not market timing. You know that Bogleheads say not to time the market, so you have created a personal definition of "market timing" in order to criticize an investment strategy you don't like. But it isn't market timing.

From 9/2007 through 8/2008, stocks were definitely paying less than bonds:

Image

Could someone have said back then, "buying any stocks is timing the market... as long as stocks pay less than bonds?"

I don't think so. Personally, over that time period, I continued to make automatic purchases of stocks and bonds in the same proportions as before, by virtue of my automatic 401(k) contributions. That wasn't market timing.

"Market timing" would have consisted of changing asset allocation--and not just new contributions, but existing holdings--in response to changes in relative performance. Specifically, someone who liquidated their stocks and went to cash would have been market timing. I know someone who did just that, but, unfortunately for him, he did it in August, 2008.

Why did I stop at September, 2008? Because that's when I was laid off from my job, and, yes, I discontinued my investing program while I was unemployed.

But, no. Maintaining an stable investment program in the face of changing relative investment performance may be wise or it may be foolish, but it is not "market timing."
Last edited by nisiprius on Thu Apr 22, 2021 7:03 am, edited 1 time in total.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by aristotelian »

Keeping a set allocation regardless of market conditions is the opposite of market timing.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by nisiprius »

A falling interest rate is not required in order for a bond fund to make money.

I want to be very clear. I'm not saying that necessarily means a positive real return, nor that other investments might not do better.

But some people really seem to think that a mere forecast that interest rates will "rise" means means that people holding bond funds will experience an inevitable dollar loss. That isn't so. This is the actual performance of the Fidelity Bond Fund, FBNDX, during an actual period of rising rates.

Image

I don't want to hide anything. It wouldn't have been a great investment and, in particular, an investor could have gotten the same returns with zero volatility in Treasury bills. But there was no actual dollar loss in the bond fund.

Image
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by UpperNwGuy »

Thanks, nisiprius. That's why I stay the course with my bond funds. And I don't consider it to be "market timing."
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by jeffyscott »

nisiprius wrote: Thu Apr 22, 2021 8:02 amA falling interest rate is not required in order for a bond fund to make money.
That's not been stated here, the OP's statement that: "If interest rates stay flat, you lose. If interest rates rise, you lose.", was referring to total returns being less from bonds than a savings account. This is just what your second chart shows, cash beat bonds in a period of rising rates.

While the OPs premise may be flawed at this time, it was certainly true a year ago that just about only way bonds (and by "bonds", I mean risk-free treasuries, not a managed or total bond fund) were going to beat a high yield savings account would have been via interest rates falling further. And I say "just about" only because it was theoretically possible that the 1.5% or so high yield savings accounts that were available could've all quickly dropped to something like 0.1% while treasury yields stayed flat.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by secondopinion »

VTI wrote: Wed Apr 21, 2021 7:58 pm (This applies to individuals, not institutions. Many institutions have no choice but to park their money in bonds.)

When bonds pay less than savings accounts or other cash vehicles, I can think of only scenario in which bonds beat cash: Falling interest rates in the short term.

When interest rates fall, your principal increases. You can then either:
  • Sell while your higher-rate bonds still command a premium (the longer you wait, the smaller the premium)
  • Hold in hopes of interest rates falling again
If interest rates stay flat, you lose. If interest rates rise, you lose. If interest rates stay flat for a long time and then fall, you probably lose, because you've been long missing out on the higher yields of savings accounts.

You're betting that interest rates will fall (and fall soon). Isn't that market timing?
This is wrong on a few accounts...

Rolling bonds is part of the reason yields can be lower and still be worth it. It is not market timing to use this strategy; anyone who has done this knows it should be highly systematic (although not predictable). This is also capital gains, not interest; it is taxed more favorably. Tax swapping (which happens while trying for rolling returns) also is helpful to offset losses. If one is to do both strategies effectively, I would find a broker with very low costs to trade bonds, and roll yearly; I suggest yearly because you can either be short-term losses or long-term gains at your command depending on what happens to rates.

Second, interest rates might drop; you propose this to be the only way to gain besides the yield, but this is definitely a possibility. Cash loses in this case.

Granted, cash options do exist that are very favorable in comparison to short-term bonds for individuals. But intermediate and longer bonds still are doing better (unless rates change unfavorably). According to yields in 4/22/2021 right now, the five year note is 0.81% and the two year is 0.15%. At these yields, rolling returns (rolling on yearly) would be about equal to the yield itself (since (0.81% - 0.15%) / 3 * 3.75 = 0.825% is a conservative estimate for current yields); so, a yearly return of 1.65% is not bad. With 10 year being 1.58%, you can get around 2.80% total returns with rolling returns.

Of course, rolling returns are not guaranteed; but it does debunk that bonds are only for market timers right now.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by vineviz »

VTI wrote: Wed Apr 21, 2021 7:58 pm If interest rates stay flat, you lose. If interest rates rise, you lose. If interest rates stay flat for a long time and then fall, you probably lose, because you've been long missing out on the higher yields of savings accounts.

You're betting that interest rates will fall (and fall soon). Isn't that market timing?
Others have eloquently pointed out several flaws in the original argument, but I want to call attention to one that is crucial and often overlooked.

It's crucial to understand that the yield curve TODAY reflects the market's aggregate expectations about changes in interest rates/yields in the FUTURE.

