3-fund portfolio: replace bonds with CDs?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.

3-fund portfolio: replace bonds with CDs?

Postby learning_head » Mon Jan 07, 2013 4:41 pm

I am looking for options to place "bond" part of my portfolio and I am having hard time justifying investing in bonds and not just buying CDs instead. My reasoning comes down to:

(a) Interest rate rise will likely not play out for bonds (yes, I know - can never time these things, but looking at big picture, this appears to be an overall non-positive)
(b) Bonds have been rising for many years now (again, can never time these things - so I suppose should disregard this)

More importantly, comparing bond fund SEC yields (e.g. BND 1.59%, VCIT 2.56%, VWITX 1.54% (after-tax)) vs CD rates of ~1.6-1.8% for ~5 years implies that with CDs I get a slightly less return but with no risk of principal loss, whereas a few percentage point gyrations in bond funds are a norm...

Am I looking at this wrong? Do I really want to take on extra risk of principal changes for a small yield improvement? (I recall one of grok's tips was to take the risk on equity side, not bond side)

I do see that VCLT (long term, not intermediate) bond fund has SEC yield of 4.35% - that's definitely better, but with even more risk as far as (a) and (b) go... So, if you buy the second part of above but not the first, would you invest only in long-term bonds for this yield/risk since anything shorter-term would be better served by CDs?

I predict someone could say that benefit of bond fund is you can rebalance in and out of it as needed when your target allocation changes, but I could do the same with CDs as well (can break the CDs as needed or create new CDs as needed). Please note that I am not "married" to CDs - I would love to invest in something with better returns / risk profile for the "non-risky" part of the portfolio, but can't seem to justify bonds as "it" today (and I had similar issues in the past - CD rates seem to always be quite close to bond rates, or at least in last 7 years or so)...

One advantage of bonds: they are easier to invest in as far as bond funds go - just add to one and you are done - no need to renew / hunt down good CDs... (but at least for now, I guess I am willing to do some extra leg work for CD hunts)
Last edited by learning_head on Mon Jan 07, 2013 6:06 pm, edited 1 time in total.
learning_head
 
Posts: 557
Joined: Sat Apr 10, 2010 6:02 pm

Re: Bonds vs CDs

Postby hoops777 » Mon Jan 07, 2013 5:13 pm

:oops:
Last edited by hoops777 on Mon Jan 07, 2013 5:33 pm, edited 1 time in total.
hoops777
 
Posts: 665
Joined: Sun Apr 10, 2011 12:23 pm

Re: Bonds vs CDs

Postby tfb » Mon Jan 07, 2013 5:16 pm

learning_head wrote:I predict someone could say that benefit of bond fund is you can rebalance in and out of it as needed when your target allocation changes, but I could do the same with CDs as well (can break the CDs as needed or create new CDs as needed).

You don't even have to do that. Leave the amount you need for rebalancing in bond funds (10% of portfolio) and the rest can go into CDs. It takes a 20% drop in the stock market to throw your balance off by 5%. 10% for rebalancing is plenty.
Harry Sit, taking a break from the forums.
User avatar
tfb
 
Posts: 6757
Joined: Mon Feb 19, 2007 5:46 pm

Re: Bonds vs CDs

Postby Karamatsu » Mon Jan 07, 2013 5:24 pm

If the goal is to minimize risk then it seems like CDs do indeed seem like the best choice for short maturities. No reason not to do it if you structure them in a ladder. Many allow early withdrawal, too, so you'd have an option if rates rose significantly.
Karamatsu
 
Posts: 1085
Joined: Mon Oct 27, 2008 2:42 am

Re: Bonds vs CDs

Postby archbish99 » Mon Jan 07, 2013 5:26 pm

tfb wrote:
learning_head wrote:I predict someone could say that benefit of bond fund is you can rebalance in and out of it as needed when your target allocation changes, but I could do the same with CDs as well (can break the CDs as needed or create new CDs as needed).

You don't even have to do that. Leave the amount you need for rebalancing in bond funds (10% of portfolio) and the rest can go into CDs. It takes a 20% drop in the stock market to throw your balance off by 5%. 10% for rebalancing is plenty.

Or have the interest on the CDs paid out rather than reinvested. Use the paid-out interest monthly for rebalancing. I recently switched to CDs, and keep the minimum amount in a short-term bond fund. As interest comes in from a CD, I evaluate whether it should go to a stock fund or into the bond fund. When one of the CDs matures, I'll take that plus any accrued interest to roll over a new rung in the ladder.
I'm not a financial advisor, I just play one on the Internet.
User avatar
archbish99
 
Posts: 1325
Joined: Fri Jun 10, 2011 6:02 pm

Re: Bonds vs CDs

Postby learning_head » Mon Jan 07, 2013 5:30 pm

hoops777 wrote:The only way to solve the bond problem is to invest in individual high quality bonds in a ladder and hold them to maturity.


