Bond Diversification needed?

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Topic Author
Bad_golfer
Posts: 4
Joined: Fri Feb 22, 2013 3:04 pm

Bond Diversification needed?

Post by Bad_golfer »

Investor Profile:
Married - He:59 retired She:53 works from home
Home owners with house almost paid off with 200K equity
Have all investments with Vanguard, target assest allocation is 65% bonds 35% stocks
Currently withdrawing < 3% a year to meet needs, expect that to increase to 4% or so when wife retires

Porfolio:
Only invested in three Vanguard funds
Vanguard Intermediate-Term bond fund Investment-Grade Admiral Shares - 36%
Vanguard Total Stock Market Index Fund Admiral Shares ----------------------- 36%
Vanguard High-Yield Corporate bond Fund Admiral Shares --------------------- 28%

Recent Rate of Return:
5 yr 7.2%
3 yr 10%
1 yr 10.6%

Investing Philosophy:
- We believe the rule of 4% (withdrawing 4% of the value of a diversified portfolio in the first year of retirement, and increasing that dollar amount
annually by the rate of inflation, will not exhaust the principal balance after 30 years) is a valid guideline
- Once you have made your number, and are living off your portfolio, then its best to invest only agrresively enough to beat inflation and possibly
continue to grow the portfolio.

Concern/Issue
Everything I read/hear tells me that it is unlikely that bonds will fare well in the future, certainly not as well as the last 30 yrs where they have out-
performed the market. And with interest rates no where to go but up and bond values being inverse to interest rates I think I need less in bonds and more
diversity. But I want to limit my investment in equities to no more than 40%.

Question:
What Vanguard funds would be good choices to replace some of my current bond investments and how much should I invest in them. I am considering their REIT and maybe their ginnie mae but at this point undecided.


Your thoughts would be appreciated - thanks.
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mhc
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Location: NoCo

Re: Bond Diversification needed?

Post by mhc »

Welcome to the forum.

The Wiki and the recommended reading list have a lot of good info.

You could look into getting some international equities.

Some people also like TIPS in retirement.

You could look into replacing some of your junk bonds with equities.

Just a few thoughts.
52% TSM, 23% TISM, 24.5% TBM, 0.5% cash
jimkinny
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Joined: Sun Mar 14, 2010 1:51 pm

Re: Bond Diversification needed?

Post by jimkinny »

If I was looking for a model to follow in the future I might consider the allocation that Vanguard will have in their Target date funds for the bond % allocation that matches your bond %.

I have read on this forum that they will be adding 1) international bonds and 2) a 2-3 year duration TIPS fund to replace the existing TIPS fund. I do not think the first is going to be a wonderful change but a marginal change for the better in regard to the international bond and I have no opinion regarding the shorter duration TIPS, but assume Vanguard knows more than me. Vanguard had a research paper 1-2 years ago about the role of international bonds in a portfolio. You could find that paper on Vanguard's site and read it.

Maybe you can find Vanguard's announcement of the changes and decide for yourself, based upon the risks involved, if that is a model worth considering. I do not know if the future allocation % that Vanguard intends to implement is reflected in the fund information on Vanguard's website.

jim

I edited this to add that I have about 1/3 of my fixed income in CD's, 1/3 in Vanguard's ST IG fund and 1/3 in TBM fund.
I am comfortable with the CDs, not so much with TBM and ST IG because of the risks vs my perceived evaluation of the rewards, which is of course an inexpert opinion.

jim

jim
dbr
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Re: Bond Diversification needed?

Post by dbr »

My take is that in the bond portfolio there is a host of differences that don't make a difference.

One that does make a difference is that high yield bonds are much riskier than the general run of bonds and should probably not be in your portfolio, at least not in such a large proportion.

I think having a significant fraction in TIPS makes sense for retirees. If a person does not want to see interest rate risk, shorter bonds are the answer to that at the cost of losing some return in the long run. I bonds can be useful if the purchase restrictions don't make the issue moot. It is also possible to hold Treasuries, TIPS in particular, in individual bonds, useful in some cases.

Today it might be the best options are bank CD's and stable value funds (not in too large a proportion) in 401k's.
2comma
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Re: Bond Diversification needed?

