What Bond ETF to use for a 3-fund portfolio?

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PursuingSimplicity
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What Bond ETF to use for a 3-fund portfolio?

Post by PursuingSimplicity » Sun Mar 26, 2017 3:35 pm

Based on the stickied forum post, Taylor recommends going with Vanguard Total Bond Market. However, based on the theory that bonds should be considered the "safe" investment, I don't actually feel all that "safe" with BND (the ETF version of VBTLX) as during the 2008 crash, BND had periods of dips. Compared with, say, IEI (iShares 3-7 Year Treasury Bond ETF), which did not dip at all (same as TLT and SHY, the Long and Short term treasury bond index funds).

The thesis behind having bonds as I understand it is to both guard against a single nest egg's catastrophic losses (diversification) and also to safe guard asset that can be used during a market crash to purchase more "risky" equity asset at "discount" prices.

Given the above thesis, my questions are:
1) Shouldn't capital preservation be the top priority for bond holdings (and not growth/tracking the economy)? Thus, funds that's coupled to stock market conditions should be avoided (e.g. BND with its sizeable share of corporate bonds)?

2) If I want to keep a 3 fund portfolio (with ~33% allocated to "safe" bonds), what's the biggest difference in terms of risk profile when looking at a short term, medium term and long term and inflation protected treasury bond funds?

3) Should I be diversifying between the durations (and if so, what breakdown?), or is going "all-in" on Long Term treasury bond index fund fine?

So far on my shortlist of treasury bond ETF's are (please feel free to suggest others I should look into!):
  • Short Term:
  • SHY - iShares 1-3 Year Treasury Bond ETF
  • VGSH - Vanguard Short-Term Government Bond Index Fund ETF

    Intermediate Term:
  • IEI - iShares 3-7 Year Treasury Bond ETF
  • VGIT - Vanguard Intermediate-Term Government Bond Index Fund ETF

    Long Term:
  • TLT - iShares 20+ Year Treasury Bond ETF
  • VGLT - Vanguard Long-Term Government Bond Index Fund ETF

    Inflation Protected:
  • TIP - iShares TIPS Bond ETF

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patrick013
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Re: What Bond ETF to use for a 3-fund portfolio?

Post by patrick013 » Sun Mar 26, 2017 4:18 pm

The last time Bogle talked about bonds he said his portfolio
was 50-50 short/intermediate term bond funds, I would suspect
that ticker BSV and BIV would be a major part of that. Ticker
IEI is a very good fund to protect against decline where stocks
decline and TRSY's rise concurrently in a flight to quality. But,
the other 2 funds will hedge the market rumors of continuing
rate rises as best as someone can guess.
age in bonds, buy-and-hold, 10 year business cycle

radiowave
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Re: What Bond ETF to use for a 3-fund portfolio?

Post by radiowave » Sun Mar 26, 2017 4:48 pm

BIV (https://personal.vanguard.com/us/funds/ ... IntExt=INT) is about half treasury half corporate. So you have some growth but safety of intermediate treasury bonds. Corporate bonds are correlated with equity so when things go bad like 2008-2009, corporates go down, treasuries go up (that flight to quality as above). If you look at the 10 year yield it is interesting to see that BIV had a very small dip during the recession but recovered nicely. If you add VTI (VG total stock) to the graph, you'll see a much bigger dip during the 2008-2009 period but for 10 yr growth VTI outpaced BIV $21K to 16k. So if your strategy if long term growth, then low cost US stock index funds like VTI will provide better returns on average. But if you are getting ready for retirement in the next couple of years and want to provide better safety, then BIV/BSV combo will provide some protection against short term unrealized losses. I can just imagine the heartache for those who retired in late 2008 or 2009.
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Doc
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Re: What Bond ETF to use for a 3-fund portfolio?

