Investment grade bonds now made up of 50% BBB rated

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ChinchillaWhiplash
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Investment grade bonds now made up of 50% BBB rated

Post by ChinchillaWhiplash » Mon Oct 08, 2018 8:43 am

Just read an article saying that 50% of investment grade US bonds in the Barclays index are now made up of BBB rated bonds. I would gather that in a recession this would be pretty bad for the bond fund's performance. Might it be a good time to invest in some other form of bond/fixed income and not rely totally on TBM for your FI portion of your portfolio? Treasuries, CDs, TIPS, ??? Or at least have a mix of varied FI with a little more security. Thoughts?
Last edited by ChinchillaWhiplash on Mon Oct 08, 2018 10:38 am, edited 1 time in total.

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vineviz
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Re: Total Bond Market fund not what it used to be

Post by vineviz » Mon Oct 08, 2018 8:59 am

ChinchillaWhiplash wrote:
Mon Oct 08, 2018 8:43 am
Just read an article saying that 50% of investment grade US bonds in the Barclays index are now made up of BBB rated bonds. I would gather that in a recession this would be pretty bad for the bond fund's performance. Might it be a good time to invest in some other form of bond/fixed income and not rely totally on TBM for your FI portion of your portfolio? Treasuries, CDs, TIPS, ??? Or at least have a mix of varied FI with a little more security. Thoughts?
I'd go back and re-read the article. Or better yet, forget you read it to begin with.

For one thing, since 1981 the highest default rate of BBB bonds in any year was 2002, when 1% of BBB-rated bonds defaulted.

For another thing, any BBB-rated bond that gets downgraded to BB gets removed from the index BEFORE it defaults.

For a third thing, most companies that default on their debt end up paying SOMETHING back to bond holders.

For a fourth thing the Vanguard Total Bond Market Index Fund, for instance, only has about 14% invested in BBB-rated bonds so even if 1% of those bonds defaulted TODAY it would barely be a blip in the total return of the fund.
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Re: Total Bond Market fund not what it used to be

Post by llama » Mon Oct 08, 2018 9:00 am

Something doesn't sound right to me. I use FSITX (Fidelity U.S. Bond Index) as my TBM fund, and the Fidelity site reports that it tracks the "Bloomberg Barclays U.S. Aggregate Bond Index" and shows this breakdown of credit quality:

Code: Select all

U.S. Government         70.34%
AAA                      4.07%
AA                       4.55%
A                       11.64%
BBB                      8.91%
BB                       0.09%
B                        0.00%
CCC & Below              0.00%
Short-Term Rated         0.00%
Not Rated/Not Available  0.14%
Cash & Net Other Assets  0.26%

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Re: Total Bond Market fund not what it used to be

Post by ChinchillaWhiplash » Mon Oct 08, 2018 9:05 am


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Re: Total Bond Market fund not what it used to be

Post by ChinchillaWhiplash » Mon Oct 08, 2018 9:09 am

Probably correct that it is best to just ignore and carry on. Hopefully TBM will remain a solid investment during a down turn with decent yields.

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Re: Total Bond Market fund not what it used to be

Post by Taylor Larimore » Mon Oct 08, 2018 9:14 am

ChinchillaWhiplash wrote:
Mon Oct 08, 2018 8:43 am
Just read an article saying that 50% of investment grade US bonds in the Barclays index are now made up of BBB rated bonds. I would gather that in a recession this would be pretty bad for the bond fund's performance. Might it be a good time to invest in some other form of bond/fixed income and not rely totally on TBM for your FI portion of your portfolio? Treasuries, CDs, TIPS, ??? Or at least have a mix of varied FI with a little more security. Thoughts?
ChinchillaWhiplash:

According to Vanguard, this is the "Distribution by credit quality" of Total Bond Market Index Fund as of 08/31/2018
64.6% U.S. Government
5.4% Aaa
3.6% Aa
11.8% A
14.6% Baa
100%
ALL are investment grade.

Best wishes.
Taylor
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Re: Total Bond Market fund not what it used to be

Post by ChinchillaWhiplash » Mon Oct 08, 2018 9:16 am

I like those numbers a lot more.

