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Discussion Starter · #1 · (Edited)
Never mind, think I found the answer in the long Bond thread…


Since it’s guaranteed interest rate is going up, probably multiple times this year. Does it mean bond funds like VAB or ZAG will go up? I believe their already close to 5yrs low. With the interest rate going up, shouldn’t the newly purchased bonds % be increasing, therefore brining the price up throughout the year? In what situation would bond funds decrease with rising interest rates?

Sold a rental property and already invested most of it to equities, however, want to keep some fixed income on the side to rebalance in case there’s a correction. Most of my salary Is going to expenses, so I won’t be able to DCA regularity.
 

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Normally when rates go up, the price of bonds goes down.

Let's say a bond is issued with a yield of 5% when rates are 5%, and it costs $100.

Later, rates rise to 7%. You can buy a brand new bond for $100 and get a 7% yield on it. How much are you now willing to pay for that old 5% yield bond? Certainly less than $100.

Conversely, if rates are falling, then let's say rates are now 2%. That 5% yield bond looks pretty good compared to the currently being issued bonds at 2%! You might want to pay more than $100 for it, which would effectively increase your personal yield (like if you pay $110 for it, then your effective yield with a 5% yield on the original $100 is 4.5%).
 

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Since it’s guaranteed interest rate is going up, probably multiple times this year. Does it mean bond funds like VAB or ZAG will go up? I believe their already close to 5yrs low. With the interest rate going up, shouldn’t the newly purchased bonds % be increasing, therefore brining the price up throughout the year? In what situation would bond funds decrease with rising interest rates?
Generally you can expect the price of the bond fund to decrease in the immediate term with rate hikes. I say "generally" because the market is also forward-looking and may price in these effects, possibly well in advance.

But personally I do expect the VAB price to go down with the upcoming rate hikes. There's one likely coming this month, and more this year. So we could see VAB's price get nailed this year. Maybe next year as well. This isn't certain, but that's the general expectation.

However... looking past the short term drop / volatility, the forward return on a bond fund actually increases as interest rates go up. With VAB the average maturity is 10 years, so the "long term" horizon for this means something like 10 to 20 years. Over this long term... which is my view in my RRSP... rising rates will increase the return of VAB.

That long term effect is due to what you said in your post. The new bonds the fund buys will have higher yields, so the fund's return will increase.

This is all about time horizon. Changes in prevailing interest rates have an acute / short term effect. In the next year or two, you really could see share prices drop significantly. However over the longer term, the short term volatility washes out, and returns do increase with rising rates.
 

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By the way, rising interest rates effect stock prices more or less the same way, since stocks (especially growth stocks) are kind of like ultra long term bonds where cashflows arrive in the distant future.

When you have a cash stream that stretches over X years, it has a present-day value. The price today very much depends on the interest rate, which is the "discount rate" in cashflow analysis.

Increase the discount rate (rising interest rates) and the present-day value falls. That's true for bonds, stocks, and in fact rental properties as well.

And for the same reason, the sharp decrease in interest rates over the last couple of years has boosted the prices of bonds, stocks, and real estate.
 

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Good info so far. Some concepts to add. Yes, bonds move inversely to interest rates, but there is no single interest rate. The Fed and BoC set the overnight very short term rate. Longer term rates are driven by the market, and don't always move the same amount or even same direction as short term rates.

Long-term rates are usually higher than short term rates to compensate investors for the risk of a longer term. One fundamental tenet of bond investing is to match your expected holding period to be at least as long as the duration of the bond or bond fund. Duration similar to the bond's term to maturity, except it takes interest into account. VAB & XBB have duration of about 8 years, so you should expect to hold those funds for at least that long. XSB and VSB have duration a bit less than 3 years so more appropriate for shorter holding period. Shorter term bonds and bond funds will be less volatile in response to changing interest rates.

Some good links:

How Changing Interest Rates Affect Fixed Income | Canadian Couch Potato

Holding Your Bond Fund for the Duration | Canadian Couch Potato

Risk of loss: Should the prospect of rising rates push investors from high-quality bonds?
 

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If you plan to sell your bond fund, the unit value will probably be lower. As rates rise, bond value drops. But if you plan to keep holding onto them, over the long term, the bonds will roll over to the higher rate. So rising rates = bad if you're going to sell, good if you're going to hold the fund long term.
 
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