Since bonds yield only 5 % or so, paying a 2 % management
fee on a bond fund can eat up nearly half your profits.
The longer the average maturity of the bond fund, the greater will be the variation in the
return on the bond fund when interest rates change.
Financial advisors and their clients should then
focus on a bond fund's portfolio rather than relying on any single metric like duration.
This figure — which should
appear on a bond fund's website — estimates the fund's total return based on interest income minus any capital losses.
As a result, you CAN lose money
on a bond fund in a rising interest rate environment.
Indeed, if rates rise gradually, the interest
payments on a bond fund will increase as older bonds mature and newer ones are purchased with higher coupons.
One of the key ways that bond fund investors reduce the returns they
get on their bond funds is from paying more in taxes than necessary.
To keep this discussion simple, I will focus on the impact of rising interest
rates on bond funds, but it's important to note that other bond investments may react differently or have different results than the examples presented below.
Such a person is currently paying tax
on the bond fund dividends at the rates that apply to interest, but by blending with dividends sourced from equities the whole lot becomes taxed at the more favourable dividend rates (or even tax free, up to the dividend allowance).
It essentially causes the retiree to lock in low bond returns and even capital
losses on a bond fund as bond yields gradually increase (on average) over time.
Your
point on bond funds is a good one; I personally use XSB (the short - term bond ETF) for larger portfolios.
But if you now have that same 0.5 % annual expense
ratio on a bond fund that in today's yield environment is now somewhere between 2 % and 3 %, that 0.5 % annual fee is a much larger chunk of cost that's eating up that return.
What's also interesting (in passing) is that —
on the bond fund front — it's essentially impossible for many of these funds to beat their benchmark.
Next, capital gains are more of a stock fund thing than a bond fund thing, so capital gains
distributions on bond funds are insignificant.
Earlier this week, the Financial Times reported that Fed officials are considering imposing an exit
fee on bond funds.
To keep this discussion simple, I will focus on the impact of rising interest
rates on bond funds, but it's important to note that other bond investments may react differently or have different results than the examples presented below.
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.
But if the Fed wants to limit the damage of raising interest rates, imposing exit fees
on bond funds is a bad way to do it.
Or should I cut down
on the bond fund and allocate more into the other stock index funds?
Here is the payout / dividend
on the bond fund:
He's also not keen on loading up
on bond funds, and indulging too much in currencies.