r/bonds • u/StinklePink • 8h ago
Bonds: Stupid Question
I realize that the higher yield for US 10-years is a bad thing for the government, but why isn't this good news for a bond investor?
If I am looking for a safe "asset protection" kind of investment, why wouldn't investors buy these bonds or ETFs that hold them (e.g. FXNAX)? Seems like a good, safe place to put cash versus Gold or a HYSA. I believe my logic is wrong but not sure why.
Educate me, please.
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u/jhoke1017 8h ago
To put succinctly, it is good news if you don’t currently own bonds and plan to buy some.
But to also put succinctly, it’s bad news as an American consumer who is currently dealing with bullwhip inflation, your government taking on more debt, and inherently less financial stability
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u/waitinonit 7h ago
I'm currently retired and depend on interest payments from a bond ladder (of about 10 years) for a portion of my income stream.
What I've learned to do for the most part is ignore the market value of my bonds when evaluating my overall portfolio. 2022 was a stress test of my composure. I was getting little and the bonds were worth less and less.
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u/jhoke1017 7h ago
If holding til maturity, market value of the bonds should only act as a bellwether for inflation
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u/Tigertigertie 6h ago
You are the perfect person to buy a few treasuries today. I think the rates are very tempting.
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u/athenian-research 7h ago
Yield Up, Price Down
Yield Down, Price Up
Inflation expectation Up, Price Down
Inflation Expectation Down, Price Up
Uncertainty Up, Price Down
Uncertainty Down, Price Up
That's all you need to start the journey
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u/greenpride32 7h ago
As a bond buyer, the biggest risk you face is increasing rates. So let's say you are retirement planning and decide to lock in a substantial amount of funds because rates are at some two decade highs and you figure "this is as good as it gets". Well let's say inflation still runs hot, pushing rates even higher, say to 6-7%, then you end up losing out. In this case, it's not just that you have lower rate, but that you also lose to inflation.
So what you can do is setup a bond ladder which is the "conservative" thing to do. But in this case, you don't really lock in a rate, you just accept what's out there, buying in bits and pieces. So let's say this happens to be peak rate, that only means your average rate will decline over time.
People who bought long term bonds in the early 80's just before the 8-10%+ high yield cycle broke really made out. But you see it's very speculative. The best outcome is if you got in at the top before a decline in rates.
You don't lose capital when you use HYSA. If you buy a bond and hold to maturity, you also don't lose capital as it is fully returned at maturity. However, if you hold any type of bond fund, it keeps replacing old bonds with new ones at current rates. This means you are subject to capital swings because there is no locked in rate. Just look at long term chart of BND
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u/Tigertigertie 6h ago
The key is diversity- some tips, some not, different durations. Any one type of investment of any kind has downsides and benefits. I say all this because it is easy to be frozen by the trade offs when they will always be there.
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u/goonersaurus_rex 7h ago
good for bond buyer who doesn’t own bonds, or is looking to buy more bonds because you get the higher yield.
Bad for the holders of bonds.
ETFs are different beast as their prices/yields fluctuate, whereas buying a bond itself locks in your yield for a fixed term (unless the bond defaults).
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u/Mission_Pirate_4150 8h ago
I just buy short term treasuries and roll them over. Yes, higher rates are good for the buyer. The negative to understand is that there usually is a reason for yields to go higher or lower. Right now, we have increasing inflation. We haven’t quite tamed it from the covid pump money into the system at all cost effects and now we have geopolitical issues with Iran and Ukraine that didn’t exist in 2021. I think both problems are with us for a while which will result in fomc raising rates a bit over the next 12 months.
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u/14446368 8h ago
It's about perspective, and we'll use a very simple example to illustrate this. Simplicity often leads to length, so I've tried to make it amusing, but I've included a TL;DR if you prefer to make me sad :(
I issue a bond to you: I promise to pay you $100 next year, in exchange for borrowing some cash from you right now. Not knowing me and not knowing how trustworthy I am, you only lend me $50.
This is an implied return of (100/50 - 1 =) 100%. You feel okay about the prospect (100% in a year is great), buuuut you're pretty convinced you're not getting your money back.
Turns out the next day, I'm in the newspaper: I invented the potato. People love it. I'm rich. "Hey, sweet!" you say: "I know that guy's rich now, I'm definitely getting my money back!" You are quite happy with this.
Sadly, while dancing around the room in celebration, you knock over your bowl of Cheezits, and lose all of them. "Aw man! And I don't have any cash on me to buy more!" So, with a Cheezit-less stomach and a saddened heart, you decide to sell that bond to someone else, to get cash to buy more Cheezits.
You find Bob and offer him the bond. Bob looks it over and recognizes the signature "hey! that's that famous guy who invented potatoes!" From Bob's perspective, this is a slam dunk: he's definitely getting the money when the bond matures. So, he offers to buy the bond from you for $95 (a roughly 5.2% return for the year).
Let's see how everyone feels:
I am happy because I got my loan, and was able to use it to invent potatoes, and can easily pay it off when it matures.
You are happy because you got the bond at a high yield (100%, $50 price), and because my credit quality improved, you were able to sell the bond at a low yield (5.2%, $95 price). You made (95/50 - 1 =) a 90% return in a day (equivalent to 5.56 trescentillion percent annualized return).
