Index funds for government bonds

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JWB
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Index funds for government bonds

Post by JWB »

I wish I had known about I Bonds and EE bonds 20 years ago, but I only learned about them at age 60. I opened a Treasury Direct account, and I Bonds were easy to buy. Buying other bonds is a little confusing, particularly TIPS. I’ve thought about a treasury bond index fund, but how grounded are they in the actual value of the bonds held? If I buy 20k in I Bonds from Treasury Direct, I know what they are worth. If I put 20k in a bond index fund how do I know whether I’ll get at least my 20k back in 5 or 10 years? Are Bond index funds based on treasuries only for people like me who didn’t have the foresight to buy them directly from the government years ago? Do people use bond Index funds to create bond ladders?
RickyGold
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Re: Index funds for government bonds

Post by RickyGold »

JWB wrote: Fri Oct 15, 2021 7:57 am I wish I had known about I Bonds and EE bonds 20 years ago, but I only learned about them at age 60. I opened a Treasury Direct account, and I Bonds were easy to buy. Buying other bonds is a little confusing, particularly TIPS. I’ve thought about a treasury bond index fund, but how grounded are they in the actual value of the bonds held? If I buy 20k in I Bonds from Treasury Direct, I know what they are worth. If I put 20k in a bond index fund how do I know whether I’ll get at least my 20k back in 5 or 10 years? Are Bond index funds based on treasuries only for people like me who didn’t have the foresight to buy them directly from the government years ago? Do people use bond Index funds to create bond ladders?
Buying individual bonds is too much work for me, so I prefer mutual funds. In my tax-deferred accounts, I have FXNAX (Fidelity Total Bond) and am very happy with the fund. I am thinking of investing in my taxable account, and am looking at FUAMX (an intermediate treasury fund).

I am trying to keep it simple!
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JoMoney
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Re: Index funds for government bonds

Post by JoMoney »

There's a lot I don't understand about this, but from what I've been told, and my basic understanding... Yes, you can build the equivalent of a bond ladder using bond funds with roughly equivalent results. It would require calculating what the duration of the bond ladder portfolio you would otherwise hold would be, and using a blend of bond funds to achieve a portfolio of the same duration, and make adjustments to the bond-fund portfolio over time to match the equivalent duration of what the bond ladder would be as the laddered portfolio's duration reduces over time as each rung matures.
The market value of the bond fund portfolio is equivalent to the marked-to-market value of a bond ladder portfolio (of the same type and maturity bonds) at any particular point in time. A bond ladder will change and reduce that portfolios duration as it matures, whereas a bond fund generally maintains a fixed duration, so you would just need to manage and adjust your bond-fund portfolio to maintain that equivalence.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
UpperNwGuy
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Re: Index funds for government bonds

Post by UpperNwGuy »

Check out iShares iBonds ETFs. Each fund has a fixed maturity (Dec 2021, Dec 2022, Dec 2023, etc up to Dec 2031), so you could build a ladder using them. (I have not tried this.)
exodusNH
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Re: Index funds for government bonds

Post by exodusNH »

JWB wrote: Fri Oct 15, 2021 7:57 am I wish I had known about I Bonds and EE bonds 20 years ago, but I only learned about them at age 60. I opened a Treasury Direct account, and I Bonds were easy to buy. Buying other bonds is a little confusing, particularly TIPS. I’ve thought about a treasury bond index fund, but how grounded are they in the actual value of the bonds held? If I buy 20k in I Bonds from Treasury Direct, I know what they are worth. If I put 20k in a bond index fund how do I know whether I’ll get at least my 20k back in 5 or 10 years? Are Bond index funds based on treasuries only for people like me who didn’t have the foresight to buy them directly from the government years ago? Do people use bond Index funds to create bond ladders?
No, you're not guaranteed to get exactly $20K back in your bond fund. You will eventually be made whole, but there will be times where it might have lost 5-6%. Fund pricing in the bond funds is mathematically sound minus the few times when the markets have gone bananas. (E.g. March 2020.)

For example, if you needed to sell in September 1987, you'd be doing so for a loss, though small, compared to stocks:

https://www.portfoliovisualizer.com/bac ... ion1_1=100

Funds are easier to manage. Also, for people still contributing to 401k plans, it might be the only way they can buy Treasuries.

EE Bonds are only worth buying if you can keep them for 20 years. At that point, their value doubles, if they didn't already because of their issued interest rate. (I.e. you get 3.5% IF you hold it 20 years. After 20 years, it reverts to the issued rate until maturity.) Between now and then, they get whatever rate (currently 0.10%) they were issued at. The short of it is that they're not worth holding right now unless you can cash them in at exactly 20 years, or wish to leave some as part of your estate. The beneficiaries can then cash them in at year 20.
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nisiprius
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Re: Index funds for government bonds

Post by nisiprius »

The word "bond" literally just means there is a contract that spells out how many dollars get paid on what days. Most bonds work more or less this way.

1) You buy them from the issuer.
2) The issuer pays you interest, perhaps every six months, and then pays the face value back at maturity.
3) You don't have any right to ask the issuer to do anything else, but...
4) They are marketable securities, and if you want the principal back before maturity, you can sell the bond to another investor, but...
5) Your old bonds with old interest rates locked in is competing against other newer bonds in the market place, so on the market it may be worth more or less than what you paid for it.

