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What should I own on the bond side ???

Posted: Sat Jan 13, 2018 6:06 pm
by e_swami
I have a target 70/30 stock/bond mix (I am 43 years old). I have struggled with the fixed income side of my portfolio for the past couple of years under the idea that since interest rates are zero, bonds prices can ONLY decline. As a result my fixed income side has been limited to the following (percentages in brackets are the percentage of my portfolio in each):

1. Vanguard Emerging Markets Government Bond Index Fund Admiral Shares VGAVX (3%)
2. Vanguard Short-Term Investment-Grade Fund Admiral Shares VFSUX (3%)
3. Vanguard Intermediate-Term Bond Index Fund Admiral Shares (2%)
4. Stable Fund in the Virginia 529 (I will transfer Virginia to the NY 529 shortly and close Virginia) - (4%)
5. "Income Portfolio" in the NY 529 (5%)
6. Certain CD-like fixed income investments in India (8%)

The "Income Portfolio" in the NY529 consists of the following:
Vanguard Total Bond Market II Index Fund (42%)
Vanguard Total International Bond Index Fund (15%)
Vanguard Short-Term Inflation-Protected Securities Index Fund (18%)
Vanguard Short-Term Reserves Account (25%)

Now my bond investments add up to only 25% due to the growth in the stock market over the past year and I realize I need to buy more fixed income. But I am really struggling to decide which fixed income fund options to use to manage interest rate risk. Except for the India investments (which will stay for now, despite the currency risk), the rest are in IRAs and 529s.

Questions
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1. I would really appreciate advice on restructuring my fixed income, along with your views on how that would manage interest rate risk
2. What else do I buy to get to my 30% allocation?
3. I realize I am using my son's 529 as a way to get fixed income into tax deferred accounts. My son is 10 years old. Should I look to put fixed income in my taxable account?

Re: What should I own on the bond side ???

Posted: Sat Jan 13, 2018 10:43 pm
by ThrustVectoring
I-bonds are a fantastic choice, though there are purchase amount limits, so it may not cover the full gap. But anyhow, your position is probably better off if you buy $10k of I-bonds.

Re: What should I own on the bond side ???

Posted: Sat Jan 13, 2018 11:14 pm
by venkman
The general BH philosophy is that you hold bonds for stability, not for return. For bonds that are part of a long-term investment portfolio, Vanguard's Total Bond Market Index is highly recommended. It's only had one negative year out of the last 15, and that was 2013, when it was down 2.15%.

If you're holding bonds for the long term, rising interest rates are a GOOD thing; any money you lose from bond prices going down, you will eventually make up for with higher interest payments. If you REALLY can't stand the thought of losing money in bonds, Vanguard's short-term bond index (or even their Ultra-short term fund) is perfectly fine and has less interest rate risk. The yield spread isn't very wide right now, so the opportunity cost of short-term bonds isn't that high.

Re: What should I own on the bond side ???

Posted: Sun Jan 14, 2018 12:42 am
by mega317
You need to revisit your premise. Interest rates are not 0, bond fund prices will not reliably and invariably decrease, and rising interest rates leads to greater yield from bond funds.

Re: What should I own on the bond side ???

Posted: Sun Jan 14, 2018 8:09 am
by Edward Joseph
mega317 wrote:
Sun Jan 14, 2018 12:42 am
You need to revisit your premise. Interest rates are not 0, bond fund prices will not reliably and invariably decrease, and rising interest rates leads to greater yield from bond funds.
I agree. I think some in the investing community have gone overboard with the fear of holding something like Total Bond Market in a "rising interest rate environment". Bond funds are not going to crater or drop dramatically like equities have at times. The purpose of it is stability and all this environment really means is you can't expect strong returns from the Fixed Income side going forward for a while.

Re: What should I own on the bond side ???

Posted: Sun Jan 14, 2018 8:30 am
by retiredjg
e_swami wrote:
Sat Jan 13, 2018 6:06 pm
I have a target 70/30 stock/bond mix (I am 43 years old). I have struggled with the fixed income side of my portfolio for the past couple of years under the idea that since interest rates are zero, bonds prices can ONLY decline.....
My bond allocation is making money. Not a lot, but steady. And has been for years and years. For a decade or so awhile back, my bond allocation made more money than my stock allocation!

Even if/when bond prices do decline, remember that is because interest rates have gone up. When interest rates go up, your bond funds start to pay you more money! You are looking at the drop in value and ignoring the increase in income.

I think your caution and fear about bonds is out of proportion to reality. Many people feel this way but it is not rational. If you are worried about bond values dropping 3%, why are you not worried about your stock values dropping 50%?

Re: What should I own on the bond side ???

Posted: Sun Jan 14, 2018 8:36 am
by student
I like using stable value fund as my fixed income. You listed one in 520. Do you have similar one available for your retirement funds?

Re: What should I own on the bond side ???

Posted: Sun Jan 14, 2018 10:30 am
by e_swami
Thanks everyone for the responses. I have been telling myself that I am perhaps too worried about loss of value vs higher interest income. This gives me more to act on that

1. What do people here think about international bonds?

2. Thoughts on using 529 for a part of my fixed income requirements overall?

Re: What should I own on the bond side ???

Posted: Sun Jan 14, 2018 10:45 am
by Prudence
venkman wrote:
Sat Jan 13, 2018 11:14 pm
The general BH philosophy is that you hold bonds for stability, not for return. For bonds that are part of a long-term investment portfolio, Vanguard's Total Bond Market Index is highly recommended. It's only had one negative year out of the last 15, and that was 2013, when it was down 2.15%.

