Stop Fleeing Bonds - Shorten Duration instead

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FinanceFun
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Stop Fleeing Bonds - Shorten Duration instead

Post by FinanceFun » Fri Feb 10, 2012 8:56 am

I do believe that Equities is the place to be for the next decade. However, AA should NOT change dramatically due to belief's - as I have NO information that is not already baked into the price of investments.

That said, clearly an environment where interest rates can either stay flat or rise is not appealing to the Bond world. Especially with the potential for inflation from loose global monetary policy. Some have suggested to combat this by changing bond allocations to Dividend Stocks. This is ok for a small portion of your bond holdings, say 25% of total bond holdings, but is a BIG mistake beyond that - as their Standard Deviation is approximately the same as the broader Equities Market - implying a massive shift to more risk. No one is recommending reaching for yield through extended bond duration's.... just mentioning this for the newbies. My remedy for this situation is simple:

- Take 25% of bond holdings and move them into a high dividend ETF (VYM for example)
- Take the remaining 75% and reduce duration to under 5 years (BSV)

The move into BSV lowers yields if moving from an intermediate term ETF like BND, but the shorter duration creating less exposure to interest rate risk.... hence overall standard deviation for this part of the portfolio decreases. The move into VYM increases risk, but compensates with yields that are 125 basis points better then BND and a potential for price appreciation and yield on cost appreciation.

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Re: STOP FLEEING BONDS - Shorten Duration instead

Post by SimpleGift » Fri Feb 10, 2012 11:02 am

Not sure I agree that shifting 25% of one's bond allocation to stocks (even high quality, dividend payers) is good general advice. Even if the added risk is offset by reduced durations on the bond side, it seems like too great a shift in the portfolio risk profile for many investors — especially for those of us with bond heavy allocations.

An alternative might be to shorten the duration on the bond side, as you suggest, but do so by moving the bonds from intermediate Treasuries to short term corporates. This should not dramatically change the OVERALL risk profile or total return of the existing portfolio, but would better position it for a rising interest rate environment. Just another alternative to consider, if one is thinking about fleeing bonds altogether.
Last edited by SimpleGift on Fri Feb 10, 2012 11:06 am, edited 1 time in total.
Cordially, Todd

FinanceFun
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Re: STOP FLEEING BONDS - Shorten Duration instead

Post by FinanceFun » Fri Feb 10, 2012 11:06 am

Simplegift wrote:Not sure I agree that shifting 25% of one's bond allocation to stocks (even high quality, dividend payers) is good general advice. Even if the added risk is offset by reduced durations on the bond side, it seems like too great a shift in the portfolio risk profile for many investors.

An alternative might be to shorten the duration on the bond side, as you suggest, but do so by moving the bonds from intermediate Treasuries to short term corporates. This should not dramatically change the OVERALL risk profile or total return of the existing portfolio, but would better position it for a rising interest rate environment. Just another alternative to consider, if one is thinking about fleeing bonds altogether.
Thats a really good idea!

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Liquid
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Re: STOP FLEEING BONDS - Shorten Duration instead

Post by Liquid » Fri Feb 10, 2012 11:24 am

Isn't this just market timing. There will always be a dog or two in the portfolio. If the portfolio cannot withstand underperformance by bonds perhaps it was an ill-conceived allocation.

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Rick Ferri
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Re: STOP FLEEING BONDS - Shorten Duration instead

Post by Rick Ferri » Fri Feb 10, 2012 11:29 am

I don't agree with either of the OP's recommendations.

1) Moving 25% from bonds to stocks increases the equity risk in your portfolio.
2) Shorting the duration of the remaining 75% in bonds all but guarantees that you'll earn a negative real return over the next several years, and that's before taxes.

A better recommendation is to stay the course and rebalance as needed.

Rick Ferri
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Re: STOP FLEEING BONDS - Shorten Duration instead

Post by NoRoboGuy » Fri Feb 10, 2012 11:55 am

If you have to make a change, sell some longer maturities and max out your I-bond purchases ($10K per year per SS#). If you still "have" to do more, you could increase your bond allocation of TIPS. If you are fortunate enough to be in the Thrift Savings Plan (TSP) I would recommend reducing your allocation to the F fund and increase it in the G fund. I don't ever recommend changing your overall bond allocation based on "market conditions."
There is no free lunch.