Thanks, I had looked into this as well, and found the same issues: low extra yield over CDs unless you go to lower-graded bonds... so question quickly becomes again, do I want to risk principal for a bit of extra yield? (Plus, this approach with individual bonds does not lend itself as easily to rebalancing, but I am sure there are some ways around it like the one tbf mentioned.)
learning_head
 
Posts: 557
Joined: Sat Apr 10, 2010 6:02 pm

Re: Bonds vs CDs

Postby learning_head » Mon Jan 07, 2013 5:32 pm

Karamatsu wrote:If the goal is to minimize risk then it seems like CDs do indeed seem like the best choice for short maturities.


No, the goal is to place ALL of my "bond" part of the portfolio somewhere... except it does not look to me like it should be in bonds...

Or stated another way, I am putting together a 3-fund portfolio, but thinking about having CDs there instead of VBMFX / BND. (I changed the thread title accordingly as well.)
learning_head
 
Posts: 557
Joined: Sat Apr 10, 2010 6:02 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby tfb » Mon Jan 07, 2013 6:43 pm

learning_head wrote:Or stated another way, I am putting together a 3-fund portfolio, but thinking about having CDs there instead of VBMFX / BND. (I changed the thread title accordingly as well.)

You may be interested in these two great articles by a presumed Boglehead:

Optimizing Fixed Income Portfolio and
Optimizing Investment Portfolio With Municipal Bonds

Very roughly speaking -- exact numbers will vary widely depending on your tax bracket, amount of tax-sheltered space, and exact mix of investments -- I would guesstimate that doing this sort of portfolio optimization will yield you around 0.5% per year more on the entirety of your portfolio, across both equities and fixed income.

Add 0.5% per year on the entire portfolio is a big deal.
Harry Sit, taking a break from the forums.
User avatar
tfb
 
Posts: 6757
Joined: Mon Feb 19, 2007 5:46 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby am » Mon Jan 07, 2013 6:59 pm

Can you put CDs into your IRA at Vanguard?

Is there any advantage to holding TBM over CDS if your goal is to reduce volatility, reduce risk of the fixed part of portfolio?
am
 
Posts: 1594
Joined: Sun Sep 30, 2007 9:55 am
Location: Illinois

Re: 3-fund portfolio: replace bonds with CDs?

Postby learning_head » Mon Jan 07, 2013 7:23 pm

Thank you very much for the links tfb, very relevant articles indeed!

By the way, I agree that 0.5% return is a big deal, but added risk of switching from FDIC insured funds (for say half of the portfolio) to something that jumps up and down a few percentage points easily seems like even a bigger deal in that the extra reward does not seems to be compensated by the extra risk... ? In other words, if someone really wants some extra risk for extra reward, I would guess it would be more "efficient" to minimize risk with CDs on fixed side and increasing risk with higher equity allocation... Would you suspect the opposite?
learning_head
 
Posts: 557
Joined: Sat Apr 10, 2010 6:02 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby tfb » Mon Jan 07, 2013 7:35 pm

learning_head wrote:By the way, I agree that 0.5% return is a big deal, but added risk of switching from FDIC insured funds (for say half of the portfolio) to something that jumps up and down a few percentage points easily seems like even a bigger deal in that the extra reward does not seems to be compensated by the extra risk... ? In other words, if someone really wants some extra risk for extra reward, I would guess it would be more "efficient" to minimize risk with CDs on fixed side and increasing risk with higher equity allocation... Would you suspect the opposite?

Let's see if the author will step forward and answer the question. You can certainly post the question as comments on his blog. The first article is about moving to CDs and EE bonds. No principal risk there. Stop there if you are not comfortable with the moves in the second article.
Harry Sit, taking a break from the forums.
User avatar
tfb
 
Posts: 6757
Joined: Mon Feb 19, 2007 5:46 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby Taylor Larimore » Mon Jan 07, 2013 7:53 pm

I am looking for options to place "bond" part of my portfolio and I am having hard time justifying investing in bonds and not just buying CDs instead.


LH:

Bonds are primarily for safety in the Three Fund Portfolio. CDs can perform the same function. In my opinion it is OK to use "CDs instead."

There is more than one road to Dublin.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
User avatar
Taylor Larimore
Advisory Board
 
Posts: 20224
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

Re: 3-fund portfolio: replace bonds with CDs?

Postby john94549 » Mon Jan 07, 2013 8:07 pm

You might consider constructing a 5-yr ladder of 5-yr CDs from existing bond funds, over a period of five years. The problem with plunking all into CDs at once is that the rates at the short end (1-3 yrs) are pretty lame. That said, you can visit Ken Tumin's blog, http://www.depositaccounts.com and shoot for the best rates for 1 yr, 2 yr, 3 yr, 4 yr and 5 yr and plop 20% in each rung. Voila, an instant 5-yr ladder. As each rung matures, swap into a 5-yr CD. But a more conservative approach would be to build a ladder over 5 years.

As I've noted in other threads, rate competition is keenest in five-yr CDs, generally speaking.

As poster "tfb" noted, keep enough in bond funds for re-balancing, if necessary. Trying to re-balance with a CD ladder is cumbersome.
john94549
 
Posts: 2972
Joined: Tue Jul 26, 2011 8:50 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby Daffy » Tue Jan 08, 2013 2:34 am

Taylor Larimore wrote:
I am looking for options to place "bond" part of my portfolio and I am having hard time justifying investing in bonds and not just buying CDs instead.


