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Weekend reading: Higher bond yields trump lower bond prices, eventually

Weekend reading: Higher bond yields trump lower bond prices, eventually post image

What caught my eye this week.

I answer comments on old posts every day on Monevator. A great many ask whether investors should still own bonds, given rates are “sure” to rise – and hence bond prices fall.

In the UK it’s still mostly an academic question. But US yields have been going up fairly swiftly. The Federal Reserve has been raising interest rates, and there are more signs of higher inflation in the US, too. Bond prices have fallen as a result.

My reply is usually some mix of the following:

  • Your bonds are there to cushion big share price falls, not to provide a huge return in themselves.
  • People have been predicting a bond bear market since 2009 (and in truth before that).
  • But inflation (and hence lower real returns) is what really kills you as a long-term bond investor.
  • A moderate correction that sent bond prices lower and yields higher would be good for long-term investors.

That last point is the hardest for people to accept. We’re so conditioned to obsess over the level of the stock market, for example, it’s easy to miss the importance of reinvesting and compounding returns. The same is true with bonds.

This week Sellwood Consulting wrote a very clear post explaining why bond investors shouldn’t fear rising rates. It is about US bonds, but the same logic holds true in the UK.

If you own bonds and yields rise, the value of your bond holdings will indeed fall. But thereafter you can look forward to a higher yield, and over time reinvesting this in now cheaper bonds can be more valuable.

Don’t hold too much in bonds, though. Not because they are super-risky – but because they’re not!

If you’re a long-term investor, being overly cautious can see you miss out on much higher returns. Michael Batnick explains why in his Irrelevant Investor blog this week.

Happy reading!

From Monevator

Gold as an asset class – Monevator

From the archive-ator: What does mark-to-market mean? – Monevator


Note: Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber.1

Pensions cold calling set to be banned by June [Search result]FT

Coinbase is launching a crypto index fund. US investors only for now – Coinbase

MPs call for ISA simplification [Search result]FT

Nimble schmimble: Most hedge fund money is held in giant funds – Bloomberg

Emerging market investors fail to reap benefits of GDP growth [Sorry, search result not working for this]FT

Great chart of the history of the US 10-year bond yield, the global benchmark – via The Reformed Broker

Products and services

Monzo, Atom, Revolut, and Starling: A guide to digital banks – Telegraph

NS&I has cut rates on two of its popular products – Telegraph

Get the most out of the free pensions help sessions for the over-50s – ThisIsMoney

LendingCrowd’s P2P rates start at 5.6%; capital is at risk – LendingCrowd

Why it’s so hard to invest with a social conscious [US products but relevant]NYT

Is this the beginning of the end for closet trackers? – Evidence-based Investor

As a rate rise looms, it’s time to fix mortgage repayments – Guardian

The key upcoming changes to the VCT and EIS regimes – Telegraph

Fitting a new flat? 🙂 Grab two Sonos One speakers for just £350 – Amazon

Comment and opinion

10 ways to safeguard your savings income [Search result]FT

How extreme frugality enabled one couple to retire early – Guardian

Unpicking the pension allowance taper – 3652 Days

The winners write the history books – A Wealth of Common Sense

The five types of retirement – Get Rich Slowly

Misfits, outcasts, criminals, financial professionals – A Teachable Moment

Would Buffett’s index tracking bet have paid for deaccumulators? – I.I.

The case for selling shares in AstraZeneca – UK Value Investor

All growth stocks end up in the same place – Gannon on Investing

Why Oscar winner Get Out resonates with value investors – The Value Perspective

Fear and greed are undefeated – The Reformed Broker

Off our beat

Bitcoin is ridiculous. Blockchain is dangerous – Bloomberg Businessweek

Chuck Feeney: The billionaire who gave it all away – Irish Times

The Boring Talks: The Argos catalogue [Podcast]BBC

Jerry and Marge go large [Lottery hacking]Huffington Post

James Altucher talks to Jim Cramer [Podcast, naughty step]James Altucher

And finally…

“The next bear market is sure to test the resolve of existing shareholders, but it will also – just as certainly – provide an opportunity for savvy trust connoisseurs to pick up bargains as trust discounts widen once more. For the forearmed investor, a crisis is an opportunity, not just a threat.”
– Jonathan Davis, Investment Trust Handbook 2018 (FREE on Kindle, saving £24.99!)

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  1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. []

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{ 65 comments… add one }
  • 51 Grislybear March 13, 2018, 7:58 pm

    @ The Rhino, regarding VWRL and VHYL because the prices are quoted in sterling I had assumed the purchase would be in sterling and would not involve fx charges. Thanks for flagging this.

  • 52 charlie March 13, 2018, 10:22 pm

    For VWRL purchases, who is it the levies this fx fee? Broker or Vanguard? I know dividends are paid out in dollars and broker applies fx fee for those, but I too assumed purchases/sales were in GBP. Otherwise what’s the difference between VWRL and it’s dollar-denominated equivalent VWRD?

  • 53 John B March 14, 2018, 9:32 am

    If you look at VWRL at HL, they do a neat little breakdown over 5 years, which has no Fx fees, only custody and dealing costs.

  • 54 Richard March 14, 2018, 12:33 pm

    The issue with taxing low income workers is you end up handing it back in benefits. True it may make them think twice about demanding tax rises, until they see their basic standard of living is assured. Why do you always hear about these people working 16 hours and topping up with tax credits (only anecdotal). You need to get peoples income to provide that basic level of living, either through decrease in the cost of living (housing?) or through boasting their salary outside of benefits. For example, increase the minimum wage but offer companies tax cuts to come out neutral but remove the benefits and bring people back into taxation.

