Bonds: Why?

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RRAAYY3
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Bonds: Why?

Post by RRAAYY3 » Sat Nov 25, 2017 9:02 pm

I understand the “basic” premise - much less volatile / won’t drop as much in a crash ...

My question is basically why would you have your “safe” portion of assets in something that can still fluctuate / drop?

I see things like 3-5 year CDs with guaranteed rates of return and I wonder why I shouldn’t just put my “safety net” in something like that when I decide to be more conservative (right now I’m strictly high yield savings + 100% equity, and will be for the foreseeable future)

mac808
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Re: Bonds: Why?

Post by mac808 » Sat Nov 25, 2017 9:04 pm

As 5 year CD rates creep up closer to 3% (with 6 month EWPs) I'm also wondering whether they are a good substitute for some or all of my bond allocation.

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oldcomputerguy
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Re: Bonds: Why?

Post by oldcomputerguy » Sat Nov 25, 2017 9:06 pm

RRAAYY3 wrote:
Sat Nov 25, 2017 9:02 pm
I understand the “basic” premise - much less volatile / won’t drop as much in a crash ...

My question is basically why would you have your “safe” portion of assets in something that can still fluctuate / drop?

I see things like 3-5 year CDs with guaranteed rates of return and I wonder why I shouldn’t just put my “safety net” in something like that when I decide to be more conservative (right now I’m strictly high yield savings + 100% equity, and will be for the foreseeable future)
Anything can fluctuate. Your 3-5 year CDs can lose purchasing power if interest rates fluctuate, or if inflation takes a spike. Even cash can lose effective value to inflation. In real terms, nothing is guaranteed not to fluctuate or drop.
It’s taken me a lot of years, but I’ve come around to this: If you’re dumb, surround yourself with smart people. And if you’re smart, surround yourself with smart people who disagree with you.

EHEngineer
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Re: Bonds: Why?

Post by EHEngineer » Sat Nov 25, 2017 9:06 pm

agree. use the CDs when they offer more return. For me, "safe money" is no riskier than Total Bond Market, and CDs meet that criteria.
Or, you can ... decline to let me, a stranger on the Internet, egg you on to an exercise in time-wasting, and you could say "I'm probably OK and I don't care about it that much." -Nisiprius

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Re: Bonds: Why?

Post by EHEngineer » Sat Nov 25, 2017 9:07 pm

oldcomputerguy wrote:
Sat Nov 25, 2017 9:06 pm
Anything can fluctuate. Your 3-5 year CDs can lose purchasing power if interest rates fluctuate, or if inflation takes a spike. Even cash can lose effective value to inflation. In real terms, nothing is guaranteed not to fluctuate or drop.
Ibonds? Inflation adjusted SPIA?
Or, you can ... decline to let me, a stranger on the Internet, egg you on to an exercise in time-wasting, and you could say "I'm probably OK and I don't care about it that much." -Nisiprius

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oldcomputerguy
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Re: Bonds: Why?

Post by oldcomputerguy » Sat Nov 25, 2017 9:16 pm

EHEngineer wrote:
Sat Nov 25, 2017 9:07 pm
oldcomputerguy wrote:
Sat Nov 25, 2017 9:06 pm
Anything can fluctuate. Your 3-5 year CDs can lose purchasing power if interest rates fluctuate, or if inflation takes a spike. Even cash can lose effective value to inflation. In real terms, nothing is guaranteed not to fluctuate or drop.
Ibonds? Inflation adjusted SPIA?
The point is, there is no such thing as a perfectly-stable investment. I bonds certainly fluctuate, at least their interest rates do. And I'm not all that certain that the calculations used to vary I bond rates bears more than a passing resemblance to the real-world market inflation I see as a consumer. (I don't consider an SPIA as an investment, it's an insurance policy.)
It’s taken me a lot of years, but I’ve come around to this: If you’re dumb, surround yourself with smart people. And if you’re smart, surround yourself with smart people who disagree with you.

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TD2626
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Re: Bonds: Why?

Post by TD2626 » Sun Nov 26, 2017 12:07 am

Yes, you can loose out in CDs. If within FDIC limits, there isn't really any nominal (pre-inflation adjusted) risk, but there is real (inflation adjusted) risk. You could be locked into a low yielding CD for years and loose money to inflation. Further, if interest rates rise, you could be locked into a low yielding CD and not be able to take advantage of higher yield CDs with the new interest rates. These are of course issues with nominal bonds as well.