LH:

Bonds are primarily for safety in the Three Fund Portfolio. CDs can perform the same function. In my opinion it is OK to use "CDs instead."

There is more than one road to Dublin.

Best wishes.
Taylor


Ditto. During the past several years I've migrated about 50% of my bond portion of my portfolio into a combination of 5 year CDs and I-Bonds to lock down principal and prepare for the eventual rise in rates. If and when that rate rise ever happens, which I'm starting to doubt it will in my lifetime, it'll present good opportunities to morph even more of my portfolio into even higher yielding CDs. Either way the real return on this chunk of my portfolio is likely to be putrid, but my goal is to at least match my measly 2.0% SWR by combining all these "safer" assets with a small 25-30% equity position. For me it's bad enough I have to watch equity volatility, so anything I can do to reduce volatility with what's supposed to be the "safety" portion of my portfolio as pointed out by experts like Taylor, I'm all for it. If your gut is telling you to get out of bonds then listen to it regardless of the pundits that say there's nothing to worry about because of the standard cliche quote "no one can predict the future" or "no one knows when rates will rise", etc.
User avatar
Daffy
 
Posts: 152
Joined: Tue Nov 06, 2007 4:05 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby nisiprius » Tue Jan 08, 2013 12:54 pm

learning_head, these are unusual times. During most or all of the time I've been investing, the returns from bonds have been quite a bit better than the returns from CDs, so that "replacing bonds with CDs" would have been a case of sacrificing too much return in the interest of risk aversion. In addition, the bulk of investment advice has traditionally been focused on securities--directly or packaged in mutual funds--because that's what traditional investment firms do, that's what you find in 401(k) funds, etc.

So you didn't hear a lot of talk about CDs as a possible alternative to bonds, because a) they weren't really competitive, and b) they lived in a different investing world. (Also they are unsophisticated, not something that ultra-high-net-worth investors concern themselves with, etc.)

Under current conditions, it's perfectly reasonable to use CDs instead of bonds. I don't know if it's better or worse. For various reasons I'm sticking with my bond funds but I'm not going to make the case that that's better.

I would make one caution. I'm a bit of a broken record on this and I'm almost certainly overemphasizing it. One normally assumes that one can "break" a CD before maturity; that is, one assumes that one has the right to pay the penalty and make the early withdrawal. This isn't necessarily always true. There's no general rule. The terms and conditions of every CD are different. Furthermore, these days most CDs have something in their terms and conditions saying that they can change the terms and conditions! So, figure out whether your strategy for using CDs assumes that you can make early withdrawals, at the cost of the known-in-advance penalty. Know what the terms and conditions say. And when you get a notice of changes, read it.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
nisiprius
Advisory Board
 
Posts: 26052
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: 3-fund portfolio: replace bonds with CDs?

Postby john94549 » Tue Jan 08, 2013 2:15 pm

I would echo nisi's last paragraph with an additional observation. We have never faced the "break in our discretion" or the "terms and conditions may change" verbiage in a rising-rate environment, at least to my knowledge.* It stands to reason that banks and credit unions will not be eager to oblige rate-chasers should CD rates begin to rise, perhaps dramatically so. As I have noted elsewhere, it might be unwise, going forward, to invest in a CD with the intention of breaking it. Always assume you may have to hold each rung of a ladder to maturity; never assume you won't.

*And certainly not since Ft. Knox FCU actually invoked the clause (successfully) not too long ago.
john94549
 
Posts: 2972
Joined: Tue Jul 26, 2011 8:50 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby grok87 » Tue Jan 08, 2013 10:24 pm

learning_head wrote:I am looking for options to place "bond" part of my portfolio and I am having hard time justifying investing in bonds and not just buying CDs instead. My reasoning comes down to:

(a) Interest rate rise will likely not play out for bonds (yes, I know - can never time these things, but looking at big picture, this appears to be an overall non-positive)
(b) Bonds have been rising for many years now (again, can never time these things - so I suppose should disregard this)

More importantly, comparing bond fund SEC yields (e.g. BND 1.59%, VCIT 2.56%, VWITX 1.54% (after-tax)) vs CD rates of ~1.6-1.8% for ~5 years implies that with CDs I get a slightly less return but with no risk of principal loss, whereas a few percentage point gyrations in bond funds are a norm...

Am I looking at this wrong? Do I really want to take on extra risk of principal changes for a small yield improvement? (I recall one of grok's tips was to take the risk on equity side, not bond side)

I do see that VCLT (long term, not intermediate) bond fund has SEC yield of 4.35% - that's definitely better, but with even more risk as far as (a) and (b) go... So, if you buy the second part of above but not the first, would you invest only in long-term bonds for this yield/risk since anything shorter-term would be better served by CDs?

