bond durations and tips allocations

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kikie
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bond durations and tips allocations

Post by kikie »

sometimes, i think i know what i'm doing , other times i don't so my portfolio is 30% equity i'm mid 40s , not needing a lot of risk premium.

with that low equity ratio, i'm still have bond duration of 3.75 yr (of the 60% bonds portfolio 40% is in savings bonds) (10% of all bonds including savings bonds are inflation protected, mostly as I -bonds)

so, roughly 60% (duration 3.75%) of the bonds can be tweaked for duration and are all in IRA/401k


1)
what bothers me, is other than being < 5 years in duration, I don't feel like I have any coherent bond strategy
a)
do I attempt to keep durations in general to 5 years and forget about TIPS till a more normal cycle returns etc

2)
much less TIPS vs. nominals

i note larrys http://thefinancebuff.com/tips-action-plan.html however , how does one implement this?

say my target is < 5 years do I use real spreads of "<5 years" or "5 years"


or do I attempt to keep durations in general to 5 years and forget about
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Re: bond durations and tips allocations

Post by gkaplan »

I can't give you any advice, but I love your avatar.
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Re: bond durations and tips allocations

Post by #Cruncher »

paix wrote:... my portfolio is 30% equity ... of the 60% bonds portfolio 40% is in savings bonds) (10% of all bonds including savings bonds are inflation protected, mostly as I -bonds)
paix, I can't understand just what your asset allocation is. Could you lay it out something like the following, based on current market value?

x% equity
x% EE savings bonds
x% I savings bonds
x% TIPS maturing in less than 10 years
x% TIPS maturing in more than 10 years
x% in CDs
x% in ABC bond fund
x% in XYZ bond fund
x% in other - explain what
---
100% total

This would help us provide advice. One thing I can recommend right away is that you try to find more recent advice from tfb and Larry Swedroe. The page you reference on tfb's web site is from 2007 and it refers to Larry's book from 2006.
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Re: bond durations and tips allocations

Post by tfb »

#Cruncher wrote:One thing I can recommend right away is that you try to find more recent advice from tfb and Larry Swedroe. The page you reference on tfb's web site is from 2007 and it refers to Larry's book from 2006.
I agree. Copying and pasting from my post in another thread http://www.bogleheads.org/forum/viewtop ... 6#p1390366:
Larry has since come up with a new strategy based on inflation protection premium rather than hard coded real yields. See recent updates published by Larry. I also changed my modification accordingly. The old strategy was flawed because it implicitly assumed short-term nominals would provide a decent real yield. It turned out when TIPS have a low real yield, the real yield on short term nominals is even lower. Although it isn't as clear cut to estimate the inflation protection premium, I think that's a better metric for deciding between nominals and TIPS.
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kikie
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Re: bond durations and tips allocations

Post by kikie »

..........I'm looking to improve from a bond strategy or "keep it below 5 year duration" ; and recheck that , that makes sense for my equity allocation, and hoping, if I can't understand the bond wiki, that someone'd be willing to ......
Last edited by kikie on Wed Jun 06, 2012 2:59 am, edited 1 time in total.
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Re: bond durations and tips allocations

Post by #Cruncher »

paix wrote:do I attempt to keep durations in general to 5 years and forget about TIPS till a more normal cycle returns[?]
It's not either-or. You don't have to avoid TIPS in order to keep duration low. I happen to know from a previous post that your TIPS is one maturing in April 2029. It's duration is about 14 years. If this long duration bothers you, you can sell it still have the same inflation protection by putting the proceeds into 1) I bonds, 2) shorter term TIPS, or 3) a short term TIPS fund like STIP or STPZ.

I suggest # 1 until you bump into the annual I bond purchase maximum. But after reaching the maximum, I don't believe you need to do # 2 or # 3. You already have about twice as much in I bonds as in your long term TIPS. Since I bonds can be considered to have a zero duration, this means the average of the two is about 5 years already.

It also strikes me that your asset allocation is very conservative for someone in his mid 40's. Are you no longer working and accumulating? If you are working I'd consider increasing the 30% equity allocation. And regardless I'd consider moving the 20% of your portfolio in the short-term VBIRX which is yielding only 0.7% into an intermediate term fund.
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Re: bond durations and tips allocations

Post by kikie »

thanks much for responding:
1) so I include TIPS in my overall duration goal of "< 5 years"? ;

a) I'm not even sure that this strategy ( to keep durations < 5 years, when there is a/any equity position) is a "strategy" (or at least it's a very simple one).

2)I wasn't suggesting selling the TIPS because of duration.
a) however, one of the long term TIPS IS , in my taxable accounts, so HAVE thought of selling it for that reason, and hence all my previous posting, about what YTM means, and struggle to understand, if holding to maturity makes any difference, in this case.