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Re: Total Bond Market fund not what it used to be

Post by EyeYield » Mon Oct 08, 2018 9:20 am

That article is not referring to the TBM, so you may want to change the subject title.

iShares iBoxx $ Invmt Grade Corp Bd ETF (LQD) is the fund referred to in the article.
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Re: Total Bond Market fund not what it used to be

Post by Dandy » Mon Oct 08, 2018 10:01 am

total bond is a decent bond fund. But I always felt that if you have a large allocation to fixed income it might be wise to have a bit more diversity. total bond isn't total like the total stock market index fund. It doesn't cover all fixed income products. There are muni bonds, inflation protected bonds, CDs, Money Market fund/deposit accounts, EE bonds, on line savings accounts, high yield bonds to name some other fixed income choices. Total bond is almost 2/3 Treasury securities which prompted Mr. Bogle to advocate adding some corporate bonds to the fund or to your portfolio.

Each fixed income product has pro's and con's. If you are aware of them you can make wise choices. As a retiree I have about 57% of my portfolio in fixed income. About 18% is in "principal safe" products e.g. CDs, Online Savings, Money Market, About 18% in short term bonds e.g. Ltd Term Tax exempt, Short Term Investment Grade and ST Index, and about 21% intermediate bonds e.g. the fixed income portion of Balanced Index and Wellesley Income, Intermediate Treasury and Inflation Protected Security funds.

Seems complex but I don't fuss too much about rebalancing the fixed income since it is usually not subject to much change and the large balanced fund holdings are self balancing. If the Fed Money Market Fund is paying 2% and on line Savings is paying 1.9% am I going to overly focus on the need to move money from the Federal fund if it is a bit larger than planned?? They are both part of the "principal safe" group. I keep an eye on the fixed income group totals and my equity exposure.

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Re: Total Bond Market fund not what it used to be

Post by Valuethinker » Mon Oct 08, 2018 11:03 am

vineviz wrote:
Mon Oct 08, 2018 8:59 am


For one thing, since 1981 the highest default rate of BBB bonds in any year was 2002, when 1% of BBB-rated bonds defaulted.
That was some big telecoms defaults (Worldcom in particular I think) and Vanguard actually got caught in that.

One has to be careful about whether the statistical characteristics of the underlying population are stable.

I would argue they are probably not. In line with what Hyman Minsky said about periods of stability leading to greater risk taking, I think the background radiation of declining credit quality is growing - weaker covenants, more complex debt structures. I think Moody's and S&P have published on this, too.

Credit ratings are relative not absolute (even if they are intended to be absolute) -- to use another analogy it's easy to go to sleep on the beach, and wake up and find the tide has moved in past your deckchair.

I don't have a huge sense of alarm but when half of European corporate investment grade bonds are issued by financial companies (I believe I read) that has to give you pause - a lot of firms that before Lehman were investment grade were most assuredly not in the weeks after Lehman bankruptcy.

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Re: Investment grade bonds now made up of 50% BBB rated

Post by garlandwhizzer » Mon Oct 08, 2018 12:21 pm

TBM holds no BBB rated bonds and almost 2/3 of its bonds are backed by the US government. Its corporate bond exposure sticks with investment grade. TBM's default risk is well controlled IMO but it does have duration risk (ave. duration 6.1 yrs. which is why its YTD return is -2.52%). No reason for panic if you're holding TBM. Having said that, spreads between Treasuries and corporates are very narrow now and you get minimal reward for taking the increased default risk of the latter. Likewise duration risk has taken a toll on longer and even intermediate duration bonds this year as principal values have declined. You basically get punished these days to take on duration risk.

The market is now pricing in low rates of expected inflation for the next 10 to 30 years, as the narrow (negative?) spreads between short term TIPS and long term TIPS demonstrate. Likewise the very narrow spreads between long term Treasuries and short term Treasuries suggest that the market believes that inflation/economic growth is not going to increase significantly over the very long term. In this environment, you can get rid of duration, default, and unexpected inflation risk with ST TIPS without paying anything for it. Vanguard's ST TIPS fund currently yields +.85% in addition the inflation adjustment. Inflation is currently running at an rate of about 2.8%. That gives you a 3.65% total yield that is government guaranteed and without inflation risk. I personally don't get the appeal of nominal bonds or increased duration in the current environment but those who are heavily exposed to nominal bonds and long duration may want to consider this option for a portion of their bond portfolio.