I predict someone could say that benefit of bond fund is you can rebalance in and out of it as needed when your target allocation changes, but I could do the same with CDs as well (can break the CDs as needed or create new CDs as needed). Please note that I am not "married" to CDs - I would love to invest in something with better returns / risk profile for the "non-risky" part of the portfolio, but can't seem to justify bonds as "it" today (and I had similar issues in the past - CD rates seem to always be quite close to bond rates, or at least in last 7 years or so)...

One advantage of bonds: they are easier to invest in as far as bond funds go - just add to one and you are done - no need to renew / hunt down good CDs... (but at least for now, I guess I am willing to do some extra leg work for CD hunts)

Hi learning_head,
I agree with the comments above. THese days here's what I would recommend on the fixed income side of things:

1) Ibonds
2) 7 year penfed CDs @ 2.0% yield, you can cash out early and just lose 1 years interest. They have the right to ask for you to request your early withdrawal in writing and to require 60 days notice.
3) fdic insured savings accounts yielding close to 1%. For example Alliant CU is yielding 0.8% I think.

cheers,
grok, CFA | Danon delenda est
grok87
 
Posts: 6524
Joined: Tue Feb 27, 2007 9:00 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby Random Musings » Wed Jan 09, 2013 4:37 pm

More recently, I have been switching my bond portfolio to be more heavily weighted in CD's (plus use of I-bonds).

For those who need to, just keep an eye on the maximum CD limit per issuer.

RM
User avatar
Random Musings
 
Posts: 5035
Joined: Thu Feb 22, 2007 4:24 pm
Location: Pennsylvania

Re: 3-fund portfolio: replace bonds with CDs?

Postby am » Wed Jan 09, 2013 5:52 pm

Long term CDs will not be so good when interest rates are back to say 4-5% in 5-6 years. Hard to imagine but this is what it was that long ago. You will also face large losses and may have trouble with redemptions.
am
 
Posts: 1594
Joined: Sun Sep 30, 2007 9:55 am
Location: Illinois

Re: 3-fund portfolio: replace bonds with CDs?

Postby epimedium » Wed Jan 09, 2013 6:43 pm

Based on reading the threads mentioned above, along with my own common sense, I've moved 2/3 of my bond allocation to I Bonds (1.76%), Stable Value (2.0 & 2.35%), and Penfed CDs (2.0%), which on average are ahead of the SEC yield on total bond(1.56%) and about even with intermediate-term investment grade (2.08%), with significantly less risk. 1/3 remains in total bond for rebalancing.
epimedium
 
Posts: 51
Joined: Tue May 31, 2011 12:02 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby am » Wed Jan 09, 2013 7:40 pm

Interest rates are not the only thing driving down prices. The long term rates have a long way to fall below they hit 0. The fed can only influence short term rates. What ever happened to stay the course? The total bond market has many different kinds of bonds, and interest rates may stay the way they are for longer than we think.
am
 
Posts: 1594
Joined: Sun Sep 30, 2007 9:55 am
Location: Illinois

Re: 3-fund portfolio: replace bonds with CDs?

Postby stevewolfe » Wed Jan 09, 2013 8:16 pm

am wrote:Long term CDs will not be so good when interest rates are back to say 4-5% in 5-6 years. Hard to imagine but this is what it was that long ago. You will also face large losses and may have trouble with redemptions.


You could've said the same thing 2 years ago when I bought a stack of 7 year CD's at 3.49%... Sooner or later you'll be right, but it's anyone's guess.
User avatar
stevewolfe
 
Posts: 1319
Joined: Fri Oct 10, 2008 7:07 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby stevewolfe » Wed Jan 09, 2013 8:18 pm

am wrote:The fed can only influence short term rates.


That's not entirely true, see operation twist.
User avatar
stevewolfe
 
Posts: 1319
Joined: Fri Oct 10, 2008 7:07 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby john94549 » Wed Jan 09, 2013 8:29 pm

If one is looking for an even-up trade, as opposed to a ladder, the best deal these days is to swap a short-term bond fund for the PenFed 3-year CD at 1.85%. This CD compares favorably to VFSTX, with a distribution yield just north of 1.85%, but with an SEC yield of 1.14%. If held as an IRA CD, and if one is over 59 1/2, partial withdrawals are permitted from the IRA CD with no EWP. Otherwise, the EWP is 6 months.

Personally, I find this a better deal than the PenFed 7-year CD at 2%. Fifteen basis points isn't enough to justify the additional four-year rate lock. And the EWP on the 7-year is 12 months.
john94549
 
Posts: 2972
Joined: Tue Jul 26, 2011 8:50 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby archbish99 » Wed Jan 09, 2013 10:16 pm

am wrote:Long term CDs will not be so good when interest rates are back to say 4-5% in 5-6 years. Hard to imagine but this is what it was that long ago. You will also face large losses and may have trouble with redemptions.

