Another approach to bonds

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reisner
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Another approach to bonds

Post by reisner » Mon Aug 20, 2018 5:14 pm

I've tried rebalancing, but I live in a high-tax state and selling the total stock fund to buy IT bonds gets expensive. (I sold all my S&P fund in 2009, tax-loss harvested, and bought right back into the Total Stock Market fund, so my capital gains in stock have been appreciable.) I've tried to maintain a 55-45 balance but gave up and now am at less than 40% bonds. Since I seldom need to withdraw any principle (retired, good pension and SS), but of course am wary of losing money in another downturn, it occurred to me to just ride out whatever happens, and if I need to take out more than interest and dividends, well then I'll just regard my bond portion as an emergency fund and hold onto my stock shares until they go back up in price. Or else sell them and move sideways again, back into the S&P 500 fund. Is this a reasonable plan?
Last edited by reisner on Tue Aug 21, 2018 9:38 am, edited 1 time in total.

chevca
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Re: Another approach to bonds

Post by chevca » Mon Aug 20, 2018 5:43 pm

If you're retired and your pension and social security cover most or all of your expenses, sure that's plenty reasonable. It probably won't matter much to you what your portfolio does if you don't need to draw down on it much.

On the other hand, no, not real reasonable. You don't want to lose money in another downturn, but don't want to pay taxes to rebalance and lower the risk of how much you would lose in another downturn. Either way costs you some money. Rebalancing is probably the lower cost option.

Are all your investments in taxable accounts? No options to rebalance in a tax advantaged account?

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dratkinson
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Re: Another approach to bonds

Post by dratkinson » Mon Aug 20, 2018 7:26 pm

There are those who believe we should stop playing after we've won the game---take money off the table.

On the other hand, Warren Buffett's plan for his wife is to be 90/10 S&P500/treasuries.

Your choice. But most choose to do what lets them sleep better.



I believe your approach is reasonable.
--You don't need the money tied up in stocks---your bonds/pension/SS take care of your needs.
--Any stock loss will be a temporary paper loss---recovering when the market recovers (2-4 years).
--Your stock dividends are mostly QDI (lower tax rate). (Bonds more highly taxed, unless appropriate munis.)
--More stocks should translate into more LT investment growth.
--More stocks are appropriate for younger heirs---stepped up basis, so don't care about yours.


I suppose you could convert to more bonds (higher tax rate applies, unless you can use munis).
--Harvest LTCG (lower tax rate applies) so you don't advance tax brackets.
--Wait for a crash and TLH LTCL (lower tax rate applies) and hope it nets against your ordinary income.
--Slowly redirect stock distributions (plus excess pension/SS) into more bonds.


So after all the planning, work, tax reporting, and getting more bonds... would your financial life be significantly better?

If doing more work would not make your financial life significantly better, then pick up the low-hanging fruit (do the easy things---redirect distributions and excess pension/SS into more bonds), but skip the extra work that does little for you.



Disclosure. I'm in a similar situation. My decision?
--Generally try to follow my IPS and maintain my AA. My AA was selected for a reason.
--But I will buy whatever is low in the current market, for as long as the market lasts.
--This means my AA may be temporarily skewed away from its baseline value.
--My heirs will thank me.



It's good to finally have a first-world problem. :)
d.r.a, not dr.a. | I'm a novice investor, you are forewarned.

reisner
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Re: Another approach to bonds

Post by reisner » Mon Aug 20, 2018 8:25 pm

Thanks, Chevca and Dratkinson. Yes, why not do what's easiest? The stock fund is all in taxable anyway. Although we have no children, my wife is fifteen years younger than me, 72. And somehow living in states without income tax, Washington and New Hampshire, has made me reluctant to add a 9% california tax to any Federal tax we would owe.

aristotelian
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Re: Another approach to bonds

Post by aristotelian » Mon Aug 20, 2018 8:41 pm

One way to think of your bond allocation is covering a certain number of years expenses that allows you to sleep in night. That might be 10, maybe more. If stocks go up, you do not need to rebalance because you still have your 10 years expenses in bonds.

reisner
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Re: Another approach to bonds

Post by reisner » Mon Aug 20, 2018 9:14 pm

I was thinking along those lines of years of expenses vs. bonds. Even discounting dividends, our bond allocation covers 15 to 20 years of expenses at our current rate. And in eight and a half years my wife's additional share of my SS will more than cover that. Yes, why am I bothering to ask this question? because that is in our nature as hunter gatherers, even if it is wonderful to have a first world problem.

