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Bond ETFs or exchange-traded funds that invest in bonds have been a popular choice among investors looking for passive income streams without the headaches of holding individual bonds. However, there is a big problem lurking in the bond ETF market: TIPS or Treasury Inflation-Protected Securities ETFs.
TIPS ETFs invest in inflation-protected bonds issued by the US Treasury, which means their interest payments and principal amounts adjust with inflation. While this might seem like a safe bet, it is not always the case.
The first problem with TIPS ETFs is that they are heavily influenced by interest rates, which tend to rise when inflation expectations go up. As a result, if interest rates go up, TIPS ETFs can suffer significant losses in market value, even if the bonds they invest in are still paying their promised interest and principal amounts.
The second problem with TIPS ETFs is liquidity. Unlike other bond ETFs, TIPS ETFs are not traded as actively, which means there may not always be enough buyers or sellers in the market to match your orders. This could lead to pricing inefficiencies, especially during times of high market volatility.
Finally, TIPS ETFs are often more expensive than other bond ETFs. They tend to charge higher expense ratios, which can eat away at your returns over time.
So, what should investors do? Avoid TIPS ETFs altogether. Instead, consider investing in other bond ETFs or individual bonds that offer better liquidity, lower costs, and less exposure to interest rate risk.
Overall, while bond ETFs can be a great way to diversify your portfolio and generate passive income, TIPS ETFs are not worth the risk, and should be avoided by cautious investors.
I like the bond etfs as a short term place to park cash. When the rates were being raised I bought BIL and SHV, short duration to avoid the interest rate risk. Now that the Fed is slowing rate increases and may not be able to raise again heading into recession, I switched to SCHP, TIPs are long duration but with the inflation pay component, they act similar to but less volatile than TLT. If the Fed panics and reverses rates down, I'll switch to TLT. Bond ETFs give me quick maneuvering in a crazy central controlled "market".
TIPS.. yes but with interest rates at a somewhat high level and the unit price now somewhat depressed and paying 6% yield, perhaps tips is a good bet at the moment?
It's not a problem…it's simply an opportunity. You're only highlighting one side of the yield moves.
Well. If you hold the indvidual bond, with each year you hold it the duration comes down. Of course when in the last year of holding the bond there is a sharp rise in interest rates, the individual bond that has only a duration of 1 left will not fall as much as the bond fund that keeps it's duration at a stable level by constantly trading the bonds it holds to match a certain duration profile.
Apples to oranges comparison. A 5 year bond becomes a 4 year bond after a year, then it becomes a 3 year bond, etc. In a rising rate environment like we're in now, shortening the duration is better which is why the individual bond beats the ETF in your cherry-picked scenario. The ETF on the other hand has to maintain a constant 5-year duration, which loses money while rates rise rapidly; but as soon as rates stabilize or fall, the ETF will outperform. That's because the ETF is currently buying 5 year Treasuries with 4.5-5% yields, while your bond is stuck at 2%. The ETF eventually will be full of Treasuries that yield 4-5%, and once rates fall, those Treasuries will appreciate, beating your individual bond.
What a superb videos. It has explained what I was thinking about ETF bonds and cleared me I was right and my mathematics assumptions were what you have shown. Thanks & subscribed
i think that is the game… people want to buy etf bonds because it is cheap now, if interest rates start to go down the etf will go up. The bonds will stay with much more less volatility
Quit waving your hands around. It's annoying as f*ck.
Wouldn't that chart say TIPS is a better buy now vs the treasury itself? The chart follows pretty closely until that massive drop…Seems the discount would be much better buying TIPS here vs the treasury even though it was reversely true prior to that?
What about BND ?
Do these problems also hold true for Bond Mutual Funds? I assume yes.
Bond ETFs are for speculators, not for investors. I was sitting on TBT this year, it was a great ride.
Dude…. Are you serious with this? Of the 5 year vs 3-7 year tracks early on in its life because its basically the same asset. As time goes on it simply is not the same product.
Hey Jimmy, you once did a video about the dogs of the dow, I think you should review that strategy again, there might be a lot of value for your fan base.
You pointed out the problem with investing in bonds in a rising interest rate environment. You are right that holding a bond directly from IPO to maturity is better vs holding the bond ETF in a rising interest rate environment, but if the opposite is true, a decreasing interest environment, then you would be better off investing in the bond ETF. The reason the bond ETF would be best in a decreasing interest environment is because the ETF bonds are appreciating in value and the bond owned directly will mature at it's face value (no appreciation). All in all, if you invest long-term into a diversified mix of bonds directly, then the return performance should not be much different than investing in an index that is similar to those bonds. So, if you believe interest rates are peaking, then long-term bond ETFs will perform better than their recent history. Also, if you think inflation is peaking, then any investment in TIPS will perform poorly in the near term. Not sure you touched on it (I didn't hear it mentioned, possibly I was distracted), but TIPS behave differently than normal treasury bonds. TIPS value increases as inflation increases, which means TIPS interest rates also increase with inflation. However, the market prices in what is expected to happen and not what is currently happening or what happened in the past. So, if TIPS are down, it means the market is expecting in the future either that inflation will decrease and thus TIPS will earn less in interest or that the economy is improving and thus investors are selling TIPS to invest more in riskier assets.
Insightful video as always but can you also discuss about portfolio management companies? This is a recognized phenomena and there are companies/individuals that help invest and manage generational wealth. Some also organize get togethers, and social events for the family. These types of trusts and corps for the super wealthy would make an interesting video.
god damn i bought TLT etf
So far in the past few months I’ve slowed down buying to only maybe an IPO or something I already own that has been overly beaten down. Only money I’m consistently putting into the market are through my financial advisor.
