Is Your Bond Fund Really Losing Money?

When the yield on 10-year federal bonds spiked earlier this year—from 1.88% on May 16 all the way to 2.55% on July 5—the value of broad-based bond ETFs plummeted sharply. But I’ll wager that many investors think their bond ETFs are performing worse than they really are.

There’s a common misunderstanding about how fixed-income ETF returns are calculated. That’s understandable, because your brokerage’s account summary is highly misleading: it indicates only an ETF’s price change while ignoring all the cash distributions. And lately, 100% of your bond ETF’s return has come from interest payments, not price appreciation. Unless you understand that, you might think your ETF has lost money when it’s actually logged a nice gain.

Why bond ETFs fall in price

Most investors understand that bond prices fall when yields rise. What’s less well known is that bond ETF prices will decline steadily even if interest rates don’t change. That’s because virtually all the bonds in a broad-based ETF today were purchased at a premium—in other words, for more than face value. As these bonds mature or get sold, the fund will incur a steady trickle of small capital losses. But that doesn’t necessarily mean your investment will lose money overall, because the interest payments from the bonds will offset at least some those losses.

So far in 2013, broad-based bond funds have indeed suffered negative returns—but the numbers are not as bad as you might think. Here are the year-to-date numbers for three popular bond ETFs (as of July 31). The total return of each fund is significantly better than the price change would suggest, because investors received monthly interest payments along the way:

Price on Price on
Dec 31, 2012 July 31, 2013 Price change Total return
XBB $31.39 $30.31 -3.44% -1.66%
VAB $25.41 $24.48 -3.68% -1.88%
ZAG $15.88 $15.31 -3.59% -1.74%

Now have a look at the year-to-date results for some popular short-term bond ETFs. All of these funds have delivered positive returns this year despite a decline in price:

Price on Price on
Dec 31, 2012 July 31, 2013 Price change Total return
XSB $28.87 $28.57 -1.04% 0.56%
VSB $24.88 $24.66 -0.87% 0.64%
CLF $19.78 $19.47 -1.57% 0.63%
CBO $20.15 $19.84 -1.54% 1.06%

When a loss is really a gain

The numbers are even more dramatic if you go back a few years with CLF and CBO. These iShares ETFs are extremely popular, at least in part because they pay unusually high yields: despite holding nothing but short-term government bonds, CLF pays almost 4%. The corporate bonds in CBO pay almost 5%. That can only happen when the underlying holdings were purchased at a steep premium, and that means these ETFs will see their prices decline steadily as the bonds are gradually sold and replaced. If you’ve held these funds in your account for a full three years, they would show a significant capital loss—and yet their total return over that period was actually quite good:

Price on Price on 3-year Total return
July 31, 2010 July 31, 2013 price change (annualized)
CLF $20.33 $19.47 -4.23% 2.75%
CBO $20.48 $19.84 -3.13% 3.53%

An investor who held CLF over the last three years (and reinvested all distributions) would have seen every dollar grow to $1.08, while CBO investors grew each dollar to $1.11. Yet I recently received an email from a reader who was alarmed that CLF “has been losing money for years.”

Go the source

One final note: don’t make the mistake of thinking a distribution reinvestment plan (DRIP) will eliminate this confusion. Index mutual funds don’t solve the problem either, even though all distributions are automatically reinvested. In both cases, the dollar amount of your total holding will increase over time if the fund delivers a positive return, but the gain/loss column in your account summary will show the same misleading price decline.

Here’s a simplified example to illustrate the idea:

  • At the beginning of the year you buy 1,000 shares of a fund for $20. Your holding is $20,000.
  • The fund yields 4%, or $0.80 per share annually. All of the distributions are reinvested, so you receive your $800 in the form of 32 new shares.
  • By the end of the year the fund’s price has declined $0.40 per share to $19.60. Since your purchase price for the shares was $20, the gain/loss column in your account summary now shows a capital loss of 2%.
  • However, your holding is now 1,032 shares worth $19.60, which works out to $20,227.20. That’s a total return of about 1.4% on your original investment.

The easiest way to check the total return on your bond fund is to simply visit its web page: published performance numbers always include both price changes and interest payments, which are assumed to be reinvested. To measure your personal rate of return (which factors in the dates of all your purchases and sales), you’ll need to use a calculator like this one from Justin Bender.