With this is mind, it should (I hope) be clear that it is inaccurate to say that you will "lose" if interest rates rise (fall): you can only lose if interest rates rise (fall) by MORE than the market expects. This is the underlying effect in the graph that nisiprius presented, and often is referred to as market efficiency.

The analogy in stocks would be to expect TSLA to outperform the broad market just because its earnings go up. That's poor reasoning, because the stock is already priced based on the market's consensus expectation that earnings will go up: to outperform, earnings need to go up by MORE than expected. If earnings go up but LESS than expected, that's often bad news.

Same thing applies in bonds.

So the "market timing" position in bonds is to buy a security with a duration that doesn't match your investment horizon. Why? Because doing this is an expression of a belief that your prediction of future rate/yield changes is more accurate than the market's prediction.

Sometimes some individuals have access to accounts (e.g. HYSAs) or securities (e.g. savings bonds) with better expected returns than institutional investors. That plays into their calculus of portfolio construction, obviously, but it is not obvious that this has anything to do with market timing per se.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by neurosphere »

VTI wrote: Wed Apr 21, 2021 7:58 pm If interest rates stay flat, you lose. If interest rates rise, you lose. If interest rates stay flat for a long time and then fall, you probably lose, because you've been long missing out on the higher yields of savings accounts.
I think this is what you are saying. Correct me if I'm wrong. That for the highly liquid or short-term portion of one's portfolio, high yield savings accounts currently provide a compelling place for such money, compared to many types of bonds or bond funds with very short maturities.

Personally, all of my retirement monies are in tax-advantaged accounts. So savings accounts don't help me with the non-stock portion of my portfolio. But yes, for cash I need in taxable accounts, HYS is what I would use compared to (for example) money market funds or short-term municipal bond funds.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by surfstar »

BHs nitpicking between 0.5% HYSA and 1.x% Treasuries as "timing" - LOL

The difference is not going to make or break someone's retirement planning or provide for a splurge purchase in retirement.


Refreshing though, compared to the crazy crypto hype of late.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by watchnerd »

neurosphere wrote: Thu Apr 22, 2021 12:00 pm
I think this is what you are saying. Correct me if I'm wrong. That for the highly liquid or short-term portion of one's portfolio, high yield savings accounts currently provide a compelling place for such money, compared to many types of bonds or bond funds with very short maturities.
It's a pretty big leap to go from saying HYSA's beat 1-3 month T-Bills (I think they always have, at least in my recollection) to extending that to bonds, generally, and then to also claim that implies market timing.

If the subject of the post was....

"High Yield Savings Sometimes Offer Better Rates than Short Bonds"

...there would probably be violent agreement.

But, also, not really noteworthy or new news.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by secondopinion »

surfstar wrote: Thu Apr 22, 2021 12:03 pm BHs nitpicking between 0.5% HYSA and 1.x% Treasuries as "timing" - LOL

The difference is not going to make or break someone's retirement planning or provide for a splurge purchase in retirement.


Refreshing though, compared to the crazy crypto hype of late.
Investing is serious business; because many posts here are correcting missing details, logic that might be limited and "comical" now applies when it make a lot of difference in the future.

Even a 0.5% difference does a bit over time.
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Re: Buying any bonds is timing the market... as long as bonds pay less than savings accounts

Post by corp_sharecropper »

vineviz wrote: Thu Apr 22, 2021 11:46 am
VTI wrote: Wed Apr 21, 2021 7:58 pm If interest rates stay flat, you lose. If interest rates rise, you lose. If interest rates stay flat for a long time and then fall, you probably lose, because you've been long missing out on the higher yields of savings accounts.

You're betting that interest rates will fall (and fall soon). Isn't that market timing?
Others have eloquently pointed out several flaws in the original argument, but I want to call attention to one that is crucial and often overlooked.

It's crucial to understand that the yield curve TODAY reflects the market's aggregate expectations about changes in interest rates/yields in the FUTURE.

With this is mind, it should (I hope) be clear that it is inaccurate to say that you will "lose" if interest rates rise (fall): you can only lose if interest rates rise (fall) by MORE than the market expects. This is the underlying effect in the graph that nisiprius presented, and often is referred to as market efficiency.

The analogy in stocks would be to expect TSLA to outperform the broad market just because its earnings go up. That's poor reasoning, because the stock is already priced based on the market's consensus expectation that earnings will go up: to outperform, earnings need to go up by MORE than expected. If earnings go up but LESS than expected, that's often bad news.

Same thing applies in bonds.

So the "market timing" position in bonds is to buy a security with a duration that doesn't match your investment horizon. Why? Because doing this is an expression of a belief that your prediction of future rate/yield changes is more accurate than the market's prediction.

Sometimes some individuals have access to accounts (e.g. HYSAs) or securities (e.g. savings bonds) with better expected returns than institutional investors. That plays into their calculus of portfolio construction, obviously, but it is not obvious that this has anything to do with market timing per se.
I would argue that an investor may want to buy longer duration than time horizon not because one believes in some imminent rate drop is likely to happen but because they believe in certain correlation/covariance characteristics with other assets of a portfolio and the rebalancing premium, and need/want longer duration in order to capture these properties in a capital efficient manner. Judging by some of your posts that I've read I think you're on the same page here, just another minute detail for us to be nit picky on.
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