  • 55 YoungFiGuy March 14, 2018, 1:35 pm

    @FIWarrior – thanks for the kind words. I’ve made a post on my blog with some thoughts.

    [To The Investor – please delete my comment if you’d rather me not “shilling” for my blog in the comments 🙂 ]

  • 56 The Investor March 14, 2018, 2:15 pm

    @YoungFiGuy — Once is okay cheers, especially as you’ve contributed plenty of thoughtful comment here first. Will take a look at your post myself. 🙂

  • 57 Kraggash March 14, 2018, 4:04 pm

    & IanT
    Reference that Sellwood Consulting article: I cannot see any reference to inflation. Unless I have missed it, doesn’t their ‘flat return over 10 years’ scenario actually mean a loss of 10 x annual inflation compounded?

    If they are talaking about ‘real return’, the yields they mention are rather high in todays environment. A real yield of 3.1% implies an actual yield somewhere north of 6% in the UK…..

  • 58 The Accumulator March 14, 2018, 9:12 pm

    VWRL vs VWRD – there is no practical difference. The £ denominated version is pure labelling smarts. Fund providers know that investors are more comfortable holding funds that show prices in home currency. You are going to pay FX charges somewhere along the line – to the broker, to the fund manager, to some agent operating on their behalf – anytime you invest in something that holds foreign securities.

    @ Rhino – I think Selftrade is being surprisingly transparent there. I’ve heard before they are reasonable on FX charges, not sure if that’s still true. Still, I’m intrigued. Think I’ll do some digging with brokers and fund providers to see if we can find out where the FX charges are levied depending on the scenario. I expect we’ll find it’s all over the shop. It usually is.

  • 59 The Accumulator March 14, 2018, 9:16 pm

    @ Kraggash – I got the impression they were conveniently skipping the inflation issue. They didn’t mention it which is suspect. Still, even with inflation the bond apocalypse is a day at the beach in comparison to equities. As long as we’re not talking 70’s style inflation with kipper ties on.

  • 60 The Accumulator March 14, 2018, 9:37 pm

    @ YoungFIGuy – re: pensions points
    Very interesting summation of the various pension fiddlings. I’ve got 2 main points in response:

    1. The changes seem to be made at least partly with a view to ensuring the State Pension survives into the future despite increases in life expectancy and the demographic bulge putting the system under pressure. As I understand it, raising the minimum age is reasonably effective. Obvs they should ditch the triple-lock vote-grabber but hopefully inflation protection stays. That should be a given for pensioners.

    2. Planning for anything 20 – 50 years ahead must account for a large degree of uncertainty. You can no more assume the same State Pension as you can the same tax system as you can world order, and we can ramp up the alarmism from there. Long-term plans must build in a degree of flexibility / reasonable sense of the limitations of contingency planning / acceptance that some things are beyond control. Hey, maybe I won’t even be here to worry about it 😉 Someone will always say, “Yeah, what you gonna do in the event of some Argentine style pension theft?” Well, what I’m gonna do is be wiped out. I can’t afford a bolthole in New Zealand, so Plan A is to hope it never happens. I’m being flippant but you could, for example, plan for the State Pension to be accessible at age 70 and worth 75% of current value. Or 50%. Or 0%. Whatever lets you sleep at night.

    On the point about private pension age increases – to the best of my knowledge that change has not been put into law, therefore not currently an issue. Do you understand differently? I understand your underlying point is it’s something that could happen / may well happen – which I agree with.

  • 61 Kraggash March 15, 2018, 1:17 pm

    @The Accumulator – without doing a full analysis (obs!) I would imagine it changes their ‘high chance of some gain with a small chance of flat return’ conclusion to ‘high chance of loss, with small chance of gain’ over 10 years. Which is not an apocalypse, but not great, with 10 years of oportunity cost as well.

  • 62 Grislybear March 15, 2018, 2:00 pm

    @Accumulator. It would be better to have Vanguard charge the fx charge than your broker. I would bet that Vanguard would be cheaper.

  • 63 The Rhino March 15, 2018, 2:52 pm

    @TA – when I say ‘exorbitant’ I mean 1%. Realistically thats probably very similar to other brokers, but I’m aware if you shop around you can get charged significantly less in this area.

    I’m pretty sure the implication was that it was selftrade applying the charge as opposed to vanguard.

    I agree with you that the denomination quoted against the ETF has no bearing on whether the underlying currency is, i.e. $ in this instance so I think there will be an FX charge involved.

    But I would be very happy to be proven otherwise on this..

    It will be both on the way in and the way out though I bet, so 2%, thats prob more than you’d pay an estate agent to sell your house, so I think my ‘exorbitant’ (to my mind) is justified..

  • 64 The Investor March 15, 2018, 3:09 pm

    I think this issue with the ‘inflation issue’ is that it applies to all assets. So your stocks will also do 3% less (or whatever) in real terms, too. As long as you’re comparing real with real or nominal with nominal, I think you’re good.

    This is not to say I don’t think inflation is a bond killer… it’s *the* bond killer as far as I’m concerned.

    But “inflation will kill your bonds” is IMHO a different argument to “base rates going up 2% will kill your bonds”.

    I’d argue they were addressing the latter here (even though the two factors are obviously somewhat interconnected). 🙂

  • 65 Adrian March 17, 2018, 11:23 am

    Hmmm which bond funds to hold?

    My bond fund holdings are in UK gilt funds. Their only purpose is to provide ballast if there is a huge equity crash. I’m not looking for growth or income from them. In the GFC corporate bonds fell along with equities but gilts went up. Logically gilts (government backed) should be inversely correlated to equities (children of the free market). But I suppose we’ll find out what happens next time…

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