Amazing video!
This is the quality information I have come to expect from this channel. One of the best channels out there!
That being said, your recent videos look alot older at a glance. I had to check I wasn't watching a 2 year old vid lol. I think it has to do with your camera quality or the yellowish lighting. It does not bother me personally, I just noticed the difference to other channels and thought I'd mention it, in case it's relevant to algorithm stuff for you, Jimmy.
The Information as I said is top notch and that's what counts.
Other Channels in mind: TomNash, PlainBagel, .. Coffeezilla, too, who has nothing to do with stocks, but is information heavy.
I'm tiping so I'll keep going. Thanks for talking about Bonds! There was until now atleast few videos about it even though Benjamin Graham's classic "The Inteligent Investor" actually advises going 50-50 Stocks and Bonds for the defensive investor (or atleast not more than 60-40 in either direction. It seemes like noone, no Buffett/Graham fan ever did that. Although if we are moving into a high interest time, like the 70s, Bonds are definitely a consideration.
Could you analyze BK, Bank of New York Mellon? Thank you for your work.
I still don't get if this under performance of ETF vs individual bond is due to the interest rates rising sharply, or would it also happen if rates rise slowly? Also, if the interest rates fall sharply, would an ETF outperform an individual bond?
Would be awesome if you do a reanalyse of BABA, since you have a position on it, talking about whether it’s a buy or not at these levels, thanks Jimmy!
I never understood why people claimed that Bond ETFs are "safe". The idea that I could lose money if interest rates rise was always a no go for me. Shame that it isn't easy to buy individual bonds in Germany
Thanks Jimmy really great video.
When u say total return in the early part of the video does that include the dividends?
Jimmy, thank you so much for explaining the difference between Bond and Bond ETF. This is some I have been puzzling for a long time. My understanding now is that Bond is not meant to be traded, but Bond ETFs are often being traded and you may not get the return the original Bonds promised. By the way, can Bond itself be traded if you wish to? so, buying bond ETFs, you have to Time the Interest Rate, which may be easier than Timing the Market?
Just buy 3 month and 6 month treasuries. They’re yielding 3-4%.
You're right, but what about short term Tips etfs? Since it is short term, the underlying assets mature faster than 5-7 year etfs, thus new bonds with new interest rates are purchase more often.
Found this out the hard way. Put 20k into bond funds summer 2021 and currently down 5500k. Trying to figure out if I should keep them or take the loss and buy cheap stocks. Good video.
You’re the man, Jimmy.
I always have a hard time when someone picks a specific period of time to show me how horribly something has performed
Thank you for pointing this out!
I guess it is important to think about Bond ETFs as a pure capital preservation / income stream? Not as an actual bond. The price return is down but in return, I should be getting higher coupon payments from it which is nice. It wouldn't make sense to sell it now right?
Great video, had been looking at bond ETFs recently but didn't understand them enough to go through with buying, now I think it makes sense! Looks like we could be approaching a good buying opportunity for bond ETFs, depending on how much further interest rates are expected to rise?
Glad my comment on the previous video motivated this one. I have reached the same conclusion… the hard way. Great video as always.
Thanks Jimmy! There has been a collective amnesia in the financial services industry on the purpose of bonds in a portfolio. Until about 2000 they were sold / marketed as a means of capital preservation. That’s only true if they are held to maturity. Bond ETFs strip that important feature out and they are simply another “total return” asset. This year has shown that the Emperor has no clothes.
Thank you for this video I was asking myself the exact same question recently so your video was well timed.
Hello
I recently found your channel. Truly amazing. Can you please do a similar video on bond mutual fund using vanguard bond fund as an example? Thanks
I’d say almost everyone would be better off directly buying bonds at your broker or from treasury direct. It’s super easy to do and you guarantee your returns. “On paper” my bond might go down if I wanted to trade it. But when I hold it I know exactly what I’m getting.
Bravo , finally someone demistifying the myth of ETFs showing their big pitfalls
Excellent description of the problem. The ETF/Fund set up is one where there is constant purchases and liquidations. Thus, in the bond fund scenario, you are guaranteed to sustain a capital loss due to the turnover within the fund. It is counterproductive to the "safety" aspect of a bond fund. It seems that risk is a relative term.
Good luck I don’t own bond etf.
Really good summary, Jimmy. Bond ETFs are for traders. Individual bonds are for investors.
The problem is most people consider CPI as a real indication for inflation !
Inflation by definition is the expansion of money supply ( or how much currency is debased) and it is much higher than CPI ! Easily 15-20%
What books do you recommend to start trading?
I’ve been invested in VTIP which is a short duration bond ETF and it is only down 3% in 2022 and that’s just on price action. In the meantime I’ve collected some nice payouts that I have been using to buy undervalued stocks.
I wish I knew this a year ago. I bought SCHP, another TIPS ETF, near the peak thinking it would be a "safe" way to counter inflation. Now it's down 20%. The question now is, hold or sell and reinvest elsewhere?
I believe you would be buying these bond ETFs for the next QE cycle, while we are in a QT cycle. Once the FED goes neutral, I believe these bond ETFs will balance out and start expanding when the FED starts buying again. The only reason why you would be buying these ETFs are for their dividends and not what the underlying base prices are. Kind of like a hold and dividend forever strategy.
Never invest in bonds with a longer maturity than you are willing to wait it out!