If you're holding bonds for the long term, rising interest rates are a GOOD thing; any money you lose from bond prices going down, you will eventually make up for with higher interest payments. If you REALLY can't stand the thought of losing money in bonds, Vanguard's short-term bond index (or even their Ultra-short term fund) is perfectly fine and has less interest rate risk. The yield spread isn't very wide right now, so the opportunity cost of short-term bonds isn't that high.
I do like VG Total Bond Market Index. A few posters have been saying that they would prefer CDs now over bond funds. I agree with them since I am assuming interest rates are more likely to go up rather than stay flat or go down. Suppose I invest $100,000 into a three year CD @ 2.2%, I will have about $106,746 at the end of three years. OTOH, suppose I invest the $100,000 in TBI instead of the CD. Today, TBI has a duration of 6.1 years and an SEC Yield of 2.61%. According to rough calculations, if market interest rates increase one half percent per year over the next three years (assumes TBI would be yielding 4.11% in three years and then stay flat after that), I will have about $101,510 at the end of three years. (Additionally, if my 2.2% CD had a six year term, it would still outperform TBI at the end of six years. TBI total return catches up and passes the 2.2% CD in the seventh year). (I assumed the value of TBI would fall about 3% at the time of each one half percent interest rate increase and that all dividends would be reinvested). I wonder if I am way off base here?

Re: What should I own on the bond side ???

Posted: Sun Jan 14, 2018 12:49 pm
by Edward Joseph
e_swami wrote:
Sun Jan 14, 2018 10:30 am
Thanks everyone for the responses. I have been telling myself that I am perhaps too worried about loss of value vs higher interest income. This gives me more to act on that

1. What do people here think about international bonds?

2. Thoughts on using 529 for a part of my fixed income requirements overall?
Regarding Int'l....Vanguard mixes them in as part of all of their Asset Allocation models (LifeStrategy, Target Date, etc.). To me, that is enough evidence of their importance as a small part of your F.I. allocation.

Re: What should I own on the bond side ???

Posted: Sun Jan 14, 2018 8:56 pm
by venkman
Prudence wrote:
Sun Jan 14, 2018 10:45 am
I do like VG Total Bond Market Index. A few posters have been saying that they would prefer CDs now over bond funds. I agree with them since I am assuming interest rates are more likely to go up rather than stay flat or go down. Suppose I invest $100,000 into a three year CD @ 2.2%, I will have about $106,746 at the end of three years. OTOH, suppose I invest the $100,000 in TBI instead of the CD. Today, TBI has a duration of 6.1 years and an SEC Yield of 2.61%. According to rough calculations, if market interest rates increase one half percent per year over the next three years (assumes TBI would be yielding 4.11% in three years and then stay flat after that), I will have about $101,510 at the end of three years. (Additionally, if my 2.2% CD had a six year term, it would still outperform TBI at the end of six years. TBI total return catches up and passes the 2.2% CD in the seventh year). (I assumed the value of TBI would fall about 3% at the time of each one half percent interest rate increase and that all dividends would be reinvested). I wonder if I am way off base here?
If the Fed continues with its plans, short-term rates will likely continue to go up; but that doesn't mean every part of the yield curve will go up uniformly. It could just become a flat yield curve, with intermediate and long term rates not going up very much. The nice thing about TBM is that you get diversity all along the curve, so big shifts in one section might be moderated by more stability in other sections.

Also bear in mind that the Fed's plans are widely known and have already been priced into bonds. There's also no guarantee that rates will go up.

If you're putting away money that will be needed in 5 years, a 5-year CD is probably the way to go. If you're investing for the long term with bonds as part of your overall AA, TBM is probably better. It depends somewhat on the withdrawal penalty for the CD.

Re: What should I own on the bond side ???

Posted: Mon Jan 15, 2018 8:54 am
by Prudence
venkman wrote:
Sun Jan 14, 2018 8:56 pm
Prudence wrote:
Sun Jan 14, 2018 10:45 am
I do like VG Total Bond Market Index. A few posters have been saying that they would prefer CDs now over bond funds. I agree with them since I am assuming interest rates are more likely to go up rather than stay flat or go down. Suppose I invest $100,000 into a three year CD @ 2.2%, I will have about $106,746 at the end of three years. OTOH, suppose I invest the $100,000 in TBI instead of the CD. Today, TBI has a duration of 6.1 years and an SEC Yield of 2.61%. According to rough calculations, if market interest rates increase one half percent per year over the next three years (assumes TBI would be yielding 4.11% in three years and then stay flat after that), I will have about $101,510 at the end of three years. (Additionally, if my 2.2% CD had a six year term, it would still outperform TBI at the end of six years. TBI total return catches up and passes the 2.2% CD in the seventh year). (I assumed the value of TBI would fall about 3% at the time of each one half percent interest rate increase and that all dividends would be reinvested). I wonder if I am way off base here?
If the Fed continues with its plans, short-term rates will likely continue to go up; but that doesn't mean every part of the yield curve will go up uniformly. It could just become a flat yield curve, with intermediate and long term rates not going up very much. The nice thing about TBM is that you get diversity all along the curve, so big shifts in one section might be moderated by more stability in other sections.

Also bear in mind that the Fed's plans are widely known and have already been priced into bonds. There's also no guarantee that rates will go up.

If you're putting away money that will be needed in 5 years, a 5-year CD is probably the way to go. If you're investing for the long term with bonds as part of your overall AA, TBM is probably better. It depends somewhat on the withdrawal penalty for the CD.
Agree completely. Thank you.