Post by Doc » Sun Mar 26, 2017 5:06 pm

patrick013 wrote:The last time Bogle talked about bonds he said his portfolio
was 50-50 short/intermediate term bond funds, I would suspect
that ticker BSV and BIV would be a major part of that. Ticker
IEI is a very good fund to protect against decline where stocks
decline and TRSY's rise concurrently in a flight to quality. But,
the other 2 funds will hedge the market rumors of continuing
rate rises as best as someone can guess.
This is a good path. Note however that a 50-50 mix of Vanguard's short (1-5) & intermediate(5-10) term bond funds has a higher duration than the 1-10 index.You could adjust the ratio or just go with iShares Intermediate (1-10) Government/Credit Bond ETF GVI
PursuingSimplicity wrote:The thesis behind having bonds as I understand it is to both guard against a single nest egg's catastrophic losses (diversification) and also to safe guard asset that can be used during a market crash to purchase more "risky" equity asset at "discount" prices.
If you want to maximize this idea I would go with four funds not two. I would break the Government/Credit into its two parts (2) Treasury funds and (1 or 2) Investment grade funds. If you have limited space in tax advantage the short Treasury component is also reasonable tax efficient in today's market and can be put in taxable. This is what I do but I use more than 4 funds because of multiple accounts and wash sale implications.

Edit: It looks like radiowave beat me to the punch. All three of us are on basically the same wavelength. (Pun intended.)
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

Swelfie
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Re: What Bond ETF to use for a 3-fund portfolio?

Post by Swelfie » Mon Mar 27, 2017 5:49 pm

GOVT is a decent one also. Kind of a US treasuries total bond market ETF if you want a good hassle free mix but want to avoid corporates.

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Re: What Bond ETF to use for a 3-fund portfolio?

Post by duckcalldan » Mon Mar 27, 2017 10:05 pm

I just got my rollover check from my employer since I'm recently retired. Since I won't need this money for over 10 years and it will hold a vast portion of my bond allocation, I'm going with 2 parts VGIT to 1 part VCIT. Similar to BND but without mortgage backed securities and allows me to vary the govt/corp allocation if needed.

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nisiprius
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Re: What Bond ETF to use for a 3-fund portfolio?

Post by nisiprius » Tue Mar 28, 2017 9:05 am

You don't say what your overall stock/bond allocation is. I think it is misplaced to worry too much about small differences in the volatility of (investment-grade, intermediate-term) bond funds if you have any significant stock allocation at all.

For example, let's compare what actually happened between a portfolio with
50% stocks (VTI, Total Stock), 50% bonds (Total Bond), portfolio 1, blue, and
50% stocks (VI, Total Stock), 50% bonds (short-term Treasuries, your SHY), portfolio 2, red.

Source
Image

Here's my interpretation. By going to the less risky, less volatile, short-term Treasuries for the 50% bond component:
  • The maximum drawdown was indeed reduced--by a completely unimportant amount, -23.71% to -22.94%. Would this have really been important to you?
  • Oddly, I don't quite know why, it made the best year better and the worst year worst, but, again, by completely unimportant amounts.
  • Overall portfolio volatility was reduced, from 8.23% to 7.70%. I think it would pretty hard to notice this unless you were really running a spreadsheet and doing actual calculations.
  • In exchange for these paper-thin improvements in risk, you gave up quite a lot of return, earning only 5.32% CAGR instead of 6.52%; over a percent per year difference. A $10,000 investment gained $6,078 instead of $7,838, a difference of $1,760.
Is the tiny difference in overall portfolio risk worth the loss in total return?

To me, the answer is clear: no. If you are risk-adverse, the important thing to do is to cut stock allocation, not to fiddle around with different things within the bond component. At least, not until you have gotten really, really, really bond-heavy. I guess if you are at something like 15% stocks or less, then the risk of the bond component might start to matter.

The only real advantage a less volatile bond fund gives you is if you are watching every part of your portfolio separately and just hate to see any part of it go down, ever... but that's not a good way to look at a portfolio.
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ps56k
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Re: What Bond ETF to use for a 3-fund portfolio?

Post by ps56k » Tue Mar 28, 2017 3:27 pm

what about the Total Bond Fund vs the Intermediate-Term Tax-Exempt Fund - for those in higher tax brackets ?
ie - VBMFX vs VWITX

tinvestor
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Re: What Bond ETF to use for a 3-fund portfolio?

Post by tinvestor » Wed Mar 29, 2017 6:44 pm

Under all my scenarios, TLT seems to outperform all other bond funds by a good margin in terms of max drawdown (3% better than BND) and CAGR (.5% better) ? I also really like the .90 vs .99 market correlation. Is it wrong to expect TLT portfolios to continue to outperform BND, IEI etc porfolios ? Do rising interest rates make this all invalid or what am i missing ?

https://www.portfoliovisualizer.com/bac ... tion4_3=25

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Re: What Bond ETF to use for a 3-fund portfolio?

