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UPDATED JULY 2018
In an environment of rising interest rates, bonds especially longer term ones are unlikely to do well.
Bond funds without any maturity date are probably in the same boat or worse.
Hold for another 2 or 3 years and wait for market to bounce back?
That is a salesperson talking.
Never ask a barber if we need a haircut.
No one cares more about our money than we do.
Not interested in reading up and have no idea about investments?
Be interested and ask pertinent questions or you will be doing yourself a great disservice.
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Earlier this year, when I delivered a talk one evening to a group of investors, one lady told me she just got into a bond fund then and after listening to me, she asked if she should get out of it.
I told her I couldn't make the decision for her.
It was her call.
I was reminded of that encounter because of this recent email from a reader:
Hi AK,
I have invested my SRS money with XXX fund beginning of this year, at that time I am not interested in reading up and have not much idea about investment.
I was told the fund has a loss of 3K out of my invested 10K now.
The agent told me I need to give him 2 -3 years and wait for the market to bounce back.
The fund consist of bonds and I just concern with the increase of interest rate may make the situation worst.
What will you do if you were in my shoes ?
I have ran the figure on excel, to make back 3K of lost based on 7K capital with 4% return a year , I need 11 years :(
Please start to talk to yourself already and I know your disclaimer by heart :p
Many thanks, J.
My reply:
Hi J,
The XXX fund you got into earlier this year sounds like a bond fund.
It is one of those things that I said I wouldn't touch with a five feet pole in anticipation of rising interest rates.
Unlike equities which can recover because of improving fundamentals even when interest rates are higher, bond prices move in the opposite direction of interest rates.
Ask your agent what made him tell you that the bond fund will recover in another 2 or 3 years?
Is he merely speculating? We want to give him a chance to explain himself.
We are reasonable people, I am sure. ;)
Best wishes,
AK
Unless we have very good reasons, don't be bonded.
Related posts:
1. Buy a bond fund?
2. SRS: A brief analysis.
Bloggy Award
5 comments:
From my FB wall:
Timothy Ho:
Actually, I be more interested to know what the heck was in that Bond Fund. 30% down for a bond doesn't seem right to me at all.
Jieren Azrael Zheng:
Why bond prices cannot go down? Bond funds are traded often as well.
Timothy Ho:
Bond prices can go down. No issue. More curious to know what are the components in it. Have a feeling that the investor who wrote in to AK wouldn't feel too comforted knowing the type of volatility within his or her bond fund.
Jieren Azrael Zheng:
Most people think bond funds are stable. If you buy and hold till maturity yes (of course an environment with rising interest rates might hurt it). Quite a bit of misconceptions out there.
Assi AK:
There is no maturity date for bond fund.
Jieren Azrael Zheng:
Because is a basket of bonds, not a single bond ma
Marcus Chua:
Bond values do go up and down, at a lower volatility. 30% sounds somethings more than a non-investment grade bond fund. I'd agree with Tim, a drastic drop of 30% in bonds aren't very likely. Furthermore, interest rates are expected to gradually increase, not cold turkey back to the norms of about 5% in the late 80s into the 90s. I'm more interested in what's in the bond fund
Assi AK:
Many are attracted by 7% or 8% yield offered by some bond funds. I have warned that such yields are possible probably because the bonds are junk bonds which are high risk. If these bonds should default and those offered by shale oil producers could very well do so, then, the value of the fund would take a hit. As a rule of thumb, I would avoid bond funds.
Personally I rather buy bonds then invest in a bond fund. Bonds are important for retired people as they give fixed income which is good for paying bills. The certainty and regular payout gives retirees comfort. People will argue why not invest in REITS and business trusts? I will say that sure but those will be holiday money as you need to do a bit more work to ensure that you buy the right REIT and also not overpaying it. Investment grade bonds bought at right time and held to maturity will not have problem of fluctuating prices. The issue is of course picking the right investment grade bond and coupon.
Hi TG,
We invest in bonds because we want certainty of income and protection of our capital. At least that is what comes to my mind when people tell me they want to hold some bonds in their portfolio. To this end, we should hold investment grade bonds that have a maturity date.
Warren Buffett said that bonds are very overvalued and stocks are the cheaper of the two.
“If I had an easy way, and a nonrisk way, of shorting a lot of 20 year or 30 year bonds, I would do it. But that’s not my game. It can’t be done in the quantity that would make sense for us.”
Source:
http://www.warrenbuffett.com/how-warren-buffett-values-stocks-today/
Jake Gan says...
But bond funds churn their bonds too right? So in a rising interest rate environment their bonds mature and they can buy higher yielding ones. Or is there something wrong with my understanding?
AK says...
Bonds are considered "safer" if they have a maturity date and you get back your capital at some point in time.
The problem with a bond fund is that the fund doesn't ever mature (even if the underlying bonds do) and if you want your money back, you will have to accept whatever unit price Mr. Market offers.
When you buy a bond fund, you have to take this into consideration because you might want to or need to make a redemption in future. So, it matters.
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