I live in the US. I often see advice that a retirement savings account should include a combination of stock mutual funds and bond mutual funds, with the relative weights depending on the years to retirement. The implication is that the bond mutual fund (e.g., VBTLX) is a low-risk, low-return investment, suitable for investors on the verge of retirement.

I understand that US treasury bonds themselves are low-risk and a guaranteed nominal return (that is, ignoring inflation) upon maturity. But why does it hold that a mutual fund composed of bonds will also be low-risk, given that its cost is determined by what the market is willing to pay? The mutual fund value could be determined by speculation, a bubble, regulations requiring pension plans to buy them, or many other things that are hard to predict and therefore high-risk.

For instance, let's say I buy $10K of 10-year bonds and $10K of VBTLX in 2020. Over the next ten years, the Fed unexpectedly raises interest rates. The value of VBTLX collapses as people cash out. When I retire in 2030, I've lost money on VBTLX but I've made exactly the expected nominal profit on the bonds. The opposite could also happen, for instance if the government requires pension plans to invest more heavily in bonds and the price of VBTLX skyrockets. Doesn't this demonstrate that the mutual fund will be more volatile than the assets of which it's composed?

  • FYI, it is not a given that a low-risk, low-return investment is suitable for an investor on the verge of retirement. It is a common misconception that this is a near-universal truth. Your risk/return profile should match your risk tolerance, which may and often does increase as you approach retirement.
    – farnsy
    Commented Dec 4, 2017 at 6:38
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    Isn't the value of a bond fund exactly the value of the bonds it holds? (Minus administrative fees, of course.) So the benefits of the fund would seem to be diversification and convenience. E.g. I could just buy a bond fund by logging into my Vanguard &c account and transferring money from a stock fund.
    – jamesqf
    Commented Dec 4, 2017 at 18:37

2 Answers 2


The short answer that the risks are the same, or very close. Differences arise primarily because the fund manager will likely rebalance to maintain a target duration while you most likely will not.

Bond Risk

You appear to be confusing bond risk with uncertainty about a bond's payout. The latter is only part of the former. A bond that is absolutely certain to pay out its contractual obligations can still be quite risky. That is, its price can fall because the discount rate we apply to those payments has increased, as it does when the rates on competing bonds increases.

But, you may ask, what if you hold the bond to maturity? Isn't this "risk free?" No. When the bond's price fell your wealth fell too. The payments will come as promised but their present value has fallen because they should be discounted harder. The practical implication is that you will feel bad about being stuck in a 2% coupon bond while currently trading bonds either have a higher coupon or a lower price than you paid. You lose money in the form of opportunity cost. If you try to cash out early you will be able to quantify how much poorer you are but this doesn't mean that this is the only circumstance in which you have lost.

Changes in Bond Value

Bonds are subject to slightly different risks than stocks, but in other ways they are comparable. If you hold a stock and its price goes way down, would you say you have not lost any money just because you haven't sold it yet? You shouldn't. Similarly, you should not say you have not lost money when a bond's price falls, even if you do not sell it.

Because a bond mutual fund is just a collection of bonds, at any given time its expected return and risk are exactly equal to those of the underlying assets it holds.

Bonds and stocks both have the property that they trade for the present value of their future cash flows. With bonds, especially, these prices are known fairly precisely and changes in bond values have good motivation. If your bond price goes down (whether individual or as part of a mutual fund) it is because the bond is genuinely worth less than it was.

The Dynamics of Portfolio Risk

The fact that at every given moment the risk of a bond fund and the risk of its underlying portfolio are the same does not mean the two will track each other perfectly going forward, however.

It is possible that as the fund manager changes the portfolio composition over time, she may actually lose or make money relative to a static portfolio of the underlying, but this is no different in a bond fund than in a stock fund. Any time you entrust money to an active manager you are trusting that as she deviates from the benchmark, you will like the results. VBTLX is an index fund so this isn't really a consideration, though.

Also, if you bought the underlying and held them to maturity, then your potfolio would start out with a long duration and grow shorter over time (Unless you keep buying bonds the same way the mutual fund manager does). If you do anything different with the dividends than the mutual fund does, then your risk will change over time while that of the mutual fund remains more-or-less constant.

Your Example

Consider your VBTLX example. The price of those bonds fell, causing both the price of your portfolio and that NAV of VBTLX to fall. In both portfolios the bonds continue to pay out as they did before and you use the proceeds to purchase new bonds. When your initial bonds mature the value of your proceeds plus the value of your newer bonds will be exactly equal to the value of the money invested in VBTLX.

The most likely way there is a difference between your portfolio and that of VBTLX is if the manager of that fund rebalances (sells aging bonds and buys newer ones so as to maintain a target maturity). You may or may not do this in your portfolio. If you do, you will match VBTLX. If you do not, your risk will change over time.

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    "No. When the bond's price fell your wealth fell too." This is a weak argument, because you bought the investment grade bond for the explicit purpose of capital protection, knowing that you were going to sacrifice higher rates of return.
    – RonJohn
    Commented Dec 4, 2017 at 3:34
  • @RonJohn It's less an argument than an undeniable statement of fact. One's intentions in buying a security are irrelevant. If you buy it and its value falls, your wealth has gone down. It's as true for a junk bond as for a TIPS.
    – farnsy
    Commented Dec 4, 2017 at 6:34
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    you're missing an important word, which fundamentally changes the meaning of the sentence: "If you buy it and its value falls, your unrealized wealth has gone down." You don't actually lose any money until you sell. If you hold the bond until maturity, then you're going to get the promised payment, no matter how low the value of the bond falls.
    – RonJohn
    Commented Dec 4, 2017 at 6:40
  • Realized and unrealized doesn't matter in this question--it will all be realized in the end. If you and I buy the same bond but I sell half way through and use the money to purchase a similar but distinct bond, by your definition I have locked in losses but we will both be equally wealthy at the end. The OP is comparing continuously holding a portfolio of bonds to continuously holding a mutual fund that holds a portfolio of bonds. There is no significant difference except what I have noted.
    – farnsy
    Commented Dec 4, 2017 at 6:45
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    Yes. If they are of similar risk and maturity and the price of both is $600, their redemption prices will also be similar. Bond prices are not arbitrary. They are the present value of the payments the bonds will make. Similar bonds will use similar discount rates, so if prices are the same, so must the payouts be and vice versa.
    – farnsy
    Commented Dec 4, 2017 at 7:39

The risk profiles are slightly different since the bond fund buys and sells bonds, and you don't. The fund tries to keep their bonds in the 5 to 10 year range. As your bond reaches maturity it is a different investment.

from their strategy page:

This index measures a wide spectrum of public, investment-grade, taxable, fixed income securities in the United States—including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities, all with maturities of more than 1 year....The fund maintains a dollar-weighted average maturity consistent with that of the index, which currently ranges between 5 and 10 years.

So when your bond's maturity is less than 5 years away if you don't sell it and buy a new one, then you aren't following their strategy for 80% of their portfolio. When your bond is less than 1 year to maturity you aren't following their strategy for 100% of their portfolio. Also since you have one bond instead of a basket of different bonds, you are less diversified than they are. Your bond may under or over perform the index they track.

Doesn't this demonstrate that the mutual fund will be more volatile than the assets of which it's composed?

No, it illustrates risk that may cause it to be more volatile, it doesn't prove anything. After all some of the underlying bonds may default and be worth zero, which is more volatile than the fund will be. Generally things that cause upward pressure and downward pressure on bonds and a bond fund should be about the same. On the other hand if you buy and hold a bond to maturity, other than probability of default there is no volatility, just the coupon rate.

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