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Vanguard Exec: Don't Ditch Bonds When Rates Rise

Comments

  • BobCBobC
    I think everyone here at MFO understands his basic message, and it is valid. But it is very important for investors to understand the definition of 'duration' and the relationship of a bond fund's duration to changes in interest rates. Owning mid to long-term government bonds at this time is potentially very risky. Investors own bonds because they want less risk/volatility than stocks, for the most part. But I look at VUSTX's duration of 15.51 and wonder how many shareholders have a clue that a 1% rise in interest rates could mean a loss of more than 15% of their principle. My guess...not many of them. There are numerous other bond funds to consider that have much, much shorter durations for the same or better yield than VUSTX. Bottom line - keep your durations pretty short if you think interest rates are moving higher.
  • Mona
    There are numerous other bond funds to consider that have much, much shorter durations for the same or better yield than VUSTX
    Hi Bob,

    Which specific shorter duration bond funds do you have in mind?

    Mona
  • BobCBobC
    You might consider OSTIX, BSIIX, GSZIX, LLDYX, THIFX, ESIIX. There are others, of course, but these are the managers we especially respect.
  • Daves
    Reply to @BobC: I don't know a lot about bonds but is it not true that if the Fed doesn't raise interest rates until mid 2015 at the earliest as they promised, bonds should be relatively safe depending on the type of funds one is in?
    I'm in PTTRX and DODIX but am not sure how "safe" they are.
  • BobCBobC
    Reply to @Daves: Good question. The Fed really only controls the Fed Funds Rate. While the Fed can have some effect on longer-term interest rates, these are often more market-related. That is the reason I would look carefully at a bond fund's average duration. That will give you a good idea of how a fund's NAV might be affected by changes in interest rates. Obviously, longer-term bonds have greater downside potential. As of this morning, PTTRX's duration was 4.77. DODIX is 3.70. Conversely, VUSTX has a duration of 15.51, FNMIX is 6.46, VWINX is 6.08, and BSIIX is 1.20. Theoretically, yes, if the Fed keeps short-term rates low, there should be no problem, but keep in mind that prices on bonds have been pushed up to big premiums in many cases. So I would err on the side of caution when it comes to duration.
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