People often consider long-term CDs to be part of their fixed income / bond allocation. CDs aren't strictly bonds, but behave somewhat similarly.

Buying CDs of many maturities, constantly trying to find good rates, and so forth can be a hassle. That is one reason many may use bond funds instead. However, using CDs instead of bonds may be reasonable in some circumstances in my opinion.

rongos
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Re: Bonds: Why?

Post by rongos » Sun Nov 26, 2017 12:59 am

My understanding of Boglehead theory is that the reason one should be invested in bonds is because, generally speaking, bonds go up when stocks go down, and vice versa, thus cushioning fluctuations in the market. CDs don't do that.

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peterinjapan
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Re: Bonds: Why?

Post by peterinjapan » Sun Nov 26, 2017 4:37 am

And yet, I watch when things to up and down and try to get a feel for what goes up/down and how much. My general impression is

JNK = high yield, dangerous for various reasons but quite interest rate resistent
LQD = corporate bonds, safe but slightly longer term, subject to going down if rates rise quickly
BND/AGG = very broad aggregate ETFs of many bonds, presumably the most safe? These are what I own most of.

Usually if stocks shoot up, bonds fall a little, and vice versa, but maybe 30% of the time bonds rise as well as stocks, or vice versa.

Am I very far off in my simplified estimation of the above?

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whodidntante
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Re: Bonds: Why?

Post by whodidntante » Sun Nov 26, 2017 5:02 am

Direct CDs will offer better expected returns with lower risk right now assuming you do the legwork to find top paying direct CDs with acceptable EWPs. This isn't necessarily sufficient reason to use CDs. CDs are more work because they require active management. Think of it like managing a portfolio of CDs. You'll need to look at what is happening in the market and make moves from time to time if you want to keep the returns close to optimal. They are more hassle to liquidate, as you usually have to call the bank while it's open to force an early withdrawal. If you're holding them in IRAs at various banks, it's even more hassle to liquidate them in order to buy stocks. And the psychological effect of the EWP means you probably won't sell them early to buy stocks after a stock market drop. It also used to be part of the terms for some CDs that the bank did not have to grant your early withdrawal request, but that seems less common now and most requests were granted anyway.

Brokered CDs are a bit more convenient but come with interest rate risk and they aren't very liquid.

I currently do not own any CDs. I keep all my fixed income in tax deferred investments and that means I need to use stable value funds and bond funds in my 401k. I cannot have a traditional IRA because I'm doing a backdoor Roth.

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whodidntante
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Re: Bonds: Why?

Post by whodidntante » Sun Nov 26, 2017 5:13 am

rongos wrote:
Sun Nov 26, 2017 12:59 am
My understanding of Boglehead theory is that the reason one should be invested in bonds is because, generally speaking, bonds go up when stocks go down, and vice versa, thus cushioning fluctuations in the market. CDs don't do that.
That negative correlation has occurred in the past (sometimes), but it may not occur in the future. And corporate bonds tend to drop along with stocks so depending on what your bond fund holds you might not see an upward movement in price.

smesman
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Re: Bonds: Why?

Post by smesman » Sun Nov 26, 2017 7:14 am

Some financial experts (e.g. Larry Swedroe) are advising people to use CDs instead of bonds also. The main difference is that institutions/governments cannot buy CDs which has kept their interest up higher.

The main disadvantage of some CDs in comparison to bond (funds) is that you'll have less liquidity. There is no aftermarket to sell them to. Since bonds are supposed to be the "safe" part of your portfolio during recessions and market turmoil, you will want to make to sure you can access them. So make sure you check the conditions and penalties for cancelling them early (e.g. some have no penalty when you get unemploymed or want to buy a house).

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Re: Bonds: Why?

Post by z3r0c00l » Sun Nov 26, 2017 7:23 am

If you do a search of this forum on this topic, be prepared to spend about a week reading all of the almost identical posts where this is covered. It becomes a personal choice rather than a set rule. Many, like me, select bonds because they can be purchased or sold at any time in any increments one wants. They also dynamically adjust to interest rates where, of course, CDs don't. I also use I-Bonds and have used CDs in the past. But when it comes to actually investing, rather than an emergency fund, I select a bond fund.