It may be that much of this tweaking and posting orf mine and others' has to do with our (Mine for sure. Yours?) situation being somewhere between having plenty and having even more to afford things that more than mere plenty would allow. I don't know what I would do with more money unless the sum reached an amount where I would be comfortable doing the following:
Buying a small second home on Cape Cod or near Yellowstone, and a part-time overseer.
Parking an SUV there permanently.
Hiring a private plane to fly us and the dogs there several times a year.

As I said, a first world problem, and then some.

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Re: Another approach to bonds

Post by AlohaJoe » Mon Aug 20, 2018 9:49 pm

reisner wrote:
Mon Aug 20, 2018 5:14 pm
it occurred to me to just ride out whatever happens, and if I need to take out more than interest and dividends, well then I'll just regard my bond portion as an emergency fund
I have a hunch (but no actual data really) that this is how most people with taxable accounts actually do things in practice. Given the amazing effort that people go through to avoid paying taxes -- even at times irrationally so -- it is hard to imagine there are a lot of people out there generating possibly sizeable capital gains through rebalancing just because their stocks are at 66% instead of 60%.

My back of the envelope calculation shows that if you started with a $1,000,000 taxable portfolio in 2008 at 55/45 then today you'd have $2,700,000 and it would be around 77/23. You'd have to sell off $650,000 to rebalance back. That would have a basis of around $160,000. So $480,000 of gains. Taxed at 23.8% that's $110,000 of capital gains tax.

Seems like a big enough number that, in practice, a lot of people would start thinking, "I've already got $570,000 in bonds...am I really that much safer having $1.2 million in bonds? Safer enough to be worth paying over $100,000 in taxes?"

reisner
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Re: Another approach to bonds

Post by reisner » Mon Aug 20, 2018 10:26 pm

And if you live in, say, California, add another 9% or so in tax to that bill. Capital gains being taxed as ordinary income.

jalbert
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Re: Another approach to bonds

Post by jalbert » Mon Aug 20, 2018 10:30 pm

What are your bond holdings?

Presumably you are not reinvesting dividends in stock but are in bonds?
Risk is not a guarantor of return.

reisner
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Re: Another approach to bonds

Post by reisner » Mon Aug 20, 2018 10:34 pm

IT Bond Index and IT Investment Grade, which I am slowly moving to IT Index because of the uncertainty about current corporate debt and also to do a little tax loss harvesting.

chevca
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Re: Another approach to bonds

Post by chevca » Mon Aug 20, 2018 11:16 pm

AlohaJoe wrote:
Mon Aug 20, 2018 9:49 pm
My back of the envelope calculation shows that if you started with a $1,000,000 taxable portfolio in 2008 at 55/45 then today you'd have $2,700,000 and it would be around 77/23. You'd have to sell off $650,000 to rebalance back. That would have a basis of around $160,000. So $480,000 of gains. Taxed at 23.8% that's $110,000 of capital gains tax.

Seems like a big enough number that, in practice, a lot of people would start thinking, "I've already got $570,000 in bonds...am I really that much safer having $1.2 million in bonds? Safer enough to be worth paying over $100,000 in taxes?"
So, this person was on a once a decade rebalance schedule? :happy

That's obviously a decade we all know was a great bull run for much of it. But, it is an example of how rebalancing can hurt gains. What does that person have now it they rebalance each year and keep the AA at 55/45?

AlohaJoe
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Re: Another approach to bonds

Post by AlohaJoe » Mon Aug 20, 2018 11:42 pm

chevca wrote:
Mon Aug 20, 2018 11:16 pm
AlohaJoe wrote:
Mon Aug 20, 2018 9:49 pm
My back of the envelope calculation shows that if you started with a $1,000,000 taxable portfolio in 2008 at 55/45 then today you'd have $2,700,000 and it would be around 77/23. You'd have to sell off $650,000 to rebalance back. That would have a basis of around $160,000. So $480,000 of gains. Taxed at 23.8% that's $110,000 of capital gains tax.

Seems like a big enough number that, in practice, a lot of people would start thinking, "I've already got $570,000 in bonds...am I really that much safer having $1.2 million in bonds? Safer enough to be worth paying over $100,000 in taxes?"
So, this person was on a once a decade rebalance schedule? :happy
Even if they rebalance every year, they are adding several thousand dollars a year in taxes. The taxes are smaller but the perceived gain in safety is also smaller.

For instance, from 2008-2009 a 55/45 portfolio would have drifted to 62/37. You'd need to sell $95,000 of equities to get back to your asset allocation. You would have had a basis of $65,000 on those equities. So $30,000 in capital gains. I don't think it is too hard to imagine people going, "wow...realise $30,000 in capital gains just to rebalance when I already have over $500,000 in bonds which seems like it ought to be 'enough' to last me through many years of a crisis?" The tax you pay on that $30,000 will depend entirely on your personal circumstances but if you have other income and live in California that could quite easily be another $8,000-9,000 in taxes paid out.

