Is a Total Bond Fund Still an Acceptable Core Bond Holding?

A reader writes in, asking:

“I have question about your VT + TIPS choice. Will you maintain that two fund portfolio throughout your life? Was wondering if your choice reflects a personal judgement about holding BND in a portfolio. BND has certainly not been a stellar performer for several years. Makes me wonder if going with TIPS only for the non-stock portion of our portfolio is also the right choice for us. Currently looking at a 50/50 BND/TIPS for fixed income as I start retirement next year, but your choice is making me doubt the wisdom of that approach.”

Bonds can perform two separate roles in a portfolio. In our household, we’re using them in a way that only individual TIPS held to maturity is really the right fit. But if they are being used as basically “the thing that’s less volatile than stocks, which will be rebalanced with the stock part of the portfolio” there are tons of options that would be fine. This article has more on that:

• What’s the Point of Bonds in a Portfolio? (And Why Individual TIPS, Held to Maturity, Are Unique)

Personally I have no significant qualms about a “total bond market” fund such as BND in that second role. Its performance in recent years is not anything strange or alarming. That’s just what happens when interest rates go up. And they went up, by a lot, from 2021-2022 (especially in 2022). If you find the fund on Vanguard, click to the performance section, then click the tab for “annually,” you’ll see the year-by-year returns. It’s really just those two years (especially 2022 with a -13.15% total return by NAV) that makes all of the performance figures look bad — and it’ll be that way until those years fall out of the various calculations. (Note that the fund’s 3-year performance is much better than 5-year performance for exactly this reason.)

And again, it’s not as if the fund did anything wrong over the 2021-2022 period. BND has an average duration of 5.8 years. That means that for every percentage point change in interest rates for bonds similar to those in the portfolio, the fund’s price should move in the opposite direction by about 5.8%. From the beginning of 2021 to the end of 2022, yields on 7-year Treasury bonds went from 0.64% to 3.96%, an increase of 3.32%. Multiplied by an average duration of 5.8, we’d expect a price decline of about 19% over the period, offset somewhat by the fund collecting some interest over those two years. (Also note that the fund holds corporate bonds as well as government-backed bonds, so the change in yield was a bit different than we see here.)

Essentially, any intermediate-term bond fund (and especially long-term bond funds) had a terrible year in 2022. That’s just the math of what happens when yields go up. For instance:

• Vanguard Intermediate-Term Treasury ETF was down by 10.67% in 2022.
• Vanguard Inflation-Protected Securities Fund was down by 11.85%.
• Vanguard Intermediate-Term Investment-Grade Fund was down by 13.78%.

The flip side of course is that all of those funds look much more attractive now, with their higher yields.

In our specific household, we aren’t using bonds as “a thing to rebalance with stocks.” Rather, we’re just planning to hold the bonds until they mature, then spend the money. So we want individual TIPS for that. And with long-term TIPS yields well over 2% (very close to 3% in fact), we’re very happy to have the bond part of our portfolio earn inflation plus 2.X% for the next 20-30 years — especially given that for most of our careers, TIPS yields were practically zero and at some times even negative.