Garland Whizzer

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Re: Investment grade bonds now made up of 50% BBB rated

Post by jclear » Mon Oct 08, 2018 6:57 pm

This plays out in other funds too. VBILX is

Code: Select all

U.S. Government	53.1%
Aaa		2.6%
Aa		3.1%
A		16.5%
Baa		24.7%
Now that's a barbell.

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Re: Investment grade bonds now made up of 50% BBB rated

Post by catalina355 » Wed Oct 10, 2018 12:55 am

garlandwhizzer wrote:
Mon Oct 08, 2018 12:21 pm
TBM holds no BBB rated bonds and almost 2/3 of its bonds are backed by the US government. Its corporate bond exposure sticks with investment grade. TBM's default risk is well controlled IMO but it does have duration risk (ave. duration 6.1 yrs. which is why its YTD return is -2.52%). No reason for panic if you're holding TBM. Having said that, spreads between Treasuries and corporates are very narrow now and you get minimal reward for taking the increased default risk of the latter. Likewise duration risk has taken a toll on longer and even intermediate duration bonds this year as principal values have declined. You basically get punished these days to take on duration risk.

The market is now pricing in low rates of expected inflation for the next 10 to 30 years, as the narrow (negative?) spreads between short term TIPS and long term TIPS demonstrate. Likewise the very narrow spreads between long term Treasuries and short term Treasuries suggest that the market believes that inflation/economic growth is not going to increase significantly over the very long term. In this environment, you can get rid of duration, default, and unexpected inflation risk with ST TIPS without paying anything for it. Vanguard's ST TIPS fund currently yields +.85% in addition the inflation adjustment. Inflation is currently running at an rate of about 2.8%. That gives you a 3.65% total yield that is government guaranteed and without inflation risk. I personally don't get the appeal of nominal bonds or increased duration in the current environment but those who are heavily exposed to nominal bonds and long duration may want to consider this option for a portion of their bond portfolio.

Garland Whizzer
Is the ST TIPS fund a suitable holding in a taxable account?

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Re: Investment grade bonds now made up of 50% BBB rated

Post by nisiprius » Wed Oct 10, 2018 6:11 am

ChinchillaWhiplash wrote:
Mon Oct 08, 2018 8:43 am
...Just read an article saying that 50% of investment grade US bonds in the Barclays index are now made up of BBB rated bonds....
Could we have the source, please?

I suspect there is some confusion here between the bond rating scales of different providers. "BBB" doesn't exist in the Moody's scale. It is used by S&P and by Fitch, and corresponds to Moody's "Baa."

Bloomberg Barclay's factsheet says that "The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market." It show this:

Image

As you can see, Baa bonds are only 14% of the index, and this number has been increasingly only very slightly. VBMFX matches this closely.

If the article means anything, it probably means that of that 14%, half of them are Baa3 rather than Baa2 or Baa1. I seriously doubt that's any reason for concern. I don't even know if that's very different from what it used to be.
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Re: Total Bond Market fund not what it used to be

Post by MichCPA » Wed Oct 10, 2018 7:30 am

llama wrote:
Mon Oct 08, 2018 9:00 am
Something doesn't sound right to me. I use FSITX (Fidelity U.S. Bond Index) as my TBM fund, and the Fidelity site reports that it tracks the "Bloomberg Barclays U.S. Aggregate Bond Index" and shows this breakdown of credit quality:

Code: Select all

U.S. Government         70.34%
AAA                      4.07%
AA                       4.55%
A                       11.64%
BBB                      8.91%
BB                       0.09%
B                        0.00%
CCC & Below              0.00%
Short-Term Rated         0.00%
Not Rated/Not Available  0.14%
Cash & Net Other Assets  0.26%
I assume this actually refers to 50% of the corporate market, which would be closer to 15% of total bonds, but that still seems to be off. The US has problems but a BBB bond rating isn't one of them.