How? There are no losses or trouble with redemptions on CDs held to maturity, and when interest rates are back up, I'll just roll over the next rung of my CD ladder at that higher interest rate.
I'm not a financial advisor, I just play one on the Internet.
User avatar
archbish99
 
Posts: 1325
Joined: Fri Jun 10, 2011 6:02 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby crowd79 » Wed Jan 09, 2013 10:23 pm

Buy EE Bonds. They deserve a place in a portfolio as a floor. Guaranteed doubling (effective 3.53%) if held onto exactly 20 years and state income tax-free. If you look at interest rates over the course of the next 20 years, will they average out higher than 3.53% if added together and divided by 20 years? I know the next few years they won't to start at least....IMO, a great hedge against ultra-low rates for a long time.
Last edited by crowd79 on Wed Jan 09, 2013 10:37 pm, edited 2 times in total.
crowd79
 
Posts: 632
Joined: Sun Nov 18, 2012 10:37 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby am » Wed Jan 09, 2013 10:35 pm

How much in I and EE bonds can a married couple buy in one year?
am
 
Posts: 1594
Joined: Sun Sep 30, 2007 9:55 am
Location: Illinois

Re: 3-fund portfolio: replace bonds with CDs?

Postby crowd79 » Wed Jan 09, 2013 10:40 pm

am wrote:How much in I and EE bonds can a married couple buy in one year?


A married couple can buy $20k each of EE and I Bonds per year.
crowd79
 
Posts: 632
Joined: Sun Nov 18, 2012 10:37 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby am » Wed Jan 09, 2013 10:48 pm

So 40k total? Do these bonds have to be kept at treasury direct and bought through them?
am
 
Posts: 1594
Joined: Sun Sep 30, 2007 9:55 am
Location: Illinois

Re: 3-fund portfolio: replace bonds with CDs?

Postby crowd79 » Wed Jan 09, 2013 11:09 pm

am wrote:So 40k total? Do these bonds have to be kept at treasury direct and bought through them?


Yes. You can only purchase I and EE Bonds through the Treasury Direct website.
crowd79
 
Posts: 632
Joined: Sun Nov 18, 2012 10:37 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby Phineas J. Whoopee » Thu Jan 10, 2013 1:33 pm

crowd79 wrote:
am wrote:So 40k total? Do these bonds have to be kept at treasury direct and bought through them?


Yes. You can only purchase I and EE Bonds through the Treasury Direct website.

It is also possible to buy an additional $5,000 worth of I Bonds, in paper form, with your income tax refund. Several here deliberately overpay so as to be able to access the additional tax-deferred, inflation-linked space. It is $5,000 per return, so no doubling for a married couple filing jointly.

You will need to file form 8888 with your tax return.
http://www.irs.gov/pub/irs-pdf/f8888.pdf

PJW
User avatar
Phineas J. Whoopee
 
Posts: 3039
Joined: Sun Dec 18, 2011 6:18 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby moneyman11 » Thu Jan 10, 2013 5:51 pm

The problem with many of the suggestions in this thread and other "boosting your fixed income return without adding risk" threads (EE Bonds, I Bonds, PenFed CDs), is that they are either impossible or very cumbersome to do in IRAs and 401ks.

All of my retirement money (and I suspect that of many other folks) is in tax deferred vehicles, so if I don't want bonds or bond funds, I am stuck with brokered CDs (which offer pretty paltry rates), or am faced with the prospect breaking up my IRAs into individual accounts at banks offering the highest CD rates. Yuck.
moneyman11
 
Posts: 463
Joined: Tue Feb 19, 2008 10:09 am

Re: 3-fund portfolio: replace bonds with CDs?

Postby john94549 » Thu Jan 10, 2013 6:50 pm

moneyman11, as I've noted in other threads, the effort involved in managing an IRA CD ladder is not terribly onerous. Once you do a custodian-to-custodian transfer or two, it's not that difficult.

That said, there are mistakes which can be made which might generate a grimace (maybe even a "yuck"). I've addressed these elsewhere, in other threads. IRA CDs don't appeal to some folks, but others find them a reasonable addition to a fixed-income allocation.
john94549
 
Posts: 2972
Joined: Tue Jul 26, 2011 8:50 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby grok87 » Thu Jan 10, 2013 8:13 pm

crowd79 wrote:Buy EE Bonds. They deserve a place in a portfolio as a floor. Guaranteed doubling (effective 3.53%) if held onto exactly 20 years and state income tax-free. If you look at interest rates over the course of the next 20 years, will they average out higher than 3.53% if added together and divided by 20 years? I know the next few years they won't to start at least....IMO, a great hedge against ultra-low rates for a long time.

meh. 20 years is a long time to wait. A lot can happen in 20 years. I can't even remember much about what I was doing 20 years ago easily. Who knows where my head will be at in 20 years.
grok, CFA | Danon delenda est
grok87
 
Posts: 6524
Joined: Tue Feb 27, 2007 9:00 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby learning_head » Thu Jan 10, 2013 11:48 pm

I really appreciate everyone's responses. To be honest I was expecting a lot of comments to the opposite of my thinking and having heard so many in agreement, it gave me confidence to go ahead with what I am doing. So I added a bunch of 1.85% 3-year CDs (2% for longer period with higher EWP did not do it for me...).

Regarding EE, I also think 20 years it too long of a term.