Post by aegis965 » Wed Mar 29, 2017 7:30 pm

Swelfie wrote:GOVT is a decent one also. Kind of a US treasuries total bond market ETF if you want a good hassle free mix but want to avoid corporates.
Second. GOVT does what David Swensen recommends: a treasury portfolio which matches the market characteristics. I also find his allocation of half treasury and half TIPS reasonable. Also, his argument for this allocation and his reason to avoid corporate bonds in Unconventional Success are quite compelling.
I may be biased.

aristotelian
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Re: What Bond ETF to use for a 3-fund portfolio?

Post by aristotelian » Wed Mar 29, 2017 7:45 pm

I am reading Swedroe "Winning Bond Strategy" right now. Very good comprehensive overview of the bond market and different types. I was surprised he recommends against Total Bond Market because of the inclusion of government mortgage-backed securities. I am leaning toward Vanguard Intermediate Government (VSIGX) and Intermediate Treasury (VFITX). I also hold PIMCO Short Term Corporate (CORP) which has no transaction fees in my Schwab account, as well as Vanguard's Wellesley Income in my employer plan.
Last edited by aristotelian on Wed Mar 29, 2017 8:38 pm, edited 1 time in total.

petulant
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Re: What Bond ETF to use for a 3-fund portfolio?

Post by petulant » Wed Mar 29, 2017 8:08 pm

nisiprius wrote:You don't say what your overall stock/bond allocation is. I think it is misplaced to worry too much about small differences in the volatility of (investment-grade, intermediate-term) bond funds if you have any significant stock allocation at all.

For example, let's compare what actually happened between a portfolio with
50% stocks (VTI, Total Stock), 50% bonds (Total Bond), portfolio 1, blue, and
50% stocks (VI, Total Stock), 50% bonds (short-term Treasuries, your SHY), portfolio 2, red.

Source
Image

Here's my interpretation. By going to the less risky, less volatile, short-term Treasuries for the 50% bond component:
  • The maximum drawdown was indeed reduced--by a completely unimportant amount, -23.71% to -22.94%. Would this have really been important to you?
  • Oddly, I don't quite know why, it made the best year better and the worst year worst, but, again, by completely unimportant amounts.
  • Overall portfolio volatility was reduced, from 8.23% to 7.70%. I think it would pretty hard to notice this unless you were really running a spreadsheet and doing actual calculations.
  • In exchange for these paper-thin improvements in risk, you gave up quite a lot of return, earning only 5.32% CAGR instead of 6.52%; over a percent per year difference. A $10,000 investment gained $6,078 instead of $7,838, a difference of $1,760.
Is the tiny difference in overall portfolio risk worth the loss in total return?

To me, the answer is clear: no. If you are risk-adverse, the important thing to do is to cut stock allocation, not to fiddle around with different things within the bond component. At least, not until you have gotten really, really, really bond-heavy. I guess if you are at something like 15% stocks or less, then the risk of the bond component might start to matter.

The only real advantage a less volatile bond fund gives you is if you are watching every part of your portfolio separately and just hate to see any part of it go down, ever... but that's not a good way to look at a portfolio.
I tried to figure out what asset allocation would make VTI/SHY match the CAGR of VTI/BND, and it didn't match until about 70/30. Here's the graph:

Image

And here's the link:

https://www.portfoliovisualizer.com/bac ... tion3_2=30

Just wow. Much worse worst year, much higher stdev, worse max drawdown...

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Re: What Bond ETF to use for a 3-fund portfolio?

Post by lack_ey » Wed Mar 29, 2017 8:19 pm

I mean, if you're going to backtest ~2008-present, you have to understand how well rewarded term risk was, particularly providing negative correlation with stocks. There were falling interest rates over the full period as well as a fairly steep yield curve throughout, combined with very low short-term Treasury rates. Even credit risk was pretty additive over the full period, despite the meltdown/recovery around the financial crisis. So of course total bond was a lot better than 1-3 Yr Treasuries. It ain't gonna be like that all the time, though in general you probably should expect a little bit more efficient portfolios going with total bond over many periods (win some, lose some, averages out a little bit favorably).

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