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Re: Investment grade bonds now made up of 50% BBB rated

Post by JoMoney » Wed Oct 10, 2018 7:47 am

This is what Morningstar shows for the iShares Broad USD Inv. Grade Corp Bond ETF (USIG)
Image
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Re: Investment grade bonds now made up of 50% BBB rated

Post by ChinchillaWhiplash » Wed Oct 10, 2018 7:56 am

Source in post # 4

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Re: Investment grade bonds now made up of 50% BBB rated

Post by nisiprius » Wed Oct 10, 2018 11:44 am

ChinchillaWhiplash wrote:
Wed Oct 10, 2018 7:56 am
Source in post # 4
Things getting stormier for investment-grade bonds

The author appears to be using "investment-grade bonds" as a nickname for "investment-grade corporate bonds." The general fact that corporate bonds are riskier than the total bond market is well-known, and so is the fact that they have declined in quality and liquidity since the financial crisis. In fact that's why the SEC made new rules for bond funds, allowing fund companies to put the brakes on hasty redemptions from bond funds.

I call BS on the article headline, based on the fact that Barclay's says the US Aggregate index US Aggregate Bond Index "measures the investment grade, US dollar-denominated, fixed-rate taxable bond market" and Barclay's says the percentage of Baa-rated bonds in the Aggregate Index is only 14%.

I also call BS on the lead sentence, "Investment-grade bonds are supposed to be a port in the storm when the financial environment gets rough." I can't imagine anybody saying corporate bonds are the port in the storm; the port in the storm is supposed to be Treasuries.

Since corporates only represent 25.8% of the US Aggregate index, a change of 38% to 50% in the percentage of Baa-rated bonds among corporates only amounts to an increase of about 25.8% of 12% = 3% in their percentage of the Aggregate Index. Combine that with the fact that Baa bonds aren't all that risky to begin with, and this is what the article is saying:

"The riskiest bonds among the lowest-risk corporates, which is one of the riskier segments of the low-risk Aggregate Index, have become somewhat riskier than they used to be."

My reaction has been the same as it has been for about a decade. Between the guys saying "Stick to pure Treasuries" and the guys saying "The Aggregate index doesn't have enough corporates," I'm happy sticking with Total Bond and the Aggregate index, going down the middle of the investment-grade road.
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Re: Investment grade bonds now made up of 50% BBB rated

Post by patrick013 » Wed Oct 10, 2018 12:14 pm

nisiprius wrote:
Wed Oct 10, 2018 11:44 am
Combine that with the fact that Baa bonds aren't all that risky to begin with, and this is what the article is saying:

"The riskiest bonds among the lowest-risk corporates, which is one of the riskier segments of the low-risk Aggregate Index, have become somewhat riskier than they used to be."
Never hurts to have a few facts. According to S&P data spanning many decades
the average default rate for BBB +or- rated is from .15 to .30%. The maximum
default rate observed has been 1.11 to 1.40% for BBB, BBB-, or BBB+ rated
corporate bonds. So, I'd expected the average but wouldn't be surprised at
the worst, deducted from the annual return.

In a fund with 1000's of bonds those results or risks are well diversified of course.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Total Bond Market fund not what it used to be

Post by JackoC » Wed Oct 10, 2018 1:36 pm

vineviz wrote:
Mon Oct 08, 2018 8:59 am
ChinchillaWhiplash wrote:
Mon Oct 08, 2018 8:43 am
Just read an article saying that 50% of investment grade US bonds in the Barclays index are now made up of BBB rated bonds. I would gather that in a recession this would be pretty bad for the bond fund's performance. Might it be a good time to invest in some other form of bond/fixed income and not rely totally on TBM for your FI portion of your portfolio? Treasuries, CDs, TIPS, ??? Or at least have a mix of varied FI with a little more security. Thoughts?
I'd go back and re-read the article. Or better yet, forget you read it to begin with.

For one thing, since 1981 the highest default rate of BBB bonds in any year was 2002, when 1% of BBB-rated bonds defaulted.

