Need help in selecting Bond index equivalent at workplace 401K option

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montero4
Posts: 3
Joined: Sat Aug 12, 2017 1:34 pm

Need help in selecting Bond index equivalent at workplace 401K option

Post by montero4 » Sat Aug 12, 2017 1:57 pm

Hello,

I'm finally looking into investing properly and I signed up for my company's 401K recently. I'm going with the couch potato type of allocation of 60% equity/40% bond using index funds. I'm confused with the bond part of this allocation. I seem to have 3 choices:

- a real 3% option. The description says it provides investors a 3% return above the Consumer Price Index (CPI). For the past 12 months this option returned about 5% which makes sense since US CPI is about 2%.

- Barclays Capital Government/Credit Index. I think this is the equivalent index that measures the performance of U.S. Dollar denominated U.S. Treasuries, government-related and investment grade U.S. corporate securities that have a remaining maturity of greater than one year.

-JP Morgan Emerging Market Bond Index Plus (EMBI+). The EMBI+ is a traditional, market-capitalization weighted index comprised of US dollar- denominated Brady Bonds, Eurobonds and traded loans issued by sovereign entities.

My money is currently in the 3% real option as it seems to be safer (i.e. you would never lose money as the lower limit will be 0%; but the upside is limited to US CPI + 3%). To follow the couch potato type of approach, should I move to the Barclays Capital G/C index? Is that equivalent to Vanguard's Total Bond Market Index Fund for example? I don't think I will consider EMBI+ as most asset allocations that I've read about don't consider international bond exposure, just US type bonds.

Any advice or thoughts would be great! Thank you so much.

montero

CppCoder
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Joined: Sat Jan 23, 2016 9:16 pm

Re: Need help in selecting Bond index equivalent at workplace 401K option

Post by CppCoder » Sat Aug 12, 2017 3:08 pm

Your first option sounds like an inflation protected stable value fund. I've never heard of such a vehicle. Given that TIPS are paying much less real interest than that, it sounds like a pretty good deal, almost too good to be true. Are there any serious restrictions on this option (e.g., limited withdrawal, minimum holding times)? What are the expense ratios for the 3% real fund and the Barclays fund? Costs and limitations being roughly equal, I would probably put most of my fixed income in your stable value fund. I'd definitely steer clear of the Emerging Market Bond fund.

jalbert
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Joined: Fri Apr 10, 2015 12:29 am

Re: Need help in selecting Bond index equivalent at workplace 401K option

Post by jalbert » Sat Aug 12, 2017 3:15 pm

montero4 wrote:
Sat Aug 12, 2017 1:57 pm
- a real 3% option. The description says it provides investors a 3% return above the Consumer Price Index (CPI). For the past 12 months this option returned about 5% which makes sense since US CPI is about 2%.

- Barclays Capital Government/Credit Index. year.

-JP Morgan Emerging Market Bond Index Plus (EMBI+).

My money is currently in the 3% real option as it seems to be safer (i.e. you would never lose money as the lower limit will be 0%; but the upside is limited to US CPI + 3%).
There is nothing particularly magical about the total bond index as an allocation preference. Its main benefit is it can be implemented cheaply. The Barclays index above is an alternative bond index. We would need to know fees and expense ratios to provide the best feedback.

The real return option looks attractive, but at one point you suggest a return set at 3% real and subsequently that this is the maximum possible return. Can you clarify?

Opinions vary on whether US investors should invest in emerging market debt, but it should be treated as part of your 60% allocation to stock from a risk management perspective. As such, you might as well pass on it and use the full 60% of risk asset space for stock investments.
Risk is not a guarantor of return.

montero4
Posts: 3
Joined: Sat Aug 12, 2017 1:34 pm

Re: Need help in selecting Bond index equivalent at workplace 401K option

Post by montero4 » Sat Aug 12, 2017 4:54 pm

Thank you both for replying.

The 3% option doesn't have any fees. The annual rate appears to be set every May, based on March-March yearly U.S CPI Index. I just checked, and the rate has been set at 5.38% for the next year. So the maximum return is always 3% above the US CPI, thus 5.38% for the next 12 months. There is no withdrawal or minimum holding time restriction that I could see.

The Barclays Capital Govt/Credit fees are 0.10% and the EMBI+ is at 0.15%

Maybe I will keep the 40% bond allocation in the 3% option then, and if the market crashes I could move it to Barclays bond index? But I guess that would be timing the market, which I don't want to do...that's why I was thinking of putting it into a bond index to start with...What do you think?