10k limit on I-bonds and 0% fixed part coupled with tax upon withdrawal have been stopping me so far, but I will think more about them / look for their discussions on other threads.
learning_head
 
Posts: 557
Joined: Sat Apr 10, 2010 6:02 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby Dario33 » Tue Jan 22, 2013 12:26 pm

learning_head wrote:10k limit on I-bonds and 0% fixed part coupled with tax upon withdrawal have been stopping me so far, but I will think more about them / look for their discussions on other threads.

FWIW, I've been mulling over I-bonds, EE and CD's as well. Objective being to park some money as a floor in my taxable account (alternative is to add TBM or tax-exempt Intermediate Term fund to my taxable).

I've read up on I-bonds here over the past week and think they're the way to go for me (for at least an initial 10k this year). Plus, the Treasurydirect site sounds fairly painless and I like the no tax implications w/these.
Dario33
 
Posts: 78
Joined: Mon Jul 02, 2012 10:10 am

Re: 3-fund portfolio: replace bonds with CDs?

Postby learning_head » Tue Jan 22, 2013 1:51 pm

Dario33 wrote:I've read up on I-bonds ... I like the no tax implications w/these.


I think the tax issue is the one that bothers me the most: I am guaranteed to lose purchasing power, I am pretty much guaranteed a negative real rate of return. Say, I have an I-bond for 30 years and withdraw it at marginal rate of 25% (who knows what the brackets will be but...). I will end up paying 25% tax on all the inflation adjustments. If inflation is 3%/year, I am guaranteed to lose ~15% purchasing power:

((1.03^30)-1)*0.25 / (1.03^30) = 14.7%

FWIW, if I invest $10k in above scenario, the taxable amount of 10k*((1.03^30)-1)=14.2k will be added to whatever is my other taxable income.
learning_head
 
Posts: 557
Joined: Sat Apr 10, 2010 6:02 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby Dario33 » Tue Jan 22, 2013 2:18 pm

learning_head wrote:
Dario33 wrote:I've read up on I-bonds ... I like the no tax implications w/these.


I think the tax issue is the one that bothers me the most: I am guaranteed to lose purchasing power, I am pretty much guaranteed a negative real rate of return. Say, I have an I-bond for 30 years and withdraw it at marginal rate of 25% (who knows what the brackets will be but...). I will end up paying 25% tax on all the inflation adjustments. If inflation is 3%/year, I am guaranteed to lose ~15% purchasing power:

((1.03^30)-1)*0.25 / (1.03^30) = 14.7%

FWIW, if I invest $10k in above scenario, the taxable amount of 10k*((1.03^30)-1)=14.2k will be added to whatever is my other taxable income.

I hear you. The outlook on bonds is rather bleak -- regardless of which way you go. Similar can be said of TBM and tax-empt bond funds. I'm not looking for a terribly big return on bonds (else I'd likely be looking for a while), but rather a tax safe placement for them. One thing to also consider with I-bonds (which I am) is that interest earnings may be excluded from tax if used to finance education when redeemed.
Dario33
 
Posts: 78
Joined: Mon Jul 02, 2012 10:10 am

Re: 3-fund portfolio: replace bonds with CDs?

Postby archbish99 » Tue Jan 22, 2013 6:32 pm

Dario33 wrote:Plus, the Treasurydirect site sounds fairly painless and I like the no tax implications w/these.


That's a mistaken impression, in my opinion. My wife's frustration with Treasury Direct led to an emotional decision to divest all of her EE bonds so she could stop dealing with them. I've been trying to purchase I-Bonds for my parents account for around 9 months with not only no success, but decreasing success. It's arguably worth some effort, particularly if you make your one-a-year purchase and leave it alone, but I would never characterize dealing with TD as "fairly painless."

Wait until you've successfully made at least one purchase before you render a verdict. :shock:
I'm not a financial advisor, I just play one on the Internet.
User avatar
archbish99
 
Posts: 1325
Joined: Fri Jun 10, 2011 6:02 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby rj49 » Tue Jan 22, 2013 7:11 pm

I'd compromise and put bonds in tax-deferred accounts, where increased interest rates will be rolled over into higher yields and a higher rate of compounding--there's a VG article you can search on that shows that increasing interest rates actually grow faster for a reinvested bond fund than decreasing rates. That would lead to less regret over bond NAV losses, especially if you don't check retirement accounts frequently. Dealing with CDs in a retirement account also seems like more of a headache than it's worth, especially if you switch institutions frequently and do rollovers.

Then for taxable accounts you could do whatever is the best option at the time--maybe some ibonds, especially if you anticipate some educational expenses down the road that would make the interest tax deductible, and then a CD ladder of some sort, or even some high-interest money market or savings accounts--a few years ago there were some good deals. Penfed usually offers better-than-everyone-else CD rates every January--I'm still enjoying 6.25% ones I bought back in 2007. If you look up Allan Roth's articles, a Boglehead financial advisor/writer, he also has chosen to go the CD route instead of bonds. Others, like Bill Bernstein, have advocated short-term bonds and avoiding the temptation to reach for yield, because it's not worth the potential losses. Frank Armstrong, another good writer on asset allocation, also advocates very short-term Treasuries for fixed income for the high level of safety. Whatever you choose, just keep it in perspective--1% difference in yields or modest losses in short-term bonds certainly wouldn't be as painful or damaging as the losses in stocks in 2008 or 2000.
rj49
 
Posts: 282
Joined: Wed Feb 23, 2011 12:22 am

Re: 3-fund portfolio: replace bonds with CDs?