3funder
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Re: Bonds: Why?

Post by 3funder » Sun Nov 26, 2017 7:26 am

Short-term corporate bonds should do fine in a rising interest rate environment. I wouldn't venture super far out in terms of duration, though, unless your time horizon exceeds it.

dbr
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Re: Bonds: Why?

Post by dbr » Sun Nov 26, 2017 10:21 am

RRAAYY3 wrote:
Sat Nov 25, 2017 9:02 pm
I understand the “basic” premise - much less volatile / won’t drop as much in a crash ...

My question is basically why would you have your “safe” portion of assets in something that can still fluctuate / drop?

I see things like 3-5 year CDs with guaranteed rates of return and I wonder why I shouldn’t just put my “safety net” in something like that when I decide to be more conservative (right now I’m strictly high yield savings + 100% equity, and will be for the foreseeable future)
1. Because bonds are not a "safety net" in the sense you most likely imagine.

2. Because, as you already know, bonds are indeed much less volatile than stocks, enough less volatile that there is nothing to be gained by seeking something less volatile.

3. Because you can control bond risk by selecting appropriate duration and credit risk.

4. Because nobody says you have to hold bonds if/when CDs, stable value funds, even interest bearing savings accounts may be competitive on yield.

5. Because you should invest according to the overall risk and return prospects of your investments as a whole rather than managing assets in isolation.

6. Because you may well have not read enough about investing and read enough threads on this topic.

7. Because you have read too many comments on the Forum from people that have an unjustified case of nerves about bonds.

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Re: Bonds: Why?

Post by Valuethinker » Sun Nov 26, 2017 10:23 am

RRAAYY3 wrote:
Sat Nov 25, 2017 9:02 pm
I understand the “basic” premise - much less volatile / won’t drop as much in a crash ...

My question is basically why would you have your “safe” portion of assets in something that can still fluctuate / drop?

I see things like 3-5 year CDs with guaranteed rates of return and I wonder why I shouldn’t just put my “safety net” in something like that when I decide to be more conservative (right now I’m strictly high yield savings + 100% equity, and will be for the foreseeable future)
In fact, you can leverage your equity position.

Be more than 100% in equities.

Poster Market Timer, here, did just that and it's worth reading about his experiences.

BTW I agree CDs are a good substitute. You lose liquidity (if you try to sell them early, you will find they do vary in value) but I agree they can be a substitute. So can ibonds.

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flamesabers
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Re: Bonds: Why?

Post by flamesabers » Sun Nov 26, 2017 10:50 am

Simplicity is one reason that comes to mind in terms of buying, holding and reporting for tax purposes. Plus, you can hold bond funds in a 401k, while you can't for CDs.

There is also the issue of second-guessing yourself with shopping for the best interest rate and maturity date for CDs.

chevca
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Re: Bonds: Why?

Post by chevca » Sun Nov 26, 2017 11:14 am

RRAAYY3 wrote:
Sat Nov 25, 2017 9:02 pm
I understand the “basic” premise - much less volatile / won’t drop as much in a crash ...

My question is basically why would you have your “safe” portion of assets in something that can still fluctuate / drop?

I see things like 3-5 year CDs with guaranteed rates of return and I wonder why I shouldn’t just put my “safety net” in something like that when I decide to be more conservative (right now I’m strictly high yield savings + 100% equity, and will be for the foreseeable future)
It's a perfectly reasonable approach to use CDs for the safe portion.

Along the lines of others, for me it's a convenience thing. The bulk of my investments are in my deferred comp account and I have no CD options there, so total bond it is.

For most in accumulation phase, it's likely tough to get a CD to just add to.

For those in maintain phase or making a large lump sum investment, it's a good possibility.

For your situation, sure, CDs or a CD ladder sound great. Just realize you're paying your full tax rate on that compared to say a tax exempt bond fund. That would come down to safety/stability vs. tax bill priorities for you though.

darrvao777
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Re: Bonds: Why?

Post by darrvao777 » Sun Nov 26, 2017 11:28 am

For taxable accounts, I love the intermediate term muni fund, nice stream of tax-free income

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Re: Bonds: Why?