And then every year the problem becomes a little bit worse (since the total portfolio is bigger). If you rebalanced in 2009 back to 55/45 then in 2010 your portfolio is back to 62/37 and you need to sell $126,000 of equities to rebalance; this time your tax bill is probably over $10,000.

I'm not trying to argue that this is right or wrong or anything; just that in my experience people care a lot about taxes and when needing to sell six-figures of equities every year when markets do well (which is what they do most of the time) and staring at an extra $9-12,000 in taxes they might wonder about the real world benefit of constant rebalancing to a fixed asset allocation.

Especially when they realise that 99% of books, papers, studies, articles, etc ignore the effects of taxes on things like rebalancing; leaving one to wonder whether the benefits outweigh the pains in a taxable account.

gostars
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Re: Another approach to bonds

Post by gostars » Tue Aug 21, 2018 12:05 am

If one has no need to draw on taxable accounts due to SS and a good pension, then perhaps the best method of rebalancing is to donate some of those low-basis (high-gain) shares to the charity of one's choice. AlohaJoe suggests an amount in excess of $600,000. Half a million bucks should be enough to start a donor-advised fund that distributes $10,000 a year in perpetuity to a favorite library, museum, performing arts center, or other charitable cause.

jalbert
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Re: Another approach to bonds

Post by jalbert » Tue Aug 21, 2018 12:09 am

reisner wrote:
Mon Aug 20, 2018 10:34 pm
IT Bond Index and IT Investment Grade, which I am slowly moving to IT Index because of the uncertainty about current corporate debt and also to do a little tax loss harvesting.
You might consider moving the bond holdings to nominal treasuries possibly with some TIPS.. The bonds you hold have some positive correlation to stocks, that is equity-like risk, and often do not diversify equity risk as well as treasuries can. Thus re-allocating your bond holdings to, say VSIGX, IT treasuries, as another way to reduce exposure to equity risk. You are already considering moving some corporate bonds to treasuries by re-allocating from the IT investment grade fund to the IT bond index, and the above idea is just moving all of the exposure you have with corporate credit to treasuries.

Holding nominal treasuries may be slightly more exposed to inflation risk than the IT bond index, but not by much. An alternative would be to hold a combination of nominal treasuries and TIPS, maybe 2/3 VSIGX and 1/3 VTAPX, to diversify inflation risk, but the timing of that now would lock in some losses from recent increases in intermediate interest rates. If you are comfortable with intermediate nominal bonds now, there would be a case to stick with them and just use VSIGX as your bond allocation. The term exposure is the source of them often having negative correlation with equities

If you are holding bonds in a taxable account and you live in CA, then treasury and TIPS interest is state-tax-free. This would lower your CA taxes a little, which would offset some CA taxes on a realized capital gain if you re-allocate a little bit of your equity holdings to bonds.

Just a few ideas.
Risk is not a guarantor of return.

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dratkinson
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Re: Another approach to bonds

Post by dratkinson » Tue Aug 21, 2018 6:47 am

aristotelian wrote:
Mon Aug 20, 2018 8:41 pm
One way to think of your bond allocation is covering a certain number of years expenses that allows you to sleep in night. That might be 10, maybe more. If stocks go up, you do not need to rebalance because you still have your 10 years expenses in bonds.
reisner wrote:
Mon Aug 20, 2018 9:14 pm
I was thinking along those lines of years of expenses vs. bonds. Even discounting dividends, our bond allocation covers 15 to 20 years of expenses at our current rate. And in eight and a half years my wife's additional share of my SS will more than cover that. Yes, why am I bothering to ask this question? because that is in our nature as hunter gatherers, even if it is wonderful to have a first world problem.
...
Forgot this.

Many retirees report keeping 5yrs of living expense in safe bonds or stable value funds to avoid selling during a down market. This assumes market recovers within 4yrs. Search forum for discussions on "sequence of return risk" for other solutions.

So you've got this covered.
d.r.a, not dr.a. | I'm a novice investor, you are forewarned.

aristotelian
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Re: Another approach to bonds

Post by aristotelian » Tue Aug 21, 2018 8:18 am

dratkinson wrote:
Tue Aug 21, 2018 6:47 am
aristotelian wrote:
Mon Aug 20, 2018 8:41 pm
One way to think of your bond allocation is covering a certain number of years expenses that allows you to sleep in night. That might be 10, maybe more. If stocks go up, you do not need to rebalance because you still have your 10 years expenses in bonds.
Forgot this.

Many retirees report keeping 5yrs of living expense in safe bonds or stable value funds to avoid selling during a down market. This assumes market recovers within 4yrs. Search forum for discussions on "sequence of return risk" for other solutions.