49 Responses to Is Your Bond Fund Really Losing Money?

  1. Dave August 7, 2013 at 11:10 am #

    I currently am invested in the TD e-series bond index fund. The distributions are fully DRIP’ed. What I usually do to calculate the gain/loss is to take the principal that I contributed to the fund and subtract from the current market value. Would that not accurately determine the gain/loss?

  2. Canadian Couch Potato August 7, 2013 at 11:19 am #

    @Dave: That will let you know your gain (or loss) in dollar terms, but unless you specify the dates of all your contributions you won’t know your rate of return.

  3. KayT August 7, 2013 at 11:44 am #

    How does one incorporate the Weighted Average Yield to Maturity into assessing total yield of a bond ETF? I note that the current YTM for XBB is 2.68%. At this rate is it reasonable to conclude that since XBB YTM is more than one can get on current short term GIC, that it would be reasonable to continue holding XBB going forward, even if the price will decline as interest rates increase? If interest rates continue to rise won’t there come a point where the YTM of a bond ETF would be less than one could get on a GIC? I’m trying to decide on a fixed income strategy for my RRSP going forward with a future of rising interest rate environment – GIC ladder vs short term bond ETF like VSB.

  4. Canadian Couch Potato August 7, 2013 at 12:00 pm #

    @KayT: The YTM of a bond fund is an estimate of your total return assuming interest rates do not change. But, of course, interest rates do change, so it is only so useful. One benefit of a GIC is that you know exactly what your return will be when you buy it.

    You can’t compare XBB to a GIC ladder, because XBB includes longer-term bonds (average 10 years). That’s the reason its YTM is higher than a five-year GIC. If you compare a short-term bond ETF to a GIC ladder you will see that the GICs do indeed yield more. That is always the case, since GICs are not liquid, so you get a little extra yield to compensate you for that inconvenience.

    When it comes to GICs versus a short-term bond fund, there are some trade-offs to consider. The benefit of GICs is predictably, price stability, slightly higher yield, and much greater tax-efficiency (not relevant in your case if you’re using an RRSP). The benefits of the bond ETF are liquidity, flexibility to add more money at any time, and easier rebalancing.

    In either case you can take advantage of rising rates over the long term: as GICs mature you will be buying new ones with higher rates, and as short-term bonds in the ETF mature they too will be replaced by higher-coupon bonds and the YTM will creep up.

  5. Al August 7, 2013 at 12:12 pm #

    How does this affect those tax advantaged etfs like CAB?

  6. Canadian Couch Potato August 7, 2013 at 12:32 pm #

    @Al: The same principles apply when measuring pre-tax returns. The only difference with CAB is the way the distributions are taxed.

  7. Serge August 7, 2013 at 3:28 pm #

    Hello,
    this is an interesting post and I’d like to know why there is such a difference in the total return between XBB and ZAG? I’ve noticed that those two funds are far from delivering the same distribution, I am very curious about this. Thank you.

  8. Canadian Couch Potato August 7, 2013 at 3:54 pm #

    @Serge: Just realized I accidentally used the market price return for ZAB and the NAV return for XBB. I have fixed the error, and you’ll see the difference is much smaller now that the comparison is apples to apples.

    In any case, when you’re looking at short periods (in this case, seven months) the returns may be affected by the timing of the distributions. Over longer periods I would expect ZAG and XBB to perform almost identically. Indeed, if you look at the one-year and three-year returns of the two funds, they differ by a mere 0.08%.

    VAB will be a little different, because it has a slightly higher allocation to government bonds than the other two.

  9. Canadian Dividend Blogger August 7, 2013 at 9:11 pm #

    Unless I’m mistaken, those numbers don’t account for inflation. With inflation, most of those gains are real losses. CBO YTD is the only one that looks like it is ahead at all this year in real terms; and over 3 years, those 2.5% gains must be real losses as well.

  10. Rahim August 7, 2013 at 9:29 pm #

    Hi CCP,

    What are your thoughts on Canadian Gov’t Bond Index funds (like the one offered by RBC)? I have a small, all-index RBC mutual fund portfolio, but the only bond index option at RBC is the Cdn Gov’t Bond Index fund. Since I’ll be sticking with RBC at least until my portfolio gets a bit larger, am I better off with this option (MER 0.67%) or opting for one of their actively managed bond funds (like the Cdn Short-term Income Fund)?