Postby Dandy » Wed Jan 23, 2013 10:18 am

CDs for at least a portion of your fixed income allocation makes some sense to me during this interest rate environment. It provides some stability to your portfolio and having some safe assets also provides some dry powder if/when interest rates rise and bond funds dip. Make sure that your CDs have a reasonable penalty (tax deductible) for early redemption. Most have a 6 month penalty - Ally Bank has a 2 month.

I like having a collection of "safe" assets as part of my fixed income. That has included stable value funds, money markets, EE and HH bonds, CDs, Savings Accounts and should include I Bonds. These often low yielding assets perform the function sometimes assigned to the fixed income portion of your portfolio - risk reduction so that more risk can be taken on the equity side. Somehow people see a short term bond fund as providing risk reduction/stability but find these "safe" assets with distaste.

There is a risk of falling in love with safety. You can feel safe and be eaten up by inflation and RMDs that can't be offset by safe yields. I would normally like safe assets to be 5 to 10% of my portfolio - it is more like 20% of total portfolio and 1/3 of my fixed income. 1/3 safe, 1/3 short term and 1/3 intermediate/Inflation pro seems about right for me.
Dandy
 
Posts: 2451
Joined: Sun Apr 25, 2010 7:42 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby Phineas J. Whoopee » Sat Jan 26, 2013 1:48 pm

archbish99 wrote:
Dario33 wrote:Plus, the Treasurydirect site sounds fairly painless and I like the no tax implications w/these.

That's a mistaken impression, in my opinion. ...

I've never experienced any problem.

PJW
User avatar
Phineas J. Whoopee
 
Posts: 3039
Joined: Sun Dec 18, 2011 6:18 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby stevewolfe » Sat Jan 26, 2013 5:05 pm

Phineas J. Whoopee wrote:
archbish99 wrote:
Dario33 wrote:Plus, the Treasurydirect site sounds fairly painless and I like the no tax implications w/these.

That's a mistaken impression, in my opinion. ...

I've never experienced any problem.

PJW


That's been our experience as well. We avoided buying electronic bonds till we could no longer get paper bonds (I'm not interested in the over pay tax return bit to get $5k more), but it's easier now than it was (with the secret decoder card).
User avatar
stevewolfe
 
Posts: 1319
Joined: Fri Oct 10, 2008 7:07 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby Bustoff » Thu Feb 14, 2013 7:11 am

tfb wrote:
learning_head wrote:Or stated another way, I am putting together a 3-fund portfolio, but thinking about having CDs there instead of VBMFX / BND.

You may be interested in these two great articles by a presumed Boglehead:

Optimizing Fixed Income Portfolio and
Optimizing Investment Portfolio With Municipal Bonds


Is the author of these articles considered to be an expert ?
Does anyone know the educational or professional background of this person ?
“There are two times in a man's life when he should not speculate: when he can't afford it, and when he can.” | ― Mark Twain
Bustoff
 
Posts: 1144
Joined: Sat Mar 03, 2012 6:45 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby Tom_T » Thu Feb 14, 2013 8:22 am

Bustoff wrote:
tfb wrote:
learning_head wrote:Or stated another way, I am putting together a 3-fund portfolio, but thinking about having CDs there instead of VBMFX / BND.

You may be interested in these two great articles by a presumed Boglehead:

Optimizing Fixed Income Portfolio and
Optimizing Investment Portfolio With Municipal Bonds


Is the author of these articles considered to be an expert ?
Does anyone know the educational or professional background of this person ?

Is that important? If the author presents reasoned and intelligent arguments for his point of view (and he does, in my opinion), that is what matters most. There are plenty of "educated experts" out there giving bad advice.
Tom_T
 
Posts: 1397
Joined: Wed Aug 29, 2007 2:33 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby nydad » Thu Feb 14, 2013 9:42 am

There is important information missing in this question - such as what is the rest of your portfolio, how much of it is in fixed income, and what is your timeframe for investing? That to me would be a key determining factor here.

Yes, you may do better with CDs over the short term. But in the long term, they add additional complication as noted above, and if you invest instead in a treasury or bond fund with a 5 year duration, within 5 years, even if interest rates rise and reinvesting dividends, you will be back where you started and holding higher yielding investments.

On the other hand, if interest rates drop further, then you will benefit from that. I bought my first bonds ever I think in 2010 or 2011, when interest rates could go no further, but I've still done better than CDs since then.
User avatar
nydad
 
Posts: 449
Joined: Wed Dec 01, 2010 11:10 am

Re: 3-fund portfolio: replace bonds with CDs?

Postby Bustoff » Thu Feb 14, 2013 10:07 am

Tom_T wrote:
Bustoff wrote:
tfb wrote:
learning_head wrote:Or stated another way, I am putting together a 3-fund portfolio, but thinking about having CDs there instead of VBMFX / BND.