Post by 2comma »

Without the whole picture (see getting started) it's tough to give much specific advice but you did ask one simple question.
Concern/Issue
Everything I read/hear tells me that it is unlikely that bonds will fare well in the future, certainly not as well as the last 30 yrs where they have out-performed the market.
Yes, bonds are expected to give lower than historical average yields based on current interest rates. That's really all anyone knows.Watch out what you read/hear; I intentionally don't pay attention to any of that. The only investment news I need I get here or in a book by Bogle. What's the news? Pretty booring really - Vanguard is adding a foreign bond fund and a short term TIPS fund. Back to our regularly scheduled program...
And with interest rates no where to go but up and bond values being inverse to interest rates I think I need less in bonds and more
diversity. But I want to limit my investment in equities to no more than 40%.
Interest rates could go no where for a long, long time too! The market has already voted on where it expects interest rates are going, what do you know that they don't? I use bonds to stabilize stock fluctations - they are good at that. I know as interest rates rise my bond funds yield will eventually rise.


I'm in the same camp as you - goal is to keep ahead of inflaton, conserve assets.
Question:
What Vanguard funds would be good choices to replace some of my current bond investments and how much should I invest in them. I am considering their REIT and maybe their ginnie mae but at this point undecided.
We're all in the same bonds boat and it's getting a little stinky if you ask me. I've got some in a stable value fund (has to be in a 401k plan) and some in tips (really just to preserve against unexpected inflation). I'll probably add some of the new foreign bond fund. A lot of people are lowering their average duration. Reits may add some diversification but you'd need a significant portfolio for them to make much difference and some say they are overvalued. But mostly, this may be one of those times to just stand there as Bogle says.

The things I'm doing about low bond rates:
Saving more
Reducing my SWR
Telling my wife she might have to work longer (not me!)

Two other comments:
If one of you lives into your 90's (pretty good odds of it) your investment horizon would be 40 years, not 30.
High yield funds are normally considered stock-like and the risk/reward picture is not considered to be favorable by most bond experts.
Last edited by 2comma on Sat Feb 23, 2013 8:44 am, edited 1 time in total.
If I am stupid I will pay.
vtanzi
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Re: Bond Diversification needed?

Post by vtanzi »

I have the same concerns--If I were you given your age --I would only be in a very short term bonds or the Vanguard GNMA fund. Bonds have been on an upswing for 30 years---moreover interest rates can only go up which will crush bonds.
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Bustoff
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Re: Bond Diversification needed?

Post by Bustoff »

Bad_golfer wrote: Porfolio:
Only invested in three Vanguard funds
Vanguard Intermediate-Term bond fund Investment-Grade Admiral Shares - 36%
Vanguard Total Stock Market Index Fund Admiral Shares ----------------------- 36%
Vanguard High-Yield Corporate bond Fund Admiral Shares --------------------- 28%

Your thoughts would be appreciated - thanks.
SPIA's are being promoted by an increasing number of retirement advisors as part of a "flooring" allocated to minimum expenses with the excess portfolio being invested in stocks and bonds.

Just curious, how did you arrive at your current bond selections ?

Regards,
Bustoff
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mhc
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Re: Bond Diversification needed?

Post by mhc »

vtanzi wrote:I have the same concerns--If I were you given your age --I would only be in a very short term bonds or the Vanguard GNMA fund. Bonds have been on an upswing for 30 years---moreover interest rates can only go up which will crush bonds.
Please define "crush bonds". How risky do you think bonds are relative to stocks?
52% TSM, 23% TISM, 24.5% TBM, 0.5% cash
vtanzi
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Joined: Sun Jan 13, 2008 9:58 am

Re: Bond Diversification needed?

Post by vtanzi »

mhc wrote:
vtanzi wrote:I have the same concerns--If I were you given your age --I would only be in a very short term bonds or the Vanguard GNMA fund. Bonds have been on an upswing for 30 years---moreover interest rates can only go up which will crush bonds.
Please define "crush bonds". How risky do you think bonds are relative to stocks?
As you know the price of a bond is inversely related to the Interest Rate. So estimates are that a 1% increase in Interest Rates will decrease bond prices by about 2.5%. However this is related to time to maturity and the bond coupon rate. If you take a TBM fund with an average of 6 years to maturity--then a 1% increase would decrease bond prices by 4.4% and a 2% increase would lead to a 8.5% decrease.