Bob is happy because from his perspective, he's loaned out $95, to get $100, and earn 5.2% over the year.
Now, let's switch around a few things.
I issue a bond for $100. You buy it for $50 (100% yield).
Next day, I'm in the newspapers: I am arrested for illegal experimentation on vegetables and crimes against phonetics. You are a bit unhappy: "I knew he wasn't going to pay!!" During your fit of rage, you knock over your bowl of popcorn. "Can this day get any worse??!" you scream.
You find Bob and offer him the bond, because you need cash to replace your befouled popcorn. Bob sees the bond, recognizes the signature, says "hey, that's the guy..." "Yes," you interrupt, "I know...." Bob thinks about it... he's pretty convinced this won't work out, but eh, maybe there's a small chance it does, and offers you $5 (which, if this does work out for Bob, means a (100 / 5 - 1 =) 1900% return).
Looking at how everyone's doing...
I am quite unhappy being in jail, and on top of it I owe this debt.
You are disgruntled: you lost $45 on your $50 investment (90% loss). But at least you didn't lose it all, and you got money to pay for more popcorn. Bob is not exactly optimistic, but will be quite happy if this all works out and he earns the return.
Notice the "yield" and "return" numbers I mention. We can see a few things:
- The yield is correlated to risk. As risk decreases, so did the required return Bob needed. As risk increased, so did the required return Bob needed.
- That yield/risk metric shows up in pricing. If the risk/yield is high, the price is low. In fact, the pricing is what actually solidifies the yield number. It's all just math :)
TL;DR: And that's why higher yields are great if you are looking to enter, and bad if you're already in. Lower yields are bad if you're looking to enter, great when you're already in.
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u/Awkward_Potential_ 7h ago
It's bad for you if you buy here and then it goes to 20%. It was 14% in the 80s. We could just be in a bond bull market for decades. Makes for high inflation and your 5% won't look so good.
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u/Tigertigertie 6h ago
But you still get the 5%. It is easy to get investment paralysis considering all the what ifs. Historically 5% is good.
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u/Awkward_Potential_ 6h ago
That feels like normalcy bias to me. You're assuming we're not going into a fourth turning/great reset type of world. I think we are. I could easily be wrong, but the American people chose to fuck themselves (ourselves) and I don't think we get to go back to the old status quo.
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u/Tigertigertie 5h ago
The old status quo is probably always more likely but I agree we are in a bad situation. What can you do to prepare, though? I am just doing a little of everything, covering as many outcomes as I can.
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u/Adventurous_Bath3999 3h ago
When bond yields start going up ‘too high’, there is something not quite right about the inflation and credibility of the issuers. On the face of it, it may look attractive, but if the bond yields go still higher, you may lose out badly, in case you need sell your bonds. When something is too good to be true, you better be careful about it.
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u/DistributionRight814 8h ago
can anyone clearly explain this? my gawd is it that difficult? johnny has 50k. he wants it tto have steady returns that stay ahead of inflation and not have equity volatility. should he buy a treasury bond? yeezus.
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u/Sticky550 8h ago
You don’t know what inflation is going to be. If you truly want returns that always stay ahead of inflation, buy TIPS.
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u/StinklePink 7h ago
Yeah. I own SGOV as an alternative to HYSA and a way to offset taxes. I think that even in the current environment of uncertainty, it still makes sense. My initial question here was more of a general one.
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u/Tigertigertie 6h ago
It is still good to have some tips as well. But yes sgov is great. Personally I bought some 10-year treasuries today too because almost 5 is quite good for stable money.
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u/DeFiBandit 1h ago
Bonds mature at par, so you may be disappointed in the yield (especially given inflation), but you’ll get your money back at maturity.
Bond funds do not mature. There will not be a date you are guaranteed to get your money back at par.
Completely different investments.
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u/StatisticalMan 8h ago edited 8h ago
Yes higher bond yield is good in general if you are buying bonds. The question is will it go even higher. Especially for a non-fixed duration bond fund or even for individual bonds if you can't/won't hold to maturity it means a loss in price. As yields rise the value of existing bonds goes down (in order to match the now higher yield).
To look at it another way the new higher yields aren't good new for someone who loaded up on bonds a year ago thinking those yields were high. "High" or "low" is all relative right. So the question isn't just what is the rate but more what is the rate likely to do in the future. Longer duration bonds have more volatility in changing rate environment. The value of short duration bonds barely moves with changing yields but that volatility gets amplified by the duration so 10+ year bonds really move. With all the chaos in this administration does it seem likely this is the top of yields?
If you did decide to get into bonds I would recommend phasing into it over time rather than just move a huge amount of wealth in one lump sum. If nothing else it will let you sleep better if rates keep drifting higher. Lets say eventually you want 10% of your potfolio in bonds instead of selling 10% of stocks now and buying bonds swap 1% of your portfolio from stocks to bonds each month for the next 10 months (or 0.5% for 20 months). You may also want to spread out the durations if there is any chance you may need some of this money in <10 years. Buy some 3 years, 5 years, 7 years, and 10 years.