    My thoughts are that the Gov’t Bond Index fund is negatively correlated with equity index funds, and therefore aside for not having other options with RBC, I have it in my portfolio for stability reasons (and to rebalance for future market corrections). Am I correct in my thinking?

  11. Canadian Couch Potato August 7, 2013 at 10:09 pm #

    @Rahim: The RBC bond index fund isn’t an ideal option, but I’m not sure the solution is to use an actively manged fund that charges twice as much and includes more than 50% corporate bonds. Those are two very different risk profiles. You’re certainly correct that government bonds are a better diversifier, so if your primary goal is to lower volatility in the portfolio, you’re probably best off with the index fund for now.

  12. Matt Becker August 8, 2013 at 9:29 am #

    I just keep track of all of my contributions and withdrawals (not that there are many withdrawals) and use the XIRR function in excel to get my personal return. Since everything is automatically reinvested into the same fund, I’m pretty sure this is giving me an accurate view of my return from each source.

  13. Gene August 8, 2013 at 7:40 pm #

    I do not really follow. If the yield is 1.4 at best then better keep the money in a HISA for the time being.

  14. J Palmer August 8, 2013 at 7:58 pm #

    So the big question is where do we Couch Potatoes go from here with our bond holdings? I have about $100,000 in TDB966 currently at the break even point – the price drop equals interest received in the past year and a half. (It was the best I could do at the time the account was opened as I didn’t have a brokerage account set up with BMO at that time). It has a .83 MER. Do I just leave it alone and keep collecting interest? Do I sell it and move it into XBB with a lower MER? Or a Short Term ETF Bond Fund? Or a laddered Fund? Or cash or? Or just hang in there for the long term and wait for everything to even out?

  15. Canadian Couch Potato August 8, 2013 at 8:28 pm #

    @J Palmer: If you now have access to ETFs and you plan on investing in broad-market bond fund for the long term, then it almost certainly makes sense to sell the TD fund and move the money to XBB (or a similar ETF). You would be dramatically lowering your cost and your exposure would be identical. There is no advantage to staying in a fund with such a high MER if you don’t need to.

    Cash and short-term bonds are just fine if they’re part of a larger plan. But if you’re moving to cash or short-term bonds with the idea of going back to XBB after interest rates have gone up, well, then you’re just making forecasts, and you probably know what I think of that strategy.

  16. Mark August 9, 2013 at 5:12 pm #

    Still seems like a pretty raw deal with bond funds. Assuming you held them in a taxable account (I will admit, most people won’t) you have been paying tax on the distributions at your marginal tax rate and then selling them at a loss at your capital gains tax rate. If you were to add the tax component into the equation the valuation on all of this would almost certainly be negative.

  17. J Palmer August 9, 2013 at 6:13 pm #

    Thanks for the reply Spud. I am still unclear as to how the price of of a bond mutual (say TDB966) differs from a bond ETF like XBB which covers the same index. The mutual fund’s price is determined at the end of the day by (presumeably) the underlying value of the bond holdings. But to what extent is a bond ETF’s price affected by market bidding, ie: buyers and sellers trying to get the best price?

  18. Bet Crooks August 9, 2013 at 6:17 pm #

    Thanks for the insights. My work pension bond fund is not doing quite as well as these I don’t think, but I’ll have to go take another look. For now, I’ve decided to just let it ride, even at a loss, because there is no other fixed income choice available, and I don’t want to be 100% in equities.

  19. Canadian Couch Potato August 9, 2013 at 7:09 pm #

    @Mark: You definitely should not hold bond ETFs in a taxable account: if you need to hold fixed income in a non-registered account it should be GICs:
    http://canadiancouchpotato.com/2013/03/06/why-gics-beat-bond-etfs-in-taxable-accounts/

    A few people have commented on the fact that even the total return on bond funds have been “a bad deal.” Let’s remember that we’re looking at a seven-month period. Bonds are in your portfolio to dampen volatility and provide a safety net if equities plummet dramatically. They continue to accomplished both of the goals. Dismissing them because they don’t provide inflation protection or huge growth potential is like criticizing a screwdriver because it won’t drive a nail.