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LH
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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by LH » Fri Feb 10, 2012 12:01 pm

Deflation may occur like it has in Japan. Interest rates may not rise again for tens of years. Even going short duration, the risk is that you will miss out on yield over the next ten years, short term now, means you are giving money away (or giving even more money away in real terms). For what, for a timing feeling you have.

Stocks may tank 50-90 percent and stay down for years.

Stay the course.

If you are in bonds to begin with to mitigate risk, why move money out of bonds into risky stocks now?

Nobody knows what will happen. You cannot predict it.

Making moves is all too human, as is shooting oneself in the financial foot. You may come out ok, you may win at roulette.

The whole point of passive indexing, is to not muck around.

Something sucks, or appears to suck, almost always......

Stay the course.

If you cannot hack this now, I would consider getting a professional to run it, because if things get worse, you will just change again to the conditions you see in the past in the rear view mirror, and fool yourself that you are looking forward, which is expectantly impossible. Any move you do, has added risk, or lower return expectantly. If you REALLY know what to do, REALLY know what will happen, just leverage it to the hilt, and become a billionaire, and quit screwing around at the margins. Or get a mad money account, time there, track your expectant failure. Or, the best course, is to stay the course.
Last edited by LH on Fri Feb 10, 2012 12:09 pm, edited 1 time in total.

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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by FinanceFun » Fri Feb 10, 2012 12:05 pm


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Tim_in_GA
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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by Tim_in_GA » Fri Feb 10, 2012 12:06 pm

I have a long time to let my investments grow so I see no need to mess with duration or anything.

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LH
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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by LH » Fri Feb 10, 2012 12:11 pm

FinanceFun wrote:For the "passive only" crowd.

http://www.bogleheads.org/forum/viewtop ... 3#p1265313
?
This is also inaccurate. Markets are driven by risk/reward (efficient markets) and supply/demand (basic economics). News, fundamentals, capital flows, compelled actions etc... All effect market prices by changing risk/reward and supply/demand. As stated earlier, efficient markets generally work (this is your argument). However, markets can become inefficient due to liquidity (depth of market) and compelled action (required buying, or lack of freedom to act). In NORMAL times these forces cannot overcome efficient markets - greed moves in. These are not normal times. Central banks are buying down the long end of the yield curve (new participant). Banks are required by regulations to raise T1 capital (i.e. US Tres. are a favorite T1 options) from ~5% to ~9%. And 'other' funds such as pension funds, sovereign funds, etc are compelled by charter to buy. Add to this a reduction in supply of T1 debt via the europe crisis and we have just trumped efficient markets through compelled buying of 'elephant' market participants... in other words your $10k to invest is nothing compared to the Trillions of compelled buying going on.

Let me also point out that every economist who ever lived would disagree with your assertion that "markets aren't driven by supply and demand."


It refers to something in the middle of another conversation. I do not take much of anything from what you said there per se.

One comment, though, there is no such thing as "normal" times. (bold added by me)

Define the normal period? Is it the 70s stagflation? is it the 80s/90sboom? Is it 2000s tech bubble????? The roaring 20s? The depression 30s? The predicted japan "century"? The japan bust?

Normal?

I mean really, define "normal times" in terms of investing?

There is no normal. The current times are as "normal" as anything else.

Also, in response to your
Let me also point out that every economist who ever lived would disagree with your assertion that "markets aren't driven by supply and demand
the fact that "50 for, 50 against" practicioners of the dismal science of economics, a priori, would ALL agree on ANYTHING, is highly dubious : P

so I leave you with this imprecise (economy not market) result of a 1 minute google search:
Bob Frank says the economy is not driven by supply and demand, but rather survival of the fittest
http://www.johnson.cornell.edu/About/Ne ... ttest.aspx

: P

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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by NoRoboGuy » Fri Feb 10, 2012 12:33 pm

LH wrote:Deflation may occur like it has in Japan. Interest rates may not rise again for tens of years. Even going short duration, the risk is that you will miss out on yield over the next ten years, short term now, means you are giving money away (or giving even more money away in real terms). For what, for a timing feeling you have.
This is why I-bonds are the optimal choice. They cannot go negative in a deflationary period like TIPS can. In most environments you won't get a real return after taxes, but you will have a solid offset to equities, and maximize capital preservation within the bond space.
There is no free lunch.