This is called interest rate risk, because if interest rates go up, another investor won't pay you the full face value because they can buy freshly-issued bonds that are better.

Immediately after you buy them, the bond is worth almost exactly what you paid for it, which in turn is usually almost exactly the "face value." Just before they mature, the bond is going to pay out its face value almost immediately, so, again, the bond is worth almost exactly its face value. So the market value of bond starts at face value and ends at face value--anchored at both ends--but fluctuates in between.

Savings "bonds" are not marketable securities.

Savings "bonds" are different.

You can't sell them to another investor. In fact, you can't use them as loan collateral. The only way you can get money from them is to redeem them from the Treasury. The redemption value is made according to a set of rules--which includes CPI adjustments in the case of an I bond. The set of rules says nothing about interest rates, so...

Savings "bonds" have no interest rate risk.

This is amazing, and different from any other "bond" I've ever heard of.

Because they are not marketable securities there is no way for anyone to create a mutual fund or ETF that holds them. They can't be held in a brokerage account, either. This means that there isn't any way for the investment industry to make much profit from them. This may explain why you hear so little about them from writers whose roots are in the investment industry.

For "regular" bonds, there is always an ongoing argument, IMHO unresolvable, about how to think about individual bonds versus bond funds. If you treat an individual bond as "illiquid" and assume that you are going to hold them until maturity, and you are certain to carry out that plan, then you know in advance exactly what you are going to get, and it does not depend on what interest rates do. If you buy a bond fund, it is a mixed portfolio of bonds maturing at different times and you don't have the option of waiting until maturity. The value of the fund will include the fluctuating market values of bonds in it that are not close to either issue or maturity.

My personal strongly-held belief is that yeah, this means that it is a little less risky-in-the-sense-of-volatility to hold a portfolio of individual bonds instead of a bond fund, but that pragmatically the differences are small. For example, the Vanguard Total Bond Market Index Fund has never (yet?) lost money over any 48-month time period in its history.

Other than for savings bonds (!) notice that the idea that "bonds are pretty safe" depends on the assumption of a suitable holding period. For an individual bond, buying at issue and holding to maturity eliminates interest risk but of course implies you hold it for the term of the bond, whatever it might be.

For a bond fund, there is a calculated number called the bond's "duration," 6.8 years for Total Bond. Without getting into details, there are mathematical reasons for thinking that "a bond fund is pretty safe over a holding period of its duration or longer." Vanguard suggests "4 to 10 years" for bonds in the general risk category of Total Bond.

There's no way to make absolute statements, because there's no limit to what you can imagine for interest rate movements. But pragmatically, it has been a good guide.

The flip side of that coin is that if you buy a bond fund with a duration of 6.8 years, you should expect fluctuations over shorter time periods, and should not complain that "people said Total Bond was 'safe,' but it lost -2.15% in 2015."

Savings "bonds"--both series I and EE--have their own issues, but unlike marketable bonds they do not suffer from interest rate risk and their redemption value never goes down.
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Capricorn51
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Re: Index funds for government bonds

Post by Capricorn51 »

UpperNwGuy wrote: Fri Oct 15, 2021 8:26 am Check out iShares iBonds ETFs. Each fund has a fixed maturity (Dec 2021, Dec 2022, Dec 2023, etc up to Dec 2031), so you could build a ladder using them. (I have not tried this.)
agreed. I have set up a 4 year ladder like this - probably will extend to a 7 year ladder
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AnnetteLouisan
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Re: Index funds for government bonds

Post by AnnetteLouisan »

I could have written your post. I actually did look into them 20 years ago but decided to pass because I perceived bond buying as too complex and the TD website as too unwieldy. I sure regret that now. I also never did the backdoor Roth IRA because being above the deductibility income threshold I thought the benefit would be marginal for the added complexity.

My mistakes know few bounds. I lived in a VHCOLA my whole life but never got munis, a CPA or a taxable brokerage. I became eligible for a retirement plan at my first job and waived it. I rented for 30 years and then bought my rental apartment for cash thinking I was saving myself interest. I don’t use rewards cards anymore so I don’t incentivize spending. I paid off all my (consolidated) student loans within 5 years of graduating before that interest was deductible. I felt rich, so I lived rich … for a while. I leant friends money. I didn’t start contributing to a 401k until my 40s, and then was way too conservative in a huge bull market. And all the while I felt smart because I read the WSJ religiously since my 20s, worked FT and saved, and did better than certain friends and peers.
Topic Author
JWB
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Joined: Mon Jul 26, 2021 9:48 pm

Re: Index funds for government bonds

Post by JWB »

Thanks everyone for the feedback. At 60, I’m trying to plan a guaranteed income from 65 to 70, so plan to put 25k in ibonds a year for the next 5 years and will either put an additional 25k in a 5 year CD every year for the next 5 years or buy Tips or a bond etf to create a ladder. Had I started ibonds 10 years ago, things would look better…but at least this plan will help lower my anxiety about retirement and keep my money safe up to 5 years if needed.
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