    @J Palmer: An ETF’s price is determined by the value of the underlying holdings (the net asset value, or NAV), just like a mutual fund. The main difference is that an ETF’s NAV is calculated throughout the trading day, while a mutual fund’s NAV is calculated only once at the end of the day. In theory, the bid and ask prices of an ETF should be very close to the NAV, with a small spread built in so the market maker and brokers can make their profit. If one bond ETF happens to have a lot of trading volume, while a similar one has little (an example might be XBB versus VAB), that doesn’t affect its NAV.

    This is a confusing concept, but these posts might help. (Or they may just be more confusing!)
    http://canadiancouchpotato.com/2012/09/10/etf-liquidity-and-trading-volume/
    http://canadiancouchpotato.com/2012/09/13/an-etf-pricing-puzzle/
    http://canadiancouchpotato.com/2013/03/13/two-ways-to-measure-an-etfs-performance/

  20. J Palmer August 10, 2013 at 2:00 am #

    Thanks Dan. That reply and the links helped a lot. I never knew what a “market maker” was. Now I understand.

  21. Pickering August 12, 2013 at 9:42 am #

    I am confused and have searched for months trying to get definitive answers. Have a reasonably large fixed income portfolio. Consists of CBO , XSB, CPD and CLF and a whack of individual re-set pref shares. This represents about 60 % of our portfolio – balance consists of dividend paying equities. Currently retired but will not need income from F/I portion for at least 7-10 years. Got lucky CBO, XSB & CLF purchased in 2009 – RBC shows us as being about even with regard to market/purchase price.
    Question – as yields rise, share value falls. Short term one hopes distributions exceed share price decline. What about long term ??? As etf portfolio keeps rolling over yields will increase ( if rates increase as expected ) Does there reach a point ie current duration , whereby the etf is not maturing their inventory at a loss to purchase price and as a result share price declines will stabilize and longer term investors can expect increased yields without an on-going and continuing share price erosion.
    Similarily, we purchased our re-sets at very close to the issue issue price of $ 25. Showed some paper gains that are now eroding. Was very careful to choose issues with a large premium to bond yields on the re-set price, thinking that they will be redeemed at my purchase price of $ 25 and we get 5 years of 5-6% yield with no capital loss. Am I correct ?
    Any thoughts would be appreciated !

  22. Canadian Couch Potato August 12, 2013 at 11:35 am #

    @Pickering: I can’t comment on the pref shares, because I really have no expertise in these securities. But as for the bond ETFs, yes, in theory you are correct that if interest rates gradually rise then at some point the ETF’s holdings will no longer be premium bonds. It’s just impossible to predict when that might be. Many ETFs include bonds that are 15 or 20 years to maturity, so it will take time. There’s an easy way to check this: just compare the ETF’s “weighted average coupon” to its “yield to maturity.” Right now the former number is always higher, but if rates gradually move up that gap will narrow.

  23. Mark August 13, 2013 at 4:08 pm #

    I really can’t see any upside in bonds right now. The effective rates are so low that I might as well put the money into a HISA. My entire portfolio is risk capital; I always keep <$10,000 in my main accounts (usually around $7k or so) but my strategy lately has been to sock it away into a ING account in the short term or put it in a low interest money market fund until I am ready to rebalance my portfolio. The cash, in many ways, is my volatility hedge in case the markets take a beating.

    My situation is unique in that I am in my late 20s, have no student debt (thanks Mom & Dad!), have no aspirations to own property in the near or medium term. I don't plan on touching that money until I retire so I couldn't care less about short term volatility. I only check my portfolio twice a year anyways.

  24. Canadian Couch Potato August 13, 2013 at 4:47 pm #

    @Mark: Someone in your situation may not need bonds in a long-term portfolio. But let’s remember that we are now almost five years removed from the last serious market plunge, so it has been very easy to tolerate a portfolio of 100% equities. That will be tested the next time markets plunge 25% or 30%, which is inevitable. During that time, government bonds are likely to rise significantly in value and offset some of those losses in a way that a HISA cannot: cash can lower volatility, of course, but not as much as bonds that can increase in value.

    The size of the portfolio matters a lot, too. It’s one thing to lose 25% of a $10,000 portfolio, which might be one month’s paycheque. It’s quite another to lose 25% of a $400,000 or $500,000 portfolio.