You may be interested in these two great articles by a presumed Boglehead:

Optimizing Fixed Income Portfolio and
Optimizing Investment Portfolio With Municipal Bonds


Is the author of these articles considered to be an expert ?
Does anyone know the educational or professional background of this person ?

Is that important? If the author presents reasoned and intelligent arguments for his point of view (and he does, in my opinion), that is what matters most. There are plenty of "educated experts" out there giving bad advice.


Tom - relax buddy, you're interpreting my curiosity as a criticism of the author. I happen think the author provides a great service and offers good advice. So my answer to your question is Yes, it's important. It's important to me because when I admire someone or something I'm interested in learning more about that someone or something. 8-)
“There are two times in a man's life when he should not speculate: when he can't afford it, and when he can.” | ― Mark Twain
Bustoff
 
Posts: 1144
Joined: Sat Mar 03, 2012 6:45 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby tfb » Thu Feb 14, 2013 11:12 am

nydad wrote:Yes, you may do better with CDs over the short term. But in the long term, they add additional complication as noted above, and if you invest instead in a treasury or bond fund with a 5 year duration, within 5 years, even if interest rates rise and reinvesting dividends, you will be back where you started and holding higher yielding investments.

On the other hand, if interest rates drop further, then you will benefit from that. I bought my first bonds ever I think in 2010 or 2011, when interest rates could go no further, but I've still done better than CDs since then.

Nothing stops you from switching back when the situation warrants. Any gains in the bond funds so far are at a cost of lower returns going forward. If one invested in 7-year CD 3 years ago, the CDs are still earning 4%+ versus 1.x% in the bond fund. Over the next 4 years, the CD value will catch up.
Harry Sit, taking a break from the forums.
User avatar
tfb
 
Posts: 6757
Joined: Mon Feb 19, 2007 5:46 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby archbish99 » Thu Feb 14, 2013 3:59 pm

tfb wrote:
nydad wrote:Yes, you may do better with CDs over the short term. But in the long term, they add additional complication as noted above, and if you invest instead in a treasury or bond fund with a 5 year duration, within 5 years, even if interest rates rise and reinvesting dividends, you will be back where you started and holding higher yielding investments.

On the other hand, if interest rates drop further, then you will benefit from that. I bought my first bonds ever I think in 2010 or 2011, when interest rates could go no further, but I've still done better than CDs since then.

Nothing stops you from switching back when the situation warrants. Any gains in the bond funds so far are at a cost of lower returns going forward. If one invested in 7-year CD 3 years ago, the CDs are still earning 4%+ versus 1.x% in the bond fund. Over the next 4 years, the CD value will catch up.

And for that matter, if we're talking about a CD ladder, why would the ladder not do exactly the same thing the bonds are doing? Reinvested rungs will be getting the higher rates, and eventually the whole ladder will be rolled over. A CD is a bond. A ladder is managing a small fund yourself, rather than paying someone else to manage a ladder for you. Less diversified, but with CDs, they're insured for principal and interest, so it's arguably an acceptable trade-off.
I'm not a financial advisor, I just play one on the Internet.
User avatar
archbish99
 
Posts: 1325
Joined: Fri Jun 10, 2011 6:02 pm

Re: 3-fund portfolio: replace bonds with CDs?

Postby fidelio » Sun Feb 17, 2013 6:09 am

moneyman11 wrote:The problem with many of the suggestions in this thread and other "boosting your fixed income return without adding risk" threads (EE Bonds, I Bonds, PenFed CDs), is that they are either impossible or very cumbersome to do in IRAs and 401ks.

All of my retirement money (and I suspect that of many other folks) is in tax deferred vehicles, so if I don't want bonds or bond funds, I am stuck with brokered CDs (which offer pretty paltry rates), or am faced with the prospect breaking up my IRAs into individual accounts at banks offering the highest CD rates. Yuck.


exactly.

i've bought a few ibonds but have little taxable and it's not realistic to place much f.i. there, as the limit on purchases makes them unrealistic as a major bond component, unless maybe you're young and married (i'm old and divorced ...).

buying cd's seems like a good idea, i have nothing against it, but as my bond allocation is what it is, my hope would be that the supposedly approaching sunken n.a.v. of the bond fund would "catch up" via reinvestment at higher rates as it approaches its average maturity. i guess this presupposes non-catastrophic long-term inflation. in any case, i shouldn't need bond fund principal for a long time, so ....

the one bright spot is that most of my f.i. in my 401k is in a s.v.f. paying 3%, so barring any black swan stable value fund event, i'm good with a few bond funds in my ira's (including s.t. tips and s.t. bond idx).
fidelio
 
Posts: 165
Joined: Sun May 04, 2008 5:28 pm

Next

Return to Investing - Theory, News & General

Who is online

Users browsing this forum: atfish, Blueskies123, Electron, FAST Enterprise [Crawler], Garco, gkaplan, Kevin M, musbane, nvst, Rick Ferri, Yahoo [Bot] and 76 guests