Retirement portfolio overweighted on High-Yield Bonds

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Topic Author
305pelusa
Posts: 59
Joined: Fri Nov 16, 2018 10:20 pm

Retirement portfolio overweighted on High-Yield Bonds

Post by 305pelusa » Mon Feb 11, 2019 7:40 am

A Portfolio question; looking for any suggestions.

Emergency funds: 1 year of expenses
Debt: No debt
Tax Filing Status: Single
Tax Rate: 24% Federal, 0% State
State of Residence: Florida
Age: 62
Desired Asset allocation: 50% stocks / 50% bonds (one of the questions below)
Desired International allocation: 30% of stocks

Current expenses are ~120k a year.
Total portfolio size of 3M.

It is all in taxable accounts:
- 2M currently invested in a brokerage account with an adviser who purchases high yield individual bonds (the account has more than 100 different high yield bonds).
- 0.5M currently invested in stocks (70/30 Total Stock Market/Total International Market) at Vanguard.
- 0.5M in Real Estate holdings (rents).
- 400k in cash

Questions:
1. This person has recently realized how risky the portfolio is due to the large holding from the brokerage account with high yield bonds. This person wants to transition to a more traditional AA (perhaps 50/50?) of investment grade/government bonds and stocks. Hopefully this would provide much more downside risk protection while still being very decent at covering expenses with returns.

However, this person would prefer not to sell all of those high yield bonds and just completely switch to 50/50. It would be preferable that as bonds mature, the money is then reinvested in the more traditional 3-Fund Portfolio.

How would a person go about doing this? And what AA should that Vanguard account have for now?

I am thinking that high yield bonds are roughly somewhere in between bonds and stocks so the Vanguard account could be a 50/50 3 Fund Portfolio and that as bonds mature from the other account, the money is invested that way at Vanguard. However, my only concern is that this is too conservative since that would be ~2.25M in bonds and 0.25M in stocks total (granted,2M of the bonds are high yield).

This person spends around 4% of their portfolio a year. Hence, she does not want it to be overly conservative either.

Any thoughts?

gd
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Re: Retirement portfolio overweighted on High-Yield Bonds

Post by gd » Mon Feb 11, 2019 9:02 am

I have access to records of a situation that has some relevance. Records start 25 years ago, with low 6-figure full service brokerage account invested for long-range income. All and only income withdrawn monthly. ~13 years ago, was at mid 6 figures, and was approximately doubled with a large deposit. From then to now, very approx. 3-4% withdrawn as needed. Classic full service brokerage account tilted for income, moreso over time as yields dropped. Nothing unscrupulous, just what they always do that has been described and discussed countless times here.
The clear withdrawal record and lack of deposits let me compare it year-by-year with index fund performance (using Portfolio Visualizer) at the same yearly withdrawal rates. This was unusual to me, because it isn't just a single active mutual fund, it tests a series of stock brokers in a single brokerage house, in a complete account over 25 years, with lots of different market conditions.

Result: about the same. 70/30 (S/B) ended up higher, but had significant deviations from the broker's as market swung up & down. 60/40 ended slightly higher, less extreme deviations than 70/30 but still more than the broker. 50/50 was roughly about the same as broker. Details varied over time, the fact that they ended up higher or same I attribute to the recent market at the random observation point of today. In general, anything more than 50/50 was better over long up markets but more variable shorter term. It is entirely plausible to me that a sustained market downturn would leave the broker momentarily better than any of the 3 index solutions-- measured over 25 years.

The person responsible for the account had a strong preference for full service brokers, valuing the personal interaction, phone service and believing they provide better products not available with Vanguard-style companies. It was a perfectly reasonable choice that my study cannot invalidate. My opinion is that I don't like dealing with brokers or the decisions involved, so my management of the same account would be using index funds and a healthy 1-2 years of cash for market drops. For all practical purposes, within the variabilities of life, it's apparently a wash (sorry for the bad news, BHs).

I understand your situation is somewhat different, in that most is in a single market sector that might be due for interesting times. The advantage I saw in my case's brokerage was stability with the large assortment of diverse and often esoteric products. Your guy seems more questionable. The question is how risky this is. I'd go to Portfolio Visualizer and play around with your target funds vs. high-yield over long times and interesting periods.