Bonds are definitely good to be part of a portfolio but like all investments you should know what you are buying. Not all bonds have the same risk. Currently, TIPs, GNMAs and short term bonds are a better option. IMHO
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mhc
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Re: Bond Diversification needed?

Post by mhc »

vtanzi wrote:
mhc wrote:
vtanzi wrote:I have the same concerns--If I were you given your age --I would only be in a very short term bonds or the Vanguard GNMA fund. Bonds have been on an upswing for 30 years---moreover interest rates can only go up which will crush bonds.
Please define "crush bonds". How risky do you think bonds are relative to stocks?
As you know the price of a bond is inversely related to the Interest Rate. So estimates are that a 1% increase in Interest Rates will decrease bond prices by about 2.5%. However this is related to time to maturity and the bond coupon rate. If you take a TBM fund with an average of 6 years to maturity--then a 1% increase would decrease bond prices by 4.4% and a 2% increase would lead to a 8.5% decrease.

Bonds are definitely good to be part of a portfolio but like all investments you should know what you are buying. Not all bonds have the same risk. Currently, TIPs, GNMAs and short term bonds are a better option. IMHO
Does not sound very crushing to me. Also, if you hold the bonds for the long run, I'm not sure how much it really matters if interest rates increase.
52% TSM, 23% TISM, 24.5% TBM, 0.5% cash
2comma
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Re: Bond Diversification needed?

Post by 2comma »

If I am stupid I will pay.
Topic Author
Bad_golfer
Posts: 4
Joined: Fri Feb 22, 2013 3:04 pm

Re: Bond Diversification needed?

Post by Bad_golfer »

Hello all and thanks much for taking the time to read/respond to my post.

A little more info about me and my original post/questions. While I am new to this forum I have invested with Vanguard for 25+ years and am a voyager level investor. Over the years I have invested in a number of diff funds and taken advantage of their free financial consulting services. At times I find their recommendations to be almost too conservative although I am conservative by nature and now age. BTW - about 80% of potfolio is in tax protected vehicles (IRS/401K), but as I will soon be 59 1/2 I have plently of accessiable funds in the open that I can access until then. Most of the funds in the open are in stocks so I will have to take some small cap gains at some point but those are offset by capital loss carry-over from the past

I have read through your posts and will offer these comments/responses.

BUSToff asked - Just curious, how did you arrive at your current bond selections? Before the market tumbled I was invested 60/40 stocks/bonds. As I watched the market free fall I started to bail out into bonds until I had around 20/80 stocks/bonds. Once the market seemed to stabalize I moved back into stocks 60/40 and in a couple of years both stocks and bonds did well to the point I felt I had made my number. About this time I lost my job (downsized) so it was time to get more conservative. So I rebalanced to 35/65 stocks/bonds but felt I needed more return than the interm bond fund provided, and I had successfully invested over the yrs in the hy yield fund and felt it was a reasonable risk. Granted its more volitle than other bond funds but not as much as stocks & I find Vanguard's Hy yield fund to be a conservative junk bond fund (oxymoron?).

rickmerril advised we look at Vanguard's take http://www.vanguardblog.com/2012.07.30/ ... ut-it.html & I found this to be interesting.

Another thought about bond funds. Typically if interest rates begin to rise you have some time to react as the feds tend to indirectly announce their intentions before their meetings in the press and they typically raise rates .25% Sometimes .50% at a time. So once they start going up there's time to move either into shorter duration or Money Markets.

Where am I now - After considering your input I am thinking that:
- I need to increase my stock holding to about 40%. I am doing this by default, as I need money I move it out of bond funds and not stock so I will work my way to 40% stocks.
- I think I will move about 5% of portfolio (out of Hy yield bond fund)into REIT.
- I will look at TIPS GNMA and consider reducing Hy yield holdings while maintaining Itermediate bond fund

Thoughts? And thanks again.
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