3)besides the above: my main question is how to figure out what percentage to hold of TIPS vs. nominals ?
a) or to have a strategy I can understand

4)I had decided to not include the savings bond when aiming for a bond duration, and forget the pros and cons of that, I guess I'd been told they almost function as cash in their liquidity, any comments on that ?
a) excluding the small portion of TIPS, and the savings bonds, my duration seems to be 3.75 years at present, I could increase it to 5 years selling some of the short term VBIRX ........ ?
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Re: bond durations and tips allocations

Post by #Cruncher »

paix wrote:
  1. so I include TIPS in my overall duration goal of "< 5 years"? I'm not even sure that this strategy ( to keep durations < 5 years, when there is a/any equity position) is a "strategy".
  2. I wasn't suggesting selling the TIPS because of duration. however, one of the long term TIPS IS, in my taxable accounts, so HAVE thought of selling it for that reason
  3. besides the above: my main question is how to figure out what percentage to hold of TIPS vs. nominals ?
    or to have a strategy I can understand
  4. I had decided to not include the savings bond when aiming for a bond duration, and forget the pros and cons of that, I guess I'd been told they almost function as cash in their liquidity, any comments on that?
  1. Yes, I'd include TIPS (and I Bonds) in determining my overall fixed income duration. And yes, it is a strategy. The higher the % that bonds are of one's portfolio, the more important duration is.
  2. There might be a tax advantage to selling these highly appreciated TIPS. You'd be converting future ordinary income into a long-term capital gain. You'd need to consider state taxes, however. For example in my state of New York, the interest income is exempt, but the capital gain would be taxed as ordinary income.
  3. First off I'd mentally combine I-bonds and TIPS into one category of "inflation-protected fixed income" and decide what percentage that should be of your total fixed income. Having so much short duration nominal bonds reduces the need for inflation protected ones. You'll get all kinds of suggestions on this forum from 0% to 100% with most being 50%. Your current 40% proportion (17% I bonds and 7% TIPS out of 59% fixed income) is fine.
  4. One nice thing about savings bonds (EE or I) is that they can be considered part of either an emergency fund or of a long term portfolio. However, in my opinion, when one obviously has enough liquid assets to fund an emergency (as you do), it's a needless complication to separate some of them out as an emergency fund.
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kikie
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Re: bond durations and tips allocations

Post by kikie »

1) funny thing, though the savings bonds are 40% or bond portfolio, when I add them to the previous durations, I'd think it would reduce my overall duration, but instead, it seems a Zero duration doesn't influence the calculation as its just addition of Zero eg Bond A allocated % x duration + Bond fund B x duration + Savings bonds allocation x duration = overall duration.
a) is that right ?

2)On my state taxes, I deduct the OID(original issue discount), which I believe is the adjustment, upwards on the value of the TIPS bond, year over year, so guess, I thought that I was paying taxes on the gain yearly, and hence there'd be no big LT gain to pay tax on?

3) good insight on how ST bond fund, is similar to a TIPS fund. thanks
a) however, my original question really was how to decide what percentage to hold in TIPS based on larry's formula before.

4) does it make sense if I need the money in 6 years, I should then hold bond funds with durations of no more than 6 years.......
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Re: bond durations and tips allocations

Post by dbr »

paix wrote:1) funny thing, though the savings bonds are 40% or bond portfolio, when I add them to the previous durations, I'd think it would reduce my overall duration, but instead, it seems a Zero duration doesn't influence the calculation as its just addition of Zero eg Bond A allocated % x duration + Bond fund B x duration + Savings bonds allocation x duration = overall duration.
a) is that right ?
No. previously you had for example 50% x 5 + 50% x 10 = 7.5, say for two bonds split evenly, one at five and one at ten.

Now you have 30% x 5 + 30% x 10 +40% x 0 = 4.5.
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Re: bond durations and tips allocations

Post by kikie »

hmm it comes
Last edited by kikie on Wed Jun 06, 2012 2:59 am, edited 3 times in total.
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Re: bond durations and tips allocations

Post by #Cruncher »

paix wrote:2)On my state taxes, I deduct the OID(original issue discount), which I believe is the adjustment, upwards on the value of the TIPS bond, year over year, so guess, I thought that I was paying taxes on the gain yearly, and hence there'd be no big LT gain to pay tax on?
I'm not sure what you mean here. But what you should have been doing over the years is to pay federal tax on the interest and the OID and no state tax on either.

This may have been answered in a previous thread of yours, but I'll try again here. Say you bought $1,000 face value of the April 2029's at par value when they were first issued. The accumulated OID to date is about $390 so their adjusted principal is now $1,390. If you sold the bonds at the current market price of about 163%, you'd receive about $2,265 ($1,390 X 163%). Your long term capital gain would be $875 ($2,265 - $1,390.)

Subtract the federal and state tax on this long-term capital gain. If you held the bond until maturity, you'd receive $915 interest in 2012 dollars ($1,390 X 3.875% X 17 years). Subtract the federal-only tax on that. You then have two after-tax figures to compare and help you decide if you should sell the TIPS.

Source: WSJ TIPS Quotes 5/18/2012
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kikie
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Re: bond durations and tips allocations

Post by kikie »

I did the crunching and NOT selling it , I'm about $3k ahead, assuming at 15% bracket(which in 15 years would seem likely); a 25% fed bracket, then its a wash.

I do appreciate this conversation in that, I have been not looking at the bonds, sellable value in my portfolio and instead using its accumulated inflation value, which is a huge (pleasant surprise) difference, thanks, as that will have some influence on trying to get ? nearer 5 yr's on a duration , once I can figure out why the addition of the 0 duration savings bonds didn't change the entire duration :)
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