  25. André August 15, 2013 at 7:36 am #

    I use 2 short term bond etfs. XSB and VSB. MER being much lower on VSB (0.15 vs 0.28), I plan to gradually move toward VSB. Before I do so, are there any differences between both etfs I should be aware of? Thanks for your help.
    André

  26. Mark August 15, 2013 at 2:00 pm #

    I have a lot of trouble even understanding the value of bonds these days. I started investing only 4 years ago and bonds have been touted as a good investment; but with an overnight rate of 1% I just don’t understand what upside there possibly could in on a long term basis. If interest rates are at historic lows I don’t see how as long term investor I could possibly come out ahead with bonds. Even if the markets were to tank the government can’t really cut rates even further which means dismal returns.

    The phrase that comes to mind for me is that past returns don’t guarantee future returns and this means that although in the past they have been a good way to reduce volatility they aren’t today. Interest rates have never been this low before and frankly I don’t think even professionals know what to make of it anymore.

  27. Canadian Couch Potato August 15, 2013 at 2:48 pm #

    @Mark: The overnight rate has almost nothing to do with bonds. I wrote about this idea here:
    http://www.moneysense.ca/2011/10/12/this-is-no-time-to-bail-on-bonds/

    It’s important to be specific about “coming out ahead with bonds.” Ahead of what? Stocks? That has never been the expectation for bonds. Cash? The current yield to maturity on the DEX Universe Bond Index is about 2.7%, which is much lower than the historical average, but it is not negligible, and there is certainly room for rates to fall. That seems unlikely, but if equity markets fall sharply it is certainly possible.

    “Although in the past they have been a good way to reduce volatility they aren’t today.” There’s no evidence for that claim. It’s true bonds a better diversifier when their yields are higher, but if you use that logic, then the next logical step would be to increase your allocation to bonds when yields are low:
    http://www.advisor.ca/retirement/think-twice-before-dumping-bonds-116095

    In the end this discussion keeps coming back to the same question: if bonds are no longer part of a diversified portfolio, what do you replace them with?

  28. Mark August 15, 2013 at 3:36 pm #

    > if bonds are no longer part of a diversified portfolio, what do you replace them with?

    Still trying to figure that one out myself. I would rather not be 100% equities, but I struggle at the moment to find an alternative to HISAs at the moment.

    I’ve considered investing in CBO due to the higher yield. The risk is higher, but it seems like a pretty good option.

  29. Anita August 21, 2013 at 2:34 pm #

    Help! When I saw the price of TD Canadian Bond Index – e drop to a 3 month low I moved all the money from my TDW savings account into it thinking it was better than the 1.14%. I thought I’d buy more equities as deals came up. $115 000 at $11.49. Then everything crashed, and prices seem to be getting worse. I am only invested in TD e-series indexes right now. Probably 80% bonds and 20% equity indexes since my bond mistake. Am I a good candidate to move my Bonds into the XBB ETF too? If I understand properly, I think yes. Please help. I’ve never bought an ETF before.

  30. Canadian Couch Potato August 21, 2013 at 2:56 pm #

    @Anita: The first thing I suggest is making sure you are comfortable with your investment plan. If you’re worried that bonds have “crashed” because they’re down a few percentage points, that’s a problem. Nor should you be trying to time the market by waiting for “deals to come up.” A better plan is to choose an asset allocation appropriate to your long-term goals and stick with it, rebalancing only occasionally.

    Moving from TD index funds to ETFs has no relevance here. The TD Canadian Bond Index Fund and XBB track the same index and have virtually identical holdings. They will move up and down in lockstep. So if you are going to hold bonds in your portfolio, the TD fund will do the job just fine.

    For the record, the DEX Universe Bond Index is now yielding over 2.8% (before fees), which is certainly better than 1.14%. But you need to stay in it for the long-term: this index is only appropriate for investors with a horizon of at least seven or eight years.

  31. Que September 4, 2013 at 6:09 pm #

    @Dan: Can you help point out considerations that would help choose a fund like XBB/VAB/ZAG over a TFSA at 3%. I can’t seem to get over the direct comparison of the YTM, 2.80%/2.72%/2.60% respectively for XBB/VAB/ZAG versus 3% with the TFSA.
    Thanks!

  32. Canadian Couch Potato September 4, 2013 at 6:57 pm #

    @Que: It would be hard to make a strong argument against a TFSA savings account at 3%. One concern would be that 3% is a teaser rate that could easily be revoked, though if that were the case you could always switch to bonds after the fact. (It’s not like they can take back the interest retroactively.) The other argument would be that if stocks take a plunge, interest rates will likely fall and bonds would move up in value. A savings account would just remain flat, so it doesn’t have the same downside protection.