So you've got this covered.
Yes, personally I would put the number higher than 5.

By the way, while thinking in absolute rather than relative terms would result in a more aggressive portfolio for a large portfolio, it would result in a more conservative allocation for smaller portfolios. For example, if you had 12 years expenses saved and SS was providing half your income, 10 years in bonds would result in only 17% stock. I'm not sure this method is "correct" but it seems to me another way of thinking about asset allocation worth some consideration.

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White Coat Investor
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Re: Another approach to bonds

Post by White Coat Investor » Tue Aug 21, 2018 8:25 am

reisner wrote:
Mon Aug 20, 2018 5:14 pm
I've tried rebalancing, but I live in a high-tax state and selling the total stock fund to by IT bonds gets expensive. (I sold all my S&P fund in 2009, tax-loss harvested, and bought right back into the Total Stock Market fund, so my capital gains in stock have been appreciable.) I've tried to maintain a 55-45 balance but gave up and now am at less than 40% bonds. Since I seldom need to withdraw any principle (retired, good pension and SS), but of course am wary of losing money in another downturn, it occurred to me to just ride out whatever happens, and if I need to take out more than interest and dividends, well then I'll just regard my bond portion as an emergency fund and hold onto my stock shares until they go back up in price. Or else sell them and move sideways again, back into the S&P 500 fund. Is this a reasonable plan?
You're asking whether the cost of rebalancing is worth it to reduce your risk. If your goal is 55/45 and you'er at 60/40+, I think it probably is worth paying enough capital gains to at least get back to 60/40.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

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Re: Another approach to bonds

Post by Dandy » Tue Aug 21, 2018 10:17 am

If you have a spouse and your pension will be reduced upon your death you may want to take into consideration the impact. There may be a need to draw down more, higher taxes (single vs married, etc.). It may not make a major difference but something to consider.

I have a pension and SS that almost matches our current expenses. If I die first my wife will lose her SS and 1/2 of my pension along with being in a higher tax situation. That made me a bit more conservative with our "safe" assets to make sure she would not be overly disadvantaged. e.g. if someone was going to keep X years of drawdown in "safe" fixed income they might want to make the X equal the most disadvantaged surviving spouse's drawdown needs.

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Re: Another approach to bonds

Post by JW-Retired » Tue Aug 21, 2018 10:54 am

reisner wrote:
Mon Aug 20, 2018 5:14 pm
Since I seldom need to withdraw any principle (retired, good pension and SS), but of course am wary of losing money in another downturn, it occurred to me to just ride out whatever happens, and if I need to take out more than interest and dividends, well then I'll just regard my bond portion as an emergency fund and hold onto my stock shares until they go back up in price. Or else sell them and move sideways again, back into the S&P 500 fund. Is this a reasonable plan?
Yes, IMO reasonable. I've been doing more or less exactly that since 2000. Only re-balance if the stock portion exceeds my target. If it goes the other way like in 2008/09 I just "ride it out" as you say. I very much like not worrying about what to do & when I need to do something.
JW
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reisner
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Re: Another approach to bonds

Post by reisner » Tue Aug 21, 2018 9:35 pm

My pension will not be reduced a dime for my wife if I die. She would lose SS until she turned 67. But we own the house clear, have no other debts, and other than vet bills and the occasional trip, don't spend wildly.

MIretired
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Re: Another approach to bonds

Post by MIretired » Wed Aug 22, 2018 10:51 am

aristotelian wrote:
Tue Aug 21, 2018 8:18 am
dratkinson wrote:
Tue Aug 21, 2018 6:47 am
aristotelian wrote:
Mon Aug 20, 2018 8:41 pm
One way to think of your bond allocation is covering a certain number of years expenses that allows you to sleep in night. That might be 10, maybe more. If stocks go up, you do not need to rebalance because you still have your 10 years expenses in bonds.
Forgot this.

Many retirees report keeping 5yrs of living expense in safe bonds or stable value funds to avoid selling during a down market. This assumes market recovers within 4yrs. Search forum for discussions on "sequence of return risk" for other solutions.

So you've got this covered.
Yes, personally I would put the number higher than 5.

By the way, while thinking in absolute rather than relative terms would result in a more aggressive portfolio for a large portfolio, it would result in a more conservative allocation for smaller portfolios. For example, if you had 12 years expenses saved and SS was providing half your income, 10 years in bonds would result in only 17% stock. I'm not sure this method is "correct" but it seems to me another way of thinking about asset allocation worth some consideration.
My underline.
It seems this also highlights the more 'need' to take risk with smallish portfolios, but then not necessarily the willingness nor ability to.
I agree with OP. That if WDs more than divs/interest are not expected to be needed, then no problem letting the equities grow like they usually would. 'This is how one gets wealthier.'

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