Post by RadAudit » Sun Nov 26, 2017 11:34 am

Why?

I seem to recall one investment writer (Bernstein?) recommended keeping 20 to 25 years of residual living expenses (RLE) in bonds just to be reasonably assured of a safe retirement.

Sounds like a good idea - if I can convince myself he's correct.
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nedsaid
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Re: Bonds: Why?

Post by nedsaid » Sun Nov 26, 2017 11:37 am

RRAAYY3 wrote:
Sat Nov 25, 2017 9:02 pm
I understand the “basic” premise - much less volatile / won’t drop as much in a crash ...

My question is basically why would you have your “safe” portion of assets in something that can still fluctuate / drop?

I see things like 3-5 year CDs with guaranteed rates of return and I wonder why I shouldn’t just put my “safety net” in something like that when I decide to be more conservative (right now I’m strictly high yield savings + 100% equity, and will be for the foreseeable future)
You are in good company. Larry Swedroe has said essentially the same thing. Nothing wrong with FDIC Insured Certificates of Deposit.
A fool and his money are good for business.

livesoft
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Re: Bonds: Why?

Post by livesoft » Sun Nov 26, 2017 11:45 am

RRAAYY3 wrote:
Sat Nov 25, 2017 9:02 pm
My question is basically why would you have your “safe” portion of assets in something that can still fluctuate / drop?
Because the possible drop or fluctuation is so insignificant to me that I don't worry about it. I don't need to have an asset that doesn't drop in value. Many people don't seem to get this. They fear any drop in certain assets while accepting even bigger drops in other assets. That makes no sense to me whatsoever.

The bond funds that I own have outperformed CDs for many years in a row, so I can "bank" that excess return mentally for the future when my bond assets drop in value. That is, I can temporally shift what is happening in the present to both the past and the future. People seem to do that with equity funds all the time, so why can't they do it with bond funds?
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Re: Bonds: Why?

Post by FireHorse » Sun Nov 26, 2017 11:56 am

I always believing in diversification and not to miss the market either. Do you consider % go to CD and % go to bond fund? Its a win-win and you can sleep well in the night.

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Phineas J. Whoopee
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Re: Bonds: Why?

Post by Phineas J. Whoopee » Sun Nov 26, 2017 2:26 pm

oldcomputerguy wrote:
Sat Nov 25, 2017 9:16 pm
...
The point is, there is no such thing as a perfectly-stable investment. I bonds certainly fluctuate, at least their interest rates do. And I'm not all that certain that the calculations used to vary I bond rates bears more than a passing resemblance to the real-world market inflation I see as a consumer. (I don't consider an SPIA as an investment, it's an insurance policy.)
I Bonds have a longer lag for adjustments than TIPS, which might explain part of it.

In a different thread I wrote about how CPI is calculated and what one can, and can't, reasonably expect from it. Nisiprius makes a good additional point in the post right below mine.

PJW
Last edited by Phineas J. Whoopee on Sun Nov 26, 2017 2:36 pm, edited 1 time in total.

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oldcomputerguy
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Re: Bonds: Why?

Post by oldcomputerguy » Sun Nov 26, 2017 2:32 pm

Phineas J. Whoopee wrote:
Sun Nov 26, 2017 2:26 pm


In a different thread I wrote about how CPI is calculated and what one can, and can't, reasonably expect from it. Nisiprius makes a good additional point in the post right below mine.
PJW
Thank you (and thanks to Nisiprius). That was very informative.
It’s taken me a lot of years, but I’ve come around to this: If you’re dumb, surround yourself with smart people. And if you’re smart, surround yourself with smart people who disagree with you.

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whodidntante
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Re: Bonds: Why?

Post by whodidntante » Sun Nov 26, 2017 2:42 pm

3funder wrote:
Sun Nov 26, 2017 7:26 am
Short-term corporate bonds should do fine in a rising interest rate environment. I wouldn't venture super far out in terms of duration, though, unless your time horizon exceeds it.
Expected return models favor long bonds right now.

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Phineas J. Whoopee
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Re: Bonds: Why?