For another thing, any BBB-rated bond that gets downgraded to BB gets removed from the index BEFORE it defaults.

For a third thing, most companies that default on their debt end up paying SOMETHING back to bond holders.

For a fourth thing the Vanguard Total Bond Market Index Fund, for instance, only has about 14% invested in BBB-rated bonds so even if 1% of those bonds defaulted TODAY it would barely be a blip in the total return of the fund.
As others have already said, around 50% of US investment grade *corporate* bonds are now in the BBB/Baa range, notably higher than it used to be.

Therefore it's not a huge issue to TBM funds which are (supposed to be and somewhat mimic) the whole investment grade bond market most of which is US govt/US govt gteed/'sponsored' etc debt.

I'm not sure it should be ignored though. Historically you lose more money getting rid of bonds which are downgraded below BBB than riding them out, substantially. That's a significant issue for corporate bond funds to the extent they are required to do that. They have more leeway in recent years not to, as a rule, although that can increase outright defaults. The point is you don't avoid losing money by getting rid of bonds which get downgraded to BB/Ba range or below from IG. Somebody else has to buy them if you sell them, they have to be compensated the increased default probability plus a risk premium. That risk premium is relatively costly.

So back to TBM this does not invalidate them because investment grade corporates are a fairly small % of them. It just raises the question of whether there's much value in them including investment grade corporates. And the fact that more IG corporates are on the cusp of junk now might exacerbate this issue, though again it's not going to kill TBM funds because the % isn't that high.

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Re: Total Bond Market fund not what it used to be

Post by mptfan » Wed Oct 10, 2018 1:42 pm

vineviz wrote:
Mon Oct 08, 2018 8:59 am
For a third thing, most companies that default on their debt end up paying SOMETHING back to bond holders.
This is such an important point. It seems to me that when most people hear the word "default" in the contexts of bonds, they assume that means the face value of the bond is not paid back and it is a total loss. This is not necessarily true. If the bond issuer misses one bond payment, the bond is technically "in default" because the bond did not meet all of its obligations on time, but this does not mean that the bond is a total loss. The bond issuer may catch up on all the bond payments, albeit late, or they may miss one payment and make all other payments, or they may stop making payments and agree to pay back less than the total amount of the bond, or in some cases the bond issuer may go bankrupt and the bond is a total loss. I have a general memory that in most cases it is a minority of bonds that go into default that are total losses, whereas in a majority of cases, the bondholder is paid most of what is owed.

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Re: Total Bond Market fund not what it used to be

Post by JackoC » Wed Oct 10, 2018 4:06 pm

mptfan wrote:
Wed Oct 10, 2018 1:42 pm
vineviz wrote:
Mon Oct 08, 2018 8:59 am
For a third thing, most companies that default on their debt end up paying SOMETHING back to bond holders.
This is such an important point. It seems to me that when most people hear the word "default" in the contexts of bonds, they assume that means the face value of the bond is not paid back and it is a total loss. This is not necessarily true. If the bond issuer misses one bond payment, the bond is technically "in default" because the bond did not meet all of its obligations on time, but this does not mean that the bond is a total loss. The bond issuer may catch up on all the bond payments, albeit late, or they may miss one payment and make all other payments, or they may stop making payments and agree to pay back less than the total amount of the bond, or in some cases the bond issuer may go bankrupt and the bond is a total loss. I have a general memory that in most cases it is a minority of bonds that go into default that are total losses, whereas in a majority of cases, the bondholder is paid most of what is owed.
The historical average price of senior unsecured corporate bonds immediately post-default is roughly 40 cents on the dollar, that's the rule of thumb for the so called recovery rate. It's generally calculated based on price after default, which is anyway appropriate for bond funds: it's very unlikely they'd see through a potentially multi-year process of restructuring or liquidation, they'd sell to 'vultures' on default, at the latest. The recovery rate varies widely by specific company, industry, part of the business cycle, etc. and type of asset. To give one example of the variation, Moody's calculated the recovery rate for senior unsecured bonds in 2010 as 63.8%, but only 37.4% on average 1982-2010, for 1st lien bank loans (not generally relevant to funds) it was 72.3% and 59.6% respectively. Very much a moving target.
http://efinance.org.cn/cn/FEben/Corpora ... 0-2010.pdf