BTW, one issue in my case was the held belief it is necessary to get yields, meaning dividends & interest, rather than selling appreciated capital. Your case is maybe this also. This was and is one of the points my subject and I do not connect on.

Topic Author
305pelusa
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Joined: Fri Nov 16, 2018 10:20 pm

Re: Retirement portfolio overweighted on High-Yield Bonds

Post by 305pelusa » Mon Feb 11, 2019 11:06 am

That is definitely very useful information. What I'm taking from it is that a 50/50 investment-grade/stock position gives roughly similar returns to 100% high yields. Because the former is much more diversified, I imagine it does it at less risk (due to eliminating the non systematic risk). The investor would be content with that.

It sounds like a 50/50 bond/stock split is roughly consistent with the high yield bond investments so that as the latter ones mature, they could be invested in the former in that same initial, desired proportion.

I appreciate the experience you have shared. Let me know if I did not take away the correct thing from it

retiredjg
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Re: Retirement portfolio overweighted on High-Yield Bonds

Post by retiredjg » Mon Feb 11, 2019 11:07 am

I would fix this all at one time. However, I don't know the consequences of liquidating an individual high yield bond early so that may be a pie in the sky thought.

The first step is getting rid of the advisor. Is your friend willing to do that? If so, what then?

Your heart is in the right place, but this is rarely the kind of thing a friend can help fix. However, you can help your friend gather information about what to do.

I'd suggest that your friend move her accounts to Vanguard's Personal Advisor Service (PAS) which charges .3% annually. Why? There is nothing in your email that indicates your friend is willing or able to manage her own portfolio. She likely needs professional management, at least for awhile.

Vanguard's PAS will not steer her in the wrong direction. They will get the portfolio fixed. After using them awhile, if she wants to manage it herself, she could simply stop using the service and maintain what they are doing. Or stay in a low cost managed service.

Your friend thinks she is spending 4%, but whatever the advisor fee (probably 1% or more?) gets added on top of that. And the 4% may not include taxes....which, by the way, are higher because she is paying her marginal rate on those bond dividends instead of a capital gains rate on stocks. There is a good possibility she is actually taking significantly more each year than 4%.

Yes, the majority of her portfolio is in an asset class most of use do not use at all or use in a very limited way (small percentage). It is a poor idea by Boglehead standards. It is good she is looking at other opportunities. I think Vanguard's PAS is the best choice for people in this situation and hope she considers it.

Topic Author
305pelusa
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Re: Retirement portfolio overweighted on High-Yield Bonds

Post by 305pelusa » Mon Feb 11, 2019 11:58 am

retiredjg wrote:
Mon Feb 11, 2019 11:07 am
I would fix this all at one time. However, I don't know the consequences of liquidating an individual high yield bond early so that may be a pie in the sky thought.

The first step is getting rid of the advisor. Is your friend willing to do that? If so, what then?

Your heart is in the right place, but this is rarely the kind of thing a friend can help fix. However, you can help your friend gather information about what to do.

I'd suggest that your friend move her accounts to Vanguard's Personal Advisor Service (PAS) which charges .3% annually. Why? There is nothing in your email that indicates your friend is willing or able to manage her own portfolio. She likely needs professional management, at least for awhile.

Vanguard's PAS will not steer her in the wrong direction. They will get the portfolio fixed. After using them awhile, if she wants to manage it herself, she could simply stop using the service and maintain what they are doing. Or stay in a low cost managed service.

Your friend thinks she is spending 4%, but whatever the advisor fee (probably 1% or more?) gets added on top of that. And the 4% may not include taxes....which, by the way, are higher because she is paying her marginal rate on those bond dividends instead of a capital gains rate on stocks. There is a good possibility she is actually taking significantly more each year than 4%.

Yes, the majority of her portfolio is in an asset class most of use do not use at all or use in a very limited way (small percentage). It is a poor idea by Boglehead standards. It is good she is looking at other opportunities. I think Vanguard's PAS is the best choice for people in this situation and hope she considers it.
Hello,
Thank you very much for your response. I can give a bit more context.

The advisor fee is 1% of every bond purchase. He does not charge anything yearly for the account. Only with purchases. Not sure if this is standard, but it is what it is.