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Sammy_M
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Re: STOP FLEEING BONDS - Shorten Duration instead

Post by Sammy_M » Fri Feb 10, 2012 1:03 pm

Shorting the duration of the remaining 75% in bonds all but guarantees that you'll earn a negative real return over the next several years, and that's before taxes.
Depends on what you use to shorten duration. Retail CDs (with minimal early termination penalties) and many Stable Value funds reduce interest rate risk while beating (or at least coming close to beating) inflation. They also have minimal credit and market risk, unlike short term corporate bonds.

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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by BigD53 » Fri Feb 10, 2012 1:10 pm

Interest rates be damned, I'm sticking with the simple, conservative, 2-fund combo you see below. I'm not going to concern myself with what Bernanke, the Fed, Greece, Europe, or whoever might do (or not do).

The heck with all that. A person could drive themselves nuts! All those things are out of my control. I want to keep investing very simple, uncomplicated, and low-stress. I'm going to enjoy retirement, have fun with some activities and hobbies, and tune all that stuff out. Come hell or high water, that's my plan. :sharebeer

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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by blevine » Fri Feb 10, 2012 11:51 pm

60 40 Intermediate / short duration funds (as the bond portion of my 50/50 bond/equity portfolio)

If you rebalance between stocks and bonds, why not between shorter/longer duration bonds ?

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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by pete82 » Sat Feb 11, 2012 12:42 am

my memory of the future is a bit fuzzy right now. with that said I'd bet my house that global equity returns are better this decade than they were last decade.

just speculation, no matter what happens I'm sticking with my AA as I have 8 years running.
"What everybody else knows is not worth knowing." - Gerald M. Loeb

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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by CaliJim » Sat Feb 11, 2012 12:57 am

I disagree with the OP's advice.

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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by Robert T » Sat Feb 11, 2012 8:23 am

Select an asset allocation to meet objectives then stick with it. If thoughtfully selected then no need to adjust based on market conditions.

However, I think a case could be made for an age based shift in bond duration i.e. when young and have high equity allocation (with value tilt) then intermediate term bonds seem to be a good fit (for greater protection against financial crises, particularly with higher equity allocation, the latter providing some long-term inflation protection), when closer to retirement (or in retirement) and have smaller equity allocation (with value tilt) then a case could be made to shortern duration (for greater protection against inflation, particularly with lower equity allocations). I would not suggest adding credit risk to fixed income as already in equities.

Robert
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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by blevine » Sat Feb 11, 2012 9:18 am

Robert T wrote:Select an asset allocation to meet objectives then stick with it. If thoughtfully selected then no need to adjust based on market conditions.

However, I think a case could be made for an age based shift in bond duration i.e. when young and have high equity allocation (with value tilt) then intermediate term bonds seem to be a good fit (for greater protection against financial crises, particularly with higher equity allocation, the latter providing some long-term inflation protection), when closer to retirement (or in retirement) and have smaller equity allocation (with value tilt) then a case could be made to shortern duration (for greater protection against inflation, particularly with lower equity allocations). I would not suggest adding credit risk to fixed income as already in equities.

Robert
.
Yes well said. That's how I think of it. Can't predict the future. Rates could stay low for a decade+ or rise tomorrow.

To add, I also believe that as you move from equity to bonds, that equity allocation should go to inflation fighting bonds,
such as I bonds, TIPS, or short duration bonds. Equity to me is my higher risk inflation protection, and must not be replaced
in your AA as you age, with bonds that will not protect you against inflation. I hold a mixture of I bonds, short dur and intermediate dur
and as I put more into bonds (or reallocate from stocks over time) I will add more outside the intermediate dur portion.