But again, investment grade funds usually sell bonds when they are downgraded below BBB-/Baa3, not when they actually default. It's relatively rare for bonds rated investment grade to go straight to default. It's pretty common for them to go to junk, quite common for ones that are only in the BBB/Baa range to begin with, which is why a higher % of IG corp bonds being BBB is significant, not so much because BBB's default a lot. Analyzing the impact on IG corp bond fund (or TBM with an IG corp bond component) investors' returns from deteriorating credit, one should focus on the economics of selling bonds downgraded below IG, in view of a particular fund's policy in that regard, rather than directly focusing on default and recovery rates. But the economics of selling downgraded bonds is not a lot less murky than default/recovery rates. The assumption it doesn't matter either way has not been correct historically. Selling off bonds when they go to junk has been significantly costlier on average than riding them out.

Bonds other than non callable govt bonds can actually be pretty complicated. There's an inherent tension between that fact and the common recommendation for TBM funds to 'keep it simple'. Those funds have a fair component of stuff that's actually not that simple (call risk and *downgrade* not just default, risk). The assumption 'the market is taking care of this by efficiently pricing any complexity' should give *some* comfort, but it doesn't necessarily equate to the stuff actually being simple.

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Re: Investment grade bonds now made up of 50% BBB rated

Post by pascalwager » Wed Oct 10, 2018 8:59 pm

catalina355 wrote:
Wed Oct 10, 2018 12:55 am
garlandwhizzer wrote:
Mon Oct 08, 2018 12:21 pm
TBM holds no BBB rated bonds and almost 2/3 of its bonds are backed by the US government. Its corporate bond exposure sticks with investment grade. TBM's default risk is well controlled IMO but it does have duration risk (ave. duration 6.1 yrs. which is why its YTD return is -2.52%). No reason for panic if you're holding TBM. Having said that, spreads between Treasuries and corporates are very narrow now and you get minimal reward for taking the increased default risk of the latter. Likewise duration risk has taken a toll on longer and even intermediate duration bonds this year as principal values have declined. You basically get punished these days to take on duration risk.

The market is now pricing in low rates of expected inflation for the next 10 to 30 years, as the narrow (negative?) spreads between short term TIPS and long term TIPS demonstrate. Likewise the very narrow spreads between long term Treasuries and short term Treasuries suggest that the market believes that inflation/economic growth is not going to increase significantly over the very long term. In this environment, you can get rid of duration, default, and unexpected inflation risk with ST TIPS without paying anything for it. Vanguard's ST TIPS fund currently yields +.85% in addition the inflation adjustment. Inflation is currently running at an rate of about 2.8%. That gives you a 3.65% total yield that is government guaranteed and without inflation risk. I personally don't get the appeal of nominal bonds or increased duration in the current environment but those who are heavily exposed to nominal bonds and long duration may want to consider this option for a portion of their bond portfolio.

Garland Whizzer
Is the ST TIPS fund a suitable holding in a taxable account?
No. You get taxed on both the interest and inflation adjustment.

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Re: Investment grade bonds now made up of 50% BBB rated

Post by grabiner » Thu Oct 11, 2018 9:16 pm

pascalwager wrote:
Wed Oct 10, 2018 8:59 pm
catalina355 wrote:
Wed Oct 10, 2018 12:55 am
Is the ST TIPS fund a suitable holding in a taxable account?
No. You get taxed on both the interest and inflation adjustment.
However, that's just the net gain, so it isn't an extra disadvantage. If you have $10K in TIPS with a 1% yield, and inflation is 3%, then after one year, you will have $10,400 and you will pay tax on $400.

And short-term TIPS are good bonds for a taxable account for other reasons. Since they have very low risk, they should also have very low yields, and thus less taxable income. And the income is exempt from state income taxes.

