and there are lots of reasons/academic support for why it makes sense to invest in a diversified portfolio.

That support is based upon the ability to invest additional cash when asset prices are lower. Hence the money market or "g fund" parking spot for a cash allocation.

Anonymous wrote:

Are you trying to say that the price of the g fund never gets cheaper

Yes, I am. It doesn't go up, either, by more than the rate of interest determined by the trailing Treasury rate. It's not an "investment" vehicle, but a place to park cash.

this statement doesn't really make any sense. Obviously it's not an investment in equities, but it's perfectly appropriate as part of a diversified investment portfolio, and there are lots of reasons/academic support for why it makes sense to invest in a diversified portfolio.

Are you trying to say that the price of the g fund never gets cheaper

Yes, I am. It doesn't go up, either, by more than the rate of interest determined by the trailing Treasury rate. It's not an "investment" vehicle, but a place to park cash.

Anonymous wrote:

In short, this delectable little plum of an investment option gives you the return of a long term bond fund with the risk of a short term bond fund. It is the closest thing in this wicked world of ours to a free lunch.

False. Long term bond funds (in a falling interest rate environment) provide increase to PRINCIPLE as well as interest income. The G Fund does not provide any opportunity for increase to principle beyond simple interest. It performs exactly like a money market fund, except the rate of return is tied to trailing Treasury bond rates.

Are you trying to say that the price of the g fund never gets cheaper, where a LTB fund drops in value allowing you to buy more shares for the same pot of money? Personally I invest in bonds to preserve capital at the best return I can find, not to grow my capital. That's what stocks are for. You don't rebalance from bonds into bonds- that's arse over ankles!

In short, this delectable little plum of an investment option gives you the return of a long term bond fund with the risk of a short term bond fund. It is the closest thing in this wicked world of ours to a free lunch.

False. Long term bond funds (in a falling interest rate environment) provide increase to PRINCIPLE as well as interest income. The G Fund does not provide any opportunity for increase to principle beyond simple interest. It performs exactly like a money market fund, except the rate of return is tied to trailing Treasury bond rates.

Some helpful links:

http://www.bogleheads.org/wiki/Bond_Basics

http://www.bogleheads.org/wiki/Bonds:_Advanced_Topics

http://www.bogleheads.org/wiki/Individual_Bonds_vs_a_Bond_Fund

Anonymous wrote: When you invest in long and intermediate term bond funds you are trading predictability for return.

There is higher potential for return right now investing in these funds, but they are not predictable. Any money that you will need in the next 2-3 years ought not to there.

As far as the G fund goes, it is it's own bird, a thing of magic unmatched in the public sphere. It invests solely in U.S. Treasury securities and it's return is based on the weighted average yield of all outstanding Treasury notes and bonds with 4 or more years to maturity, guaranteed to never lose principal. In short, this delectable little plum of an investment option gives you the return of a long term bond fund with the risk of a short term bond fund. It is the closest thing in this wicked world of ours to a free lunch.

Anonymous wrote:13:09 - you seem to be saying that long and intermediate term bond funds will be predictable, and not go down. That isn't what some news articles say.

Next question: does the (TSP - right?) G fund differ?

No 13:09 is saying a long term bond fund may offer a higher interest rate, but will give you less predictability (i.e. can lose principal more easily).

The G fund is different because it is like a money market fund with an interest rate pegged to med/long term Treasury notes-so you get the better interest rates without the unpredictability/risk the fund value will go down.

13:09 - you seem to be saying that long and intermediate term bond funds will be predictable, and not go down. That isn't what some news articles say.

Next question: does the (TSP - right?) G fund differ?

Also, the bond portion of your portfolio is not your moneymaker, it's your hedge, and it should be treated as such. When you invest in long and intermediate term bond funds you are trading predictability for return. This is fine when you are thirty, but by the time you are in your early sixties you should be appropriately invested in short term funds, or have a ladder of individual bonds.

Creating a ladder of CDs and bonds is more work than simply investing in funds, but it can be more lucrative and less turbulent. In this case, though, you are forgoing liquidity.

None of this applies to the G fund, by the by. Anyone who has scope to sink their whole bond allocation into that puppy is in like Flynn.

What about if you hold ST or med-term bond funds - those shouldn't be hit much, and the ST ones should rise with inflation, maybe just lagging by a few months. right?

It depends. Trying to predict how a given product will behave in what may become a loonie market is hard. But, yes, the shorter the duration the less volatile the price, generally.

And for the LT bond funds, wouldn't bond fund managers look at the "break-even" points and figure out when to dump old bonds and buy new ones?

The break even point for any asset means selling at the same price you paid, wiping out any previous gain. The problem with a falling market is that the asset is going south of the break even price the instant you buy it and not likely coming back.

What about if you hold ST or med-term bond funds - those shouldn't be hit much, and the ST ones should rise with inflation, maybe just lagging by a few months. right?

And for the LT bond funds, wouldn't bond fund managers look at the "break-even" points and figure out when to dump old bonds and buy new ones?

You have to understand the difference between individual bonds and bond funds. You also have to take into account opportunity cost.

Funds generally come in three different flavours- Short term, Long term and Intermediate, determined by when bonds held by that fund are due to mature. Right now long term bond funds have good returns because of the general low interest rate environment. However, once interest rates start to rise, the long term funds will be locked into a 3% interest rate that no longer looks so hot when 5-8% rates are out there and inflation is creeping up.

This is where opportunity costs come into play. Say you own an individual bond you bought for $100, returning $3 a year in interest and set to mature in 30 years. Interest rates rise. Now you find you own a bond with 25 years till maturity, yet on the market new $100 30 year bonds are returning $10 a year!

Now the question becomes, at what price would you sell your original bond in order to invest at the higher interest rate?

I'm struggling with understanding how bonds and bond funds will take a big hit with rising interest rates
Here's what I understand: If I have a bond, it should pay the coupon rate until mature or recalled. And there is an underlying value, which is related to interest rates. FV is usually 1000. Based on these factors (coupon rate, value, duration), I believe one derives the NAV (net asset value) for a bond fund.

Here's where I have trouble: Unless the bond is recalled or goes unpaid, wouldn't it always be worth the coupon rate as a floor? Doesn't this limit how far the value can drop? And why would the drop be large?