    I think it’s fair to say that 3% rate on savings is exceptional today. Online banks are paying about 1.35% and even five-year GICs are paying under 3%. I think you need to be suspicious of deals that sound too good to be true. Are there liquidity restraints, such as holds on the funds? Limited online access? Hidden fees? I’d suggest checking it out thoroughly before investing.

  33. Que September 4, 2013 at 8:18 pm #

    @Dan: It’s been at 3% for over a year now I think, and no fees and typical online access:
    http://www.peoplestrust.com/high-interest-accounts/todays-rates-3/

  34. Que September 5, 2013 at 12:49 pm #

    @Dan or Anyone else: Do have any knowledge of Peoples Trust, or opinion, or have heard about any experiences?

  35. Jeremy September 7, 2013 at 9:44 am #

    Alright, I’m not quite understanding this.

    I’ve invested $4232 into the TD e-Series Canadian Bond Index. Those shares are currently worth $4099, so if I sold them tomorrow I’d lose $133 (or about 3%). But you’re saying somehow I would actually be up beyond the $4232?

    I’m not understanding how I would go about getting that money to break even beyond the principal amount.

  36. Canadian Couch Potato September 7, 2013 at 10:06 am #

    @Jeremy: It’s very possible you have lost money in a bond fund: it depends when you purchased it. Broad based bond funds like TD’s are down about 1.6% over the last 12 months. However, if you have held the fund for at least two years, it has not lost money over that period, even if the price has gone down, because the interest payments will have offset the price decline.

    Your bond fund may never “break even” in terms of price. For that to happen, interest rates would have to fall sharply and push that price back up. But read the example at the end of the post again to see why that isn’t necessarily a loss.

    It’s impossible for me to comment on your specific situation because I don’t know when you invested or the amount of your contributions. But when you say you have invested $4,232 in the fund, is that because that’s your book value? If so, you may overstating your contribution. That book value includes reinvested interest payments. So, for example, two years ago you may have invested $4,000 and received $232 in interest payments since then (that’s about 2.9% a year for two years). Then the price of the fund may have declined about 3% over that period, reducing your $4,232 to $4,099. You think you’ve lost money, but in fact your original $4,000 has grown to $4,099.

    I just made those numbers up: your actual situation may be different. But that’s the general idea.

  37. Mike September 12, 2013 at 1:24 am #

    @Que: Many users on this forum bank with People’s Trust and seem to like it. I’ve never done business with them personally.

    http://www.financialwebring.org/forum/viewforum.php?f=35

  38. Jakob September 15, 2013 at 3:46 am #

    People’s Trust is indeed the highest-grossing TFSA right now, and has been for a while I guess. Forums and rate histories on http://www.highinterestsavings.ca/chart/ are really useful and although I opened my account at Canadian Direct Financial instead (they’ve since lowered their TFSA rate from 2.55% to 2.25%), People’s Trust seems to be well-regarded as an upright player. With the recent rise in bond yields, they might not even have to cut their 3% as had been highly likely.

  39. Jon September 22, 2013 at 1:01 pm #

    So just to be clear, when rebalancing, should I be using the market value or the book value?

    Also, for rebalancing bonds, should I be going to the bond’s website to factor in pay outs or just use the number my account says I have in there?

    Thanks again for your invaluable advice!

  40. Canadian Couch Potato September 22, 2013 at 1:37 pm #

    @Jon: Always use the current market value when rebalancing. No need to look up anything else.

  41. rick October 21, 2013 at 3:29 pm #

    I have a question I want to set up and follow the couch potato strategy. By I find the 40% in TD e-series Bond fund scary. Are bond funds going to fall over the next few years?

    Rick

  42. Rahim October 21, 2013 at 4:18 pm #

    I want to tag along to Rick’s question. I have some money available to “rebalance” my index fund (mutual fund) portfolio. My bond index fund (now about 19% of my portfolio; target allocation is 25%) is the laggard and needs to be topped up. Should I really top up this fund (vs. my equity index funds)? I’m 34 years old and have a while before retirement, but just wondering if this makes sense in the context of the bond market.

    Do bond index funds work the same way as equity index funds? (i.e., buy low now and reap the rewards many years/decades later as bond prices increase)?