Therefore, unless you are in a very high tax bracket (so that you should use a short-term muni fund instead), short-term TIPS are good in a taxable account if the fund fits your needs.
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Re: Investment grade bonds now made up of 50% BBB rated

Post by catalina355 » Thu Oct 11, 2018 10:31 pm

grabiner wrote:
Thu Oct 11, 2018 9:16 pm
pascalwager wrote:
Wed Oct 10, 2018 8:59 pm
catalina355 wrote:
Wed Oct 10, 2018 12:55 am
Is the ST TIPS fund a suitable holding in a taxable account?
No. You get taxed on both the interest and inflation adjustment.
However, that's just the net gain, so it isn't an extra disadvantage. If you have $10K in TIPS with a 1% yield, and inflation is 3%, then after one year, you will have $10,400 and you will pay tax on $400.

And short-term TIPS are good bonds for a taxable account for other reasons. Since they have very low risk, they should also have very low yields, and thus less taxable income. And the income is exempt from state income taxes.

Therefore, unless you are in a very high tax bracket (so that you should use a short-term muni fund instead), short-term TIPS are good in a taxable account if the fund fits your needs.
Thank you for the explanation.

I am keeping living expenses from years 3-6, until I receive Social Security, in ST Bond Index. ST Bond Index and ST TIPS have about the same current yield (CPI-U is 2.3%) and both are exempt from state taxes. Does this mean that ST TIPS would be suitable for years 3-6 living expenses?

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Re: Investment grade bonds now made up of 50% BBB rated

Post by pascalwager » Fri Oct 12, 2018 1:43 am

catalina355 wrote:
Thu Oct 11, 2018 10:31 pm
grabiner wrote:
Thu Oct 11, 2018 9:16 pm
pascalwager wrote:
Wed Oct 10, 2018 8:59 pm
catalina355 wrote:
Wed Oct 10, 2018 12:55 am
Is the ST TIPS fund a suitable holding in a taxable account?
No. You get taxed on both the interest and inflation adjustment.
However, that's just the net gain, so it isn't an extra disadvantage. If you have $10K in TIPS with a 1% yield, and inflation is 3%, then after one year, you will have $10,400 and you will pay tax on $400.

And short-term TIPS are good bonds for a taxable account for other reasons. Since they have very low risk, they should also have very low yields, and thus less taxable income. And the income is exempt from state income taxes.

Therefore, unless you are in a very high tax bracket (so that you should use a short-term muni fund instead), short-term TIPS are good in a taxable account if the fund fits your needs.
Thank you for the explanation.

I am keeping living expenses from years 3-6, until I receive Social Security, in ST Bond Index. ST Bond Index and ST TIPS have about the same current yield (CPI-U is 2.3%) and both are exempt from state taxes. Does this mean that ST TIPS would be suitable for years 3-6 living expenses?
The various ST funds' duration (2.7 years) seems a little short for the 3-6 year time horizon. You might combine a ST and IT fund to provide a longer duration to reduce the reinvestment risk.

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Re: Investment grade bonds now made up of 50% BBB rated

Post by grabiner » Fri Oct 12, 2018 6:58 am

catalina355 wrote:
Thu Oct 11, 2018 10:31 pm
I am keeping living expenses from years 3-6, until I receive Social Security, in ST Bond Index. ST Bond Index and ST TIPS have about the same current yield (CPI-U is 2.3%) and both are exempt from state taxes. Does this mean that ST TIPS would be suitable for years 3-6 living expenses?
I would prefer TIPS for this type of expenses, as it tracks inflation better, although it doesn't mean much in the short term.

Both of these bond funds have a slightly shorter duration than your needs; you are holding 1-5 year bonds for expenses 3-7 years in the future. Intermediate-term funds are longer than your needs. You could hold a mix of short-term and intermediate-term, switching to all short-term over the next two years, but that may not be worth the complexity.

Short-Term Bond Index is not fully exempt from state taxes. It is more than half Treasury bonds, which is why Vanguard lists it in the Government Bonds section, but it does hold some corporate bonds. You will owe state income tax on the portion of the dividend that came from non-Treasury bonds. You can look this information up on Vanguard's web site, in the Tax Center.
Wiki David Grabiner

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