At this point, my friend has told the advisor to not purchase any more bonds. So at this point, the advisor is not earning anything. So there is no rush in liquidating and moving to Vanguard just for the sake of saving on yearly fees.

The investor is certainly a buy-and-hold type of investor (I am too) so I don't dislike the idea of just holding the bonds to maturity. I think it would be a very large change, especially psychologically, to move 66% of your portfolio from X to Y all at once. I'm afraid it might be unnecessarily drastic. Don't you think?

It is clear to her the tax consequences and lack of diversification so she knows it's in her best interest. Once she was shown the expenses of Vanguard, she could not believe it either haha.

I will keep the PAS in mind. I think there's the possibility to have a very simple but extremely effective 3 Fund + MM account that would require minimal work. But that might take some time so for now, the PAS might be a better call. Unfortunately, 0.3 yearly feels kinda steep. That would quickly accrue more fees than she would with her current advisor.

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David Jay
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Re: Retirement portfolio overweighted on High-Yield Bonds

Post by David Jay » Mon Feb 11, 2019 12:54 pm

305pelusa wrote:
Mon Feb 11, 2019 11:58 am
The advisor fee is 1% of every bond purchase. He does not charge anything yearly for the account. Only with purchases. Not sure if this is standard, but it is what it is.
I honestly do not believe this. I have never heard of such a fee structure.

I would want to know the ERs on the stock, bond and REIT funds, I suspect this there are some front loaded funds or at least some 12b-1 payments. I have heard advisors say things like “you don’t pay me, the fund companies pay me” but this comes out of front loads and high ERs. Which, of course, comes out of the client’s portfolio.

Are the REIT funds publicly traded? If not, your friend needs to look at getting out of those assets as well.

[edit] For clarity, publicly traded REITs are acceptable investment vehicles. Non-publicly-traded REITs are sold with a big commission and are not liquid.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Wiggums
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Re: Retirement portfolio overweighted on High-Yield Bonds

Post by Wiggums » Mon Feb 11, 2019 1:15 pm

Perhaps the 1 percent fee is a front end load.

Topic Author
305pelusa
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Re: Retirement portfolio overweighted on High-Yield Bonds

Post by 305pelusa » Mon Feb 11, 2019 1:34 pm

David Jay wrote:
Mon Feb 11, 2019 12:54 pm
305pelusa wrote:
Mon Feb 11, 2019 11:58 am
The advisor fee is 1% of every bond purchase. He does not charge anything yearly for the account. Only with purchases. Not sure if this is standard, but it is what it is.
I honestly do not believe this. I have never heard of such a fee structure.

I would want to know the ERs on the stock, bond and REIT funds, I suspect this there are some front loaded funds or at least some 12b-1 payments. I have heard advisors say things like “you don’t pay me, the fund companies pay me” but this comes out of front loads and high ERs. Which, of course, comes out of the client’s portfolio.

Are the REIT funds publicly traded? If not, your friend needs to look at getting out of those assets as well.

[edit] For clarity, publicly traded REITs are acceptable investment vehicles. Non-publicly-traded REITs are sold with a big commission and are not liquid.
I'm very confused. What mutual funds? What expense ratios?

The account is made up of 100+ individual high yield bonds. As in good old fashioned "buy X company's bond" and then you get the coupons and it eventually matures.

retiredjg
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Re: Retirement portfolio overweighted on High-Yield Bonds

Post by retiredjg » Mon Feb 11, 2019 2:04 pm

No, I don't think it is unnecessarily drastic. However, it may be too drastic for her. But whatever she does, she needs to reduce the percentage of high yield bonds in the portfolio significantly in the short run even if she does not fix it all at once.

How much of that account is in bonds that will mature this year?

I will keep the PAS in mind. I think there's the possibility to have a very simple but extremely effective 3 Fund + MM account that would require minimal work.
This is true, but you have not shown any indication that she can do this or is willing to do this.

Unfortunately, 0.3 yearly feels kinda steep.
It is not steep at all for a person who needs help with management or setting up a proper portfolio. In fact, it is very cheap and way below the industry standard. Very few places offer lower fees and "lower" often means a few bonus points and only robo service.