Post by Phineas J. Whoopee » Sun Nov 26, 2017 3:23 pm

whodidntante wrote:
Sun Nov 26, 2017 2:42 pm
3funder wrote:
Sun Nov 26, 2017 7:26 am
Short-term corporate bonds should do fine in a rising interest rate environment. I wouldn't venture super far out in terms of duration, though, unless your time horizon exceeds it.
Expected return models favor long bonds right now.
Can you provide links to those models? I like to check things out myself (although I probably won't act on the models' output). Thanks.
PJW

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whodidntante
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Re: Bonds: Why?

Post by whodidntante » Sun Nov 26, 2017 4:04 pm

Phineas J. Whoopee wrote:
Sun Nov 26, 2017 3:23 pm
whodidntante wrote:
Sun Nov 26, 2017 2:42 pm
3funder wrote:
Sun Nov 26, 2017 7:26 am
Short-term corporate bonds should do fine in a rising interest rate environment. I wouldn't venture super far out in terms of duration, though, unless your time horizon exceeds it.
Expected return models favor long bonds right now.
Can you provide links to those models? I like to check things out myself (although I probably won't act on the models' output). Thanks.
PJW
The quantitative tactical allocation models are based on different factors that lead to higher expected returns or to achieve a goal of expected volatility within a band. Momentum and valuations, or just valuations, etc. AFAIK these models are proprietary though some are transparent enough that you can do a reasonable job of reverse engineering them.

Here's an ETF I have bookmarked though I don't own it. Because there is an ETF that you can look at to see the output of the model. You can see the output of their model says to hold long term treasuries. The model's goal is 10% target volatility and it uses momentum/trend following and possibly other factors.

https://www.globalxfunds.com/funds/effe/

There are several others.

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Phineas J. Whoopee
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Re: Bonds: Why?

Post by Phineas J. Whoopee » Sun Nov 26, 2017 5:38 pm

whodidntante wrote:
Sun Nov 26, 2017 4:04 pm
Phineas J. Whoopee wrote:
Sun Nov 26, 2017 3:23 pm
whodidntante wrote:
Sun Nov 26, 2017 2:42 pm
3funder wrote:
Sun Nov 26, 2017 7:26 am
Short-term corporate bonds should do fine in a rising interest rate environment. I wouldn't venture super far out in terms of duration, though, unless your time horizon exceeds it.
Expected return models favor long bonds right now.
Can you provide links to those models? I like to check things out myself (although I probably won't act on the models' output). Thanks.
PJW
The quantitative tactical allocation models are based on different factors that lead to higher expected returns or to achieve a goal of expected volatility within a band. Momentum and valuations, or just valuations, etc. AFAIK these models are proprietary though some are transparent enough that you can do a reasonable job of reverse engineering them.

Here's an ETF I have bookmarked though I don't own it. Because there is an ETF that you can look at to see the output of the model. You can see the output of their model says to hold long term treasuries. The model's goal is 10% target volatility and it uses momentum/trend following and possibly other factors.

https://www.globalxfunds.com/funds/effe/

There are several others.
I see. Its fact sheet says it holds 40% stock and 10% gold, and only 50% in fixed income: 20% emerging-market bonds; 10% investment-grade corporates; and only 20% in long Treasuries.

Thank you for the link. Without access to the models you cite I'm unconvinced, not in the sense I'm saying you're wrong, but in the sense I'm saying it'll take more than a single unexplained sentence for me to commit to a bond strategy. Others may be less cautious.

Thanks again.

PJW

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eye.surgeon
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Re: Bonds: Why?

Post by eye.surgeon » Sun Nov 26, 2017 5:44 pm

RRAAYY3 wrote:
Sat Nov 25, 2017 9:02 pm
I understand the “basic” premise - much less volatile / won’t drop as much in a crash ...

My question is basically why would you have your “safe” portion of assets in something that can still fluctuate / drop?

I see things like 3-5 year CDs with guaranteed rates of return and I wonder why I shouldn’t just put my “safety net” in something like that when I decide to be more conservative (right now I’m strictly high yield savings + 100% equity, and will be for the foreseeable future)
This is all you need to know about why bonds...

https://www.youtube.com/playlist?list=P ... h2EGOnOu6H

And FYI a CD is a type of bond.
"I would rather be certain of a good return than hopeful of a great one" | Warren Buffett

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