  43. Canadian Couch Potato October 21, 2013 at 6:58 pm #

    @Rahim and Rick: Rebalancing only works if you are willing to buy asset classes that have recently declined in price. Whatever the asset class, expected returns always go up when price goes down. Certainly equities are more volatile and can move up (and down) more quickly than bonds, but the overall principle is the same. If you were willing to by bonds when yields were low, why would you be reluctant to by them when yields are higher?
    http://canadiancouchpotato.com/2013/09/16/ask-the-spud-should-i-fear-rising-interest-rates/

    Rick, bond funds could deliver negative returns if interest rates move up, as has happened this year. If rates stay the same or fall (or go up very slightly) the returns will be positive. Unfortunately there is no way of predicting the movements of interest rates.

  44. Que December 2, 2013 at 6:47 pm #

    @Dan: Can you please help me sort this out; Can you simply use the “Weighted Average Yield to Maturity” of a bond fund as a comparison tool to alternatives?

    I have two choices for my bond allocation of my portfolio: a 3% high interest account, or a bond fund (example ZAG). At first it seems cut and dry the 3% account is higher than ZAG’s Weighted Average Yield to Maturity of 2.61%.

    Then I looked at the last distribution amount and calculated that it is paying more than 3% (or 0.042/unit). So then I thought what are the drawbacks of bond fund versus saving account. If rates go up, ZAG’s unit price will go down, but it’s a long term investment so I shouldn’t care, especially since I would still have the same amount of units that would be now paying higher distribution payments.

    Am I missing something?

  45. Canadian Couch Potato December 2, 2013 at 7:29 pm #

    @Que: A couple of points. First, it is highly unusual for a savings account to yield more than a bond fund. The going rate for savings accounts right now is about 1.2% to 1.4%. I know People’s Choice has been offering a 3% TFSA for some time, so I’m guessing that’s what you’re referring to. I don’t how they are able to do that unless they have a reliable way to lend that money out for a higher rate. It has to be a loss leader.

    The other thing to remember is that the yield to maturity of a bond fund is not the same as its expected total return. During a year when interest rates rise, ZAG will return less than 2.6%, as it has done this year. If rates were to to fall, its total return could be much higher: in 2011, for example, bonds started the year with a similar yield to maturity and ended up delivering over 9% on the year when interest rates fell sharply.

    The distribution of a bond ETF is almost totally irrelevant to the comparison. It is related to the average coupon (which for ZAG is almost 4%), not the YTM.

    So be careful of comparing bonds to savings accounts. Clearly a 3% rate is outstanding compared to everything else out there and I’m not going to talk you out of it, especially if your goal has a short time horizon. But bonds do offer more advantages as a diversifier in a long-term portfolio, since they tend to go up during stock market declines, whereas a savings account will not behave that way. As long as you understand the different risks you should be able to decide which makes the most sense in your situation.

  46. Masoud January 21, 2014 at 2:06 pm #

    I looked over at the td bond index e and did not see any interest or dividends paid out chart. In your article is says you do get paid but i do not see anything except for the rate of return which is currently negative for thr month.

  47. Jonathan April 13, 2014 at 1:42 am #

    You couldn’t have made it clearer, Spud. If I still find it confusing, it is my brain that demands to be taught with a hammer. 1. Regarding avoiding Capital Losses, is there a fund that goes around buying bond issues at a discount? I mean on purpose. These would be lower interest, but in the end provide capital gain. 2. If by buying a bond fund, I’m making a small bet that interest rates will drop … is there a way to effectively short a bond fund? I’d prefer to make a small bet that interest rates will rise.

  48. Canadian Couch Potato April 13, 2014 at 1:17 pm #

    @Jonathan: happy if this helped. The answer to your first question is yes:
    http://canadiancouchpotato.com/2014/02/13/new-tax-efficient-etfs-from-bmo/

    Buying a bond fund is not making a bet that interest rates will drop. It’s making a reasonable assumption that bonds will lower the volatility of a portfolio that also includes equities. A bond index fund will deliver a positive return if it is held for its duration, regardless of whether rates move up or down. Shorting bonds (or anything else) is just speculating. If you feel rates are likely to rise in the near future the prudent strategy is to simply hold short-term bonds or GICs and reinvest the proceeds as these investments mature.

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