Topic Author
305pelusa
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Joined: Fri Nov 16, 2018 10:20 pm

Re: Retirement portfolio overweighted on High-Yield Bonds

Post by 305pelusa » Mon Feb 11, 2019 3:03 pm

retiredjg wrote:
Mon Feb 11, 2019 2:04 pm
No, I don't think it is unnecessarily drastic. However, it may be too drastic for her. But whatever she does, she needs to reduce the percentage of high yield bonds in the portfolio significantly in the short run even if she does not fix it all at once.

How much of that account is in bonds that will mature this year?

I will keep the PAS in mind. I think there's the possibility to have a very simple but extremely effective 3 Fund + MM account that would require minimal work.
This is true, but you have not shown any indication that she can do this or is willing to do this.

Unfortunately, 0.3 yearly feels kinda steep.
It is not steep at all for a person who needs help with management or setting up a proper portfolio. In fact, it is very cheap and way below the industry standard. Very few places offer lower fees and "lower" often means a few bonus points and only robo service.
Presumably about 10% of them will mature this year. He mostly purchases 10 year bonds I believe and staggers them. Might be more or less, I'm not sure.

She's done terrific over the years. Most of the bonds return 6-8% every year. As long as they don't default, she always obtains the capital at maturity so it doesn't matter if the bonds drop in value (credit risk). I believe only 1 has defaulted in 10 years. That's well under the average and she knows she's been lucky. That's why she's willing to transition.

I'm trying to understand her perspective. Moving everything to a bond fund returning 3% and stock funds that have absolutely no guarantee of any returns yearly, is a huge psychological step. Heck, it would be for me too. So I'm not entirely sure that's the best way to go. I like the idea that she lets them mature, gets the principal back, and reinvests it more effectively. Feels like better baby steps.

I am personally helping her a bit with her Vanguard account at the moment. Whether she can handle the portfolio herself or needs Vanguard, that's a different story (although a great point so thank you for mentioning it). For now, the priority is just to make some intelligent investments at Vanguard that an advisor or herself could take over in the future.

I have gotten great answers here thank you everyone

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David Jay
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Re: Retirement portfolio overweighted on High-Yield Bonds

Post by David Jay » Mon Feb 11, 2019 3:03 pm

305pelusa wrote:
Mon Feb 11, 2019 1:34 pm
David Jay wrote:
Mon Feb 11, 2019 12:54 pm
305pelusa wrote:
Mon Feb 11, 2019 11:58 am
The advisor fee is 1% of every bond purchase. He does not charge anything yearly for the account. Only with purchases. Not sure if this is standard, but it is what it is.
I honestly do not believe this. I have never heard of such a fee structure.

I would want to know the ERs on the stock, bond and REIT funds, I suspect this there are some front loaded funds or at least some 12b-1 payments. I have heard advisors say things like “you don’t pay me, the fund companies pay me” but this comes out of front loads and high ERs. Which, of course, comes out of the client’s portfolio.

Are the REIT funds publicly traded? If not, your friend needs to look at getting out of those assets as well.

[edit] For clarity, publicly traded REITs are acceptable investment vehicles. Non-publicly-traded REITs are sold with a big commission and are not liquid.
I'm very confused. What mutual funds? What expense ratios?

The account is made up of 100+ individual high yield bonds. As in good old fashioned "buy X company's bond" and then you get the coupons and it eventually matures.
Sorry, my failure to accurately read your head post.

I thought it was a single account, with 2M in bonds, .5M in funds, .5M in REIT, .4M in cash.

On re-read, I see it is separate accounts and it is “rents”. Ignore my comments about 12b-1 and REIT.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

retiredjg
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Re: Retirement portfolio overweighted on High-Yield Bonds

Post by retiredjg » Mon Feb 11, 2019 3:16 pm

Your friend is accustomed to "living off the dividends" and transitioning from that to "living off total returns" will not be easy. But it is considered a better way. Here is a white paper that Vanguard published in the past.

Note that one of the reasons that "living off the dividends" is a poor idea is that it requires a lopsided and riskier portfolio....such as the one under discussion.

https://personal.vanguard.com/pdf/s557.pdf

Dividends are an illusion and they cost more in taxes too. :happy

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