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Re: STOP FLEEING BONDS - Shorten Duration instead

Post by Leesbro63 » Sat Feb 11, 2012 8:11 pm

Rick Ferri wrote:I don't agree with either of the OP's recommendations.

1) Moving 25% from bonds to stocks increases the equity risk in your portfolio.
2) Shorting the duration of the remaining 75% in bonds all but guarantees that you'll earn a negative real return over the next several years, and that's before taxes.

A better recommendation is to stay the course and rebalance as needed.

Rick Ferri
But Rick, in last weeks thread you said to "tweak" that by delaying the yearly creep toward more bonds.

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Rick Ferri
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Re: STOP FLEEING BONDS - Shorten Duration instead

Post by Rick Ferri » Sat Feb 11, 2012 10:09 pm

Leesbro63 wrote:But Rick, in last weeks thread you said to "tweak" that by delaying the yearly creep toward more bonds.
What "yearly creep" are you talking about, Lees? I have never been an 'age in bonds' advocate, with exception of those investors who have absolutely no idea what allocation to have, and no desire or ambition to move beyond an overly simplistic 'age in bonds' method.

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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by hsv_climber » Sat Feb 11, 2012 10:16 pm

Why would anyone wants to reduce bond duration when Ben Bernarke pretty much guaranteed that rates won't rise till 2014?

Nothing beats "Stay the course" (except I-bonds :idea: ).

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Rick Ferri
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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by Rick Ferri » Sat Feb 11, 2012 10:20 pm

I-bonds were a good deal, once. But not anymore, now that Mel has educated the world about I-bonds and then Treasury decided that it was too good a deal for us. It's all your fault, Mel!

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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by hsv_climber » Sat Feb 11, 2012 10:23 pm

Rick Ferri wrote:I-bonds were a good deal, once. But not anymore, now that Mel has educated the world about I-bonds and then Treasury decided that it was too good a deal for us. It's all your fault, Mel!
Rick, how are I-bonds not a good deal if they have 0% real return while 5-year TIPS are -1.27% and 10-year TIPS @ -0.24%?

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Rick Ferri
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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by Rick Ferri » Sat Feb 11, 2012 10:27 pm

Because they used to yield much more than 0% until Mel stated telling everyone they were a good deal! You're right, though, iBonds are a better deal than the negative yields from TIPS. Expected TIPS returns are so bad that I really don't want to discuss them, particularly since I still own them. :annoyed

Only kidding, Mel!

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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by actor10 » Sat Feb 11, 2012 10:41 pm

Weren't we all just fine with our asset allocations a month ago?
It's the rule of the game to stay with the AA?
Aren't we supposed to say "oh, I won't get freaked out at the bottom and dump my stocks"?

But now all of a sudden, Buffett and Blackrock say "Go all in on stocks and bonds are a loser. And we supposed to change?"

Take a look at the bond yields of Germany, Sweden and Japan. The 30 year bond yield can go lower. And it can be there for a very long time. The FED is saying the rates will be low for a long time. If everyone is saying they can't go lower, I bet they can.

Let's not forget a year ago, somebody whose reputation got her on 60 Minutes said that there were going to be massive municipal bond defaults. So people fled but get what? Munis turned out be a pretty good investment.

And let's not forget that Bill Gross last year said that rates were obscenely low and he bet they would go higher. Here is a man who has his finger on the pulse of the bond market like nobody else and he got it wrong.

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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by Mel Lindauer » Sun Feb 12, 2012 3:34 pm

Rick Ferri wrote:I-bonds were a good deal, once. But not anymore, now that Mel has educated the world about I-bonds and then Treasury decided that it was too good a deal for us. It's all your fault, Mel!

Rick Ferri
I was just trying to share a good thing with my Boglehead friends, Rick, and I can't say I'm sorry about that. I am, however, sorry that they became so popular that Treasury decided to strike back at me by not allowing me to buy my beloved paper I Bonds any longer! :D
Best Regards - Mel | | Semper Fi

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Re: Stop Fleeing Bonds - Shorten Duration instead

Post by gasman » Sun Feb 12, 2012 4:31 pm

Any data on just how much in Ibonds the treasury has actually sold over the years?

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