Ferri: The Risk Of Short-Term Bond Funds

July 07, 2014

The growth of $10,000 in each of these funds in the five-year period ending June 30, 2014 is illustrated in Figure 1. An investor in would have earned $1,284.14 more in the intermediate-term VBTLX over short-term VBIRX. This was an extra 11.3 percent in total return.

Figure 1: The hypothetical growth of $10,000 over 5 years ending June 30, 2014**

Growth_Of_10K_Over_5_Yrs

Source: Vanguard VBTLX  Total Bond Market Index; VBIRX  Short-Term Bond Index

The extra return earned in the intermediate-term Total Bond Market Index fund really adds up over time. VBTLX investors would still be ahead of VBRIX investors even if interest rates jumped by 3 percent this year.

The growth of $10,000 in each of these funds over a three year period ending June 30, 2014 is illustrated in Figure 2. An investor in would have earned $657 more in the intermediate-term VBTLX over the short-term VBIRX during the period. This was an extra 6.3 percent in total return.

Figure 2: The hypothetical growth of $10,000 over 3 years ending June 30, 2014**

Growth_Of-10K_Over_3_Yrs

Source: Vanguard VBTLX  Total Bond Market Index; VBIRX  Short-Term Bond Index

Investors who made the switch to short-term bond funds between 2009 and 2011 missed out on higher interest over the following years. This “opportunity cost” from being out of intermediate-term bonds cost short-term bond fund investors 6.3 percent in total over the past three years and 11.3 percent in total over the past five years ending in June 2013. Even if interest rates started rising, investors who stayed put in intermediate-term would still come out ahead.

The moral of the story is not to let the fear of rising rates stop you from investing properly. By all means buy a short-term bond fund if you have short-term liabilities. If your liabilities are long-term, stay in an intermediate-term bond fund for the duration. It pays to do so.

**Figures include reinvestment of dividends and capital gains but don’t reflect the effect of any sales charges or redemption fees, which would lower them. The initial investment used in the graph may be higher or lower than the initial minimum amount required to invest in each fund. The performance of an index is not an exact representation of any particular investment as you cannot invest directly in an index. The performance data shown represents past performance, which is not a guarantee of future results. Investment returns and principal value will fluctuate, so that investors’ shares, when sold, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data cited.

 

 

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