Thank you for any additional thoughts you can provide.

M

ThrustVectoring
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Joined: Wed Jul 12, 2017 2:51 pm

Re: Need help in selecting Bond index equivalent at workplace 401K option

Post by ThrustVectoring » Sat Aug 12, 2017 5:22 pm

CPI + 3% is nuts for fixed-income. Like, that's above the rate you'd pay on a mortgage. I'd take a serious look at the funds financial documents - the interest rate they're offering is roughly equivalent to a B rated corporate bond. (As a concrete example, Tesla recently took on $1.5B or something of unsecured corporate debt @ 5.75%, IIRC. I could remember the numbers wrong, it's roughly equivalent to that).

If you understand how it does what it does and are satisfied with the apparent risk profile of it, I'd put my entire fixed income percentage in there. Hell, with those terms I'd think about altering my fixed-income percentage.

Rainmaker41
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Re: Need help in selecting Bond index equivalent at workplace 401K option

Post by Rainmaker41 » Sat Aug 12, 2017 5:23 pm

3% real return is a more optimistic long-run return than I 'plan' on getting for my entire portfolio during my career!

If there are no gotchas or withdrawal restrictions/penalties, then I'd absolutely use that for the bond portion of your allocation. The risk-adjusted return on it sounds incredible.
My username is not about money, but is my old online gaming username. I can't say that I make a great deal of money; I just hate spending it. Marrying the most loving woman in the world October 2017.

jalbert
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Joined: Fri Apr 10, 2015 12:29 am

Re: Need help in selecting Bond index equivalent at workplace 401K option

Post by jalbert » Sun Aug 13, 2017 3:51 am

The 3% option doesn't have any fees. The annual rate appears to be set every May, based on March-March yearly U.S CPI Index. I just checked, and the rate has been set at 5.38% for the next year. So the maximum return is always 3% above the US CPI, thus 5.38% for the next 12 months. There is no withdrawal or minimum holding time restriction that I could see.
CPI has not been 2.38%, so something seems to be amiss. Also, in the current financial clinate it is not possible to earn a real return of 3% with a guarantee against principal loss. If that were what the provider were offering, someone is subsidizing a hefty otherwise uncompensated risk. I would suggest finding out what the underlying investments are and confirming your understanding of the product.
Risk is not a guarantor of return.

montero4
Posts: 3
Joined: Sat Aug 12, 2017 1:34 pm

Re: Need help in selecting Bond index equivalent at workplace 401K option

Post by montero4 » Sun Aug 13, 2017 7:48 am

Thanks so much for your replies.

I didn't know if the 3% real option was good, but it seems to be, based on your replies here. It is unusual, you are right. Based on the description that I did have, I checked the US CPI for the period March 2016 to March 2017, it did rise by 2.4%.

https://www.bls.gov/opub/ted/2017/cpi-r ... h-2017.htm

I will look into how they are doing that, and who is assuming the risk. I will use that for my 40% bond allocation then. Thank you all!

M

student
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Re: Need help in selecting Bond index equivalent at workplace 401K option

Post by student » Sun Aug 13, 2017 7:53 am

jalbert wrote:
Sun Aug 13, 2017 3:51 am
The 3% option doesn't have any fees. The annual rate appears to be set every May, based on March-March yearly U.S CPI Index. I just checked, and the rate has been set at 5.38% for the next year. So the maximum return is always 3% above the US CPI, thus 5.38% for the next 12 months. There is no withdrawal or minimum holding time restriction that I could see.
CPI has not been 2.38%, so something seems to be amiss. Also, in the current financial clinate it is not possible to earn a real return of 3% with a guarantee against principal loss. If that were what the provider were offering, someone is subsidizing a hefty otherwise uncompensated risk. I would suggest finding out what the underlying investments are and confirming your understanding of the product.
I am wondering which CPI index that they are using. Maybe it is attached to a region of the employer. I looked at some of these indices. For Miami area, the numbers for HALF1 and HALF2 in 2016 and 2017 are 248.156 and 255.916 respectively. So the rate is 3.13%.

jalbert
Posts: 2169
Joined: Fri Apr 10, 2015 12:29 am

Re: Need help in selecting Bond index equivalent at workplace 401K option

Post by jalbert » Sun Aug 13, 2017 2:34 pm

If the risk is not an unfunded liability and the organization(s) underwriting the risk have strong credit ratings, you may want to consider increasing your allocation beyond 40%.
Risk is not a guarantor of return.

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